Ask Money

A stipend and a Roth

Chris Farrell Aug 24, 2011

Question: I am a 26-year-old PhD student in Chemical Engineering. I have no debt, and I receive a stipend from a fellowship. I save about $800/month, but right now nearly all my savings are either in CDs or in a low-interest savings account. I was thinking about putting some of my savings in either a Roth IRA, or in bonds (which I have to admit I’m confused how to research). But I’m hesitant about both because of the swings in the stock market recently. Furthermore, I expect that in two years I’ll be making at least $95k/yr, which might put me near the limit for Roth IRA contributions in a few years, so I don’t know if it would be worthwhile to start one now. Kathryn, Minneapolis, MN

Answer: My sense is that you’ll do better for now keeping the money safe in savings. It’s great that you’re putting aside that much every month. The money will be there to help you pay for your transition from graduate school to a job, especially if your career involves a move to another part of the country. For an investor with a time horizon of 5 years or less I would focus on keeping principal safe.

I would be wary of investing in bonds at this point. For one thing, bond yields are so low that you would barely make anything off the investment. For another, at some point (I hope) the next move in interest rates will be up. You could quickly show a paper loss since bond prices and bond yields move in opposite directions.

You’re studying a lot in school and I doubt if you have much time for additional research. A sound guide if you want to go into depth on investing, but still enjoy a good read is the investment classic, A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Completely Revised and Updated) by Burton Malkiel. He also has a much shorter and to-the-point guide, The Random Walk Guide To Investing.

I’ve held off on your Roth-IRA idea for a reason. It’s smart.But you probably can’t do it.

Contributions to a Roth are funded with after-tax dollars. It’s a safe bet that your tax rate is low right now. However, considering your graduate degree you’ll probably be in a higher tax bracket during retirement. The tax free withdrawal of earnings from a Roth when you’re older will be extremely attractive to you.

Another benefit: You can always withdraw contributions–not earnings–from a Roth without tax or penalty if you need the money in a pinch.

Problem is, a Roth must be funded with earned income. Most fellowships, scholarships and stipends don’t come with a W2. They don’t count as earned income for the purposes of an IRA. However, I would open up a Roth if your stipend comes with a W2 or if you have some other source of earned income during the year. I wouldn’t worry about how long you’ll be able to fund a Roth. It would still be a useful retirement savings vehicle for you.

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