Looking to buy a house in 1-2 years. Does starting a Roth IRA now make sense?
With a Roth IRA, you can withdraw the contributions at any time without penalty as long as you don't withdraw the earnings/interest. There are some circumstances where you can withdraw the earnings such as disability (and maybe first home). Also, the Roth IRA doesn't need to go through your employer and I wouldn't do it through your employer. I have mine setup through Fidelity though I'm not sure if they have any guaranteed 3% return unless it was a CD. All of mine is in stocks. Your wife could also setup a Roth IRA so over 2 years, you could contribute $20,000. If I was you, I would just max out any 403-b matches (which you surely are at 25% of gross income) and then save my down payment money in a normal money market/savings account. You are doing good contributing almost 25% to the 403-b. There are also some income limitations on Roth IRAs. I believe for a married couple, it is $160k. If you are going to be buying a house in 1-2 years, I would be putting my money into a short term holding area like a high interest (which isn't that high right now) or a CD (also low interest) because of your near-term need.  I wouldn't use the Roth option for your down payment money. If you invest in something volatile (and stocks/mutual funds are very volatile in a 1-2 year term) I would consider it too risky for your need and time frame. First, look at the local housing market, and the price to rent ratios. If you are comfortable that a house can be had for near to the cost of renting, and are not still dropping is price, then focus on the down-payment. I don't imagine housing prices to start picking up any time soon, so you don't be too rushed. If you feel like you have a longer time to save before you want to buy, I would focus as much money as I can into a retirement account while still saving for a down payment. Since you are young, you really want your retirement accounts working for you as soon as possible. You should not be investing in 3% stable funds, but the stock market index funds. Retirement is for 40 years in the future. Using funds for a down-payment from a retirement account should be a last resort. Remember this money is to provide you security later in life, not to get you into a house. When you take out money and put it into a house, it will not be appreciating nearly as fast. It is easy to say you will save later, but the money you save early in life will make up 50% or more of your funds when you retire. That is why it is critical to save for retirement as soon as possible. Lets do the math (assuming a lot of stuff, like your interest rates and that you make the contribution at the beginning of the year, also your tax bracket at the withdrawal time frame.) 1.) Beginning of year 1 Roth Option $5k contribution Non Roth Option $5k contribution 2.) Beginning of year 2 Roth Option $5000 + $150 interest + 5K contribution = $10150 Non Roth Option $5000 + $75 interest + 5K contribution = $10075 3.) End of year 2 Buy a house! yay! Roth Option---before withdrawal account value = 10150+10150*.03=10454.5 after withdrawl (assuming 38% tax on earnings withdrawal (10%penalty + 28% income tax estimate.) = 10327.17 Non Roth Option = 10 226.125 So you are talking about a significant amount of paperwork to either 1.) Net yourself $100 toward the purchase 2.) Cost yourself $226 on the purchase but have $454.50 in your roth ira. I am not sure I would do that, but it might be worth it.
Years before retirement isn't related at all to the Pretax IRA/Roth IRA decision, except insomuch as income typically trends up over time for most people.  If tax rates were constant (both at income levels and over time!), Roth and Pretax would be identical.  Say you designate 100k for contribution, 20% tax rate.  80k contributed in Roth vs. 100k contributed in Pretax, then 20% tax rate on withdrawal, ends up with the same amount in your bank account after withdrawal - you're just moving the 20% tax grab from one time to another.   If you choose Roth, it's either because you like some of the flexibility (like taking out contributions after 5 years), or because you are currently paying a lower marginal rate than you expect you will be in the future - either because you aren't making all that much this year, or because you are expecting rates to rise due to political changes in our society.  Best is likely a diversified approach - some of your money pretax, some posttax.  At least some should be in a pretax IRA, because you get some tax-free money each year thanks to the personal exemption.  If you're working off of 100% post-tax, you are paying more tax than you ought unless you're getting enough Social Security to cover the whole 0% bucket (and probably the 10% bucket, also). So for example, you're thinking you want 70k a year.  Assuming single and ignoring social security (as it's a very complicated issue - Joe Taxpayer has a nice blog article regarding it that he links to in his answer), you get $10k or so tax-free, then another $9k or so at 10% - almost certainly lower than what you pay now.  So you could aim to get $19k out of your pre-tax IRA, then, and 51k out of your post-tax IRA, meaning you only pay $900 in taxes on your income.  Of course, if you're in the 25% bucket now, you may want to use more pretax, since you could then take that out - all the way to around $50k (standard exemption + $40k or so point where 25% hits).  