Generation Roth: How millennials can retire tax-free

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Business Week | By Ashlea Ebeling, Forbes

Roth IRAs offer two huge advantages to young savers: lots of flexibility and tax-free withdrawals in retirement.

During a recent visit to a Pennsylvania steel plant, President Obama touted the flexibility that his new myRA account provides young workers just starting to save. "In an emergency you can withdraw contributions without paying a penalty. So it's a pretty good deal."

Fact is, myRA is just a Roth individual retirement account with training wheels; the full, grown-up version is an ideal savings vehicle for millennials, including well-paid ones who also have a 401k.

A Roth IRA has two main advantages for younger folks. Money you contribute to an old-fashioned, pretax IRA or 401k isn't taxed now, but all withdrawals in retirement are taxed at high ordinary income rates. Roth IRAs work in reverse: You get no tax deduction for your contribution, but withdrawals after age 59 are tax free.

By then your income should be higher, in real dollars, than at, say, 25, so your tax rate is likely to be higher, too, making the back-end tax break more valuable than the front-end one. A Roth could also shield you from a growing list of tax and benefit penalties on higher income retirees.

The second big selling point for a Roth IRA is flexibility. Retirement is decades away and you might need cash sooner -- to start a business, pay the rent while you return to school or, as Obama suggested, for an emergency. Take money out of a pretax IRA or 401k before retirement and you can get hit with a 10 percent early withdrawal penalty, as well as ordinary income taxes. (There are ways you might be able to avoid the penalty, but an estimated 5.7 million folks still got stuck paying it in 2011.)

By contrast, you can withdraw your original contributions from a Roth IRA without taxes, penalty or jumping through hoops. "Life is unpredictable," says Dan Keady, a financial planner in TIAA-CREF's advice strategy group. "The idea of having that money there in a Roth IRA that you can just pull is a big advantage for people."

Wait a minute, isn't a 401k the best place to start saving? Yes, usually, provided you're offered an employer match -- in the most common matches, your employer kicks in 50 cents or $1 for each $1 you save, up to maybe 6 percent of your salary.

But if you're planning a decent retirement and saving for other goals, too, you'll need to sock away a lot more than 6 percent a year. So put enough into your 401k to snag the full match and then fund a Roth IRA.

For 2014 you can contribute $5,500 per person to a Roth IRA, provided your adjusted gross income isn't more than $114,000 for a single or $181,000 for a couple. Above that, the allowed Roth contribution shrinks and then disappears.

Not to worry: If you earn too much, you can get around the restriction with a little fancy footwork (and paperwork). Put $5,500 in a nondeductible IRA and then convert it to a Roth IRA.

Fortunately, you have until Apr. 15 to fund an IRA for calendar 2013. If you don't have the cash but expect to soon -- say you've just started a high-paying job -- hit your parents up for a short-term loan to make the contribution. Another option: If you file your 1040 early enough, you can ask the Internal Revenue Service to deposit your refund into a 2013 IRA.

What if you are already snagging the match in your 401k and fully funding a Roth IRA, and can save still more? Build an emergency account (three to six months of expenses) outside the Roth IRA, so you can leave the Roth untouched, growing tax free.

Once you have an emergency cache, consider maxing out your 401k -- you can contribute up to $17,500 for 2014. Keep in mind, however, that your pre-retirement access to 401k funds is limited, particularly if you stay with the same employer.

A growing number of 401k plans give workers the option of directing some or all of their contributions into a Roth 401k subaccount. If yours does, consider using it, particularly if you expect your income and tax rate to rise. By law all employer contributions are made pretax, so by using the Roth you're spreading your tax bets.

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Why Generation Y fears the stock market

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| By J,J. Zhang, MarketWatch

For Millennials, financial security is a fragile hope amid high educational debts, stagnant upward mobility and poor employment prospects.

