22 year old needs some financial advice

Hi everyone, I'm brand new to this forum! :)

So, I'm 22 years old and I graduated in May '07. I currently work for a boutique management consulting firm that doesn't have a 401k because the company is about 3 employees :( I've been with the company since July/August '07.

I was thinking about investing in a Roth IRA...but I wasn't 100% sure if that is the best investment vehicle for me right now. Do you guys have any advice on what I should do?

Thanks in advance.

thinking about investing in a Roth IRA...but I wasn't 100% sure if that is the best investment vehicle for me right now.
A Roth IRA is an incredible investment vehicle, but just to gain some insight into your situation, why do you feel that a Roth IRA may not be best for you right now?

Well since I'm young I can take a bit more risk, so maybe some type of mutual fund?

Would it be smart to contribute to a roth 401k?

Now you will see why I asked.

A Roth IRA can be mutual funds. The title "Roth IRA" simply refers to the tax treatment of your investment, but it is not the investment itself. You can open a Roth IRA and purchase mutual funds within it.

For example, you want to buy XYZ mutual fund and be aggressive because you are young. You buy the mutual fund(s) of your choice, and title the "account type" as a Roth IRA registered in your name.

Within a Roth IRA you choose your investment vehicle, and so at any age such an account can be appropriate. You can choose a more aggressive investment at this age, taking advantage of the time diversification that you're allowed (given your age), and then change the allocation later in life when your time horizon is different.

RE: a Roth 401(k) - if your company doesn't offer a standard 401(k), it's highly unlikely that they offer you a Roth 401(k) either... it's worth checking into, because if you have it available, the Roth 401(k) would be even better than the Roth IRA.

Kudos to you for having the propensity to begin saving at your early age... you won't regret it!

Thanks for the advice! My company doesn't have a Roth 401k either. But the income-eligibility limits on annual contributions to a Roth IRA for individuals is $116,000 I believe. I should be making around that amount within the next year or two, what would happen at that point?

1) talk the company into a 401(k) plan - they can do it pretty cost-effectively, and if their employees are making sizeable incomes (as you indicate) it can be a helpful tool to increase retention
2) for tax deferral, you could do a non-deductible IRA.

After that, your options begin to be more esoteric and will require the assistance of an advisor - in my opinion.

the Roth 401(k) would be even better than the Roth IRA.
I may have to respectfully disagree with this statement at first glance. I believe that if you can qualify for a Roth IRA (income limits), it is still a better option than a Roth 401k.

For one, a Roth 401k doesn't remain liquid like a Roth IRA cost basis and is subject to Plan Summary Description loans if you need you funds in an emergency, usually limited to 50% of value.

Also, perhaps a matter of scemantics, but a Roth 401k is also subject to RMD at age 70.5. Of course, this can easily be remedied by a rollover.

To add, investment choice and control is superior with the IRA option. Of course, high income individuals and/or those who have the ability to fund to the limits of an IRA AND 401k, the 401k would be a huge advantage.

Funding a Roth IRA to the limit, then looking to a Roth 401k would perhaps serve most investors better.

Okay, I'll take that... qualifying my answer: the Roth 401(k) has a higher limit, and if you're using the account for long-term retirement savings, the lack of liquidity shouldn't bother you (as price described). The limitations on investment options can be an issue, although if you're talking your employer into establishing a Roth 401(k) plan, you should also work to influence the investment choices.

Thanks for pointing out the fallacy in my response, price....

I was hoping that it wouldn't add to the crotchetty-ness.

If I decide to stay with this firm for over a year I will definitely talk to my boss about a 401k option...but I am thinking about leaving the company to pursue another opportunity. It seems like the Roth IRA is the way to go for me at least until I hit the income eligibility limit...right?

If you are eligible for Roth, it's almost never wrong to get it. However, if you pursue another opportunity, watch out for exceeding the Roth income ceiling for the tax year.

What happens if I do exceed it? I have to withdraw the 5k I put in?

Withdraw the over-contribution plus any growth attributable to that contribution by April 15 of the following year...

Okay makes sense, I guess I'll do that then...thanks for all the help!

Remember, however, that removing excess contributions carries a 10% penalty on the earnings unless you fall into one of the exemptions... read publication 590 on IRS.gov.

Also, you have to pay regular income tax on the earnings when you remove them as excess contribution.

The penalty only applies if you do not remove the excess prior to April 15 of the following year. And you're correct, ordinary income tax applies to the growth/earnings attributable to the overcontribution...

But Jim, if you are younger than 59 1/2 years old and distribute early, you still pay 10%. Correct?

Of course, you can recharacterize a part of Roth to a Traditional and avoid the tax and penalty... Then, in 2010, roll it over to a Roth and be sitting pretty:)

No - it doesn't count as having been contributed (in theory) if you remove it prior to tax day.

From IRS Pub 590:

What if You Contribute Too Much?
A 6% excise tax applies to any excess contribution to a Roth IRA.

Excess contributions. These are the contributions to your Roth IRAs for a year that equal the total of:
Amounts contributed for the tax year to your Roth IRAs (other than amounts properly and timely rolled over from a Roth IRA or properly converted from a traditional IRA, as described later) that are more than your contribution limit for the year (explained earlier under How Much Can be Contributed?), plus

Any excess contributions for the preceding year, reduced by the total of:

Any distributions out of your Roth IRAs for the year, plus

Your contribution limit for the year minus your contributions to all your IRAs for the year.


Withdrawal of excess contributions. For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made.

Applying excess contributions. If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year.

If there was no growth and/or the original excess contribution equals less than the following years limit and you are eligible, all you have to do is call the trustee and have it applied as a current year contribution.

This is explained in Blanks quote in the last paragraph.

"Applying excess contributions. If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year."

For instance, your IRA has a "2007" excess contribution, then all you have to do is say, "Hey, let's make that for 2008 instead". Eazy-peazy. The only stipulation is that it can't exceed the new year's limit.

Good call Jim. Thanks.