Confession time: Even though I worked during college, I didn’t save any money for retirement. Looking back, I wish I would have. Putting money in a retirement account during college isn’t a necessity, but it is a great idea.
Many students turn to student loans to pay for expenses like tuition and housing. When you are going into more debt each year, the idea of saving for retirement might sound strange. Surprisingly, putting money in a retirement account during college may be the best move financially. It also provides many intangible benefits.
While many different retirement plans are available, I’d argue that one plan stands out as the very best option for college students.
Student Debt vs. Saving for Retirement
Many people are legitimately concerned about their student loans. As such, the figure they should use whatever income they generate during school to reduce borrowing. It is a responsible plan, and the logic is sound.
However, it isn’t the only reasonable option.
On average, the stock market gains about 10% per year. However, the returns are not guaranteed, and some years are significantly worse than 10% while others are considerably better. That being said, if you can borrow money at 5% interest and invest it to generate 10% interest, you will come out ahead.
Whether or not investing in this situation makes sense will depend upon your appetite for risk. For example, if you can accept that you might lose money, investing might be a good option. On the other hand, if you need a guaranteed return, minimizing student debt is probably ideal.
Additionally, some graduates will qualify for student loan forgiveness on their federal loans. If you have a slightly larger loan balance because you chose to put your summer earnings in a Roth IRA, it could mean more debt is eventually forgiven.
Looking past the basic accounting and risk considerations, there are additional benefits to putting money aside for retirement during school.
Benefits Beyond Dollars and Cents
Getting an early start on saving for retirement can be fun and educational. You can make some risky stock picks because the stakes are low. Losing money might still be a valuable lesson.
If you lose $500 betting on GameStop or the latest meme-stock, it sucks. However, if that lesson means you make smarter investments for the next 40 years, it is money well spent.
It is never too early to learn about saving for retirement. If you make mistakes in your early-to-mid-twenties and learn from them, you will be well ahead of the curve.
A basic understanding of investment strategies could lead to smart decisions when evaluating your retirement plan options at your first job out of school. Many people find saving for retirement, the stock market, and investing to be overwhelming. However, once you have a basic understanding of your options and strategy, it becomes more exciting. The sooner this transition takes place, the better off you will be in the long run.
Roth IRA Benefits for College Students
For college students, I think a Roth IRA is the best type of retirement account available.
Two reasons, in particular, stand out:
Tax-Free Withdrawals in Retirement – Most retirement accounts offer a tax break for contributions. If you are in a high-income tax bracket, the traditional method is a huge perk. As a college student, you are likely in a lower income tax bracket. Instead of getting the tax break at the beginning, you get the tax break on withdrawals. Money in a Roth IRA grows tax-free, and eligible withdrawals are also tax-free. Roth contributions are an excellent way to take advantage of being in a lower income tax bracket.
Withdraw Contributions at Any Time – Most retirement accounts have complicated rules for withdrawal. Taking money out early normally means a tax bill and penalties. However, with a Roth IRA, savers can withdraw their contributions at any time. The only way they run into penalties or taxes is if they pull earnings early. For example, if you put $1,000 in a Roth IRA and it grows to $1,500, you can pull that $1,000 out any time you like. The $500 of growth must stay in the account until retirement, or an early withdrawal penalty may be imposed. This feature means a Roth IRA can serve as an emergency fund.
When is Saving for Retirement a Bad Idea?
While I am enthusiastic about the potential of a Roth IRA for college students, there are times when it would be a mistake.
If you are dependant upon any of the following to pay for school, putting money in a Roth IRA is probably a bad choice:
- Credit Cards – Most credit cards have interest rates over 20%. Pay down this debt as soon as possible.
- High-Interest Private Student Loans – Like credit cards, a student loan with a high interest rate tilts the scale towards paying down debt first.
Comparing the debt expenses and projected retirement earnings is helpful, but it isn’t the only step. Students need to carefully consider how they would react if they lost money on their investments. Investing isn’t for everyone, but a Roth IRA during college could be the perfect educational experience, and a head start towards retirement.