Expert: Paul Henneman - 10/9/2007

Question
QUESTION: I'm 20 years old and halfway through college.  Right now I have zero debt and have the discipline and means to save enough that by the time I'm between 40 and 50 I can maintain an early retirement.

Currently, my company does not have a 401k but I am slowly increasing my savings.  My problem lies in not knowing what to invest in.  I know I want to invest in mutual funds, but should they be inside or outside a Roth IRA?  Obviously the benefits of investing in a Roth IRA mean a tax-free deduction when I'm 59.5 years old.  However, I plan on retiring when I'm between 40 and 50.  And yes, I am aware of the 72(t) rule but I'm not sure if I would really want to maintain that consistent withdrawal all the way to 59+.  Additionally, since the current max distribution for Roth IRA's is $4,000 and will be $5,000 next year, should I really limit myself to only being able to contribute that amount, especially since it costs $3,000 to open a Vanguard Roth IRA.  Does this mean I can only open one mutual fund per year if I were to have those mutual funds in a Roth IRA and the minimum opening was $3,000?  OR I could just open mutual funds outside of the Roth IRA, have no maximum contribution limit (i.e. open as many mutual funds as I would like), BUT be penalized via the tax.  I know this sounds all very confusing but hopefully I made sense.  Basically it comes down to, "should someone who is retiring a full 10-15 years before they are 59 1/2 invest in a Roth IRA or should they just stick to normal mutual funds?"  Or maybe I should do a combination of both, that way I will receive even more money in retirement when I'm 59 1/2? Thanks!

ANSWER: James,
  Thank you for your question! Everyone would probably have a different take on what you describe in your question, but here is my two cents on the subject.
   You can not ignore the tax savings for the Roth Ira. It is huge over time. The way that interest compounds over time, by not paying taxes on the profits each year it is truly a massive difference down the road.  Plus, with a Roth you do not pay tax when you finally do access the funds at 59 and 1/2. I cannot say enough what an advantage this will be to you.
  I think that you really nailed the overall issue in your last few sentances. Consider investing the maximum on the Roth Ira each year, and plan to not touch it until you are 59 and 1/2. Then you should have a sizable amount.
  Whatever you can invest in over the current maximum of $4,000 a year for the Roth Ira ($5k next year), can go to individual accounts in preparation for retirement at your planned age of 40 to 50. This gives you two sets of goals. First, your individual accounts need to grow to the point where you can retire and fund your life style until you are 59 and 1/2. Then your Roth Ira funds will become available to you at no penalty, so smooth sailing from then on out.
  To sum up, YES, someone who plans to retire 10 to 15 years early should definitely invest in an Ira or Roth Ira. The tax advantages are just too great. You simply need to plan for other investments to hold you over until you turn 59 and 1/2 and the Roth Ira funds become available to you.
  Congratulations on thinking about this so early. You have a 20 year head start on most people, and yes, you have a very good chance of realizing your goals if you start this early. Keep at it, and please do not hesitate to follow up with me if I can be of any additional service.

Sincerely,
Paul Henneman
President
ValuEngine Inc
www.ValuEngine.com

---------- FOLLOW-UP ----------

QUESTION: Paul,

So I decided to take your advice and open a Roth IRA, but I'm a little bit confused.  I e-mailed my friend and asked him this question but I was too impatient too wait so I thought I'd ask you.  Here's my question to him.  A side note, however.  This question does not technically have to apply to Vanguard, it could be used for any company, but Vanguard is the company I have chosen to go with.

So a quick question for you.  The typical minimum to open a Roth IRA with Vanguard is $3,000.  However, I don't want to wait to save up $3,000 to open one.  That being said, it is possible for me to open a Roth IRA with the Vanguard STAR Fund (the minimum is only $1,000).  Once my Roth IRA is open with that fund, can I then contribute any amount to other funds within my Roth IRA (i.e. Total Stock Market Index Fund, International Stock Market Index Fund, S&P 500 Index Fund) and not have to pay that $3,000 minimum?  I guess my question comes down to "is the minimum only applicable when opening an IRA or every single time you want to open a new fund within the IRA?"  Because if the latter was the case, then I would only feasibly be able to open a maximum of 2 funds this year within my Roth IRA since the maximum contribution limit is $4,000 ($1,000+$3,000=STAR + S&P 500 Index).  

Thanks for the help.

James


Answer
James,
  Thank you for your question! It sounds like the minimum with Vanguard is $3,000 to open the Roth IRA, no matter which fund you choose. Most mutual funds have a 1 to 2 thousand minimum, not 3 thousand.
   There is a way around this. There are many good online brokerage services such as www.scottrade.com, www.etrade.com, www.ameritrade.com, www.FOLIOfn.com to name a few. Most of these have little to no minimum requirement to open a Roth Ira account. You could start with whatever you want now, and when the funds grow enough, then it is always possible to move your IRA account to a different service, such as Vanguard.

I hopet his helps! Please do not hesitate to follow up with me if I can be of any additional service,

Sincerely,
Paul Henneman
President
ValuEngine Inc.
www.ValuEngine.com