I recently became eligible for the IRA benefit at my workplace. It is a simple IRA, they take out money pretax and the employer matches up to 3% of my gross wages. Which, at the end of this year would probably be around $800
However, being i am this young, ive been told i should be looking into a Roth IRA instead?
With a Roth you pay your taxes up front unlike for a regular IRA (which is tax-deductible). However, the benefits are that you can withdraw the money down the road tax-free. This can be a big advantage since you will likely be withdrawing the money when you’re retired and therefore at a lower tax-bracket. I say take the Roth if you meet all its qualifications, which I think you will since you’ve just started working.
When a retirement program is offered by a US employer, it’s almost always a 401(K) or a Roth 401(K) or both. IRAs are typically not associated with an employer. In fact they were invented by Congress precisely for the people who don’t have any employer-related retirement plans.
So I’d ask the OP to be sure he’s really dealing with an IRA plan and not a 401(K) plan. At a very high level they’re both tax-advantaged savings vehicles, but once you scratch below that surface all the details are different. So knowing which you’re really dealing with is important.
The rule of thumb I’ve always lived by is that for either IRAs or 401(K)s Roth is better than non-Roth. But if there’s a difference in employer matching between the two, take the better match instead.
Although there are some circumstances in which money can be withdrawn before retirement, in most cases you can’t do so without incurring a penalty. This is as true of Roth IRA’s as it is of traditional IRA’s.
Good on you for starting at 20! I wish I had done so.
At 45, someone showed me the magic of compound interest with a comparison of two investors - one started at 20 and contributed $x per year until 30. The second didn’t start until age 35 and contributed $x per year until 65.
The first had more money at age 65 - with just 10 years of savings vs 30 years. Of course the difference is even more striking if the 20 year old continued until age 65.
Here is a very simple example at 7% interest and $5000 yearly contribution.
age 20-65 : $1,533,759 at age 65
age 20-30 : $789,192
age 35-65 : $510,365
Other advice above is good, but the most important is to avoid withdrawing (or taking a loan) with the IRA money before age 59 1/2 - the penalties are killers and work faster in reverse than compound interest.
Most financial advisors recommend setting up your retirement savings as follows:
If you have an employer-matched plan available, use it to save up to the amount of the employer match.
If you have additional money to save, put it in a Roth IRA.
If you max out the Roth, you can put additional unmatched money into the employer plan.
Getting started at age 20 is the best possible thing you can do for your retirement. Although I always saved in a savings account, I really wish I had been given this advice earlier.
Also, if you don’t have a savings account/emergency fund, you should be putting away money for that as well.
Oh, and since people are mentioning withdrawal rules, it’s worth mentioning that you should never view your retirement money as a savings account. Once that money goes in, you should consider it gone until you retire. Like a roach motel, “Money goes in, but it doesn’t come out.”
I agree with SpoilerVirgin, but with the caveat that there’s a whole lot of information we’re missing and that individual needs may vary.
With a SIMPLE at work, the OP is probably still eligible to put another $5,000/yr into a Roth (again, depending on total income and various other factors). So it’s not an exclusive choice.
I always recommend that clients have BOTH a taxable (IRA/401k) and nontaxable (Roth) source of income in retirement. The taxability of Social Security depends on total taxable income, and your standard deduction and personal exemptions can cancel out some of the taxable income. By supplementing taxable and non-taxable, you can effectively make it ALL nontaxable and get the best of both worlds. (For example: $25k from Social Security, 20k from 401k and 25k from Roth would give you almost $6,000 a month in living expenses, and you’d pay $0 tax if you’re married. Taking $45 from 401k makes $20k of the social security taxable, and you tax is now ~$5,000.)
Starting early is so important, regardless of the plan type(s). One calculation I am always reminded of is this: Contributing $10,000 per year from ages 20-30 puts you at the same ending retirement balance as putting in $10,000 per year from 30-60. Compounding interest is the secret to just about everything.
What you’re describing sounds more like a 401(k) than an IRA but perhaps the employer has it set up as an IRA instead?
Anyway: you may not have the choice to do this at work, but if you’re putting your own money aside in an IRA unrelated to work, then I’d say a Roth might be an excellent choice for you. At age 20, you’re likely to be in a higher tax bracket later on than you are now. If you put aside 1,000 dollars and you pay 10% tax on it now, your net cash outflow is 1100 (the 1000 you save, plus the income tax).
In 40 years, if that has grown to 10,000 = you’ve got that 10,000 free and clear. 10,000 minus 1,100 is 8,900.
Whereas now, if you put that thousand aside in a pretax IRA, you don’t pay the 100 dollars. In 40 years it’s worth 10,000. Then you withdraw it. If you’re at 10% tax, you’ve got 9000 dollars. If you’re at 15% tax bracket, you’ve got 8,500 dollars instead.
Plus with a Roth, you can withdraw your initial contribution without penalty earlier than age 59. I don’t recall all the rules for that - maybe it has to be there at least 5 years or something. And of course it’s fiscally a bad thing to do… but if you’re stuck for money, it’s a fallback.
Some companies offer a Roth 401(k) (mine does) - which works exactly like a Roth IRA, often with company matching as well (not sure if the company matching is taxable though). The advantages with that are the matching, plus the higher savings limits.
Anyway - whatever your employer does, take as much advantage of it as possible - that’s free money you’re turning down otherwise.
I don’t know if this is possible with a Simple IRA, but if you can have it set up as a Roth, I’d suggest that.
Do you (or anyone else here) know how the employer’s portion would work, income-wise? I would envision it either being treated as income right now (which might work with a Roth), or having to go into a regular IRA where it’s taxed when you withdraw it.
FYI - even if it all goes into a regular (tax-later) IRA, at some point you can convert it to a Roth. You have to pay the tax on it at that point, but then it’ll grow tax-free thereafter. So if there’s a point at which you can swing the taxes, do it sooner (before it’s grown much) vs. later.
Regardless of which you end up with, this is a good thing to do. You won’t even miss the money, and it builds up faster than you would expect. I can’t tell you how many people I know today (I’m 63) that are scraping by because they failed to plan for the future and instead accrued massive debt throughout their lives.
When or if you leave that job, the employer contributions will stop, but you’ll still have that accumulated money invested in the IRA. Just make sure you actively manage it, rather than just letting it sit in some poorly-performing fund. Generally, you can move that money to a different IRA without penalty, as long as you don’t actually have the money in your possession.
Also, if he’s only twenty, the contributions he makes now will be dwarfed by the capital gains and investment return. So it’s better to pay the taxes on the smaller amount now so that the larger amount later is tax-free.