retirement fund for 21 year old

[ExPirateShopGirl]

You're smart. Regardless of the uncertain (and currently, phantom) tax consequences, your son will will have the two most important things going for him:

Compound Interest + Time

thanks for all the replies. going to go with roth.

With regard to possibly being taxed in the future: I feel it would be better to have a nest egg and be taxed then to have nothing at all.

 

[Judique]

My 21 year old son wants to start putting money away for retirement (like a 401 K). What is the best option for him to do it himself. company he works for does not have a 401k.

First of all, thank you for starting this thread!

My 20 year old is in school and also works for the school. They recently converted her from a contract worker to a part time employee eligible for benefits. (She now has a future pension.)

She has had her job since day one of starting school and one benefit is a tuition benefit, so she has been able to save a lot of her earnings. (Her hours were minimal so not huge amounts!)

I've been watching her savings grow and was trying to figure out a way for her to earn more than simple interest but still keep the money sort of available.

The suggestion of a Roth confirms what I had been thinking.

So, how much can a student who earns maybe a thousand a month put in a Roth account? Is there a max or a minimum? Is it a percentage of what she earns?

I am clueless as I've never had to worry about my future - just hers. Eventually she will have a considerable inheritance but learning to budget and save is an invaluable tool and she has it, but still needs guidance for maximum value.

 

[PatsMom]

Roth IRA. As long as your income does not exceed the limit (and few young people will since it is around $112K for filing single) you can contribute $5,500 per year as long as you earn that much money.

 

[amcnj]

I believe the 2012 limit is $5000, and in 2013 it will be $5500. As long as you have earned income(wages , tips, etc from work you performed) you can contribute an amount up to the earned income you have. So if your child earned $5000 or more in 2012, they could contribute the full $5000. There are phase outs on the amount you can contribute, but for a single person, I think the current income at which the amount allowed starts to be phased out is $110,001.

 

[MSSANDRA]

Some see politics in everything.

The topic is "retirement fund for a 21 year old". How can we discuss retirement savings without discussing the future of Social Security, Medicare, and Taxes? If you want to say that bringing up those topics is "political" then I guess that's your point of view. But to me ignoring them would be like saying you're looking for advice about sailing around the world but you're not going to discuss the type of motor your boat will have, how big your boat is, and the size of your boat's gas tank. You COULD ignore those topics but it'd be stupid to do so.

If you want to project future retirement "living" you HAVE to make assumptions about what SS, Medicare, and taxes will look like. If you don't you're not making a wise financial plan.

Now, given what I just wrote, I would argue that my view is not a political view. It is a mathematical view. 2 + 2 = 4 is not political. Saying that when Medicare was passed into law there were 20 workers per retiree and in 40 years there will be 2 workers per retiree is not political.

It is a known fact that Social Security and Medicare can't continue on as they are right now. That's not political, that is a mathematical fact. For gosh sakes, even the Social Security Administration has it on their website that in 2033 it will only be able to pay 75% of promised benefits unless there are changes to taxes or the SS system. The SSA had that on their website under Bush and under Obama. It's not political, it's just a fact.

So if I were 21 and investing for my future I'd like to take into account the known fact of increased taxes in the future to pay for the growing elderly population. That's not political, it is demographic and mathematical. And given that demographic information I'd like to make some assumptions about whether Roth IRAs are likely to remain "tax free". To me that is wise financial planning. Because if Roth IRAs will not be tax free in 2060 it really throws a monkey wrench into the whole "The Roth is the best thing for you" plan, doesn't it?

If I did not believe it was political, I would not be investing in real estate to ensure we did not have to count on what our economy and government will do. Political threads however, get shut down quickly sometimes and this one is offering some good advice and while it goes MUCH deeper than a simple choosing between two, I was trying to limit the answer to keep thing on target.

 

[Jasonkat]

A Roth IRA is the best option for anyone below 40 years old regardless of their income (I'll get to that the fact there are no income limitations the end). That is a blanket statement I feel comfortable making regardless whether Roth IRAs are taxed or not in the future.

Why do I say this? Let's compare the Roth to saving in a 401k to saving in a normal brokerage account given various situations. Let's also assume Congress changes the law and your Roth earnings are fully taxable when you take them out (worst case scenario).

