Chances are that as a Millennial you have a lower income than you will have as you progress in your career. The great thing about a lower income now is that you will pay less in taxes. Contributions made to a Roth IRA are done so on an after tax basis, meaning it will not lower your income for the year. Also at certain income levels you could be phased out from contributing to a Roth or have to make partial contributions. For most individuals the long term tax saving potential exceeds the cost of not receiving a reduction in income.
Tax Free Contributions
Individuals under 59 ½ can make full contributions up to $5,500 for 2014 to a Roth if their adjusted gross income is below $114,000, the amount for couples would be $181,000. Contributions to Roth IRA’s are always tax free. If you happen to invest the funds, and make a profit you will be taxed on the earnings if you take a distribution and certain conditions are not met. For example, let’s assume you contribute the full $5,500 to the account and the value grows to $7,000. The $5,500 can be taken out of the account tax free; the remaining $1,500 may be subject to taxes and a 10% early withdrawal penalty. In a sense taking a distribution from what you have contributed is like getting a tax free loan.
Potential Tax Free Distributions
At some point the entire value of the account may be tax free. Withdrawals of earnings taken from a Roth IRA after the five-year aging period has been met are tax and penalty free if one of the following conditions is met: 59 ½, disability, death, or qualified first time home purchase.
Compounding of Money
The younger you begin to save the more time your investments have to grow and benefit from compounding. Another benefit to Roth IRAs is that they do not require original account owners to begin taking a minimum required distribution (MRD) at age 70 ½, meaning your money has even more time to grow if not needed. Below is a graph which shows the effects of compounding at different returns.