A few questions

[Guest chauncy]

I am considering setting up a Roth IRA account. I'm 19 years old, and would like to find out some information on if this would be a good idea. I have tried to read through this web site but haven't really been able to pick up on a lot of the details. If someone could explain the Roth IRA in laman's terms that would be great. Thanks.

[John G]

The Roth IRA was establish a few years ago by Congress as an alternative the standard IRA. Both were created as an incentive for individuals to make personal contributions for their retirement. Think "tax shelter".

First requirement to participate is that you must have "earned income" which for most people means a paycheck although certain kinds of self employment income can also qualify. The current maximum annual contribution is $3000 per year if your earned income is that much, otherwise it is capped at your earned income. Your parents, uncle or grandparents can make the contribution, it does not have to be your money. Second, there are restrictions based upon tax filing status and income level. I assume you do not make over six figures and that you file a "single" tax return so this should not be a problem. Note, you do not need to put in the max amount. One option could be to put in a fixed amount each month, such as $100.

Next issue is finding a custodian who will keep your assets. The common choices include: brokerages, mutual funds and banks. I would recommend that someone just getting started choose a mutual fund or fund family. Something to ask about is the annual fees (if any) that your custodian might charge. Anything above $20 per year should be avoided.... and zero is most cool. You can find a list of mutual funds in the March issue of Consumer Reports. Vanguard, T Rowe, Janus are some of the NO LOAD funds (no front end or back end commissions charged) that you can find on the www. I further recommend that you choose a broad based stock fund, such as an S&P index fund which will give you market performance. I do not recommend individual stock picking or trading for someone getting started. An index fund requires very little "maintenance" by you... just check you periodic statements. Talk to three different custodians. Ask them for their "just getting started" materials, which are often very good.

Why mutual funds? Because you get "diversification" which means you don't put all your eggs in the same basket. Why the stock market? Over many decades you should expect assets to appreciate the most in stocks (also called equities). The last three years have been ugly, but that is a very unussual string of negative years. IRA investments for a 19 year old should be thought of in decades.

Contributions to a ROTH are not deductable. However, many years from now you can withdraw tax free. If you put the max amount in each year for the next 40 years... then you can retire at age 60 with a nest egg that will probably exceed 1 million dollars. Marry someone who also thinks about their future and you will have twice that amount. You don't have to be a doctor, lawyer or MBA.... Congress created this great tax shelter for everyone. The tax sheltered compound growth of you assets is a key value of the Roth.

Two final notes: You did not say if you are just working or going to college or both. Remember that IRA money is locked up for a long time and that there are penalties for taking money out early. Be sure that you have some "emergency" money set aside in case the worm turns against you. Education is another big investment for the future and I hope you are pushing in that area as well.

Post again if you need more info or have questions.

[Guest chauncy]

Thanks for the info. That helped a lot. I also believe that education is important and will strive to make that my number one priority. Thanks again.

[Guest warren7]

John G,

Thanks for your posting, very helpful and insightful.

Do you recommend any certain brokers to go through, (i.e. TD Waterhouse or Brown & Co.) What are the major concerns I should consider as a 21 year old college student opening a Roth IRA?

Thanks.

[John G]

Issues for a college student:

1. Can I fund an IRA now? - paying for education and having a cash reserve come first. However, you may find a grandparent, mom/dad, or other relative who will help you fund an IRA. With two kids in college right now, I am quickly learning that college students come with a wide range of jobs and cash resources. If you have "excess" funds than an IRA is a great idea. By starting early, you get max benefit out of the tax sheltering of funds.

2. Who should be my custodian? - this depends very much on what kind of person you are and what kind of local access you have to financial firms. Internet savy folks have a wide array of choices, others may value the face to face approach. Things to consider: what kind of investments you plan to make, convenience and service, and annual fees. If you are going the mutual fund route then direct placement with a mutual fund or fund family is an option. Many brokerages also offer access to mutual funds (like Etrade, Schwab, etc.) and they often have better online access. There are probably thousands of choices... but you need just one custodian for the next few years. Keep the arrangement simple, you can consider other options after you have run a few years and built a decent size account.

3. Time is valuable, so I can't screw around doing research right now. - Good reason to stick initially with mutual funds, especially index funds with broad holdings (diversification) and low annual expenses (like Vanguard index funds). Generally, I would recommend NO LOAD funds... funds that do not charge an up front or backend commission.

4. Are you eligible? - be sure that you have "earned income" which ussually means a paycheck and W2. As a college student, you should not have problems with the max income limits.

5. IRAs are not the only investment option. - If you are about to graduate and take a job (age 21?), you will be exposed to many more tax shelter / retirement savings options like 401k and 403b. If you live below your income, you can amass an amazing amount of money in these accounts. Think seven figures after the next 40 years. It is possible.

6. Watching investments can be like watching paint dry. Things happen over a very long period. If you get a 10% return each year, then your assets will double in about 7 years.

Good luck, post again if you have other questions.