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Why Every College Freshman Should Start a Roth IRA
At no time since the Great Depression have college students
worried more about money. Tuition continues to rise, financing
sources continue to contract. So why should a student worry
about finding money for, of all things, retirement?
Because even a few dollars a week put toward a Roth IRA can
reap enormous benefits over the 40-50 years of a career lifetime
that today's average college student will complete after
graduation. Take the example of an 18-year-old who contributes
$5,000 each year of school until she graduates. Assume that
$20,000 grows at 7.5 percent a year until age 65 — that would
mean more than a half million dollars from that initial
four-year investment without adding another dime.
Consider what would happen if she added more.
There are a few considerations before a student starts to
accumulate funds for the IRA. First, students should try to avoid or extinguish as much debt —
particularly high-rate credit
card debt — as possible. Then, it's time to establish an
emergency fund of 3-6 months of living expenses to make sure
that a student can continue to afford the basics at school if an
unexpected problem occurs.
Certainly $5,000 a year sounds like an enormous amount of
outside money for today's student to gather, but it's not
impossible. Here's some information about Roth IRAs and ideas
for students to find the money to fund them.
The basics of Roth IRAs: It's good to start with
describing the difference between a traditional IRA and a Roth
IRA and why Roths might be a better choice for the average
student. Traditional IRAs allow investors to save money
tax-deferred with deductible contributions until they're ready
to begin withdrawals anytime between age 59 ˝ and 70 ˝. Roth
IRAs don't allow tax-deductible contributions, but they allow
tax-free withdrawal of funds with no mandatory distribution age
and allow these assets to pass to heirs tax-free as well. If
someone leaves their savings in the Roth for at least five years
and waits until they're 59 1/2 to take withdrawals, they'll
never pay taxes on the gains. For someone in their late teens
and early 20s, that offers the potential for significant
earnings over decades with great tax consequences later.
Getting started is easy. Some banks, brokerages and
mutual fund companies will let an investor open a Roth IRA for
as little as $50 and $25 a month afterward. It's a good idea to
check around for the lowest minimum amounts that can get a
student in the game so they can plan to increase those
contributions as their income goes up over time. Also, some
institutions offer cash bonuses for starting an account. Go with
the best deal and start by putting that bonus right into the
account.
It's wise to get advice first. Every student's
financial situation is different. One of the best gifts a
student can get is an early visit — accompanied by their parents —
to a financial advisor such as a Certified Financial Planner™
professional. A planner trained in working with students can
certainly talk about this IRA idea, but also provide a broader
viewpoint on a student's overall goals and challenges. While
starting an early IRA is a great idea for everyone, students may
also need to know how to find scholarships and grants and smart
ideas for borrowing to stay in school. A good planner is a
one-stop source of advice for all those issues unique to the
student's situation.
Plan to invest a set percentage from the student's
vacation, part-time or work/study paychecks. People who save
in excess of 10 percent of their earnings are much better
positioned for retirement than anyone else. Remarkably few
people set that goal. One of the benefits of the IRA idea is it
gets students committing early to the 10 percent figure every
time they deposit a paycheck. It's a habit that will help them
build a good life.
Get relatives to contribute. If a student regularly
gets gifts of money from relatives, it might not be a bad idea
to mention the IRA idea to those relatives. Adults like to help
kids who are smart with money, and if the student can commit to
this savings plan rather than blowing it at the mall, they might
feel considerably better about the money they give away. At a
minimum, the student should earmark a set amount of
"found" money like birthday and holiday gift money
toward a Roth IRA in excess of the 10 percent figure.
August 2009 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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