If you haven't done so yet, start your IRA right now! I almost feel like this article is complete. That’s it. Start it now!
I’ll go into a little more detail though just to make sure we are clear on why. An IRA is an Individual Retirement Account which is a special type of “tax-advantaged” account. Tax advantaged means that the government has put incentives in place related to your taxes to encourage people to use these accounts. You are allowed to open an IRA at any age as long as you have "earned income". This means you have been paid to complete a task or for your product by someone else. It can be a part-time job or the income can come from your own businesses! There are two types of IRA and they get treated differently when it comes to taxes.
A traditional IRA is a pre-tax account. This means that when you put money in there, you are putting in money which has not yet been subjected to income tax by the federal government or your state. The money then gets invested (more to come on that) and it grows in your account until you withdraw it. When you take it out, you then pay income tax on the amount you withdraw. This includes what you put in plus all the growth.
A Roth IRA is a little different. Instead of using pre-tax money, you pay taxes on all your income, and then put the money into your Roth IRA. The reason you would do this option is that you are now done with paying taxes on your money! The money you put in gets invested (still more to come) and grows, but all that growth is tax free unlike in the Traditional IRA. When you take out the much larger sum than you put in, it is tax free which is a really cool perk of this type of account.
Which should I pick?
It’s totally up to you and neither is a bad choice since you are starting to think about your future and putting your money to work. For most young entrepreneurs, such as those doing The Simple StartUp Challenges, your income levels are so low, that you likely are going to pay very minimal tax on your earnings anyway. Therefore, it makes way more sense to put your money into a Roth IRA where you’ve paid little tax up front and all the growth will be tax free after. If you already have a high paying job, or your business really takes off ($100,000+ kind of takes off), then you may want to consider the Traditional IRA as a way to reduce your taxes now, and you may be living off of less in the future, so the amount you withdraw will be less than your current earnings.
What’s the catch?
There is always a catch to a sweet deal like this! In the case of IRA’s you are not allowed to access your money until age 59 ½ (yes we are using half birthdays again like we did when we were 3 ½ years old). These accounts are designed to encourage people to save money for their retirements so they have plenty to live off of when they want to stop working. There are some important exceptions though!
If you have a Roth IRA, you can take out the money you put in at any point without any penalties. So say you put $1000 in your Roth IRA and it grew to $1500. You are still allowed to take your $1000 out at any point, but you have to leave the $500 growth in there until later.
Will this impact college aid?
Another key thing to consider is college. When it comes to college you are going to fill out a FAFSA form (if you go to college that is!) that asks you about you and your parents income and assets (money in savings or investments). When you put your money in a savings account or a brokerage account (an account you can use to buy stocks or bonds), this money counts as something the government would expect you to contribute towards your college expenses, so they offer less in financial aid. However, if you put the money in an IRA (Roth or Traditional) that money is not considered to be available for college, so it is not counted. That makes IRAs a great place to put money that you don’t need for college and still have it invested to work for you.
What did you mean by invested?
When you invest your money, you are attempting to grow your money into a larger amount. Investing in your business is a way to do this. You take your profits and use them to grow your business which results in more profits. Another way to invest your money is through things like stocks, bonds, collectibles, precious metals, real estate, and cryptocurrency. You are purchasing these assets in the hope that they will grow in value over time or will pay you for owning them in the form or interest, rent, or dividends.
In your IRA you can invest your money into these assets to get your money to grow, and then your growth is what really accelerates your path to wealth. While I cannot give you specific financial advice, what I do with my Roth IRA is invest in Vanguard’s Total Stock Market Index Fund (VTI) so that I own a piece of every company in the US that is publicly traded. I am investing in other business owners and employees who are working hard, like me, to increase the value of their business.
If you have any questions about where to set up an IRA, I do recommend Vanguard and Fidelity as being great businesses to work with from personal experience. I am also happy to answer any questions you have via email. As soon as your business is earning income, get that IRA open and start adding a small bit of your money to it as well as reinvesting back into your business!