But on the other hand, Social Security would probably change that equation back to using primarily Roth if you're getting a decent Social Security check. "There's currently not much reason to keep around a long-term non-deductible Traditional IRA in my opinion -- a Roth IRA is almost strictly better. Think about it: a non-deductible Traditional IRA vs. a Roth IRA of the same amount. In both cases, contributions are after-tax (so no tax deduction). But when you withdraw, for the Roth IRA you don't have to pay tax, and for the non-deductible Traditional IRA, you have to pay tax on the ""earnings"". A Roth IRA can be contributed to at pretty much any income level, thanks to the backdoor Roth IRA process (which uses a temporary non-deductible Traditional IRA in the process). So there is not much reason for a long-term non-deductible Traditional IRA. As for your question, a non-deductible Traditional IRA vs. a taxable account. Well, a non-deductible Traditional IRA is contributed to with after-tax money, and taxed on the earnings only on withdrawal. So the taxation is almost identical to things like stocks and homes, where the gain is not realized until the thing is sold. However, compared to things like savings accounts and bonds, where you get taxed on the interest yearly, it is much better. Every time you get taxed on gains like this, it is taxing gains earned from after-tax money, so if you think of an amount of money as being equivalent to the amount of money it grows to over time (time value of money), then it is taxing money that is (or grown from money that is) already taxed. So it is better to have this only happen at the end at withdrawal than every year." "I would like to buy hubby a beer and talk some sense into him.  Do you have 2 years gross income saved as your retirement balance? That's about where he should be at age 30. I wrote about this in an article Retirement Savings Ratio.  Blowing the 401(k) for anything less than an extreme emergency is downright foolish.  The decision whether to roll it to an IRA or the new account isn't so simple. If you roll it to new plan, yes you can borrow, up to 60 months at a low rate, 4% or so. Taking the cash and then making an IRA deposit just means paying the penalty for nothing, unless you manage it just right, depositing the amount within 60 day, etc. You don't mention what he wants to do with it. You need to sit down and have a long ""money talk.""  Keep in mind, if you oversave, it's easy to retire early, or at 50 just stop saving, spend every new dime. But it's something else to turn 50 and realize you will have to work till you die. I've seen both situations. (I am 48, the Mrs, 54 our multiple is now 13. The target is 20 to retire. The house is not counted as it can't be spent. The mortgage IS counted as it must be paid) Edit - as I read this again, I see the OP asked about opening an IRA in the same year they withdraw the 401(k) and pay tax and penalty. Wow. I also see her user reverted to generic, which means, I think, she's never returned. I hope they made the right decision, to keep the money in retirement accounts. Hubby never even said what he wanted the money for." Well, I was about to ask a similar question. Unless you get into stocks/mutual funds it seems like returns on less risky items such as CDs (certificate of deposit) are terrible. I don't think it is a good use of folks time to ask what a Roth IRA is.  We were considering buying a new car (~$20000 with zero down and 0.9% interest rate) but we drive maybe 6000 miles per year. We would be paying ~$550/month to park something in our garage. Our current car is sexless but absolutely reliable.  I am now looking elsewhere and may either invest the money in our house (i.e., refinishing upstairs) or paying down our debt. We have a home loan - $132,000 at 3.5% - and a student loan - $12,675 @ 3.375%.  Depending on the loan rate on your car, I would pay that down first. Alternatively, find a fee-only broker and drop around $500 for them to come up with a financial plan for you. They will probably recommend a Roth IRA with a specific mutual fund in mind. You'll need $2500 or so to open the Roth, contributions from there should be such that you can start/stop them on demand without fees. "I wrote a brilliant guest post at Don't Mess With Taxes, titled Roth IRAs and Your Retirement Income. (Note - this article now reflects 2012 rates. Just updated) Simply put, it's an ongoing question of whether your taxes will be higher now than at any point in the future. If you are in the 25% bracket now, it would take quite of bit of money for your withdrawals to put you in that bracket at retirement. In the case of the IRA, you have the opportunity to convert in any year between now and retirement if your rate that year drops for whatever reason.  The simplest case is if you are now in the 25% bracket. I say go pre-tax, and track, year by year what your withdrawal would be if you retired today.  At 15%, but with a good chance for promotion to the 25% bracket, start with Roth flavor and then as you hit 25%, use a combination. This approach would smooth your marginal rate to stay at 15%.  To give you a start to this puzzle, in 2012, a couple has a $11,900 standard deduction along with 2 exemptions of $3800 each. This means the first $19,500 in an IRA comes out tax free at retirement. If you believe in a 4% withdrawal rate, you need a retirement account containing $500K pretax to generate this much money. This tick up with inflation, 2 years ago, it was $18,700 and $467K respectively. This is why those who scream ""taxes will go up"" may be correct, but do you really believe the standard deduction and exemptions will go away?  