With this indispensable savings tool, your money grows tax-free, you can invest in almost anything and you get several cool perks.
Why You Need a Roth IRA-From Kiplinger
One of the smartest money moves a young person can make is to invest in a Roth IRA -- and setting one up is easy.
Follow the rules and any money you put into one of these retirement-savings accounts grows absolutely tax free: You won't owe Uncle Sam a dime as you let your savings accumulate, or when you cash out in retirement. Plus, an IRA is more flexible than a 401(k) and other retirement plans because you can invest it in almost whatever you want, from stocks and mutual funds to bonds and real estate.
If you haven't yet opened this gift from Uncle Sam, do it now. You have until your tax return deadline to set up and make contributions for the previous tax year. The government sets a limit on how much you can contribute to a Roth. That limit was $5,000 for 2011 and also for 2012. That means if you act before April 17, you can invest $5,000 now to count for last year, giving you a solid start to your savings. And you have until next year's tax deadline to kick in your $5,000 for 2012.
Don't let the 2007-09 stock market meltdown scare you. Stocks historically do well over the long run, so a good place to start is with a well diversified mutual fund. But if you really don't like risk, the Roth lets you save in less-volatile investments, too, such as bonds or money-market accounts. The key is to find your comfort level and get started soon.
The tax advantage
The idea of saving on your taxes may seem a tad obscure, but it really can pay off big. If a 25-year-old contributes $5,000 each year until she retires and makes an average annual return of 8% on her investment, she'll have $1.4 million saved by the time she retires at age 65. And the money is all hers -- she won't have to give the IRS a cent of it if she waits until retirement to withdraw the money.
If that same 25-year-old invested that same $5,000 a year in a taxable account earning the same 8% return, she'd only have about $1 million after 40 years if her earnings were taxed at 15% federal. That's more than one-fourth less money than if she'd gone with the Roth. If she owed state taxes on the money, too, she'd be down even more.
Roth rules
As with any government gift, the Roth IRA comes with a few strings attached. First, you can contribute to a Roth only if you have earned income from a job. Say you're in school, you're not working and you have a little extra money left over from your student loan or your parents gave you money. You cannot put it in a Roth. Also, you cannot save more than you made. So if you worked a summer job and made only $3,000, the most you could contribute to a Roth would be $3,000.
It's also possible to make too much. You can contribute the full $5,000 in 2012 as long as your income falls below $110,000 if you're single, and $173,000 if you're married filing a joint tax return. The contribution limit is then phased out incrementally if you make between $110,000 and $125,000 (single) or $173,000 and $183,000 (married-joint). (See IRS Publication 590 for more on calculating your contribution.) Make more than those upper limits, and you don't have to cash out the account -- you simply cannot contribute any more money to a Roth IRA.
If you expect to exceed the Roth income limits at some point during your career, you should open a Roth now while you're young and your salary is low enough to qualify. If a 25-year-old saved $5,000 a year for only five years, then didn't contribute another dime for the next 35 years because his income was too high, that money would continue to grow -- to nearly $481,000 by the time he turned 65. That alone certainly won't be enough to retire on, but it'll be a nice tax-free bonus to his other retirement savings.
Bonus!
If the savings power, flexibility and tax-free status aren't enough to persuade you of the Roth's virtues, Uncle Sam throws in a few extra perks, making the Roth an indispensable tool in a young adult's financial life.
You can take money out in a pinch.
Although the purpose of a Roth is to save for retirement, and your money can grow only if you leave it in the account, you can withdraw your contributions at any time, tax free and without penalty -- and you don't have to pay it back, like you do with a 401(k). Of course, it's best to leave your money in the account so you can earn more money, and you really should have a separate emergency savings account on standby, but it's nice to know the Roth is there for you if you need it.
Notice we said you can take out your contributions at any time -- not your earnings. If you withdraw any of your earnings before age 59½, you'll trigger a tax bill on the money, plus you'll have to pay a 10% penalty. Ouch.
