Why save in a Roth IRA in your 20s and 30s

A Roth IRA lets you balance long-term savings with your short-term needs.

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Key takeaways

  • Roth IRAs offer flexibility. You can withdraw your original contributions anytime with no penalty or taxes due.
  • Withdrawing earnings before age 59½ could result in taxes and a 10% penalty, but there are some exceptions.
  • Ideally your money will stay invested in the account—potentially growing for decades. Then all of the earnings in the account can be withdrawn tax-free in retirement.1
  • Your income determines your ability to contribute to a Roth. In tax-year 2019, the income cutoff (based on MAGI) is $137,000 for single filers and $203,000 for married filing jointly. In tax-year 2020, the cutoff is $139,000 for single filers and $206,000 for joint filers.2

Retirement is far away—you may wonder if it really makes sense to lock your money up in a special retirement account when you're young. While it is true that retirement accounts come with some rules, the Roth IRA has some unique benefits that could help you save for the future—and access the money you put into the account when you really need to.

Roth IRAs offer flexibility

When you deposit money, or contribute, to a Roth IRA, the money goes in after income taxes have been paid on the amount. You're allowed to pull that money out of the account at any time—with no taxes and no penalties.

However, if you were to withdraw any earnings (growth and appreciation on investments) on your contributions before age 59½, you would probably have to pay income tax on the withdrawal and a 10% penalty. After age 59½ your withdrawals would be known as qualified distributions as long as another rule is satisfied: the 5-year aging rule, which applies to all withdrawals of earnings, even if you're over 59½. The 5-year aging rule requires you to wait 5 years after your first Roth IRA contribution before you can withdraw earnings tax-free in retirement or qualify for an exception to the 10% penalty.

Given this, it could make sense to contribute to a Roth early in life to give you more flexibility if you decide to tap into your earnings before retirement age. While you may not plan to do so, getting the 5-year rule out of the way could give you more options down the road—like if you decide you want to use a portion of your IRA for a big expense like a down payment on a home or paying for part of an education.

Penalty-free withdrawals to buy a first home or pay for education

Nearly everyone has to pay for these big-ticket items at some point: a home and an education (your own or someone else's). With a Roth IRA you may be able to withdraw both contributions and earnings at any age with no penalty if the money is used for one, or both, of those expenses.

First-time home buyers, or home buyers who haven't owned a home for at least 2 years, may be able to withdraw up to $10,000 of earnings from a Roth IRA with no penalty. If you've satisfied the 5-year rule, earnings can be withdrawn without paying taxes or the penalty. If it hasn't been 5 years since your first Roth contribution, you would owe taxes on the earnings withdrawn, but not the 10% penalty.

You can also use Roth IRA money to pay for qualified educational expenses, like paying for college or graduate school for yourself, your spouse, or your children. In this case, you can withdraw earnings penalty-free (but not tax-free) as long as the 5-year rule has been satisfied.

If you do choose to take money out of your Roth IRA before retirement, do what you can to replenish your account with future contributions.

Withdrawals are tax-free in retirement

After age 59½, no taxes will be due when you take money out of the account—contributions or earnings. (Again, as long as the 5-year rule has been satisfied.) That's a potentially powerful benefit for a couple of reasons:

  1. If you invest for growth, your money has a chance to earn a return and your investments could appreciate in value. Depending on how you invest and the performance of the stock market, it could add up to a substantial amount. Remember: As long as you follow the rules, earnings are tax-free.
  2. Potentially paying income tax at the lower rate you owe today in your 20s or 30s could help you save on taxes in the long run. Ideally, it would work like this: Taxes are paid now and money put into a Roth IRA. Over the years, if all goes well, your salary will go up and the amount of taxes you pay will go up as well. Once you're in your 60s, you may be in a higher tax bracket than you were in your 20s. With a Roth IRA, you get tax-free income in your golden years when you have the time to do everything you want.

And, who knows? You could be so successful that you don't even need to touch your Roth IRA savings. In that case, with a Roth IRA, you're in luck—you don't need to take required minimum distributions, as you do with a traditional IRA or 401(k). You can withdraw and use the money when you're ready, or you could choose to leave money to your heirs income tax-free.

Take advantage of a Roth early

The ability to contribute to a Roth phases out at higher incomes. In 2019, for single taxpayers, the phaseout starts at $122,000 in modified adjusted gross income (or MAGI). If your MAGI is over $137,000 you won't be able to put money into a Roth. For taxpayers who file as married in 2019, the limits are between $193,000 and $203,000.2 In 2020, the cutoff is $139,000 for single filers and $206,000 for joint filers.

So, the time to take advantage of a Roth IRA is while you're young: Your income is lower than it may be later in your career, and your savings have plenty of time to grow.

Even if you can only save a little bit, small amounts can really add up over time. In fact, time is nearly as important to long-term saving success as the amount you're able to save. If you begin saving and investing early in your career, the total amount you need to save throughout your life will be much less than it would be if you had started later.

When you add in the potential tax-free growth and compounding the Roth IRA offers, your regular savings have the potential to snowball into a significant amount of money—and that can help give you the freedom to live your life the way you want in the future. Time is on your side. Make the most of it by saving for the future while you're young.

Next steps to consider

Take advantage of tax-free growth potential.

Choose between paying taxes now or in retirement.

Consider these saving opportunities that offer tax breaks.

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