Taxability:
Roth: Earnings taxed at distribution
401k: Earnings and contributions taxed at distribution
Brokerage: Earnings taxed annually

In regards to taxability: Brokerage comes out a distant 3rd. So the question between 401k and Roth comes down to an assumption whether your tax bracket will be higher when you retire than it is now. For the 401k your contributions are taxed in the future, for the Roth you contributions are taxed today. So the only difference between what you "net" post tax is the tax rate you will pay on the contribution. This means you have to make a "political" forecast of what you think tax rates will be. Since middle class tax rates have never been lower than they are right now (not counting pre WWII era) I personally believe middle class tax rates will be higher in the future. Advantage: #1 Roth #2 401k, strong disadvantage to brokerage

Emergency situation:
A brokerage account has ultimate flexibility as you can get the money at any time. A Roth IRA allows you to take your contributions out at any time without penalty. A 401k will only let you take a loan which must be repaid. If you withdraw money from a 401k and don't pay it back via a loan you will owe income taxes and a 10% penalty. Advantage: #1 Brokerage #2 Roth, strong disadvantage to 401k

Down payment for a house/ paying for college:
A brokerage account can be withdrawn at any time without penalty. A Roth IRA allows you to take your contributions out at any time, and after 5 years since you first opened a Roth IRA you can take out your earnings for a down payment tax-free. So within 5 years you can take out your contributions, and after 5 years you can take out the entire thing without taxes. A 401k only has two options: a loan that you must repay or a withdrawal that will be taxed at your income tax rate plus a 10% penalty.
Advantage: Brokerage/Roth with a very strong disadvantage to a 401k

- In 2010 after I finished graduate school my wife and I used our Roth IRAs for our down payment on our condo. If we'd put more money into 401ks instead of doing both 401k and Roth we'd have had to take out 401k loans that would've had to have been repaid. Yes we "lose" the Roth IRA tax free growth in the future on the money we withdrew but since we're in our mid-30s and the Roth IRA contribution limit is 11,000 per couple we have a lot of time to make up the money we took out.

Required Minimum Distribution:
A brokerage account has no required minimum distribution. A Roth doesn't either. A 401k does have the RMD, so you will be forced to take money out of your 401k/IRA and pay taxes on the money whether you need the money or not. Advantage: Brokerage/Roth a wash, 401k a distant 3rd

Age:
A Roth is best for people below 40 because they aren't at their peak earnings yet (current tax rate is not yet at the highest level it will be during their life) and they have the longest time before they withdraw the money, so tax-free compounding will have the biggest benefit. After 40 a person may be at their peak earning years with their peak income tax level, in which case a 401k may be better than a Roth because of the tax savings today for 401k contritubions. Advantage: pre 40 Roth, post 40 401k (maybe)

Contribution Income Limitations
Any income level can contribute to a brokerage or a 401k. A Roth has income limitations of 178,000 for married and 112,000 for single. Now, if your income exceeds these amounts does that mean you can't contribute to a Roth? Nope. You could instead open a non-deductible IRA (open to anyone regardless of income) and then "roll" the non-deductible IRA into a Roth IRA (no income limitations). Since you didn't deduct the non-deductible contribution you won't owe taxes on the rollover. And since there are no income limitations on contributions to non-deductible IRAs or Roth IRA conversions there are basically no income limitations on Roth IRAs, as long as you take these two extra steps.

 

[sarah4770]

First of all, thank you for starting this thread!

My 20 year old is in school and also works for the school. They recently converted her from a contract worker to a part time employee eligible for benefits. (She now has a future pension.)

She has had her job since day one of starting school and one benefit is a tuition benefit, so she has been able to save a lot of her earnings. (Her hours were minimal so not huge amounts!)

I've been watching her savings grow and was trying to figure out a way for her to earn more than simple interest but still keep the money sort of available.

The suggestion of a Roth confirms what I had been thinking.

So, how much can a student who earns maybe a thousand a month put in a Roth account? Is there a max or a minimum? Is it a percentage of what she earns?

I am clueless as I've never had to worry about my future - just hers. Eventually she will have a considerable inheritance but learning to budget and save is an invaluable tool and she has it, but still needs guidance for maximum value.

As long as she is working, she can contribute the normal amount per year,which is $5,500 or up to all of her taxable income, per year. But I would not look at the money as " sort of" available. She can only take out her contributions after 5 years, not the interest earned on the contributions. Better to look at that money as long term savings.

 

[preschoolmom]

Have him check out Mr. Money Mustache. It's a great site about living beneath your means and investing - and retiring young (if that is something that he might be interested in!).

So much potential when you're 21!

 

[Pesky]

Roth IRA or regular IRA. I'd probably look into Vanguard funds that play the whole stock market (not just S&P 500) -- low cost and diversified risk. He can look to go more specific in his investments over time.

