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| Decision Center | Why you need a Roth IRA -- now!
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- You can tap your Roth to buy your first home. The IRS lets you cash out up to $10,000 from your Roth IRA tax- and penalty-free -- which can include earnings -- to help you achieve the American dream. However, the account must have been opened for five years. So, if you open an account before April 17 this year, that can count for 2005. You could use tax-free money from your IRA to buy a house starting in January 2010. Wait until after the tax-day deadline, though, and it'll count for 2006 -- you'd have to wait until 2011 to buy a home. That $10,000 limit is per person, so couples could withdraw up to $20,000.
If you don't meet the five-year test, you still can take out the money for your home purchase, but you'll have to pay taxes on it. 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 loans to pay for college, but none to help fund your retirement. 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 (see College plans for the rich, poor and in-between). 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, you'll owe taxes -- 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.
How to open a Roth IRA
When you're just getting started investing, 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 (Heres a comparison of brokers). 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 -- or as little as $50 a month if you sign up with its automatic investing program.
Use Fund Finder to search for funds with 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 1.5%). And check out How to invest with $500 or less for some specific low-cost fund recommendations, and for more information on diversifying and evaluating your investment options.
Many fund companies will let you open an account and make contributions online. Make sure you designate whether your contributions are for 2005 or 2006.
Not sure where to find the money to fund your account? Consider investing your tax refund. About 70% of us will get a refund this year, and last year the average check totaled more than $2,000. 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.
by Erin Burt, Kiplingers Personal Finance
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MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.
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