How to Explain a Roth IRA to Your 25 Year Old


Roth IRA Eligibility

To be eligible for a Roth IRA you need to have earned income.  This is typically from wages earned as an employee.  Earnings from self-employment also qualify. The annual contribution is the lesser of your earned income or $5,000. The contribution can be made at any time during the year and up to April 15th following the year.

The Roth IRA Benefit

Unlike the IRA, there is no tax deduction with the Roth IRA. However if the account is open at least 5 years and the distributions are made after age 59 1/2, then all of the distributions are tax-free. Most 20 year olds pay little to no income tax.  They don’t need the tax deduction of an IRA.  They do need to save for retirement however.

Additionally, unlike an IRA, the Roth IRA is not subject to the Required Minimum Distribution (“RMD”) rules. These rules force IRA owners to start withdrawing from their IRA after age 70 1/2. This means the account holder or their surviving spouse never has to take money out of a Roth. This makes the Roth IRA a great wealth transfer tool. It’s only non-spouse beneficiaries like children or grandchildren that must take an RMD.


Back Up Plan

The Roth IRA offers some flexibility. You can always withdraw your contributions at any time tax-free. As there is no tax deduction with the contribution, this can be withdrawn without paying income taxes. If someone needed some funds to buy a car or make a down payment on a house, they could access the Roth IRA if needed.  This certainly is not recommended, but it is an option.


The Conversation

Knowing they likely have a short attention span, you’ll need to get to the point. Most people, particularly younger people just starting out can’t ‘save up’ $5,000 and then write a check to their IRA.  It’s better to try and make it as painless as possible.  Assuming they have some monthly income, have the contributions made monthly by having them directly deducted from their checking account.

You’ll need to convey to them how they are truly on their own.  They can’t reply on their employer, the union or the government for their retirement. They need to rely on themselves.

Will you use these points to discuss the benefits of a Roth IRA to your 25 year old?

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Tom Scanlon has over thirty years experience in public accounting with an extensive background in the areas of financial, tax, and estate planning. He prides himself on providing in-depth and customized solutions to privately held businesses and their owners. He is a Certified Public Accountant and Certified Financial Planner®. Tom is a frequent speaker for area organizations and has  recently been quoted on CNBC, Fox 61 News and AARP's blog. Tom also has been a guest columnist for numerous publications including The Wall Street Journal, Barron's, Money Magazine, The Hartford Courant, The Hartford Business Journal, and The New Haven Register. He is a member of the American Institute of Certified Public Accountants, the Connecticut Society of Certified Public Accountants, and the Financial Planning Association. Active in the community, Tom supports a variety of not-for-profit organizations.

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