You can tap your Roth to buy your first home.
The IRS lets you withdraw 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. That means if you make a contribution now and count it toward 2012, you could use tax-free money from your IRA to buy a house starting in January 2017. 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 your earnings for your home purchase, but you'll have to pay taxes on the amount you withdraw. 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. 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.
[More from Kiplinger.com: Calculate: Will Your Retirement Savings Meet Your Needs?]
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 starting to invest, 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. 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 $100 a month if you sign up with its automatic investing program.
Use our Fund Finder to search for funds that have 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%).
[More from Kiplinger.com: Start Investing in a 401(k)]
Many fund companies will let you open an account and make contributions online. Make sure you designate what year the contributions are for.
Not sure where to find the money to fund your account? Consider investing your tax refund. For the 2011 tax-filing season, the average check totaled nearly $3,000. 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.
2) In the Markets today:
The 83-point advance was driven by signs that U.S. employment gains and global manufacturing are sustaining their recent strength.
Dow Snaps 4-Day Losing Streak-From The Wall Street Journal
Stocks snapped a four-day losing streak, pushing higher on solid manufacturing reports around the globe.
The Dow Jones Industrial Average climbed 83.55 points, or 0.7%, to 12716.46, one day after closing out a January that was its best opening month since 1997. Earlier in the session, the Dow surged 152 points, bringing it within 26 points of a multiyear high.
But those gains evaporated in late trading, extending the Dow's string of days without a triple-digit move in either direction. The blue-chip index hasn't seen such a move since Jan. 3.
The Standard & Poor's 500-stock index rose 11.68 points, or 0.9%, to 1324.09, and the Nasdaq Composite advanced 34.43 points, or 1.2%, to 2848.27.
All 10 S&P 500 sectors traded in positive territory, with the gains led by financial and industrial stocks. Bank of America rose 3.2% to top the Dow components. United Technologies gained 2.4% and Caterpillar, which has seen its 22% surge this year account for one-third of the Dow's gains in 2012, added 1.3%. Technology stocks were also vibrant, as Hewlett-Packard rose 2.8%.
The gains were driven by signs that U.S. employment gains and global manufacturing are sustaining their recent strength. The U.S. added 170,000 new private-sector jobs in January, in line with economists' expectations, though the previous month's total was revised lower. The reading is seen as a preview to the government employment report due Friday.
Separately, a reading on U.S. manufacturing came in at 54.1 for January, a touch below expectations but better than December's revised reading of 53.1. Construction spending, however, jumped 1.5% in December, better than expectations for a 0.5% rise.
In Europe, the Stoxx Europe 600 finished with a climb of 2%, and Germany's DAX index gained 2.4% after purchasing managers indexes rose in the euro zone, Germany and the U.K. Both of those stock indexes closed at their highest level since last August.
"Investors who were incorrectly bearish on equities are now coming in and recognizing that stocks may have some value here," said Michael Strauss, chief economist and chief investment strategist at Commonfund in Wilton, Conn.
Even so, skepticism remains high. In a report to clients Wednesday, Bank of America Merrill Lynch noted that Wall Street sentiment toward stocks had fallen to a two-and-a-half-year low. According to the report, Wall Street strategists are steering investors away from stocks at a level rarely seen in the past 15 years.
Gold futures edged up $9.30, or 0.5%, to $1,747.10 a troy ounce, an 11-week high, while crude-oil prices fell 0.9%, to $97.61 a barrel, a six-week low. The dollar fell against the euro and yen. Demand for Treasurys fell, sending the yield on the 10-year note to 1.846%, from 1.799% late Tuesday.
In corporate news, Amazon.com slumped 7.7% to lead the S&P 500 decliners after the online retailer reported better-than-expected fourth-quarter earnings but fell short on revenue. In addition, the company indicated that it could post an operating loss for this quarter and provided a revenue outlook that was below analyst forecasts.