Edit - and as time passes, and I learn more, new info comes to my attention. The above thoughts not withstanding, there's an issue of taxation of Social Security benefits. This creates a The Phantom Tax Rate Zone which I recently wrote about. A single person with not really too high an income gets thrust into the 46% bracket. Not a typo, 46.25% to be exact." "It's not so much a matter of your age as it is a matter of what your current tax rate is vs. what your tax rate will be when you take out the money.  As long as your current tax rate is lower than what you anticipate it will be when you withdraw the money, it makes sense to pay the tax now. Of course you can't know for certain what your tax rate will be when you take out your money, but the answer for most people is going to be ""higher than it is now"".  Some reasons why: As you age you start to lose deductions (home mortgage gets paid off, kids grow up and move out).  You likely won't gain any new deductions that would lower your tax rate as you age, you'll only lose them. Tax rates now are historically low, and budget deficits are high.  That means that higher tax rates are almost certainly coming. So unless your circumstances are very unusual, I would pretty much always recommend saving after-tax dollars. Now that I've said that, I'll throw a small wrench into that plan - when you save with a Roth IRA, you are paying taxes today with the anticipation that you won't have to pay taxes later.  But this may not necessarily be the case: The government could decide to tax Roth IRA gains in the future (would be a very unpopular move, but if they decided to do it, who's to stop them?) The government could change the tax system by lowering income tax rates and creating a VAT, or instituting something like the ""Flat Tax"".  Your Roth money is exempt from income tax, but not from a VAT or national sales tax. So, you also need to consider the possibility of those things happening and how that would affect you.  Ten years ago nobody would have dreamed of the US having a VAT, but now it looks more and more possible." 2.5 years is a short period in the stock market. That means there is a significant chance it will be lower in 2.5 years, whereas it is very likely to be higher over a longer time period like 5-10 years. So if you want the funds to grow for sure then consider an online savings account, where you might earn 1-2%.  If you want to do stocks anyway, but don't have any idea what fund to buy, the safest default choice is to buy an index fund that tracks the S&P 500. Vanguard's VFINX is one example. If it's either/or, I'd pay down the mortgage, no question. I know I'm in the minority, but I'm not a fan of tax-advantaged retirement accounts.  There are too many things that can change between now and the next 30 years (the time frame that you'll be able to withdraw from your IRA account without penalty).  The rules governing these accounts can change at any time, and I don't think they'll be changes for the better. Putting the money toward your mortgage will relieve you of that monthly payment faster.  The benefits of IRAs come retirement age are too uncertain for my taste. "To answer the first part of your question: yes, I've done that!  I did even a bit more.  I once had a job that I wasn't sure I'd keep and the economy wasn't great either.  In case my next employer wouldn't let me contribute to a 401(k) from day one, and because I didn't want to underfund my retirement and be stuck with a higher tax bill - I ""front-loaded"" my 401(k) contributions to be maxed out before the end of the year.  (The contribution limits were lower than $16,500/year back then :-)) As for the reduced cash flow - you need of course a ""buffer"" account containing several months worth of living expenses to afford maxing out or ""front-loading"" 401(k) contributions.  You should be paying your bills out of such buffer account and not out of each paycheck.  As for the reduced cash flow - I think large-scale 401(k)/IRA contributions can crowd out other long-term saving  priorities such as saving for a house down payment and the trade-off between them is a real concern.  (If they're crowding out basic and discretionary consumer expenses, that's a totally different kind of problem, which you don't seem to have, which is great :-)) So about the trade-off between large-scale 401(k) contributions and saving for the down payment.  I'd say maxing out 401(k) can foster the savings culture that will eventually pay its dividends.  If, after several years of maxing out your 401(k) you decide that saving for the house is the top priority, you'll see money flow to the money-market account marked for the down payment at a substantial monthly rate, thanks to that savings culture. As for the increasing future earnings - no.  Most people I've known for a long time, if they saved 20% when they made $20K/year, they continued to save 20% or more when they later made $100K/year.  People who spent the entire paycheck while making $50K/year, always say, if only I got a raise to $60K/year, I'd save a few thousand.  But they eventually graduate to $100K/year and still spend the entire paycheck.  It's all about your savings culture. On the second part of your question - yes, Roth is a great tool, especially if you believe that the future tax rates will be higher (to fix the long-term budget deficits).  