 

[mrspaha]

Great thread! I've been trying to encourage my kids (in 20's) to contribute the most they can to a Roth -- not even thinking about the possibility of the future changes to its taxability. But it still sounds like a Roth is the way to go for the younger ones. My question now to those that are knowledgeable about investing -- would a 20-something be best off putting their roths into one of those funds that a lot of brokerage houses offer that are geared for certain age ranges (more risk when you're young; less as you age). And are there certain funds where you have less built-in fees (like a Vanguard fund vs a Fidelity fund?

 

[BuzznBelle'smom]

You'd have to research the fee thing. Sometimes, fees can be waived if you get accounts "linked" to the point where there's a high-dollar value. By this I mean, if your child were to go to your investment company, they might be umbrella-d in with yours for fee purposes, even though they're not joint accounts.

It's probably not good to put all your investment eggs in one basket, but those age-based funds aren't a bad way to start. The one thing I absolutely don't suggest is putting everything in just one or two stocks. Most investment companies have a few dozen types of funds--DH and I have 6 different ones, with different rates of risk, and we re-balance every year or so. For a newbie, it might be best to start with 2 or 3, just for a little diversity. Let it build for a few years, and give the investor a chance to build up some value, and then decide if he wants to actively manage the account, or be more passive--I would call DH and my approach to be passive, with the annual balancing. Set it and forget it isn't a bad way to start--just don't go too aggressive.

 

[Jasonkat]

My question now to those that are knowledgeable about investing -- would a 20-something be best off putting their roths into one of those funds that a lot of brokerage houses offer that are geared for certain age ranges (more risk when you're young; less as you age). And are there certain funds where you have less built-in fees (like a Vanguard fund vs a Fidelity fund?

Here's where I will disagree with the main point of view:

First answer: do not use a "strategic retirement date 2050" fund right now. Those funds will have some bonds and anyone below at 40 should have NO bonds. Now I realize this is against conventional wisdom but here's the reason: Over long time horizons (30+ years) bonds have the same "risk" as stocks but they return 2% less. So why would you invest in something with the same risk but lower returns? You wouldn't. Over short time horizons (less than 30 years) bonds will have less "risk" than stocks. So if you have 30 years or more until you retire you should have no money in bonds. I'm 36 right now and I have 100% stocks. When I'm 40 I'll go to something like 90/10 and move the bond portion up slightly every few years.

People will tell you that bonds dropped less than stocks in 2008-2009. While that's true that brings up this point: are you planning on "trading" your retirement fund? Or just leaving it as-is? Because if you're going to trade and time the market than go ahead and use bonds and wait for a crash, but if you're just investing for the long term then you would not have benefitted from the drop in stock prices because you wouldn't have shifted all of your bonds to stocks in Feb 2009.

Second point: type of fund. Well this really depends on how interested your kids are for retirement. A Vanguard total stock market index fund is probably the "wisest" choice. But I see nothing wrong with them opening a stock account and splitting their $5500 between a mutual fund and two stocks. If they really love Apple then they should own some shares. This will keep them interested and excited about investing. Even if they "lose it all" it's irrelevent at this point. Investment gains are made through years and years of continual regular contributions. So if you lose all $5000 in your first year that doesn't really matter too much. But if investing in Apple keeps them excited wheras a S&P 500 fund would make them lose interest then by all means keep them interested.

It's hard enough to get a 25 year old to think about life at 65, so if individual stocks will help then I say go for it!

 

[Mary2e]

Way back in the early 1980s, they came out with all these new retirement plans called 401ks and IRAs. I was lucky and started out saving into both those plans at the start, and have never stopped contributing. I always contributed enough to get the company match.

At the beginning, I was afraid to lose that money and put it in stable investments, but after about 10 years moved into mostly stocks, and as my salary went up and/or I got a raise, I would raise my contribution by 1% until I maxed out.

Back then, people were saying not to invest in them because the tax treatment would have to be changed and definitely would be changed.

Guess what? It hasn't happened, and this new vehicle, called a Roth, came about instead. THIS is the best thing to happen to young savers in a long time. I do not believe they are going to change the tax treatment, or at worst, will tax a portion of those lifetimes of earnings (not principle). I'd rather have those earnings, even if taxed, than none at all.

I would strongly suggest a Roth and investing in low cost index stock funds in either vanguard or fidelity. Perhaps a mix of domestic and some international exposure. While the international market isn't doing very well right now, I'm plugging away and investing anyway on a regular basis. It will turn around and when it does, I'll be sitting on some nice gains.

 

[mommycrawford]

One thing he might want to do (as well) is buy whole life insurance since it helps build credit, has cash value, and a dividend that can accrue, or be taken out or borrowed against. I bought some when I was 18, and almost 30 years later, my premiums are very low....Just something that doesn't depreciate, and is always going to come in handy eventually.