Saving for retirement as a graduate student.

December 26, 2012 5:49 PM

I am a new graduate student and was hoping to put some money into a Roth IRA to start saving for retirement, but just read that contributions must be made from earned income and now I'm not sure if that is the best plan for my circumstances.

This fall I started a PhD program that provides fellowships without a requirement for teaching or research (I mean, there are TAships and RAships, but that's not what I have). Although I pay tax on the fellowship, the university does not withhold anything for retirement and I will not receive a W-2. My impression is that this fellowship cannot be considered 'earned income' for the purposes of funding a tax-advantaged retirement account. In 2012, I did make the minimum $5000 of earned income from work earlier in the year, so I would be able to make the maximum contribution for 2012, but then I wouldn't really be able to do anything with the fund until the distant future after I graduate and/or my funding runs out.

Given that I will have no source of earned income for the next several years, is it still a good idea to start a Roth IRA now, when I have the opportunity? If so, can I just use one of Vanguard or Fidelity's well-known products or is there some better option that I don't know about? I do not have good role models for financial planning in my family and feel very anxious about the possibility of making the wrong decision and being doomed forever. My partner suggested putting some of my savings into CDs but the rates look so discouragingly terrible that I feel there must be a better use of my savings. I saw some advice elsewhere on the internet encouraging graduate students to contribute in other ways to their long-term financial well-being (e.g., save aggressively for a down payment on a house or buy a car outright instead of financing), but I can't help feeling that the chance to start a Roth IRA now is something I should not pass up.

As for the rest of my financial picture, I owe several thousand in student loans, but they are all subsidized loans and the interest rate is very low (although not as low as my savings account's, of course). I don't have any other kind of debt, except for a hospital bill but that is interest free, too, at least for now. I do have an emergency fund in place, in addition to the $5000 that I am hoping to invest, but I do not have any kind of retirement savings (my lifetime SS contributions are laughably small and I have no company-sponsored 401k to roll over). My plan is to contribute $200 a month to whatever thing I go with and I would like the return to be more than the .10% I'm getting from my savings account but I do not have much time/energy/expertise available for keeping an eye on stocks and making frequent trades.

I've looked at a bunch of questions on retirement planning and dug through grad student forums for questions about finances, but I would still appreciate your advice. There is not really anyone I can talk to about this in my family and most of the people in my department are independently wealthy international students and I don't really want to talk with them (or really anyone with whom I have a professional connection) about my financial woes. Thank you!

posted by anonymous to work & money (7 answers total)

For graduate students (at least, those who are in their 20s) immediate flexibility is more important than long-term savings. Put your money somewhere you can get to it, like a savings account. Or use it to pay off your student loans if your emergency fund is sufficient to sustain you for at least 6 months, including paying your tuition and other educational expenses. If you lock up your money in an IRA and then your funding dries up, you will pay significant penalties to get the money back. Furthermore, your student loan interest is likely to exceed your rate of return for the IRA in the near future, and the loans cannot be discharged. You might as well pay them off as soon as possible.

If you decide to go with an IRA, I think Vanguard is probably the best company to go with. You should check with an accountant to see if it is legal to contribute your $5k.
posted by twblalock at 6:12 PM on December 26, 2012

I just finished a PhD program in the humanities -- we put away some money in my wife's IRA each year, but are raiding it now for a down payment on a house. My suggestion would be to put it in a savings account instead, perhaps (at most) to lock it up in a short-term CD. Things come up and in grad school the line between feast and famine can be pretty thin -- especially if you'll be going on the academic job market at the end of the process. You'll want to be able to access the money without significant hassle and penalty if it turns out you need it.
posted by gerryblog at 6:13 PM on December 26, 2012

Roth allows for access of funds that represent invested capital. So if you invested 1000 and ended up with 1200 through capital gains, you can withdraw the original capital sum (1000) with no early withdrawal penalty.
posted by Hurst at 6:23 PM on December 26, 2012 [1 favorite]

You are correct regarding educational stipends and compensation income. For planning purposes, there are several other sources of compensation possible. Many institutions will allow you to do additional TAing for cash during research time, treated as wages. Since it sounds like you are in science, you may be switched from direct grant-supported stipend to payed as an employee at some point. Additionally, if you marry your partner and file jointly, her/his compensation can count.

