Monday, March 2, 2009

Reason 10: Putting It Away in a ROTH IRA

After approximately two years of procrastination, I finally made the move and put some of my savings into a ROTH IRA. Hallelujah! It has been on my to-do-list forever, and I love being able to cross it off the to-do-list (yes, I experienced a list maker’s high!). Anyway, my real motivation to move my money was when I realized how much of paycheck was going to taxes. “What? All of that money is going to the government? Isn’t there a way to get some back?” So that is when I decided to take action and start the research….

First off, move your money into a ROTH IRA only after:
- You have paid off all of your credit card debt
- You have an emergency fund of at least six month’s living expenses

If you have extra money remaining start to save! Here is the pecking order for savings http://
1) Employer plan with a match
2) Roth IRA
3) Employer plan without a match
4) Traditional IRA
5) Taxable investment
6) Annuity

Now to illustrate the power of putting money away in an IRA, see scenario below:

Tim and Ryan are twin brothers who are 65 years old. 45 years ago (at the end of the year when he reached 20), Tim started an IRA and put $2,000 in the account at the end of each year. After 20 years of contributions, Tim stopped making new deposits but left the accumulated contributions in the IRA fund. The fund produced returns of 10% per year tax-free. Ryan started his own IRA when he reached the age of 40 (just after Tim quit) and contributed $2,000 per year for 25 years, making his last contribution today. Ryan invested 25% more money in total than Tim. Ryan also earned 10% on his investments tax-free. What are the values of Tim’s and Ryan’s IRA funds today?

Tim has $1,365,227. Ryan has $218,364. Ryan invested 25% more than Tim, but through the magic of compounded returns, Tim’s IRA fund is worth more than six times as much!

IRAs are easy to set up as I learned today! Don’t be intimidated by them as I was for the last two years. Once I did my research, it took me about ten minutes to apply for it online at

IRAs are Individual Retirement Accounts or in a simpler term a “bucket” that you place investments in. The purpose of IRAs is to encourage people to save for their retirement, by offering them a significant tax break. They are targeted toward working individuals – not the wealthy (income limits prevent them from participating), or trust fund kids (contributions have to be made from salary not inheritance, investments, etc). There are two types: Traditional IRAs and ROTH IRAs. With a traditional IRA, the money you invest is tax deductible now, but the money you pull out at retirement will be taxed at the then-current rate. A ROTH IRA, on the other hand, does not enable you get a tax deduction on the money you contribute now, but at retirement, earnings can be withdrawn tax-free. In other words, money in a ROTH IRA is taxed at the front end, money in a traditional IRA is taxed at the back end. Other facts on ROTH IRA:

* In 2008, you are eligible to contribute a maximum of $5,000.

* You can use a ROTH IRA even if you have a 401K or other retirement plan.

* You must make your contributions by the tax deadline each year (therefore I just made my contribution for 2008 as the deadline is April 15, 2009).

* You may withdraw your contributions at any time without penalty. If you attempt you withdraw your earnings before the age of 59 ½, they will be subject to taxes and a 10% early withdrawal penalty.

* You may withdraw up to $10,000 in earnings without penalty in order to buy your first home.

Many financial institutions offer IRAs. It is important to search for a company that suits your needs. You have three main options: a bank, a brokerage or mutual fund company.

Bank Option: This will be a good choice if you don't have much to invest or can not decide where to put your money. You often can open an account for as little as $100. Most let you invest in CDs or money market accounts, sometimes without an annual fee. Check for average rates.

Mutual Funds Option: This is a simple option as you leave the stock picking to the pros and spread your money and risk instantly across a large number of investments. You may start with just a single fund, but as the IRA grows, you will want to split it up into a number of funds with different investment styles.
*Many of these funds require a minimum initial investment of $1,000-$3,000.

Brokerage Firm: This is an option for more experience investors who want to select their own mix securities or choose from thousands of mutual funds.

After completing the research, I chose the mutual fund option and used I was able to apply online and transfer funds from my savings account into the ROTH IRA in a matter of minutes. Now after completing my research, my only regret is that I did not put my money into an IRA sooner! Please ask questions if you have any!

DISCLAIMER: While I do have a finance degree, I am not an investing expert, and I recommend doing your own research before making a decision.

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