This year, although I’m 40+ years out from retirement, I’ll be maxing out my Roth IRA. Time is the greatest asset that we, as Millennials, have on our side and we need to act now in order to set ourselves up for financial well-being in our Golden Years. Specifically, here is what I love—but what may not be clearly understood—about the Roth IRA:
The Roth IRA is an individual retirement account that allows a person to set aside after-tax income up to a specified amount each year. Both contributions and earnings on the account can be withdrawn tax-free after age 59½.
1. A lower tax bracket today means fewer taxes. We, Millennials, should be optimistic that our earnings potential will continue on upward trajectories as we pursue our work and careers. Since, theoretically, we are earning less today than we will just prior to retirement, we can assume that our tax bracket today is also lower than it will be in 40+ years. If we contribute to a Roth IRA today, we will be paying taxes upfront, most likely in a lower bracket.
2. The future is unknown…but taxes will inevitably go up. No one can predict our future tax code. But if history is any indication, higher marginal taxes are likely on the horizon. Let’s not forget, for example, that in the 1970s and 80s, marginal tax rates hit 70.0% (today the highest marginal tax rate is 39.6%). Therefore, if you believe that tax rates will rise, contributing to your Roth IRA while you are in a lower tax bracket can act as a hedge against future, higher tax rates.
3. Withdrawals on earnings are tax-exempt. One of the greatest benefits of the Roth is that all of our earnings grow tax-free (provided that we wait until age 59 ½ to withdraw them). Over the course of 40+ years, investments compound exponentially. That means the Roth IRA's earnings can equate to hundreds of thousands of tax-free dollars upon withdrawal.
4. There are no required minimum distributions. Unlike Traditional IRAs and 401(k)s, you are not obligated to begin withdrawing a percentage of your assets from your retirement accounts at a certain age.
5. Your Roth IRA contributions can technically double as an emergency fund. Both contributions to and earnings from your Roth IRA investments are tax-exempt upon withdrawal when you reach age 59 ½. But did you also know that you can withdraw your contributions at any time before age 59 ½ without penalty? If you are hoping to hold an emergency fund as well as a Roth IRA but don’t have the means to do both, you can designate your Roth contributions as an emergency fund if need be.
Every person's financial situation is unique and a Roth IRA may not be right for everyone. My hope, however, is that if we, Millennials begin to think about our saving and investment options earlier, rather than later, we will be on solid financial ground when we reach our Golden Years.