If you are going to save the money anyway, as stated above you can withdraw the roth contributions later without penalty in a pinch. Some banks will have roth ira cds. Vanguard and the like will allow you to have any kind of asset you want in your roth, including money market funds (basically a savings account), but check on minimums and such. One thing that you gain by contributing now is than your yearly limit is use it or lose it. However, if the cash can help you avoid expenses (car example, buying things that last longer) that is also tax free savings.
posted by a robot made out of meat at 6:52 PM on December 26, 2012

In favor of Roth:

TAX DEFERRED GROWTH! (must be emphasized!!)
Can withdraw from the principal if needed
Much less likely to need to withdraw anything if you have a good emergency fund

And I'm going to have to disagree with anyone who says that "you aren't likely to get better interest rates than what you're paying on the student loans" in your IRA. I'm not sure what they're invested in, but I'm invested in Vanguard standard retirement index funds and target retirement year funds and my personal rate of return for the past year is 12.1%. For the past 5 years it's 6.8%. So yeah, I'm glad I didn't leave it languishing in some savings account somewhere!

You are not 'doomed forever' regardless, you can always roll the Roth over into something else in the future if you want to.

If I were you I'd put in the $5K you can now into the Roth, and just invest it and then during grad school, save what you can in whatever other reasonable interest-bearing account that you can. Since you're talking a small amount of money, may I recommend rewards checking accounts? They earn a much higher level of interest than regular savings accounts or even money markets/CDs these days, and all you have to do to get the higher rate is usually 1 direct deposit and usually ~10 debit transactions with the account monthly, or something like that. There's usually a cap like $20K for the high interest rate, but if you're only saving $200/mo for the duration of grad school you won't hit that. Anyway, grad school isn't forever and you won't be sorry that you started a Roth IRA while you were feeling gung ho about it. I started a Roth IRA before med school and could not contribute for those 4 years, but now I sure am glad I did it... (even though I only had about 5 years of income total before my income exceeded the contribution limit, it's still great to have the money in there growing!)
posted by treehorn+bunny at 8:19 PM on December 26, 2012 [1 favorite]

I'm in more or less the same situation as you (except I'm a couple years farther along in my program).

In addition to the already-mentioned ability to withdraw the principal from a Roth IRA, you can also avoid the early withdrawal penalties if you are using the money for certain purposes, including the down payment on the purchase of a (first) home or medical bills. Educational expenses might also be on the approved list. So you do lose some flexibility by putting the money into a retirement account, but it is still there for many major life expenses.

Thanks to the Fed's insistence on keeping interest rates at or near 0, my understanding is that traditional bank products (checking, savings, money market, even CDs) are not going to bear any meaningful interest for the foreseeable future. It's thus imperative to get retirement money into some kind of investment vehicle. The Roth has lots of advantages, as expounded already (and as evidenced by the fact that rich people have invented ingenious tricks to obtain them).

I'm not quite sure why you hesitate about "starting a Roth now." The money will be in there, growing, and you can start contributing to it again when you've got some earned income. On that note, it might be worth investigating side jobs that you can do in grad school in order to have earned income. I know several grad students in my program who have gotten paid from professors' grants for odd jobs (5 or 10 hrs/wk during the semester, or a summer's worth of full-time-ish work). As far as I know, these are earned wages, reported on a W2, and allow one to make IRA contributions.

The Vanguard "target date retirement" funds are the best option for retirement savings (IMHO). Vanguard is known for charging very low fees to its investors, and the target date funds are basically "set and forget": they start out in high risk/growth investments, and gradually move to safer ones as the target date is approached.
posted by dendrochronologizer at 11:39 PM on December 26, 2012

I would be able to make the maximum contribution for 2012, but then I wouldn't really be able to do anything with the fund until the distant future after I graduate and/or my funding runs out.

Given that I will have no source of earned income for the next several years, is it still a good idea to start a Roth IRA now, when I have the opportunity?

Yes, you can start a Roth IRA with your 2012 contribution even if you don't anticipate having any earned income for a few years. You can (hopefully) take advantage of the power of compound interest during the years you are in grad school.

If you are funding your Roth in 2013, be sure to specify that your contribution is for 2012. You mention some things about $5000 total and $200 per month, I'm not sure what you mean by that. There is a deadline for making Roth contributions for 2012, and you will not be able to continue to add more money for 2012 after that.

I'm not sure what you mean about not being able to do anything with the fund, but you would be able to change how the funds held in your Roth IRA account are invested (assuming you do not buy something that precludes that), or even move your Roth account to a different company.

Making your money less available to yourself is sort of the point of having a retirement account. I disagree with the posters who suggest you keep it easily available, if you really need money it's possible to take it out. Or, if your money woes get dire, you might be applying to something that does not count retirement accounts in determining financial need, and some states have certain protections on retirement accounts.

I wouldn't count on not having any earned income coming up, you might end up with an internship or doing some sort of consulting on the side, or even picking up a part time job at times, many grad students do.
posted by yohko at 11:20 AM on December 27, 2012