Should I Start a Roth IRA?: Everything You Need To Know

As a collegiette, retirement is probably one of the last things on your mind. Though you’re probably thinking about your future, it’s unlikely you’re already considering what your life is going to be like when you’re 65!

Although retirement may seem like it’s so many years away that it’s not worth a second thought, looking into setting up a Roth IRA can be a great financial move for someone who is young and in a low tax bracket (that’s you, collegiette!). But before you jump right in and sign up to open your account, HC is here to make sure you know the facts. And we’ve talked with James Phelps, the managing director of Kendall Capital Associates, a business and financial advisory services firm, to get you all your need-to-know info!

The basics

First, it’s important to know the difference between a Roth IRA and a traditional IRA. An IRA is an Individual Retirement Account that allows you to save money and defer the taxes you pay on that money until you’re ready to withdraw it.

“An IRA allows anyone to put aside some money and have it grow over time. How much it grows is dependent on how you decide it is invested, and how ‘risky’ the investment is (a U.S. government bond has no risk but low reward, while a high tech stock could have a high reward but high risk),” explains Phelps. “But - and this is the key - you can only fund your IRA from ‘earned’ (employment-related) income (waitress, investment banker, taxi driver…doesn’t matter), but it can't be from a gift or from other income.”

The amount of money you can put in an IRA per year is limited to $5,500. Then however much you decide to invest per year is deducted from the income that you have to pay taxes on.

“In a ‘regular’ IRA, you can dead cut the amount you contribute (to the IRA) from your income,” says Phelps. “So, if you made $40,000 a year, and you contributed $4,000, you would only pay taxes on $36,000…That’s not a bad deal, but then when the money grew (and became, in 40 years, something like $40,000) and you took it out, you would then pay taxes on the whole amount (at your then-current rate).”

An IRA would be a good investment for someone who has a steady job making pretty good money, because you could assume that you have a high tax rate now and might have a lower one later on in life. But for collegiettes working part-time, summer or work-study jobs at low wages, it’s probably not the best idea.

That’s where a Roth IRA can come in handy! The main difference between a Roth IRA and a traditional IRA is that with a Roth, you pay taxes on the money you invest now so that when you take it out later (by which time it has presumably turned in to a lot more money), it’s completely tax free. So for a college student with a low-paying job and a low tax rate, you’ll end up paying much less in taxes now than you would on that same amount of money later in life.

“I really think a Roth IRA is the best way for college students to start saving for the future,” says Lauren, a senior at the University of North Carolina. “It doesn’t require putting away a huge sum, but by retirement age there’s a lot of growth potential. It’s a good way to ensure having a little money down the road.”

Getting started

Before you decide to open up a Roth IRA, it’s good to get some advice from an expert. Every collegiette’s financial situation is different, so talking to a financial advisor who’s trained to work with students can really help you to decide what’s right for your unique situation. Try getting a referral from a peer or someone else who has already opened a Roth IRA or a traditional IRA. Once you’ve decided on an advisor who is right for you, call to make an appointment and get on the path to opening your account.

If you decide you want a Roth IRA after some consulting, opening one is fairly easy. The hard part is deciding where you want to open yours. Along with talking to your financial advisor, you may also want to do some research on your own. Here are some questions you should consider: Is there a minimum initial investment and minimum contributions? Are there fees that go along with the account? What investment options are available (stocks, mutual funds, real estate)?

There are some providers who even offer a cash bonus for opening up an account with them, so looking around for the best deal can definitely be beneficial. Try checking out different companies’ websites to find out the information you want to know. Fidelity, Wells Fargo and Schwab are a few good suggestions to look into.