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Q. My daughter now out of college is working but her company does not offer a 401(k). She would like to start saving for retirement and wants to open a Roth IRA. She has $1,000 that she wants to start with and then she would contribute a small amount each month. She’s unsure of what investment it should go into. Do you have any suggestions?
— Dad

A. Congratulations to your daughter on her new job and for thinking about her retirement.

It’s never too soon to start saving and she is wise to consider an IRA with no 401(k) at her company.

Before getting to investments, first let’s consider what kind of IRA she should choose.

The key difference between a traditional IRA and a Roth IRA is the tax treatment, said Claudia Mott, a certified financial planner with Epona Financial Solutions in Basking Ridge.

The appeal of a traditional IRA for many is the ability to deduct the contribution against earned income when filing taxes each year, Mott said.

“Traditional IRAs require distributions (RMDs) to begin at age 72 while Roth IRAs have no such rule,” she said. “The RMDs are considered income and must be reported on your tax return if the contributions were deductible in the year they were made.”

In contrast, with a Roth, you can’t deduct contributions, but when you take the money out, it’s completely free of tax.

Mott said the decision on whether to open a traditional IRA or a Roth is often based on whether the investor believes future income tax rates are going to be higher than they are currently.

“For a recent college graduate, in the early days of a career, the likelihood is that today’s income tax bracket is lower than what it will be in the future,” Mott said. “This would tip the scales in favor of a Roth IRA.”

Mott said your daughter may want to consider investing her contribution in a target date mutual fund. These are also called lifecycle funds.

She said the funds are designed to be well-diversified by owning both domestic and international stock funds as well as fixed income bond funds, she said, noting that some fund families may also include other specialty investments such as REITs or commodities.

“The attraction of these investments is the fact that the allocation is managed by the fund company and will become increasingly conservative as the retirement date ages,” she said. “For those who are not comfortable with the allocation between stocks and bonds for their retirement date, a more conservative version of the fund can be purchased.”

She said for a young investor, a typical target date fund that corresponds to a retirement date of 2060 or 2065 will be 90% invested in stock investments with the remainder in fixed income.

They are offered by just about every custodian and mutual fund company that works with individual investors, she said.

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This story was originally published on Jan. 18, 2022.

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