Why You Need a Roth IRA
If you don't meet the five-year test, you still can take out your earnings for your home purchase, but you'll have to pay taxes on the amount you withdraw. You won't have to pay the 10% early-withdrawal penalty, though.
You can, of course, take out your contributions at any time to help pay the bill. If you dip into earnings, you'll owe taxes -- but you don't have to pay the 10% early-withdrawal penalty if you use the money for college. The Roth shouldn't be used as the sole savings vehicle for higher education, but it's nice to know you can use it if you need it.
How to open a Roth IRA
When you're just starting to invest, the Roth should be your first stop -- even before you open a regular, taxable account, or contribute to a workplace retirement-savings plan. The only exception is if your employer offers a match on your 401(k) contributions. That's free money you don't want to pass up. In that case, contribute enough to win the match, then send any extra money into a Roth IRA. (Yes, you can invest in both a Roth and a workplace retirement plan.)
You can invest your Roth IRA in almost anything -- stocks, bonds, mutual funds, CDs or even real estate. It's easy to open an account. If you want to invest in stocks, go with a discount broker. For mutual funds, go with a fund company. For CDs or money-market accounts, you can go through your bank.
Because you're young and have a long way to retirement, you'll want to invest in the stock market to get the highest returns over time. Rookie investors should stick to mutual funds that invest in stocks. They're easy to understand, you leave the stock-picking to the pros, and they make it easy to spread your risk around several stocks or bonds without putting all your eggs in one basket.
Most mutual fund companies even lower their minimum investment requirements when you open an IRA. T. Rowe Price, for example, requires $2,500 to invest in a taxable account, but IRA investors need only $1,000 to get started -- or as little as $100 a month if you sign up with its automatic investing program.
Use Fund Finder to search for funds that have low investment minimums and that meet your other criteria. Stick to no-load funds with low expense ratios (the average expense ratio for stock funds is about 1.5%).
Many fund companies will let you open an account and make contributions online. Make sure you designate what year the contributions are for.
Not sure where to find the money to fund your account? Consider investing your tax refund. For the 2011 tax-filing season, the average check totaled nearly $3,000. That cash would make a great start to your Roth.
Another way to fund your account is to put it on autopilot. Most banks and brokers will allow you to set up an automatic investment plan taking the money directly out of your bank account and putting it into your Roth. It's much easier to find the cash when it's considered already gone than if you have to make a physical effort to write the check each month.