Investments That Do Double-Duty For Retirement, College Expenses

Featured in this Show

• Start Investing In A Roth IRA When Young, Says Financial Expert

  Download

  Thanks to day-to-day expenses, entry-level wages and student loans, the first few years of living as an independent adult can be financially challenging. But according to Frank Armstrong — a certified financial planner and the founder and president of Investor Solutions, Inc. — it’s nevertheless a smart idea to begin investing in a Roth IRA early to save for future needs.

  A Roth IRA is different from a traditional IRA retirement plan in that there are no tax advantages that come from depositing into an account. However, when an individual withdraws money decades later, there is no tax to pay.

  With traditional IRAs, the opposite is true: Deposits are tax-free up front, but taxes are paid upon withdrawal.

  Armstrong said that the reason investing in a Roth IRA is a good idea for young people — assuming their income increases over time — is that they’ll likely be in a lower tax bracket when they pay the tax on the deposit amount.

  Here’s an example that Armstrong offered to illustrate the benefits of investing in a Roth IRA:

  Say that when a child is born, a parent contributes $5,500 to a Roth IRA each year — the most a working adult can contribute annually, albeit with some limitations. After 18 years, the principal alone will have grown to $99,000. Assuming an 8 percent annual return, the principal and interest would equal $205,000.

  “So if they were to withdraw their $99,000 contribution, it would be totally tax-free. And that goes a long way towards paying for college,” Armstrong said.

  Even if the full $99,000 in principal was withdrawn to pay for college expenses, that would leave $106,000 in interest to continue growing. Armstrong said that if the parent began contributing at 25, they would be 43 when the money was needed for college. Even with no further contributions, that $106,000 would have a couple of decades to grow before it would be needed for retirement.

  “If you just left that $106,000 alone, it would grow to $581,000 at age 65. And if you waited until you were 70, and you got the same 8 percent net, it would grow to $854,000,” Armstrong said.

  Sometimes, children decide not to go to college, or they are able to pay their way with scholarships. Tax-free withdrawals of contributions to a Roth IRA are not limited to education and can be used for other large expenditures, like a vehicle purchase, medical expenses or making a down payment on a home.

  Whether it is the entire amount of principal and interest, or just the remainder after a deduction, compound growth in a Roth IRA over a couple of decades can add up significantly.

  “For most of us, those are not trivial amounts, and it would generate a substantial amount of tax-free income for the rest of your life,” Armstrong said.