So, contributing to 401(k) to maximize the match, then max out Roth, as others suggested, is a great advice.  After you've done that, see what else you can do: more 401(k), saving for the house, etc." "The Roth/Traditional decision is complex, but can be broken down into a set of simple rules.  Ideally, you want to choose to tax your money at the lowest possible rate. This specifically refers to your marginal rate, the rate you last $100 was taxed or next $100 of income with be taxed. That, in itself, is another issue, answered with questions here discussing marginal rates.  My suggestion has been that if you are in the 15% bracket, use Roth. And continue to do so until you hit 25%. At that point, begin to shift to the traditional, pre-tax 401(k) or IRA. (My article The 15% solution, goes into detail on this, although it references the 2013 tax rates. I need to re-edit). If you are already in the 25% bracket, I'd suggest just going pre-tax. Given the ability to convert, it's not as if there are 2 points in time (deposit and withdrawal) but you can decide every year if your situation changes. It's not uncommon to get married, have a baby, buy a house, and find you just dropped back down to 15% marginal rate when you were solidly 25% prior.  Let me explain why you should go 100% pretax if already at 25%.  A single person hits the top of the 15% bracket (in 2017) at $37,950 taxable. Add the standard deduction and exemption, and you are at $48,350. The tax on this is $5226, less than 10% average, despite the next $100 being taxed at 25%. It would take over $1M to have an account large enough to withdraw $40K/yr.  If you blow through that number, you hit 25%, I agree, but why pay 25% now, for sure, to avoid 'maybe' hitting 25% later? You have decades of opportunities for conversion, and even more when the funds are transferred to IRAs if you have a job change. (And the conversion discussion has multiple layers when the IRA is involved) Say you are 'too' successful. You are hitting $2M before age 55. If you retire post-55, you can withdraw from the 401(k) penalty free. But, you have 15 years before you'd start to take SS benefits. 15 years to use conversions, even if pushing into 25%, to reduce the impact of SS taxation.  My advice is not a set-and-forget solution. It's an annual evaluation of the plan for the coming year.  Further notes on my choice of ""15% Solution"" - This is the 2017 tax table for singles -  I note that median individual income is ~$30K which puts that median single at ~20K taxable. This is where the analysis begins. This earner might have upward mobility, to reach the 25% bracket and begin to save pre-tax. The goal would be to have a mix of pre/post tax money, so that over the course of their life, the 25% bracket was avoided, perhaps completely.  In general, my writing tend towards the second highest quintile, the 60-80% slice of the population. The numbers might appear arbitrary, but, in the end, the discussion has to start someplace. The concept I described here is best implemented by the single or couple who is still at 15%, but soon pushing higher than the 15/25 line. This enables them to start by saving in the Roth, and slowly shifting towards pre-tax. The final mix at retirement depends on that timing as well as their opportunities for conversions along the way.  Part of my focus on that line is that the differential is greatest in bracket shifts between 15 and 25%. Much of the benefit in the whole IRA/401 discussion is in that shift, depositing at 25%, yet withdrawing at 15%. The 28% couple might wish to avoid the 33% bracket at retirement, but that level of income impacts far fewer people, and fewer still that are either reading these boards or my other writing." You are in the perfect window for making an IRA contribution. The IRS allows you to make IRA contributions for last year until tax day. So you know that for 2014 you didn't have access to a 401K at work. You want to avoid making a deductible IRA contribution for this year (2015) until you are sure that you wont have a 401K at work this year. Take your time and decide if the detectible IRA or the Roth works best for your situation. Having a IRA now will be good becasue you have many years for it to grow. Keep in mind that it is not unusual to have multiple retirement accounts: Current 401K; rolled over into a IRA;  Roth IRA... Each has different rules, limits, and benefits. There is no reason to pick one way of investing for retirement becasue you never know if the next employer will have the type of plan you like. I am assuming that your spouse, if you are married, doesn't have access to a 401K; otherwise you would have to consider the applicable limits. I think others have made the key points. Let me just add: As others have pointed out, the traditional IRA is better if your tax rate in retirement is lower than it is when you are building the account. The Roth IRA is better if your tax rate in retirement is higher. For most people, your income in retirement will be lower than your income in most of your working years. On top of that, a significant percentage of your income will come from Social Security, which is generally not taxed, and so the tax rate you pay on the remaining income will be lower still. If you're just starting out, if you're in your 20s, it's likely that your income will go up significantly in the next couple of decades and so you might be making more in