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If you can afford to contribute—or have a parent or grandparent who can help—opening an individual retirement account (IRA) while you're still in school can be a great way to start saving for your future. As long as you've earned money during the year and the contribution doesn't exceed IRS limits, saving even a little bit now could pay off nicely when you're ready to retire.
Here's how IRAs work for students and whether saving for retirement might be a smart move now.
Can I Start an IRA as a Student?
You can open an IRA as a student as long as you've earned income during the year. Earned income does not include your allowance, student loan money, gifts or investment income; it's money you earned doing work. Your IRA contribution can't exceed the IRS contribution limit for the year—$6,000 in 2022. And it can't be greater than your taxable income. If you made $2,000 at a summer job, for example, you can't contribute more than $2,000 to an IRA.
Why Invest for Retirement When You're a Student?
Contributing to an IRA may not be a top priority during your student years. After all, many students don't have much left over after paying for tuition, textbooks and living expenses. But if you can swing an IRA contribution, you might be glad you did later in life.
Suppose you started contributing $100 a month to an IRA when you were 30. With an average annual return of 8%, your retirement account could be worth $206,780 by the time you reach 65. Not bad. But if you started investing the same $100 monthly at age 20, you could have $463,807 by the time you reach 65—more than double what you'd have if you waited until 30 to start saving. This is a hypothetical example, of course, and your mileage will vary. However, it's clear that starting sooner is better than later when it comes to saving for retirement.
Here's an additional benefit: By opening and funding an IRA now, you'll lay the groundwork for future savings. Once you're fully employed and have a steady income, it'll be simple to make an annual contribution, set up automatic monthly deposits and monitor and adjust your investments if you already have an open account.
When to Hold Off on Retirement Savings
On the other hand, funding an IRA doesn't work for every student.
Your student years are likely to be some of the lowest paying of your adult life. There's a good reason: You're focused on learning and completing your education, not maximizing your earnings at a job. Setting aside money for retirement during your student years can be a solid choice, but not if it causes housing or food insecurity, more student loan debt or credit card debt.
Do try to contribute to an IRA during your student years but don't despair if that's not practically possible. You can also get on track with contributions as soon as you graduate and start earning real money.
Should a Student Open a Roth or Traditional IRA?
You can open either a traditional or Roth IRA as a student. Each type of account has its pros and cons. Here are a few of the differences between traditional and Roth IRAs—and why a Roth might be a better choice for student savers.
| Traditional IRA vs. Roth IRA | ||
|---|---|---|
| Traditional IRA | Roth IRA | |
| Tax deductions now | Funded with pretax dollars: You deduct your contribution amount on your tax return. | Funded with after-tax dollars: No tax deduction in the year you contribute. |
| No taxes as your money grows | Grows tax-deferred until retirement: You won't pay capital gains tax or income tax on dividends as your money grows. | Grows tax-free within the account: As long as your money is in your Roth account, you don't pay capital gains taxes or income taxes on dividends. |
| Taxes when you retire | Taxed as income when you retire: Every dollar you withdraw in retirement is subject to income taxes. | Withdraw tax-free in retirement: Qualifying Roth withdrawals are tax-free in retirement. |
| Taxes and penalties on early withdrawals | Penalties for early withdrawals: If you take out funds before age 59½, you may pay a 10% penalty plus income taxes. Exceptions apply for college and first-time home purchases. | Some early withdrawals are penalty-free: In addition to exceptions for college and first-time home expenses, Roth IRAs let you withdraw your contributions (not earnings) tax- and penalty-free. |
Why a Roth IRA Might Be Better for a Student Saver
If you're a student earning part-time income, a Roth IRA might have advantages over a traditional IRA.
Here's why. Students typically don't pay high income taxes. In fact, if your income is less than $12,950 as a single taxpayer in 2022, you won't owe income taxes at all. For that reason, being able to deduct a traditional IRA contribution from your taxes doesn't offer much of a benefit: You don't need the deduction.
If you fund a Roth IRA instead, you'll forgo the tax deduction this year but will enjoy tax benefits for as long as you have your account. Earnings in a traditional IRA are tax-deferred: You don't pay taxes on your earnings as they grow but do pay income taxes on all your withdrawals when you retire. With a Roth, you've already paid taxes on your contributions, so you'll never pay taxes on your earnings—not when you realize gains, not when you collect dividends and not when you withdraw the money in retirement.
How to Open an IRA As a Student
Opening an IRA is simple. If you're 18 or older, you can open your own IRA account with the financial institution of your choice. If you're under age 18, you'll need a parent, grandparent or other trustworthy adult to open a custodial account on your behalf. They'll manage the account for you until you reach the age of majority in your state. A custodial IRA converts to a regular IRA at that point.
Follow these basic steps to open an IRA:
- Choose a provider. Investment firms, mutual fund companies, banks and credit unions all offer IRA accounts.
- Apply online or in person. You'll need a government-issued ID, Social Security number and employment information.
- Fund your account. If your income is regular, you can have money automatically deducted from your checking account every month. Otherwise, deposit a lump sum and add to it throughout the year as you can.
- Keep track of your income and contributions. Remember that your IRA contributions can't exceed $6,000 or your total taxable income for the year. You may want to wait until you know your year-end income so you don't over-contribute. You have until tax day the following year to make your final contribution.
Your IRA contribution is supposed to come from your earnings. However, your parent, grandparent, friend or family member can provide money for your IRA contribution as long as your total contribution isn't greater than your taxable income.
The Bottom Line
Opening an IRA while you're a student isn't essential, but doing so can give you a valuable head start on retirement savings. Establishing good money habits like saving for retirement, spending responsibly and maintaining good credit early in life can pay dividends for years to come. If you're a student and want to start building a solid credit history now, check out Experian Go™, which helps you establish your credit report and get a jump start on building good credit.