When you’re in your 20s and studying in grad school or college, whether part-time or full-time, retirement planning may not be your main concern. Let’s face it, even with a stipend or job, you’re probably on a tight budget already. Can’t saving can happen later, when you have money and success? After all, isn’t that what further education is for?
Well, grad school might be a stepping stone toward a better job and a larger paycheck someday, but there are good reasons to start on your retirement savings now.
Why? Compound interest.
The earlier you start saving, the more time your money can enjoy compounded growth. Essentially, your savings will earn more money, and those earnings will earn even more money the longer they sit around. Even if your account balance doesn’t look so impressive at first, it’ll knock your socks off by the time you retire!
What is an IRA?
IRAs or Individual Retirement Accounts are self-funded retirement plans that allow people to save and invest money for their future. These accounts act as envelopes for various investments and keep earnings from being taxed. There are several types of IRA plans, but traditional and Roth IRAs are the most common choices.
Who Can Contribute, and How Much?
Only single people earning under $133,000 or married couples filing jointly and earning under $196,000 may contribute to a Roth IRA. If you’re under the age of 50, you can contribute up to $5,500 per year or the total taxable compensation you receive, whichever is lower.
Your stipend counts as taxable compensation if it’s reported on a W-2, but income from fellowships or training grants does not. You could contribute to a spousal IRA if you’re married to someone with an outside income, but the same limits apply.
Remember, you may have to pay tax and penalties if you make a withdrawal before the age of 59½ years, so leave that money alone unless it’s a real emergency.
Traditional vs Roth IRA: Which is Better for Grad Students?
Definitely the latter.
Here’s why you should start saving in a Roth IRA for yourself or as a gift for college-goers:
- Tax-Advantaged Growth – Interest and gains from investments are not taxed until you withdraw them, so they grow much faster. And, since you’re in a lower tax bracket now than you will be later, you’re saving on income tax as well.
- No Tax/Penalty on Contribution Withdrawals – Unlike traditional IRAs, a Roth IRA is funded with after-tax money. You will not be taxed when you withdraw your contributions from the account, as long as you aren’t dipping into the earnings.
- Flexibility on Withdrawals (Earnings) – There’s a bit of wiggle room if you want to withdraw earnings too. If your Roth IRA has been open for 5 years, you can withdraw up to $10,000 of earnings to buy your first home without tax or penalty.
- No Effect on Student Aid – Roth IRAs are not counted as income or financial assets for you or your parents by FAFSA (Free Financial Application for Student Aid), unless you withdraw earnings before your final year in college or grad school.
- Control Over Investments – You should open a Roth IRA even if you’re working and your employer offers a 401k. Investments in 401ks are restricted to those your employer chooses, but with an IRA, you choose where your money goes.
- No Forced Distributions – Traditional IRAs and 401k plans have required minimum distributions (RMDs) after you turn 70½ years of age. With a Roth IRA, you can choose when to start, or even leave your money to keep growing forever.
- Benefits Pass On – If you were to pass on, the tax advantages of your Roth IRA will pass to your beneficiaries as is. With a traditional IRA or 401k, your heirs would be liable to pay taxes on the money they receive from the account.
Personal finance isn’t rocket science, but you need to make smart decisions about where to invest your money. To fully leverage the benefit of early savings, start by putting away whatever you can spare into a Roth IRA today.
Bonus Article: Learn why I invest with a Roth IRA.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last 10 years has turned his focus to self-directed accounts and alternative investments.
Rick regularly posts helpful tips and articles on his blog at SD Retirement as well as Business.com, SAP, MoneyForLunch, Biggerpocket, SocialMediaToday, and NuWireInvestor. If you need help and guidance with traditional or alternative investments, email him at [email protected]