In Part II of the video series, we will talk about just how one should start a Roth IRA. Roth IRA’s are an essential tool to have when it comes to retirement planning. The money you place into your Roth IRA and the earnings that accumulate over time are never taxed. When you reach your retirement years, 401k’s, pensions and social security are all taxed. This is why it is important to have a non-taxed account to supplement your retirement years. Ramit explains Roth IRA’s below and where you can begin funding your very own account.
The shifting retirement landscape has come to the point where companies rarely offer pensions for employees anymore. Instead, 401k plans are the preferred choice. Contributing to your employer-sponsored 401k plan to get the full company match is a given. If they contribute 50 cents on the dollar for the first 6% then you put in 6% of your paycheck and the employer contributes 3%. A total of 9%. Not too shabby.
Contrary to many news outlets, companies are handing out raises to employees. It could be in the form of an annual 3% raise. A promotion can often times carry a raise of 6% to 20%. No matter how big or small the raise is, you SHOULD consider raising your 401k contribution beyond the full company match.
It is the end of your company’s fiscal year and they award you a 3% raise (this is how employers make sure their employee salaries keep up with inflation). Let’s say you contribute 6% of your paycheck and the employer matches you 3%. You have a total of 9% of your paycheck being contributed to your 401k. If you make $5000 a month this equates to a monthly contribution of $450. If you were to take your 3% raise, increase your 401k contribution by 2%, a total of 8% that YOU are contributing, and add in your employer’s match of 3%, you now have a total of 11% of your paycheck going to your 401k. Now, instead of having $450 a month deposited into your retirement account, the amount leaps up to $550 a month.
Adding 2% of the 3% raise to your 401k contribution still leaves you a little, 1%, increase to your paycheck. You won’t miss the 2%. Why? Because you have already been conditioned to get by on the money you were currently earning.
Small raises to your 401k contribution can pay dividends later in your retirement life. The following link shows you just how much a small increase now can pay you much more in your retirement years.
In his plan for the 2016 budget, the president and his administration are seeking to disrupt the current retirement process. A number of retirement topics were mentioned such as Social Security, the elimination of a “back door” Roth, and a cap on the amount eligible in a person’s retirement accounts.
For the subject of this post, I will discuss the president’s plan to limit the amount held in retirement accounts for an individual. Presently, an individual can have an unlimited amount in retirement accounts. This includes employer-sponsored 401k’s, traditional IRA’s, and Roth IRA’s. The only limitations currently imposed on retirement accounts are the amount you can contribute. This includes$5500 ($6500 for people over 50) for IRA’s and $18,000 ($24,000 for people over 50) for 401k plans. These limitations are currently set so that individuals don’t stash all of their retirement savings in tax-free or tax-deferred retirement accounts. The government has to make its money somewhere.
The 2016 budget proposal would now not only put a limit on the number of contributions you can put into a retirement account, but also on the amount held in your various retirement accounts. The proposed limit: $3,400,000. For a younger person saving for future retirement, this amount might seem astronomical. However, I am here to tell you that it is not. Granted a lot has to happen for this limit to take effect. It has to be voted on and passed, and then I would assume the government would adjust this number to reflect inflation, roughly 3% a year. If, and again this is a big if, this law were to be put into place it would impact roughly 10% of 401k plan participants according to Forbes.
Take the proposed limit on retirement accounts: $3,400,000 and adjust it for inflation of 3%. In 40 years this inflation adjustment amount would be approximately $11,000,000.
Mike is a 25-year-old with $20,000 in retirement assets. This includes an employer-sponsored 401k plan along with a Roth IRA. Mike will contribute $18,000 a year to his 401k and get an employer match of $3,000. He puts in $21,000 a year into his 401k. Additionally, he contributes the maximum $5,500 into his Roth IRA every year. Mike spreads this amount out evenly over the 12-month year. When Mike turns 50, he contributes the new limit, $24,000 in an employer-sponsored 401k with a $3,000 match and $6500 in a Roth IRA. Assuming Mike’s portfolio returns 10% a year, Mike will have over $15,000,000 in his retirement accounts, more than what would be allowed. He would then have to divert some of those funds to a taxable brokerage account or be forced to spend it.
