The Ultimate Guide to Traditional and Roth IRAs for Millennials

According to a recent study by USA Today, millennials will need between 1.8 million to 2.5 million for retirement.  That is a lot of money!  Of course, that is taking into account inflation by the time we get ready to retire and the fact that social security may be unavailable.  Nevertheless, it is still a lot of money!  In order to get there, millennials will have to do more than just save in their 401k – or company-sponsored retirement plan.  That is why every millennial needs a Traditional and/or Roth IRA.

Today, we will break down what an IRA is, the similarities and difference between Traditional and Roth IRAs, and which saving vehicle is best for you.

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What’s an IRA?

IRA stands for individual retirement account.  An IRA is a type of savings vehicle designed to help you save for retirement.  An IRA can be invested in a variety of securities: bonds, stocks, CDs, mutual funds, and other assets.  It is often mistaken than an IRA is an actual investment; however, an IRA is just the investment vehicle.

There are several different types of IRAs: Traditional, Roth, Simple, SEP, and SARSep IRAs.  Simple, SEP, and SARSep IRAs are employer-sponsored retirement plans.  Therefore, your employer must offer them.  Today we are going to focus on the IRAs that an individual can open: Traditional and Roth IRAs.

Similarities Between Traditional and Roth IRAs

Both Traditional and Roth IRAs are tax-advantaged vehicles meant for retirement.  Tax-advantaged means that you aren’t taxed on the growth of your assets.  Therefore, the interest, dividends, and capital gains can compound each year without having to worry about taxes.

Other Similarities include:

  • The limit is $5500 or 100% of taxable compensation if you are under 50, or $6500 or 100% of taxable compensation if you are 50 or older.
  • The deadline to make a contribution to both Traditional and Roth IRAs is your tax filing deadline.

Differences Between Traditional and Roth IRAs

The biggest difference between Traditional and Roth IRAs is when you pay taxes.  On a Traditional IRA, you pay taxes when you take the money out at retirement.  Therefore, a traditional is pre-tax money.  On a Roth IRA, the money is taxed before you put it in.  Therefore, you don’t have to worry about taxes when you take the money out at retirement.

Both Traditional and Roth IRAs are investment vehicles meant for retirement; however, there are different rules about taking money out prior to retirement.

  • For a Traditional IRA, if you take money out prior to age 59 1/2, you may incur a 10% early distribution penalty.  In addition, you will be taxed on the total amount.
  • For a Roth IRA, if you take money out prior to age 59 1/2, you are able to take out anything you put in without taxes or penalties.  However, if you take out any earnings, you may incur a 10% early distribution penalty and taxes on the earnings.

*Please note, if you need to take money out of your IRA prior to age 59 1/2, please consult a tax advisor to review all the rules and regulations.  The money is meant for retirement; however, there are some exceptions you may qualify for – like for a first-time home purchase or school expenses.  A tax advisor can review your specific situation and advise what is best for you.  

Investment Strategy for Millennials

Now that you know you need a Traditional or Roth IRA, you are probably wondering how much you should be investing in your IRA.  Honestly, everyones situation is different but follow this model.

If your company doesn’t offer a 401k or similar retirement plan, you should open up an IRA.  If your company does offer a retirement plan but doesn’t offer a match component, you should consider opening an IRA.

In the event, your company offers an employer sponsored retirement plan (like a 401k for example), invest into the 401k in order to get the matching contribution.  Therefore, if your company matches dollar for dollar up to 3%, you need to put 3% into your 401k in order to get that match or free money.

  • For example, if you make $50,000 and your employer matches dollar for dollar up to 3%, over the course of the year you need to put $1500 into your 401k and then your employer will put $1500 in your 401k as well.

Millennials are going to need between 1.8-2.5 million dollars for retirement!  Therefore, just putting 3% into your 401k is not going to be enough.  Many financial advisors estimate that you should be putting 12-15% of your income away for retirement.

Enter your Traditional or Roth IRA.  The additional money that you are able to invest over what you put into your 401k, should go into your IRA.  Keeping in mind the limits for IRAs mentioned previously.

If you are just starting out, invest what you can.  Just make sure you are investing early and often.  Start out with 3%, for example.  As you get a raise at work, increase the percentage by 1 or 2%.  Continue to increase the amount as you get future raises.

Related: 4 Things Millennials Need to Do Now for Retirement

The ultimate guide to Traditional and Roth IRAs for Millennials

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Determining if a traditional or roth ira is right for you ca be tough. You need to know the facts to make an educated decision about investing for your future retirement.

5 comments

  1. I definitely agree that the earlier you start investing the more lucrative it is in the end. Also shocked about that millennials are going to need between 1.8-2.5 million dollars for retirement. What age is being used for the mortality age as far as what age the money should last?

    1. I agree Andre! It is a daunting number. Unfortunately, the USA Today article doesn’t provide a mortality rate of length of time the money would be needed. Here’s a link to the article: http://www.usatoday.com/story/money/columnist/powell/2016/03/29/millennials-new-retirement-number-18-million-more/81329246/

  2. I can’t say it enough – the earlier someone starts saving/investing the better.

    A big benefit of a Roth IRA is that although we don’t know what tax rates will be when we retire in 30+ years it is probably safe to assume they’ll be higher than they are today. So paying taxes now will hopefully save us from paying more taxes later.

  3. The best advice I received early in my career was to apply any raises or cost of living increases into my 401k until I had fully maxed it out. I was finally able to realize that goal four years ago and it’s a fantastic feeling. Now that I think of it I should thank that guy. Thanks for the reminder!!!

  4. A few comments –

    IRA = Individual Retirement Arrangement. This subtle difference is often discussed when it’s time to take Required Minimum Distributions. All (non-inherited) Traditional IRA accounts are added together to calculate the numbers. You can have many accounts under that IRA umbrella.

    April 15, 2017 is a Saturday, so tax day for most is Monday, April 17. Unless it’s a holiday in your state, or the IRS office is in such a state. My tax day is April 18th, but I hope to be done by mid-February.

    Last, I suggest that those just getting started understand how marginal rates work, and consider the Roth while in the 10 or 15% bracket, then shift to pre tax Traditional IRA as they earn into the 25% bracket. Simple, once you understand how.

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