One of the largest transfers of wealth between generations is starting to occur in the U.S. As baby boomers enter the retirement phase, the next generation of workers, Gen Y or the Millennials (those born in the 1980s and 1990s), are now entering the workforce and beginning their prime earnings phase.

According to research firm Iconoculture, Gen Y comprises over 76 million people with almost $900 billion in spending power. In contrast the baby boomers, also numbering 76 million, have $2.5 trillion in spending power.

However, for this new generation, it's a very different world than the one seen by their parents. The baby boomers saw the rise of the U.S. into the world's only superpower and all the accompanying economic growth and rewards that came with it.

They reaped the rewards of the chemical revolution, the golden age of manufacturing, the computer revolution, the information age, energy abundance and globalization. They also juiced growth via the use of debt which turned the U.S. into today's debtor nation.

In contrast, the future outlook for Gen Y is that of a nearly bankrupt nation, rising global competition from emerging countries, crumbling infrastructure and insolvent retirement and welfare programs, among other ills. For this generation, financial security is a fragile hope due to high educational debts, stagnant upward social mobility and poor employment prospects.

For Gen Y, it becomes even more important to start retirement planning early as government Social Security guarantees, employment security and wage-growth prospects will not be what their parents experienced.

However, this generation has also suffered through several financially traumatic experiences that have and are continuing to shape its investing views.

Baby boomers saw a relatively stable and strong growth period during the '50-'70s which influenced their long-term belief in market returns. In contrast, Gen Y adults experienced two major bubbles and recessions and high volatility, which have led to one lost decade already.

Indeed, the early vanguard of the Gen Y'ers joined the real world only to experience the dot-com crash. They subsequently started investing in their mid 20s only to find the housing bubble and the subsequent great recession. The first impression is the most important and so far it doesn't look promising.

This lack of tangible gains, roller-coaster volatility and recent scandals such as the bank bailouts, mortgage shenanigans, Ponzi schemes and scandals like Goldman's designed-to-fail securities have all made them cynical and distrusting of the stock market and investing in general.

This isn't hypothetical. In a recent MFS Survey, 40% of Gen Y agreed with the statement "I will never feel comfortable investing in the stock market." Among Gen Y investors, 54% feel overwhelmed by available choices and 47% tended to put off investment decisions.

Due to fear of risk, 30% said their primary investing objective is protecting principal and have allocated an average of 30% to cash, more than other age groups, and nearly equal to the 33% allocated to stocks. T. Rowe Price noted in 2010 that almost one in five self-directed participants age 25-35 had over 80% of plan assets in cash.

While protecting principal is no doubt important, excessive risk aversion does not lend well to long-term investing: after all, no pain, no gain. With 54% of Gen Y concerned about when they would be able to retire and 44% lowering their retirement expectations, they need to put aside their fears and tiptoe back into the markets.

Though these psychological traumas have already influenced Gen Y actions, luckily time and youth is on their side. With the first wave still in their early 30s, there's still plenty of time to start and let compound investing work for them.

The important first step is learning to let go of their fear of the market, or at least reduce it to a healthy level. Yes, the stock market can be a scary place sometimes, but there are precious few ways to generate returns significantly above inflation -- a necessity in a Social Security-less future.

Notably, high volatility and risk averseness have caused Gen Y to make more use of financial advisers and other experts. Especially for those concerned about market volatility and risk, seeking a financial adviser to help them tiptoe into investing is a good idea.

However, it's particularly important that one find a good and trustworthy adviser -- those with fiduciary duty is a must. While advisers do charge fees that can undermine returns, in this case it's still a net positive over the high cash many Gen Y'ers are holding.

And keep in mind; advisers are not a lifetime commitment. There's nothing wrong with learning from them and then striking out for yourself.

One trait of Millennials is their considerable sophistication in finding information and learning for themselves. The widespread availability of financial products and services such as ETFs, online discount brokerages, instant financial info like real time quotes and new tools such as computer-aided rebalancing have given then all the help needed to create a well-rounded and diversified portfolio ready for the long term.

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