Young couples looking to establish retirement savings sometimes turn to Roth individual retirement accounts to allow their money to grow over the long term. New couples are faced with many uncertainties, but the ability to withdraw your contributions at any time from a Roth IRA makes it easier to commit funds to retirement. Exchange-traded funds, called ETFs, are efficient vehicles for diversified investment and are a reasonable addition to an IRA. Your IRA must be self-directed so that you can choose which ETFs to buy.
You deposit post-tax dollars into a Roth IRA. Because you have already paid the tax on the money, you are free to withdraw your own contributions at any time without penalty. There are restrictions on withdrawing the money you earn within a Roth IRA. If you withdraw earnings within the first five years after funding the account, or before you reach 59 ½ years of age, you may be subject to taxes and penalties. There are a few loopholes that may allow you to escape penalties — Internal Revenue Service Publication 590 spells them out. Also, check out IRS Form 8880 to see if you qualify for a special tax credit that Congress has granted to IRA contributors.
An ETF is a basket of securities, usually stocks or bonds, that may be tied to a particular index. These indexed ETFs simply try to replicate the returns on the associated index. For instance, you can buy shares in an ETF that replicates the S&P 500 stock index. For retirement investing, you buy and sell ETF shares just like regular stock shares, through a brokerage account within your IRA. The value of each share is closely related to the current index value, but may deviate a little due to supply and demand for the ETF shares.
You can select ETFs from a wide variety of dimensions such as geographies, industries and investment styles. Some ETFs provide wide diversification while others may have a more narrow focus. You can buy and sell ETF shares freely throughout the trading day. Open-end mutual funds do not provide intra-day trading, as you must buy and sell shares through the mutual fund company after the trading day has ended. Thus, ETFs give you the ability to quickly respond to news events that you lack if you instead use a mutual fund.
While the fees for most index ETFs are quite low, you will have to pay a brokerage commission whenever you buy and sell shares. If you are an active trader, these costs can add up. You also have no guarantee that an ETF will mirror its index, although the overall track record of ETFs in this regard is good. ETFs do not help you with market timing, whereas many mutual funds have that ability. An ETF will normally stay 100 percent invested at all times, even in bear markets. Mutual funds can go to cash when the going gets rough.
- The Roth Revolution: Pay Taxes Once and Never Again; James Lange
- Exchange-Traded Funds For Dummies; Russell Wild
- Ponzi Schemes and Investment Fraud: How to Beat Ponzi and the Crooks 98% of the Time; Paul R. Hamilton
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.