401(k) plans? Nice, but don't forget the IRA.
401(k) plans are a great way to save for retirement. But adding IRAs to 401(k) plans gives savers additional flexibility.
Give anyone age 40 and older a time machine and they would likely go back to their early 20s _ to open an IRA.
That's because by 40, many of us have learned the miracle of compound earnings over time. We kick ourselves for not socking away even tiny sums in a tax-sheltered individual retirement account when we were younger.
Consider the math: A 22-year-old who invests $100 a month in an IRA for 10 years and then stops will end up with more money at age 65 then a 32-year-old who saves $100 a month in an IRA for 33 years. Baltimore's T. Rowe Price says the first investor, assuming a 7 percent annual return, would accumulate $174,217; the other winds up with $155,307.
That's why Price's recent survey of young investors is disappointing.
The investment firm polled 860 adults age 21 to 50 who have at least one investment account, so these are folks already engaged in investing. According to Price, just 45 percent of these Gen X and Gen Y investors say they would contribute to an IRA for the 2011 tax year, down from 71 percent who invested in an IRA the year before.
And if these investors had a spare $5,000 _ the maximum amount those under 50 can contribute yearly to an IRA _ only 16 percent say they would put the money into the account. More than half would pay off debt or put it in a rainy day fund.
Not bad choices, but again, young investors need to take advantage of their most valuable asset _ time. And that's where an IRA can help.
You can open an IRA with an investment firm, and you'll have a greater choice of investments than the typical 401(k). This money is meant for your retirement, so you'll generally have to pay a penalty if you cash out early, similar to the 401(k).
There are two kinds of IRAs.
Depending on your income, your contributions to a traditional IRA could be tax-deductible. And when you pull money out in retirement, it will be taxed as regular income.
With a Roth _ available to those within certain income limits _ you don't get an upfront deduction. But withdrawals, which include all the money you earned over the years, won't be taxed in retirement.
A Roth is the preferred IRA for younger investors, who are likely to be in a higher tax bracket when theyretire. The Roth is considered so beneficial for young investors that many financial bloggers last month participated in the Roth IRA Movement, a day in which they wrote about the account to raise its profile.
Young investors gave T. Rowe Price a variety of reasons for not contributing to an IRA. Most frequently said they thought their 401(k) was good enough for now, which it could be if they are saving the recommended 15 percent of pay each year.
About one-third said they don't think they could afford it.
"There will always be more demand for your money than there is money," said Stuart Ritter, a T. Rowe Price senior financial planner. He adds that young investors need to make retirement a priority despite competing goals.
Many young investors have also lost faith in the stock market because of subpar returns in the past decade, Ritter said. And the timing of the poll might also have dampened investors' enthusiasm.
The poll was taken in December, a highly volatile month for the stock market. The total return _ including dividends _ of the S&P 500 index last year was 2 percent, but many investors came away thinking the market lost ground, Ritter said.
Price found that only one in five of those surveyed had any confidence in the markets this year. And among young IRA investors, many planned to put their money in staid investments such as money market funds that won't provide the growth they need over time.
Of course, there is no time machine that will allow today's twentysomethings a do-over in the future. If you have extra dollars after participating in a 401(k) or you don't have a retirement plan at work, contribute to an IRA. You have until the tax deadline _ April 17 this year _ to make a contribution for the 2011 tax year.
I'm not the only one nagging young investors to stash money in an IRA.
Jeff Rose is a 34-year-old financial planner in Illinois and the creator of the Roth IRA Movement. Rose says he came up with the idea after speaking to 50 or so college seniors at his alma mater last month. He asked how many had ever heard of a Roth.
"Not a single one of them raised their hand," Rose says.
He says that depressed him, figuring that by the time they learned about a Roth they could be well into their 30s and have lost valuable investing years.
Rose, who blogs on personal finance, reached out to fellow bloggers to suggest they raise awareness by writing about the benefits of the Roth on the same day, March 27. More than 140 bloggers and media outlets did so last week, Rose said, and he hopes to make this an annual event.
Young investors should try to make investing in an IRA an annual event, too.