Why there's never been a better time for millennials to contribute to a Roth IRA

Financial experts have long considered Roth IRAs ideal investment vehicles for young workers. And with tax rates as low as they're likely to be for the foreseeable future thanks to the 2017 Tax Cuts and Jobs Act, there has never been a better time to contribute to one, experts agree. Especially because it is almost certain that tax rates will eventually increase.

Roth IRAs are the inverse of traditional IRAs: You contribute money after you have paid taxes on it, and your contributions and earnings can grow tax-free, assuming you follow the withdrawal rules. You lock in your current tax rate when you contribute, which means those currently in lower brackets, like young people, benefit the most.

"If tax rates do go up, which I think is a good assumption, the Roth becomes even more attractive because of its tax-free nature," says John Gugle, a certified financial planner. "That means tax-deferred money, like in a 401(k) or 403(b), is going to get hit harder."

So you are getting more for your money with a Roth.

Roths are particularly valuable for millennials and other younger workers, who will likely increase their earnings — and move into higher tax brackets — over time. If you start contributing when you are young and have decades before you touch the money, the tax benefits of the Roth will keep compounding.

"That's the thing about the traditional 401(k): You're given the tax benefit now but from here forward, all that growth, that compounded appreciation, is taxed," Gugle says. "Whereas if I'm in my 20s and I put that money aside and I'm not going to touch it for 20 to 30 years, that growth is not going to be taxed, which to me is the best deal."

But it is not just the potential tax savings that makes them ideal investment vehicles. Because contributions can be withdrawn at any time, tax- and penalty-free, they can be used as a secondary emergency fund. If you have only a 401(k) or IRA to tap into in an emergency, then you will have to "pay" an additional 20 to 25 percent of the total when taxes and penalties are taken into consideration.

That said, Gugle warns against borrowing from your Roth IRA if at all possible so that you can actually benefit from the compounding returns over time. "You've put the money in there, why would you take it out? That's what's going to grow," he says. But the account does offer some protection, if you absolutely need it.

Contributing to a Roth IRA in addition to a 401(k) or other tax-deferred account, assuming you can afford to do so, adds some diversity to your retirement income streams, which is always a good idea.

Another benefit: You actually have 15 months to max out your $6,000 contribution limit for this year. The government allows you to contribute up until tax day, meaning you have until April 2020 to make contributions for 2019. That gives earners some flexibility, and it means right now you can effectively go back in time and max out your 2018 contributions if you haven't already, says Luis F. Rosa, a certified financial planner (the contribution limit for 2018 was $5,500 for those under 50).

Plus, if you are planning to be a homeowner one day, you can take advantage of the five-year rule, says James Bayard, a certified financial planner.

"The rule states that after five years from account establishment you can withdraw your contributions and earnings penalty free at any age if you are using the proceeds for a first-time home purchase, up to $10,000," he says.

You can set up a Roth IRA at traditional financial companies like Fidelity and Vanguard, or with a robo-advisor like Betterment. Roths work like a 401(k) or other retirement vehicle: You open the account and then use your money to invest in index funds, individual securities, real estate, etc.

Make sure you pick your investments when you make your initial contribution. Otherwise, you have opened a glorified savings account, without even the benefit of the better interest rate you can get with some high-yield accounts.

The ability to contribute begins to phase out for single individuals with a modified adjusted gross income of $122,000 per year for 2019, and completely disappears for those earning $137,000 or more.

But if you're a high earner, you can take advantage of the backdoor conversion option. To do this, you can contribute to a traditional IRA and convert it into a Roth. You will pay income taxes on the conversion amount, though, and you will need to move the funds within 60 days to avoid any early-withdrawal penalties, according to RothIRA.com.

Assuming you fall in that category, and assuming you can, Gugle says you should take advantage of the backdoor conversation option every year. "If you're at a lower income level it might be hard to scrape together $6,000 to put into your Roth IRA, and $7,000 if you're over 50, but if you have higher income and can do it, it begs the question, why wouldn't you?" he says.

And if you have the ability to contribute to a Roth at all, says Gugle, then there is no better time to go for it.

"The Roth IRA is one of the greatest tools investors have to save and grow their money," he says. "It's the most powerful tool in our tool kit."

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