Daughter's IRA Startup

[Guest Stiggy]

Good day to all, my daughter is finally going to start an IRA(she finally got a full time job after graduating from college). Unfortunately, her company tells her she needs to wait 1 yr before 401k contributions can occur so I thought that the IRA would be the best alternative. My understanding is she can contribute to a traditional IRA for $4k(to get the tax deduction) and then convert to a Roth for the tax free opportunities upon withdrawals in the future(sound advice I hope)? My questions are as follows:

1) How soon can you convert from the traditional to the roth(can this be an immediate pass-thru?(she is planning on monthly contributions not a lump sum since she's just starting out).

2) If she needs to touch the money, isn't there a 5 year holding period before she can touch her contributions(without the 10% penalty)?(I know she can't touch the interest/capital gains portion).

Anything else I need to inform her on? Thanks for your time. I try to visit this site frequently and find this forum to be exceptional in respect to helping folks like myself.

[papogi]

Once you convert from Traditional to Roth, you have to pay tax on the funds. There is no tax advantage to open a Traditional IRA, get the tax deduction, convert to Roth, then pay tax on the entire amount converted. It becomes a wash, and is not worth the administrative steps. Just start with the Roth.

Contributions (not earnings) to a Roth can be withdrawn at any time and for any reason.

[WDIK]

The $4,000 also becomes taxable when it is converted into a Roth.

[John G]

I would suggest a Roth IRA rather than the regular IRA. Yes, you give up the deduction.... but 4 decades of compounding and then tax free is awfully enticing.

And... don't forget that 401k may be a very compelling deal is there is a match. One year from now, reassess the priorities. You daughter can do both.

Dad - you job is to "suggest", ultimately your daughter needs to take charge of her own money. You can be a huge help by giving her a subscription to "Kiplinger Financial" magazine which covers investing, careers, credit, home buying and general consumer issues. If she spends a few hours each month reading, she will be way ahead of her contemporaries.

[Guest collegegirl]

Definitely get her to start with a Roth. My local bank has helped me figure out a CD where i could start with $250 and add to it whenever I wanted (but additions had to be over $50, no big deal!) and it has 3.2% interest. I like it a lot, until I get more money and can switch it to a more powerful CD that gets me 5.25% a year. There are also funds online that let an investor to contribute $50 a month toward their Roth IRA, but I haven't look that into it, I've just heard they exist.

I hope your daughter makes the right choice! I started mine in June and am so glad that I did!

[John G]

To college girl: Congratulations on getting started. You have many years of compound growth ahead, which rewards those that start early.

BUT..... that 3.2% interest rate is terrible. Your money is barely keeping up with inflation. Continue what you are doing for now, then when your Roth assets grow to $2000 you need to look into transferring the account to a mutual fund. Search on "mutual fund" and you will find lots of discussion about how to choose a NO Load fund.

Here is why 3.2% should only be a short term approach: funds invested in a diversified stock portfolio on average double in about 7 years. Funds earning 5% in a CD double in size in about 14 years. Lets use 2000 and assume you are 22 years old and retire at 66. At 5%, you will get approximately 3 "doubles", so your $2000 will grow to $16,000. But if your mutual fund averaged 10%, your 2k would grow to $128,000 over 44 years because you assets double in size 6 times!

(To find how fast a fixed amount will double, divide 72 by the annual percent earnings to get a "rule of thumb" estimate of the number of years to double. This is called "The Rule of 72". Example: at 5% you have 72/5 or about 14 years. At 10%, 72/10 is just over seven years.)