Starting a Roth IRA and how it works....

[Guest The2002Man]

Hello all,

I am new to all of this and if someone could answer a couple simple questions, it would be much appreciated. OK, first off, I am 19-years-old and I live in Pennsylvania. I work two jobs, one of them is cleaning cars and the other is cleaning office buildings for a cleaning company. I first heard about the Roth IRA in a USA Today newspaper a couple days ago and I thought I'd get on here and see what the uproar was all about.

My annual income may not be such a great figure due to the poor economy around this area, but I would still like to start early so I have a nice amount to fall back on when I decide to retire. My father had almost nothing to fall back on and I wouldn't like to see myself end up where he is now so I started to look into something to set myself up with.

My questions are...first, what are basic requirements for setting up a Roth IRA? Second, if I made deposits of $2000 after taxes every year, by the time I turn 50, what would that figure come out to and would there be any interest?

I appreciate anyone that read this message and hope that someone will answer my questions.

Thanks,

Robert

[John G]

A Roth is a type of Individual Retirement Account (IRA) that is a method Congress has created for saving/investing for retirement. Two big advantages are that the amount you set contribute grows without any taxation... and with a Roth you eventually withdraw the funds in retirement without any taxation. (highly simplified summary)

To qualify, you need to have "earned income", which in most cases is paychecks from an employer. If you make atleast $3,000 per year you can contribute $3,000 to a Roth. The previous $2,000 limit was just increased this year.

A Roth requires a custodial account. That means some financial institution holds the funds in your name. Typical custodians includes banks, mutual funds and stock brokerages. A good custodian to consider is Vanguard which is based in Valley Forge area of PA. They offer a variety of mutual funds like the S&P500 index fund that are good starter investments.

You comment about interest suggests that you need to learn more about the general concepts of investing. I would recommend that you read the March issue of Consumer Reports on various retirement investing. Also ask a couple of potential custodians (a bank, a broker, perhaps Vanguad) to give you some information for adults just getting started on investing for retirement. There is a blizzard of info available, be sure to tell them you are just getting started so that what they send will be more likely to help you.

Interest: Sure, anytime you "loan" someone your "capital" or "assets" you should expect some kind of return. For example, give your money to a bank and you expect interest. What type, kind and level of return depends upon the type of investment you make. When you have money sheltered for a very long time, like 30+ years, you want to make sure those funds give you a return better than the rate of interest. It is generally accepted in the investment community that very long term investments should include a substantial component in stocks. An investment in stocks ussually provides some return in "dividends" (very similiar to interest) and "appreciation" or "capitial gains" which is a fancy way of saying the stock moved up in price.

Whooaa. Stock moved up in price? In this market? Well, actually some stocks have indeed moved up in value this last year. However, most have moved lower so the headline reads "Stock Market Declines". Scary events make for great headlines. A knowledgeable investor knows that markets move up and down, but good years out number bad years by anywhere from 4:1 to 7:1 depending upon how you measure. We have just had two bad years, which is very rare.

How big a nest egg can you build? You mentioned 50... I will also give you to age 65. Lets assume that means 30 and 45 years.

Contributing $1,000 each year for 30 years will grow to $113k if you invesments average 8% per year, and $164k if your investments return 10% per year. Leave the nest egg grow to age 65 and the results are $386k and $718k for the two interest rates. If you contribute $2,000 each year just double the results, and triple the above numbers if you max out at $3,000. As you can see, starting early and setting aside as much as you can afford might get you past the $1 million mark. Great system eh?

You caught a wiff of the benefits of Roth IRAs. I hope this motivates you to spend a little time on understanding how IRAs work and getting started, even if you contribute less than your max.

As a young guy, let me also suggest two other paths toward a rewarding future: running your own business and education can be extremely rewarding if you have the patience and discipline.

Good luck. Post again if you have more questions.

John G - - PSU class of '74