Young adults are commonly known to not have wealth compared to their older counterparts. Young adults having a low net-worth usually stems from the individual being young and not having enough time so far in their life to build wealth. Depending on a person’s situation, they may start to work full time after high school or after college. Regardless, it is essential for every young adult to have a plan on how they will begin to accumulate wealth. One common way to accumulate wealth for the long term is by investing in tax-deferred accounts (investment accounts that can adjust when the money is taxed). One of the most common types of tax-deferred accounts for young adults are Individual Retirement Accounts (IRAs).
What is an IRA?
Individual Retirement Accounts, to reiterate, are investment accounts that allow a person to save and grow their money because of the account’s advantages with taxes. Common investments that are in these types of accounts are stocks, bonds, and mutual funds.There are a variety of different IRAs an individual can use to build wealth. The two most common IRAs are a Traditional IRA and a Roth IRA.
How do I fund it?
A person that has either of these IRA accounts can contribute up to $6,000 of taxable income per year. The key difference between a Traditional and Roth IRA is when a person’s money is taxed. In a Traditional IRA, you are able to contribute money into the account and then deduct that contribution from your taxable income for the year. The amount you’re able to deduct depends on your yearly income. Higher income decreases the amount a person can deduct from their taxable income. Once you withdraw funds from the account though, the money is taxed at your current income tax rate. A Roth IRA is taxed in the opposite way. When a person uses a Roth IRA, they are able to deposit money that has been received after taxes and then withdraw money later in life tax-free. After you decide what type of IRA fits your situation, you can then choose where you would like to open the account. You can choose brokerage firms (like Charles Schwab or TD Ameritrade) or a robo-advisor (like Betterment or Marcus Invest) as a location for your IRA account(s).
When can I take money out?
Although IRA accounts have tax advantages, there are rules on when you can withdraw money. If these rules are broken, the individual can be penalized financially. For a Traditional IRA, withdrawals taken before age 59½ will receive a 10% penalty. There are certain qualified distributions that avoid this penalty like a first time home purchase, qualified higher education expenses, birth or adoption of a child, medical expenses and health insurance premiums, and death or disability purposes. Roth IRA’s have different withdrawal rules mainly because the money deposited are after-tax dollars. The contributions (money deposited) can be withdrawn from a Roth IRA without penalty and income tax liability. The earnings however, are subject to income tax and penalties if withdrawn before age 59 ½ and the account is less than five years old. Like the Traditional IRA, the Roth IRA also has qualified distributions that avoid penalty like a first time home purchase, death or disability, or qualified education expenses.
IRAs are a just one method for building wealth. While in most cases the majority of the wealth belongs to older generations, we have one advantage over them which is our youth (time). Investing wisely now, improves the likelihood of financial stability later in life. Overall, IRAs are a great option for building wealth because of their tax advantages and rules forcing participants to invest for the long term.
Disclaimer: Thegrownwave.com is a personal finance blog, not a professional investment advisor. The content produced from the blog is provided for free and only for informational purposes. Thegrownwave.com does not and cannot promise the accuracy and reliability of any content in comparison to your individual circumstances.
Sources
Folger, J. (2021, May 24). Roth IRA Withdrawal Rules. Investopedia. https://www.investopedia.com/roth-ira-withdrawal-rules-4769951.
Kagan, J. (2021, May 25). What’s an Individual Retirement Account (IRA)? Investopedia. https://www.investopedia.com/terms/i/ira.asp.
O’Shea, A. (2021, May 3). Traditional IRA Withdrawal Rules. NerdWallet. https://www.nerdwallet.com/article/investing/ira-distribution-rules.
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