At that age, I wouldn’t worry so much about putting more money into retirement savings, instead just concentrate on saving. Those in their 20-30s are not at their peak earnings age (that is 45-54 - just googled it). So, it is not as important to invest in tax free investments (treasuries, IRA accounts, etc.) Also, they will have so many things they may need this money for in the next 30 years - a home, emergency needs (getting laid off, car breaking down, etc.), children, vacations, education, etc. This is why I suggest, getting a healthy interest from a CD on it for the next year and then you reevaluate at the end of that year (do I need it now for a home, education, etc.) I like the idea of reevaluating your savings and spending each year. Great habit for a young person to develop.
With compounding interest…money put into retirement accounts at an early age…maybe not the max, but something, will make a difference in the end. Our kids contribute as much as they can to retirement and we support this! But they have other savings as well.
We always only put into retirement accounts (company 401Ks) what the company would match or when we got older that plus the catch-up. However, we also saved a lot of money, which we invested in lots of other places - munis (to ease our tax burden), CDs , mutual funds, etc. These investments also got compounded interest, as they sat there unspent for many years. We are now retired and have about half our savings in retirement accounts and half not. We are living off the non-retirement savings right now (so that we don’t have to pay taxes yet on their earnings). It was always nice to know throughout the years that we had easy access (without any withdrawal penalties) to quite a bit of our savings.
I have to respectfully disagree. Once they have a sufficient safety net (in a savings or money market account), investing is a far better option for someone in their 20s.
The stock market returns over a 40 year period are absolutely unbeatable.
I did not say not to invest in the stock market as a long term investment. Since as you say it performs great over time. I am saying not to tie it up in designated retirement type accounts (IRA, 401(K), Roths), that you cannot withdraw from (without penalty) until you are old.
I would advise putting the $10K in VOO. People in their 20s can afford to take on more risks.
You can withdraw your contributions from a Roth IRA at any time without penalty. So it’s a great option for young adults as long as they qualify to contribute to a Roth. If they need the money they can take it out. And if they leave it there until retirement, they can withdraw it all tax free. A win-win.
(Note: they can also withdraw the growth after 5 years for certain expenses like a home down payment).
I also recommend young adults to at least contribute enough to their 401k to get their employer match. That’s free money that’s there for the taking.
There are legal strategies to get money for retirement out of qualified accounts early. Even if it’s not used for retirement, the tax savings at the outset and on the earnings usually offset the penalty. Much has been written about this. Certainly there are advantages to after tax accounts, but not for large amounts held over many years.
If you have it in mind for him to use if as safety net funds or long term (retirement savings, house etc), do let him know. In other words, once you gift the money the decisions are his. Extreme example: he may (or may not) want to splurge on a vacation grander than you’d take yourself.
One idea I like is to put it into short term CD or investment… have available for a future big purchase (car, house). That way he could have a smaller loan.
And the return is further enhanced because there will be no capital gains tax, which can be a hefty sum after 40 years of growth. A regular investment will be subject to capital gains.
Of course, there should be adequate liquid savings to cover “emergencies”, but after that, unless one is saving for a specific large investment, like a house, the waterfall should be tax advantaged retirement account then regular diversified investment.
Yes. That’s why I said it was a win-win.
This assumes that investor B has no other taxable income other than his Roth conversion.
“Since Investor B converts less than his standard deductions and exemptions each year, he avoids paying taxes on the conversion and ends up having exactly the same amount of money in his Roth IRA as Investor A does when they reach standard retirement age.”
I struggle to envision that scenario, but as always, my struggle is probably biased by my own experiences. I suppose a person could save nothing other than his 401K & IRA monies, or have really tax-savvy investments in his post-tax account, but he will need some money to pay the taxes on the Roth conversion at FIRE age. And it will depend on how many years of FIRE runway the investor has to process conversions.
I continue to advise my son to contribute as much as he can to the company 401K Roth (and nothing to the 401K) and to complete a backdoor Roth for the Roth IRA. Absolutely impossible to predict where tax rates will be in 50 years, let alone next year, but I am comfortable with this approach until the next marginal bracket.
This is a helpful reference on prioritizing investments that you could share with your son:
That’s only one scenario out of several in both of those articles. The linked Bogleheads article is good too.
Time invested is critical for retirement savings. If a person in their 20’s invests $10k in a Roth and gets 10% before inflation and 7% return after inflation, then the $10k would be worth $450,000 in 40 years at retirement or $150,000 after inflation – a 1400% gain of $140,000 after inflation and taxes. 98% of the retirement balance is from compounding, and only 2% is from the initial $10k investment. Compounding gains would be much smaller for persons who instead invested in retirement later, in their 30s or 40s, with decade(s) of missed compounding.
In contrast, with 3.3% inflation and 25% marginal tax bracket, $10k invested in a 1-year 5% CD would be worth $10,043 after taxes and inflation – only a 0.4% gain of $43, after inflation and taxes.
If you have short-term expenses coming up or you are saving for a home, then it may make sense to prioritize short-term savings over long term retirement, but I certainly wouldn’t recommend that young persons generally avoid retirement savings, or it doesn’t matter whether you put money in a CD or tax-advantaged retirement account, so long as you are saving.
Also note that there are ways to withdraw from retirement savings prior to retirement age. For Roth, you can withdraw contributions (not investment gains) at any age without penalty.
How is that a fair comparison - you are comparing a one year gain vs a 40 year gain.- $10K invested in 10% over 40 years gives you the same result (whether it is in a Roth or not)
If you can find a 10% return then go for it - but why make it a Roth.
I can’t understand the obsession over Roths on this forum. Our income was always to high to do Roths and so is my 30 yo daughters.
The thing that young people need to learn and know is to save instead of spend. If they do that, they will have plenty for retirement!
The backdoor Roth is a good way to contribute if your income is too high for a deductible traditional IRA.
I would definitely suggest that to your daughter.
My S has had income too high for a Roth since he graduated (I know, it’s a good problem to have). Just how does a “Backdoor Roth” work in that case?
I am comparing short-term savings in a 1-year CD vs long-term savings in retirement account. A 1-year CD is inherently a short-term investment. Retirement accounts are inherently long term investments. However, the CD only had a 0.4% gain after taxes and inflation in this example, so there is going to be a large difference in return, regardless of investment period. If you repeat the same 0.4% gain over 40 years,then $1,800 gain over 40 years with repeated investment in CDs vs $140,000 gain with market investment in Roth – 80x larger.
It does not give the same return after taxes. In the earlier example, 98% of account value after 40 years was from from investment compounding gains, rather than the initial deposit. Those investment gains composing 98% of account value are not taxed with a Roth. However, they are taxed with a standard brokerage investment.
If you can find a 10% return then go for it - but why make it a Roth.
I can’t understand the obsession over Roths on this forum. Our income was always to high to do Roths and so is my 30 yo daughters.
You can’t find a 10% return on a short-term fixed income investment, like a CD, which was one of the main points. I used Roth because the title of this thread mentions Roth, and the OP mentions investing a Roth. I don’t know whether Roth or traditional is better for the OP’s kid, but I do know that he is currently investing in a Roth. That said, Roth backdoor does not have a max income limit.
The thing that young people need to learn and know is to save instead of spend. If they do that, they will have plenty for retirement!
As noted it makes a difference both in what investment vehicle you choose, and how long you maintain the savings. Saving x% in a CD is not the same as saving x% in your tax-advantaged retirement account. If a young person keeps all their savings in a traditional bank account, they are likely to have a net loss after taxes and inflation, and are unlikely to “have plenty for retirement.”