Ask Stacy: Should a 22-Year-Old Have an IRA?

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Today’s reader question is about retirement accounts. Specifically, whether a 22-year-old who inherited one should let it ride, or take the money and run.

Here’s the question:

Hi Stacy,

My 22-year-old son is about to inherit just under $50,000 as a result of being named as a beneficiary to an IRA account from my recently deceased mother. Her financial adviser has strongly recommended he simply roll the money over into an IRA account in his name that he won’t be able to access until he’s 59½.

While I can see the benefits of reinvesting that money, I’m just not convinced that it is his best option. What are some other shorter-term investment options, five- to 10-year plans, that you would suggest?

Much appreciated! — Sue

First, Sue, I’m sorry for your loss.

When my father died a few years back, he left some money to me, my older sister and my niece, who was about 25 at the time.

I salted my money away, and as far as I know, so did my sister. My niece, on the other hand, used most of hers to supplement her meager income, although she did use the last of it for a wise purchase: a small house, which she bought cheap during the housing bust.

If I still had them, I’d share the emails I sent to my niece practically begging her to invest her inheritance rather than spend it. But now it seems I have another chance with Sue and her son.

Inheriting young is like being born rich

Imagine that when you were 22, you were handed the opportunity to have $2.2 million at age 62.

I’m not talking about working, scrimping and saving. I’m talking about just being handed an extra check for that amount on your 62nd birthday. Wouldn’t that be nice?

That’s the opportunity Sue’s son now has. If he earns 10 percent annually on that 50 grand, and never adds a penny, 40 years from now it will have grown to $2,262,962.72.

While $50,000 isn’t a game-changer, $2.2 million is. And while I obviously don’t know what Sue’s mother had in mind when she left that money to her grandson, I’ll bet she hoped it would one day make a significant difference in his life.

Here’s the bottom line: Being born so rich you never have to worry about money would be ideal. But the next best thing is having the opportunity to avoid worrying about retirement. Sue’s son has that opportunity, and he should seize it by leaving that money alone to whatever extent possible.

Inherited IRAs are complicated

The rules surrounding inherited IRAs are complex. If you want to read about them in mind-numbing IRS-speak, begin on Page 36 of IRS Publication 590.

Your options for an inherited IRA depend on the type of IRA (Roth vs. regular), whether the person you inherited from was over 70½ when she or he died, the ages of other non-spouse beneficiaries, and other factors.

You can read more about your options, including rolling the IRA over into a special IRA, by reading “How to Inherit an IRA” from CBS MoneyWatch. Warning: Although this article is light reading compared with IRS Publication 590, it’s still no walk in the park.

You may be best off talking to a tax professional. But the gist is, there’s more to inheriting an IRA than “simply roll[ing] the money over into an IRA account in his name.” If their financial adviser doesn’t understand that, they need to find one who does.

Leave it in an IRA as long as possible

While the mechanics are complicated for IRA beneficiaries, one likely option will be using an inherited IRA beneficiary distribution account, or IRA BDA. This is essentially an IRA rollover. If he’s eligible for that option, Sue’s son should use it.

Leaving as much as possible within an IRA offers several advantages:

  • Earnings compound tax-deferred. Until they’re withdrawn, no taxes are due on earnings in a traditional IRA.
  • No penalty. If he takes excess distributions from the IRA, Sue’s son will pay a 10 percent penalty on the amount withdrawn.
  • No taxes. Take a distribution and you pay taxes on the money as if it were ordinary income.

In short, the only time to make withdrawals from an IRA prior to age 59½ is when you have no choice. Inherited IRAs typically do require distributions before then, however, so Sue’s son will likely be forced to take money out anyway. But he should keep it to a minimum, and immediately put any money withdrawn back to work elsewhere. 

Don’t confuse an IRA with a lack of flexibility

Keep in mind that an IRA isn’t an investment. It’s an investment account. While it’s true that you can’t withdraw money from a regular IRA whenever you want without taxes and perhaps penalties, as long as it remains in the account, you can buy, sell and invest it however you like, as often as you like.

For example, you can buy stocks. That’s where I got the 10 percent rate of return I used in the compounding example I provided above. Depending on which index you use, that’s about the average annual return for stocks over the long term.

Of course, stocks involve risk. They don’t go up at a steady 10 percent per year. Because of their volatility, they’re best for those with the time to ride out the ups and downs — for example, 22-year-olds.

Avoid commission-based financial advisers

While I agree with the recommendation from Sue’s mother’s financial adviser, I may not agree with leaving her son’s account with that adviser.

Despite the fact that I spent 10 years as a commission-based adviser — or maybe because of it — I don’t recommend these folks. Fee-based advisers are more objective than those earning commissions and are more likely to suggest investments that will benefit you, rather than them.

Once it’s set up, investing this account may not require a lot of advice. It’s not rocket science. For a leg up, read articles like “Ask Stacy: How Do I Invest in the Stock Market?” and “Why You’re Stressed About Your 401(k) — and How to Get Over It.”

Got a money-related question you’d like answered?

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The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.

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Comments & discussion

We welcome your opinions, but let’s keep it civil. Like many businesses, we reserve the right to refuse service to anyone. In our case, that means those who communicate by name-calling, racism, using words designed to hurt others or generally acting like an uninformed bully. Also, comments that include links to email addresses or commercial websites typically aren't posted. This isn't a place to advertise your business.

  • John Hughes

    When I was 27 a friend of my fathers that I worked with advised me to invest in our companies 457 plan. It is a lot like a 401 except there is no minimum age and you can not borrow against it. That advise was one of the best things that I ever did. I retired at age 44. I had $500,000 saved up in 17 years. Between my companies 401 and it I was able to leave the work force. YOU CAN NOT START TO EARLY.

  • ModernMode

    Exactly what I was thinking. Only high risk would pay that now.

  • davessworks

    The advice given here is excellent. When my mother in law passed her IRA was split two ways between her two surviving daughter It was distributed in 2009. One daughter immediately liquidated the assets and paid the tax due. The other, my wife, set up an IRA BDA account and has seen 135% return. Each year she makes the RMD (required minimum distribution) which is approximately 2 or 3 percent of the value of the account (and changes each year according to a predefined table).

  • davessworks

    See above comment. Depending on your age and tolerance for risk there are plenty of opportunities but it is wise to look at your financial situation holistically and invest accordingly.