I know that most young people don’t make very much money. I also know that it’s hard to be a college student, at least financially. Costs are up. Aid is down. Loans are expensive. I get it. Seriously, I get it.
Having acknowledged all of that, I want to remind the young people about the biggest financial opportunity that is available to them. It takes full advantage of the two greatest assets young people enjoy: time, and tax-free growth.
It’s called the Roth IRA. You have probably heard of it. But in case that term is not familiar to you, permit me a moment to outline the basic features of a Roth IRA.
Let me warn you up front: this might hurt. I am not being facetious. I know that if you don’t make much money, or don’t have a job at all right now, this is going to require sacrifice. If you don’t have a job (say you are a full-time college student), you will need to get one. If you are living on the money you are making, you will need to find a way to earn some more, or to spend less. What I am convinced of is that the effort on your part will be completely and totally worth it.
You may contribute money each year, up to $5,500 or your earned income, whichever is less. This is important: you have to EARN the money either through a job or from self-employment. Investment income doesn’t count. Gifts are not income. You put the money into a retirement account (the Roth IRA, named after a former Delaware senator) where it is invested in the usual assets: stocks, mutual funds, bonds, etc. Then you leave it alone.
You put another $5,500 in next year, and the year after. Lather, rinse, repeat. You do this until one of two things happens: either you reach retirement age or you make too much money to be able to make a contribution. That limit is presently $114,000 per year if you’re single, and $181,000 per year if you’re married. You have to be doing pretty well before you get shut out. Once you reach age 59 and 1/2, any withdrawals from the Roth IRA are TAX FREE. (Yes, I know there are nitpicky exceptions, but I’m going to ignore them right now to emphasize the larger truth). If you want all the glorious details, I suggest you curl up with a recent copy of IRS Publication 590. Don’t wait for the movie to come out.
How much money are we talking here? An 18 year old who contributes $5,500 per year for every year through age 30 (13 years) and then leaves the money alone until age 70 will have $3.9 million in his account. If he contributes through age 35, that number grows to just over $4.6 million.
All of that assumes an annualized return of 9%. That is below the CRSP database annualized return of 9.9% for all US stocks from 1926 through 2013.
Yes, I know that inflation will mean those dollars will be worth less. That’s why you have to put the money in stocks and leave it alone for decades: stocks are the one asset that has been proven to beat inflation over long periods of time.
Time is on your side, young people. Use it!
Tools in the shed
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