In this post, I outline why even graduate students should open, and contribute regularly to, an individual retirement account, or IRA. Specifically, a Roth IRA. I also describe what an IRA is and what tax advantages if has to offer.
Making ends meet isn’t easy for many graduate students. Whether you’re balancing school and a full-time job, or are living on a stipend from a research or teaching position, chances are that money is tight. Most graduate students live on a lean budget out of necessity. But many also view that time as a temporary phase, and therefore neglect financial good practices like saving for emergencies and retirement. That’s for later, when you have a real job. Right?
That attitude was exactly how I thought about things for the first few years I was in grad school. Money management would be for later. When I would have that so-called real job, and, you know, actual sums of money to work with. I saw grad school as a phase that I just had to make it through before getting serious about my finances. And honestly, I thought I was in pretty good shape. I was lucky enough to have a research assistantship that had notable perks like tuition remission and health insurance. I was so excited to have those health benefits, it didn’t occur to me that there was one type of benefit that I didn’t have access to: an employee sponsored retirement plan. And I was not alone here. Retirement savings, it turns out, are not a huge priority for most students. One of the most compelling reasons to go to grad school is for that better job, and (hopefully) better paycheck on the horizon. Retirement is something to worry about when you hit that horizon.
The problem with horizons is you don’t reach them. Those who are constantly saying they’ll save/invest/get smart about money at a later phase in their life, usually find a seemingly perfectly reasonable excuse to keep pushing that later date further and further back. Even if you are living on a lean grad student budget, when you graduate isn’t actually a better time to start investing for your retirement.
So when is the best time?
Now Is The Best Time To Start Investing For Your Retirement
The reality is, retirement savings really should be a priority, even for grad students in their 20s. Perhaps especially for grad students in their 20s. It’s easy to get so focused on how great of a position you’ll be in when you finish your degree, that you neglect the fact that if you aren’t investing anything in your 20s, you are missing out on the best compounding years of your life.
What does that mean?
When you put your money to work in smart ways, that money earns money for you. In a savings account, you earn interest. And with an investment account where you have invested in stocks, you make a return when the stocks you’ve invested in go up in value. If you keep all of that earned money in the account and continue to let it grow, then every time that money earns a return, you are getting a return not just on the initial amount you invested, but also on the money your money has earned. At first these gains are typically small and rather unimpressive. But over a period of many years, a small investment can grow to be many, many times its original value even if you don’t continue to put more money in.
If you want to learn more about the power of compound interest, I highly recommend you check out some of the following resources. These wonderful people have crunched the numbers and have generated some compelling visualizations.
- Investing 101: The Concept of Compounding
- 10 Things You Need to Know About Compound Interest
- Why Waiting Can Be Costly
- The Power of Compound Interest
The earlier you recognize the power of compounding, and admit that you have no excuse good enough to justify not putting that power to work for you, the better off you’ll be. Some are lucky/smart/savvy enough to start in their early 20s, and some get a later start. If you’re a later starter, take a moment to have a little pity party for yourself, and then get over it. I have occasional moments of regret that I wasn’t more savvy about finances and investing earlier in life. Did I lose out on some potential earnings and benefits? Yes. Am I letting that stop me from doing the best I possibly can now that I have better knowledge and the ability to change my practices? Absolutely not! It would almost always be better if you had started saving and investing years ago, or even yesterday, but you have today and that makes today the best day you’ll ever have to get started.
I mean it. Today is the best day to open an IRA. Repeat after me, “Today is the best day to open an IRA.” Look at you, punny reader.
Don’t get caught up in how of course you should open an IRA but couldn’t possibly because you’re broke. I get it. I was a broke grad student until just last year. In the next post in the IRA series I’ll go into more details about why you don’t need to invest a lot each month to reap the benefits of opening an IRA early. I’ll also help brainstorm ideas for funding it. For now though, let’s go into what an IRA even is.
So Why A Roth IRA and What Is It?
An IRA is an Individual Retirement Account. Most people open an IRA account when they do not have access to a 401(k) account through their employer. If you’re a grad student who has access to a 401(k) with an employer match on your contributions, absolutely go to your HR rep at your company right away and make sure you are taking full advantage of those benefits. Most grad students, however, don’t have access to a 401(k) through their university because they are not full-time employees of their institution. But almost everyone has the ability to open an IRA. There are exceptions based on age and income, but I am going to assume that readers here are under the age of 70 and earn less than $100,000 a year. If you meet those criteria, we can safely assume you qualify for an IRA.
There are several kinds of IRA accounts, but for now you really only need to know about two — traditional IRAs and Roth IRAs. The main difference between these accounts is how they are taxed. Specifically, WHEN they are taxed. Your contributions to a traditional IRA are tax free until you take the money out of the account many years down the road when you are retirement aged. You pay the full taxes on that money that you take out, however, including on the earnings you’ve acquired through those many years of compounding. With a Roth IRA, you pay taxes on the when money you put into the account, but then you do not owe taxes on the money when you withdraw it from your account at retirement. That means that you never pay taxes on your earnings so long as you don’t take penalties by withdrawing early.
A Roth IRA is the better choice for most grad students because you likely have the advantage of time—many years before you will be withdrawing these funds—and very likely are in a lower tax bracket for the time being. Most grad students after all, are not high income earners. Not yet, at least. So if you are relatively young and are not earning a high income in grad school, a Roth IRA is likely a good choice for you.
In this post, I hope I have convinced you that starting to save for your retirement even in grad school is an important step for taking care of your financial well-being. I have also walked through the basics of an account that will be ideal for most grad students—a Roth IRA. In the next few posts, I’ll explain how to open—and fund—your IRA, as well as share some ideas for how to come up with money to contribute each month, even on a lean grad student budget.