Saving for retirement on a part-time salary

(Money Magazine) -- Question: I'm a full-time student who has a part-time job at a community college. Can I start contributing to an IRA? -- Eiko, Atlanta, Georgia

Answer: Yes, you almost certainly can. And if you can swing it, you probably should, since contributing to an IRA early in life can be an excellent way to lay the foundation for a more secure financial future.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

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That's true, by the way, not just for someone in your position, but for high school and college grads starting new jobs, not to mention students with summer gigs.

Although the rules governing IRA contributions can get a bit convoluted (as this IRS publication makes painfully clear), the gist is that as long as you have earned income, you can contribute as much as you make in a given year up to a maximum of $5,000. People 50 and older can do an extra $1,000 catch-up contribution, but that's not going to apply to many college students.

So, for example, if you earn $5,000 or more from your part-time work, you can salt away the max. If you're paid, say, $3,000, then you can contribute up to three grand.

Just to be clear, the dollars you contribute to an IRA don't have to be the same dollars you earn. Let's say, you earn $5,000, but after expenses manage to put only $2,500 into the IRA. If you can come up with an additional $2,500 from other sources, such as savings or a cash infusion from mom, dad or a kind relative, you can throw that money into your IRA account to get you to the $5,000 limit. Any parents looking to help their kids parlay a summer job into a leg up on their eventual retirement security may want to keep this in mind.

That said, you should also know that an IRA is meant to be a long-term savings and investment vehicle. So you should fund that account only with money you're reasonably sure you won't dip into for many, many years, preferably not until you retire. An IRA isn't the place to put cash you might need for traditional college expenses like tuition, room and board, textbooks and late-night pizza runs. Nor should your IRA serve as an emergency fund you can turn to when unexpected expenses pop up. Ideally, you'll want to have a separate savings account -- or helpful parents -- for that.

But if you're in a position to be able to set aside some bucks for the very long term, starting an IRA at a young age is a good way to jump start your retirement savings effort.

For example, let's say you're 18 when you enter college and manage to put $5,000 a year into an IRA during each of your four undergraduate years.

By the time you're 65, those four $5,000 contributions alone would grow in value to just over $280,000, assuming a modest 6% return. Granted, that amount by itself isn't going to fund anything close to a lavish retirement. But combine that near three hundred grand with the other savings you accumulate during your career, and you've got a pretty good shot at a comfortable retirement.

Assuming you do want to go ahead and contribute to an IRA, you have to decide on what type. A nondeductible IRA is clearly the least attractive option, so for all practical purposes the choice comes down to a deductible IRA or a Roth IRA.

With a deductible, IRA, you get to deduct your contributions from your taxable income, which trims your tax bill now, plus you pay no income tax on investment gains as long they remain in the IRA. When you eventually pull money from your account, however, you'll owe tax at ordinary income tax rates on all withdrawals.

With a Roth IRA, by contrast, you get no tax deduction for your contributions, but assuming you meet the criteria, all the money you withdraw, including investment gains, is tax free.

As I've noted before, you can make a good case for either type of IRA. Generally, though, a traditional deductible IRA is a better deal if you think you'll be in a lower tax bracket when you pull the money out than when you put it in. The opposite is true for the Roth IRA. It's generally a better choice if you think you'll be in a higher tax bracket when you pull the money out than when you put it in.

As a college student working a part-time job, you're probably in as low a tax bracket as you're ever going to be, so I'd say you're likely better off going with the Roth IRA. A Roth IRA also has the advantage of allow you to withdraw your original contributions at any time without tax or penalty, which can be a plus should you need to tap your account earlier than you planned.

Besides, you'll likely have plenty of other chances during your career to set aside pre-tax dollars in 401(k) and other retirement accounts that will be taxed at withdrawal. So if nothing else, having access to tax-free cash in a Roth IRA is a good way to diversify your tax exposure and provide more flexibility for managing your tax bill once you retire.

So if you can afford to set aside some of your part-time earnings in an account that you're reasonably confident you won't have to dip into until after your career, by all means consider funding an IRA. Come retirement time, you'll be amazed at how much three or four decades of compounding without the drag of taxes can boost the value of however much you manage to put away.