Graduation season is upon us, and you, like me, may be pondering what to get our loved ones. Thinking back, I remember four letters that meant a lot to me when I was graduating: C-A-S-H! But that’s too boring. This year, give some thought to four letters that I happen to find even more exciting: R-O-T-H! After all, what better way to celebrate a joyful occasion than with a tax-advantaged retirement account named after a U.S. senator from Delaware?
What? Not convinced that a Roth IRA is just what every high school or college graduate wants? Maybe you’re right. But still, a Roth is a gift that can last a lifetime.
Indeed, Roths are IRAs, and they’re designated for retirement. If your graduate ends up using it for retirement, all the better. In fact, I have written about the importance of retirement savings at an early age, as the power compounding can be astounding.
But, Roths may be financial tools for other things. For example, contributions can always be pulled out without tax consequences. Furthermore, there are some qualifying exceptions to avoid early withdrawal penalties and income taxes on earnings. These include distributions for postsecondary education and distributions made for a first-time home purchase (up to lifetime maximum of $10,000). Roths provide flexibility, and the account can grow tax-free if used for purposeful goals. (You can learn more about IRAs at vanguard.com/IRA.)
Now are you having the same “aha” moment as me?
There are two stipulations to keep in mind. First, you’ll want to make sure your graduate has earned income. Think summer job, odd college jobs, or college graduate starting her full-time job in the fall. The contribution limit is either the lesser of $5,500 or earned income. Second, the contribution doesn’t have to be made by the graduate. That’s where generous family and friends can step in. It is considered a gift, but given that the contribution limit is lower than the annual gift exclusion ($14,000 per person in 2013), there are no federal gift tax consequences. Keep in mind that if she is a minor, then the account will need to be opened as a custodial account.
Admittedly, funding a Roth IRA may run you the risk of a furrowed brow from your loving graduate. So you may want to consider also buying them something fun, like a Mustang convertible (just kidding!).
Notes: We recommend that you consult a tax or financial advisor about your individual situation. All investing is subject to risk, including possible loss of principal.