Sure, the example of Mike listed above is an outlier. Many of us can only dream of having so much set aside for retirement. The fact is that some people DO! We can agree this would be a good problem to have, but nonetheless a problem. Are you aggressive enough with your retirement planning that you have to worry about this law possibly being passed? I am! And for that reason, my vote is against it.
You get a job with a company that offers a 401k with a match. What do you do? You do what you’ve been told to do. You contribute what you need to get the max contribution from the employer. For me, I contribute 6% and get a 3.5% match, totaling 9.5%. I am nearly saving 10% of my salary in my early 20’s. I’m doing a good job of preparing for retirement right?… Well yes and no. ALWAYS, I repeat ALWAYS, contribute what you need to your 401k to get your company match. It’s FREE MONEY.
This is where I will tell you about the easiest way one can double his or her retirement income. It is through a Roth IRA. You see a 401k is pre-tax money, so you will pay taxes on your withdrawals in retirement along with whatever social security you are receiving at the time. Combine social security and your 401k and you will have only 75% (assuming a 25% income tax bracket) of the income you receive during retirement. A Roth IRA allows you to pay taxes on the money now, so regardless of what tax bracket you are placed in the future you can keep all of the income you withdraw!
Check out the spreadsheet I have attached to truly see how a Roth IRA can double your retirement income. Keep in mind also with a Roth you never owe taxes and with your 401k you will.
Actionable step for the day, set up a Roth IRA!
To project your retirement income with a 401k and a Roth IRA, simply enter your salary into the cell along with your contribution and your employer match and watch the pie chart on the left shift! Consider increasing your 401k contribution at work for more income in retirement.
The older we get the less “stuff” we get for Christmas. As kids, our Christmases were often filled with various toys and gadgets. However, once you reach your 20’s you tend to want bigger items such as iPads, new cell phones, and money.
I gifted unto my sister this year what I consider to be the perfect financial gift. It was a check worth $200. Now, most of the time when we get a check for Christmas or our birthday we think of what we could possibly buy with that money. This check was different. I wrote out the check, but I did not date or sign the check. The check is currently worthless. Under the “For” spot on the bottom left part of the check I wrote: “Roth IRA”. The check was given unto my sister with the stipulation that it be used as funds to go towards her opening a Roth IRA. When she decides to gather up another $800, she will have $1,000 to put towards a low-cost index fund through Vanguard, and I will sign and date the check. This Roth IRA money will aid in her retirement goals many years down the road.
I would like to think that this gift can one day make her a MILLIONAIRE, and it can. If she were to open an account with the $1,000 needed and put in the maximum contribution allowed to a Roth IRA, given an 8% annual return on her investment. She would have an account balance of well over $1 million dollars by the time she is just 60!!!
Maybe you received some money for Christmas or recent birthday. My challenge to you is instead on spending it frivolously on the latest iPad or TV, open yourself a Roth IRA. Vanguard offers low-cost mutual funds that can be started with as little as $1,000. Be diligent and stay the course, you could turn some Christmas cash into a million dollars!
You might say it’s your financial advisor, your parent, a relative or maybe even a mentor who has had great financial success.
Your best friend when it comes to investing is: Compound Interest
People who are new to investing often wonder what is compound interest, or why is compound interest important. I’ve touched briefly on the subject of compound interest in a past post but I feel it is so vital to creating long term wealth that I am circling back to it again.
Money can be made and lost. However, time cannot. Each of us has only a finite amount of time here on Earth to build up a financial wealth. Mr. Time is your next best friend.
Check out the following article which shows a visual representation of how Compound Interest and Mr. Time can work together to create a substantial amount of financial wealth for oneself.
A recent survey completed by Fidelity Investments showed that approximately 1 in 3 people who were changing jobs touched their old employer’s 401k. Cashing out your old 401k will cause one to pay income taxes, along with penalty taxes if one is not of age.
Touching this precious “Retirement Money” takes away from the money’s potential to compound upon itself, accelerating growth in your retirement account.
How to avoid the penalty and current income taxes on an old employer 401k?… Roll it over into a traditional IRA. This will give you the same preferential tax treatment that your old employer plan had and continue to keep you on track towards retirement.