Starting Out


Why You Need a Roth IRA

Kevin McCormally

With this indispensable savings tool, your money grows tax-free, you can invest in almost anything and you get several cool perks.



You can tap your Roth to buy your first home. As noted, you can always withdraw contributions tax- and penalty-free for any purpose. And, if you tap your Roth for a first-home purchase, in addition to using your contributions for the down payment, you can also withdraw up to $10,000 of earnings tax- and penalty-free if the account has been open for at least five years. Even if you fail the five-year test, the withdrawal will still be penalty-free, but you will have to pay tax on the withdrawn earnings. That $10,000 limit is per person, so couples could withdraw up to $20,000 of earnings if they each have a Roth.

If you don't meet the five-year test for tax-free earnings, you still can take out your earnings for your home purchase, but you'll have to pay taxes on the amount of earnings you withdraw. You won't have to pay the 10% early-withdrawal penalty, though.

You can use it to save for Junior's education. Many new parents don't know whether to save for retirement or the baby's college tuition. Hands down, retirement wins. There are lots of ways to borrow to finance a college deduction; for retirement, not so much. But starting a Roth is a great way to cover both bases, just in case. Focus on your retirement now, saving as much into a Roth as you can. And as your finances allow, consider opening a specific college-savings account for the new baby — say, a Coverdell or 529 plan. Then, when the day comes for Junior to head off to school, you can assess whether you can afford to — or need to — sacrifice some of your retirement dollars to make it happen.

You can, of course, take out your contributions at any time to help pay the bill. If you dip into earnings before age 59 1/2, you'll owe taxes (and before the account has been open for five years) — 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.

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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.

Use our Mutual 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 1.3%).

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 2012 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.

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