First Job? Make This Money Move Your Top Priority

It's never too early to start saving -- and this is the best way to do it.

Dan Caplinger
Dan Caplinger
Feb 25, 2019 at 7:55AM
Investment Planning

It's harder than ever for young people entering the workforce. Even as unemployment levels have dropped, getting ideal jobs that match up with your talents is more challenging than ever. Meanwhile, rising student loan debt and uncertainty about being able to find reliable long-term work with key employee benefits like health insurance are added obstacles to financial security.

It might therefore seem unrealistic to think that anyone just entering the workforce could afford to think about using a retirement account. But the benefits of a Roth IRA make it a perfect vehicle for saving for those just entering the workforce, and recent tax law changes make those benefits more valuable than ever.

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How a Roth IRA works

A Roth IRA is a special retirement account that most workers can contribute to every year. As long as you have enough earned income from a job, freelance gig, or other work to fund your contributions, then you can put up to $6,000 into a Roth IRA for 2019.

Once money is in the Roth IRA, it grows on a tax-deferred basis, with any income and gains generated by the investments in the account being free of immediate taxation. Moreover, with the Roth IRA, as long as you follow the rules, you can make withdrawals in retirement tax-free -- escaping tax entirely.

Why young workers should look at Roth IRAs

Many people overlook the Roth IRA because it doesn't offer an upfront deduction on your taxes. That's what you can get if you contribute to a traditional IRA instead, and many people prefer to grab a bigger refund now. However, there are several reasons why Roth IRAs are more appropriate for those who're just starting out in their first jobs:

  • Low current tax rates make the tax savings from a traditional IRA worth less for those with modest incomes.
  • The prospect for potential higher tax rates in the future makes contributing to a Roth now less taxing in the long run.
  • Roth IRAs offer opportunities to make early withdrawals with no penalty that traditional IRAs don't.

The key to comparing traditional and Roth IRAs is looking at what your tax rate is now and what your tax rate will be in the future when you retire. A traditional IRA contribution gives you an immediate tax break based on your current tax rate, but you'll have to pay taxes at your future tax rate when you withdraw money in retirement. A Roth IRA contribution offers no tax break up front, essentially making you pay taxes at your current rate. But future withdrawals are tax-free, so you get to avoid tax at whatever the future rates are.

Young workers with modest salaries tend to be in the lowest tax brackets, currently at 10% and 12%. For them, the deduction for a traditional IRA contribution isn't worth a lot. However, if you're successful in boosting your earnings and saving a sizable retirement nest egg, then your tax rate when you start taking withdrawals from your IRA could be higher -- much higher in some cases. That's why it's smart to forgo a minimal tax break now in favor of bigger savings later.

In addition, there's always a threat that tax law changes will boost rates in the future. Locking in the current low-tax rate structure could be a huge boon, allowing you to let as much after-tax money as possible compound for decades and grow into a huge pot of retirement savings.


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Easier access to your money

Ideally, once you contribute to an IRA, you should leave the money alone until you retire. But if financial problems come up, Roth IRAs give you far greater access to your savings than traditional IRAs.

With a traditional IRA, nearly any withdrawal you make before age 59 1/2 is subject to a 10% penalty on top of the tax liability from the withdrawal. There are some exceptions for certain types of expenses, but they're fairly limited in scope.

By contrast, with a Roth IRA, you're always allowed to withdraw the amount of your original contributions without tax or penalty. So if you contribute $6,000 to a Roth IRA each year for two years and it grows to $15,000, you can take out as much as $12,000 without any tax consequences. Only if you have to tap into the $3,000 in income that the Roth produced will you start to see potential penalties and tax impacts.

Be smart with your savings

Most young adults aren't in a position to focus on their long-term financial futures. But using a Roth IRA can be the best of both worlds, because it offers the chance at tax-free growth for decades while still letting you tap into your savings on an emergency basis if you have no other choice. That kind of flexibility is exactly what today's young workers need in their financial lives.