retirement that you are now, and so the Roth is probably your better bet. But if you're in your 40s or 50s you are probably making your peak income, you will have much less in retirement, and the traditional IRA is likely better. If your income is well above average and you are saving enough to have a retirement income well above average, then social security may be a very small part of your retirement and my comments on that may not be relevant to you. It's true that tax rates could change in the future. But will they go up or down? It's also possible that the laws about retirement accounts will change. If you think you have some insight into what will happen in the future you may want to take that into account when making plans. But politics is very hard to predict. First of all, it's pretty rare that would cash out your entire Traditional IRA at once when you retire. That would incur major taxes and negate much of the tax deductibility benefit. Instead, you'd want to take distributions of just what you want to live on, which are taxed at income rates, and let the rest continue to grow tax free until you need/want it. As to your main question, if you don't expect to be in a lower tax bracket in retirement, then yes, Roth makes sense. But this is a pretty major assumption. When you're working, your salary pushes you into higher tax brackets. Once you're retired, you don't have as many sources of income. It could be mostly distributions from retirement accounts, and even coming from a Traditional IRA a lot of that will be tax free or taxed at a low rate (e.g. 15%). If when it was earned it would have been taxed at a higher marginal rate (e.g. 25%), then the Traditional IRA was a better choice than the Roth. Traditional versus Roth, if both are options to you (with deductibility for the Traditional), all comes down to tax rate now versus what you expect your tax rate to be in retirement. There is no universal answer. I would wait, and invest that money in a Roth IRA. Because taxes are paid on the contributions to a Roth IRA, you can withdraw the contributions at any time, tax and penalty-free. In addition, you can withdraw contributions and earning to purchase your first home. "Couple of clarifications to start off: Index funds and ETF's are essentially the same investments.  ETF's allow you to trade during the day but also make you reinvest your dividends manually instead of doing it for you.  Compare VTI and VTSAX, for example.  Basically the same returns with very slight differences in how they are run.  Because they are so similar it doesn't matter which you choose. Either index funds and ETF's can be purchased through a regular taxable brokerage account or through an IRA or Roth IRA.  The decision of what fund to use and whether to use a brokerage or IRA are separate. Whole market index funds will get you exposure to US equity but consider also diversifying into international equity, bonds, real estate (REITS), and emerging markets.  Any broker can give you advice on that score or you can get free advice from, for example, Future Advisor.  Now the advice: For most people in your situation, you current tax rate is currently very low.  This makes a Roth IRA a very reasonable idea.  You can contribute $5,500 for 2015 if you do it before April 15 and you can contribute $5,500 for 2016.  Repeat each year.  You won't be able to get all your money into a Roth, but anything you can do now will save you money on taxes in the long run.  You put after-tax money in a Roth IRA and then you don't pay taxes on it or the gains when you take it out. You can use Roth IRA funds for college, for a first home, or for retirement. A traditional IRA is not recommended in your case.  That would save you money on taxes this year, when presumably your taxes are already low. Since you won't be able to put all your money in the IRA, you can put the rest in a regular taxable brokerage account (if you don't just want to put it in a savings account).  You can buy the same types of things as you have in your IRA.   Note that if your stocks (in your regular brokerage account) go up over the course of a year and your income is low enough to be in the 10 or 15% tax bracket and you have held the stock for at least a year, you should sell before the end of the year to lock in your gains and pay taxes on them at the capital gains rate of 0%. This will prevent you from paying a higher rate on those gains later.  Conversely, if you lose money in a year, don't sell. You can sell and lock in losses during years when your taxes are high (presumably, after college) to reduce your tax burden in those years (this is called ""tax loss harvesting""). Sounds like crazy contortions but the name of the game is (legally) avoiding taxes.  This is at least as important to your overall wealth as the decision of which funds to buy. Ok now the financial advisor.  It's up to you.  You can make your own financial decisions and save the money but it requires you putting in the effort to be educated.  For many of us, this education is fun.  Also consider that if you use a regular broker, like Fidelity, you can call up and they have people who (for free) will give you advice very similar to what you will get from the advisor you referred to.  High priced financial advisors make more sense when you have a lot of money and complicated finances.  Based on your question, you don't strike me as having those.  To me, 1% sounds like a lot to pay for a simple situation like yours."