The European Commission blocked the merger between NYSE Euronext and Deutsche Börse, citing concerns that a combination would create a "quasimonopoly" in derivatives trading. The decision had been expected. NYSE's stock slipped 0.5%, while rival Nasdaq OMX Group gained less than 0.1% after fourth-quarter earnings and revenue topped forecasts.
Whirlpool surged 13% to lead the S&P 500 gainers after the appliance maker cut costs and saw improved sales activity in North America, which helped offset softer sales globally. Whirlpool also issued a higher earnings forecast than expected.
Broadcom jumped 8.1% after the semiconductor maker reported fourth-quarter results that exceeded estimates and announced an 11% increase in its quarterly dividend to 10 cents a share.
AOL soared 9.6% after fourth-quarter earnings and revenue beat estimates.
Hershey gained 0.4% after the candy maker matched fourth-quarter earnings estimates and raised its quarterly dividend 10%, to 38 cents a share.
Aflac edged up 0.1% after the insurance provider reported fourth-quarter earnings that fell short of expectations, even as revenue beat estimates, and provided a downbeat outlook for 2012 earnings.
Seagate Technology rallied 21% after the disk-drive maker's fiscal second-quarter earnings came in well above forecasts.
Medivation ran up 22% after the company and its partner announced positive results from a Phase III trial of an investigational drug for the treatment of prostate cancer.
3) Top financial story of the day:
The private sector added 170,000 jobs in January, in line with expectations, as small-business hiring fueled the increase.
January private-sector jobs rise 170,000: ADP-From MarketWatch
Employment in the nation’s private sector is improving at a moderate pace, with two years of job gains now on the books, according to a monthly labor-market report released Wednesday by payrolls-processor Automatic Data Processing Inc.
Nonfarm private employment rose 170,000 in January, marking the 24th consecutive month of gains, led by small businesses and the service-providing sector, according to ADP. In December, private employment rose 292,000, compared with a prior estimate of 325,000.
“Other indicators suggest some firming of labor-market conditions as well, including the downward trend in unemployment claims, upturns in the components of consumer sentiment and confidence influenced by perceptions about the availability of jobs, and a rising trend in workers voluntary quitting their jobs,” said Joel Prakken, chairman of Macroeconomic Advisers, which produces the ADP report.
Indeed, ADP’s report echoes other recent positive employment data. For starters, initial jobless claims are down about 10% from the pace of filings in the prior year.
In addition, while there was a dip in January for an overall gauge of consumer confidence, the data also showed that consumers’ outlook for jobs ticked higher. Also, the proportion of workers leaving their jobs by quitting is up from last year, according to Labor Department data.
On Wall Street, stocks started out broadly higher on the heels of the ADP data, with the Dow Jones Industrial Average /quotes/zigman/627449 DJIA +0.98% adding about 100 points. Read more in Market Snapshot.
Details
By firm size, nonfarm private employment in January rose 95,000 at small businesses, 72,000 at medium businesses, and 3,000 at large businesses, according to ADP. By sector, service-provider employment rose 152,000, while goods producers added 18,000 jobs.Wall Street economists had expected an overall private-employment gain of about 182,000. See economic calendar.
Markets look to ADP’s private-sector figures to provide some guidance on the U.S. Labor Department’s figures, which include private and public payrolls. However, ADP is known for diverging from the government’s data, which indicated that private-sector employment rose but only by 212,000 in December.
The Labor Department’s jobs estimate will be released Friday. Economists polled by MarketWatch expect nonfarm employment to have risen by 125,000 in January, compared with payrolls growth of 200,000 in December. Economists expect the U.S. unemployment rate to remain at 8.5%.
4) Quote of the Day from Dave Ramsey.com:
The value of sacrifice is to advance a cause greater than ourselves. If we are unclear of the cause we are to advance, our sacrifice will become suffering. — Simon Sinek
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