When young teachers ask me what to do to get ahead financially, I typically have a list of about ten different items: create a budget, start investing now, make sure you have the right insurance, and so on. But I was thinking about it a few days ago and if I absolutely had to narrow it down to one thing, I’d say to open up a Roth IRA.
A Roth IRA is an investment account that I love almost as much as a nice steak dinner at Ruth’s Chris. Typically, the first retirement account young teachers hear about is the 403(b) offered by their district A big point here, if your district offers a 403(b) plan with a match, go for it because the match is free money. But, even then you should still own a Roth IRA to save above and beyond the amount to get your company’s match.
Before I go too far into a Roth IRA love fest, let’s talk about the basics and a little history. Roth IRAs have only been around since 1997 when they were created by Congress and named for the Senator who helped push the concept through, William Roth. A Roth IRA, as the name implies, is an account an individual retirement account that can be used to save for retirement on a tax-advantaged basis.
Roth IRAs are similar to traditional IRAs, but one major difference that really makes it worthwhile for young professionals is the tax benefits. With a traditional IRA, you typically get a tax deduction in the year you make the contribution. When you take the money out at retirement, you pay taxes on those withdrawals. Since young teachers are typically in a lower tax bracket, saving this way typically helps a little on taxes now, but later when you retire and will probably be in a higher tax bracket, you end up paying taxes on your withdrawals.
With a Roth IRA, you don’t receive an upfront tax deduction, but when you take the money out in retirement, the withdrawals are tax-free. So, for young teachers, the tables are turned. You don’t get that little bit of tax help now, but that’s okay because it doesn’t provide a very big savings. And down the road when you’re in a higher tax bracket, your withdrawals won’t be taxed saving you potentially A LOT of money.
There are many other reasons why a Roth IRA is the ultimate investment account for young teachers. Let’s briefly review them:
1. Because of the tax advantages, if you start a Roth IRA today at age 25, contribute $5,000 every year until age 65, and earn a 7% rate of return, you end up with around $1,000,000 in tax-free money at retirement, not too shabby.
2. You can withdraw the contributions you make at any time, without penalty. This is a huge benefit for young teachers, who may expect large expenses like a down payment for a home, getting married, or going to grad school. In addition, you are able to take out earnings for your first home purchased if you meet the eligibility criteria for as “first-time homebuyer”. Important to consider, even with this flexibility, early withdrawals should be thought of as a last resort because they diminish the growth that compounds over time.
3. As we quickly touched on above, you can contribute to a 403(b) and a Roth IRA at the same time. When you participate in a 403(b) plan, the IRS limits the contributions you are able to make to a Traditional IRA, but not a Roth IRA. As long as you are under the income phase-out limits (currently $114,000 if single/$181,000 if married) you can contribute the maximum of $5,500 to a Roth IRA annually, in addition to contributing to your 401(k)/403(b).
4. You can open a Roth IRA at any age as soon as you have earned income. So, parents, that means if your daughter babysits or your son mows lawns starting in middle or high school, they can start contributing. The IRS isn’t picky about the exact funds used for contributions, so if you’d like you can make the contributions for them up to what they earn and let them enjoy the fruits of their labor.
5. You can keep contributing to a Roth IRA even after you retire. With a Traditional IRA, you typically cannot make contributions after you are age 70 ½. That rule doesn’t apply to Roth IRAs, so as long as you have the earned income, even on your 100th birthday, you can make a contribution.
6. Your money can keep growing after you retire. Most tax-deferred retirement accounts (401(k)/403(b)) require you to start taking required minimum distributions after you turn age 70 ½. On the contrary, with a Roth IRA, you aren’t required to take money out at any age. The money can grow for your lifetime and if you don’t need it, be passed on to your heirs.
7. You have four additional months each year to make a contribution. For your 403(b), you generally have until December 31 to make contributions for the year. For your Roth IRA, you have up until the tax filing deadline, typically April 15, of the new year to make contributions. This give you a good amount of flexibility, but remember, the sooner you make contributions, the sooner the money is invested and working for you.
Young teachers have the great advantage of time. Even small contributions today to a Roth IRA can grow to a nice tax-free next egg! If you have any questions or would like assistance evaluating how a Roth IRA can fit into your financial plan, we’re happy to help! Learn more at www.AnExceptionalLifeFinancial.com or get in touch at Info@AnExceptionalLifeFinancial.com.
Mychal Eagleson, CFP®, AAMS® is the President of An Exceptional Life Financial, a firm that specializes in financial planning for teachers and families with special needs. He frequently writes and speaks regarding personal finance topics relating to these clients. Mychal also serves on the board of the Financial Planning Association of Greater Indiana as the Director of Public Relations & Social Media. To read more of his articles or learn about An Exceptional Life Financial please visit: www.anexceptionallifefinancial.com.