My daughter and I had a conversation last week that took me down memory lane. Trying to be a good parent, my first goal was to help her avoid the mistakes I made. She was wondering whether it was worth her time to start in individual retirement account, or IRA, now at age 19. My answer was short and sweet:

HELL YES!

I was bit older but in my mid-20s when I faced the same question. Like an idiot, I listened to my parents who had no relation to life and the cost of living in the U.S., both having been born in other countries where living was cheap or the state provided for the elderly, ergo no need to save. Both advised me I was too young to worry about those things and my focus at the time should have been entirely on getting a better job and more income. While that advice was logical, it completely ignored the reality of what would happen financially to me some 30 to 50 years later. So that's where I'm at now, in my parents shoes, and being asked the same question by my kid.

What I Learned Getting Older

And my answer is the opposite. Start early, save hard, and save smart. IRAs are an incredibly useful way to save for retirements tax free or tax-deferred, depending which one you choose.

In the U.S., the two main choices are the Traditional IRA, which allows you to save until 73 1/2 pre-tax monies. This means you can divert your paycheck money to the account without tax hits, and pull it out later when you're older and in a lower tax bracket earning less in retirement. In the meantime, depending on the IRA, you can invest without tax hits, again only paying taxes at the time of withdrawal (ergo tax-deferred).

The Roth IRA, on the other hand, is for funds after paycheck taxes that you save in an IRA, but it can also be tax free. What you earn and grow in the IRA isn't taxed again, including the gains, ergo a tax shelter. Depending on the account, a depositor can invest in a variety of choices with the Roth IRA, grow that money, and build an nest egg for later years. 

Caps and Catch-Up Years

Both IRA types are capped on the amount that can be deposited, but it gets bigger the older you get closer to retirement. The base annual deposit allowed is $6,500 and, if over age 50, it's $7,500 per year. These increases are known as "catch-up" periods to help build more savings for retirement. Why would the government do this at all? Because IRAs help avoid the government having to bail out people for everything in retirement if they don't save at all. Not a dumb idea considering how much government social programs cost already.

Here's My Advice Now

So, back to my daughter, who is just about to turn 20 herself, starting now is ideal. What she puts away under the cap, currently about $6,500 a year as of 2023, can compound and add up. If she sticks with it, the base amount alone in 40 years would be $260,000. Add in interest, compounding and investing, it could, in theory be as much as $500,000 to $1 million by the time she needs the funds. Not a bad strategy. But IRAs are not an auto-saving tool; you do have to manage the funds actively in the IRA to make them gain well. Fortunately, people can also move funds from one IRA account to another if its the same type to take advantage of investing options (this is known as a "rollover"). So if your bank only offers a savings account IRA, an owner could move their IRA funds to an IRA account with a broker who offers mutual funds and stocks for better investment returns. It's really back to understanding risk and long-term savings goals. 

The big restriction is conversion from one IRA type another. Generally, this applies to converting Traditional IRA funds to Roth IRA funds. If one does so, there is a tax hit at the time of conversion. That tax hit charges based on the person's income tax bracket at that time. So it makes sense to do a conversion in a tax year where a person is not making much income, i.e. retirement. Alternatively, the person can just wait and withdraw the funds when needed, with minimum withdrawal amounts required starting at age 73 1/2.

So again, if you're a young person considering an IRA, just do it. Either type is a smart idea, and you can start a Roth IRA if you just have $50 or $100 sitting around already in your pocket or regular savings account. You'll thank yourself for being smart years from now. Personally, I mentally kick myself in the rear for not doing the same.