I've often wondered why high schools require classes like algebra and geometry ... but they don't even offer a class on how to manage money or prepare for retirement! Although Ken and I are both college graduates with management degrees we've had to teach ourselves most of the basics on how to prepare for our future.
While I'm far from an expert, I have learned some basics of retirement accounts. Since Ken and I are self-employed, I don't know much about opening up anything through an employer. However, if you have that option you should take advantage of it. If you're lucky enough to have an employer that will match it ... that's a no brainer!
Everybody should have a retirement account! Even if it's just $40 per month ... believe me it's better than nothing and it will add up. Just have the money automatically withdrawn from your checking account, and don't think about it. If you're realistic with your monthly contribution, you won't even miss it after a while. The money is not at risk, and these days you could expect to make around 4% interest, which isn't bad compared to CDs which don't even pay 2%! When opening a retirement account, there are two kinds to consider: a "Traditional" IRA and a "Roth" IRA. The main difference is when you pay the taxes ... you didn't think you could avoid that did you?!
Basically, the money put into a "Traditional" IRA is not taxed (you can deduct it from your income), but when you "cash out" later it is taxed at that time. With a "Roth" IRA, the money put into the account is not deductible, but when you take out the money later you won't have to pay taxes on it.
Anyway, I would think that a "Roth IRA" would be the best bet for the average income earner. My reasoning is that if you put in $100,000 (just a random figure) over many years and paid taxes on it, then imagine that when you "cash out" you have $400,000 (random figure) which you can get tax free ... that's a pretty big savings! There are different ways of looking at all of this, and if you need some tax deductions, a "Traditional" IRA has its benefits. There are also limits on the amount you can contribute every year, but I don't know the exact amounts.
What if you have a "Traditional" IRA and you want to switch it to a "Roth" IRA? Well, you can "roll over" into a Roth, and the money rolled over will be considered income on your tax return. After that, you won't have to pay any more taxes on that money! Since a "roll over" is considered income, when you choose to do this should be a consideration. If you choose to make the "roll over" during a year that you did not earn much income, then you may still not have to pay taxes (or not nearly as much) after your standard (or itemized) deduction and exemptions.
One other thing, if you have to take out some or all of the money (from Traditional or Roth) before the age of 59 1/2, then you may be a charged a 10% penalty. Again, depending on when you choose to do this and your annual income, this may not be that big of deal because your deductions and exemptions may help offset this.
I hope this information is helpful, and if I could just get a few of ya'll to go open a retirement account ... then I'm happy! It's never too late, unless you are 70 1/2 or older ... than the IRS says it's too late to contribute to a "Traditional" IRA, but not a "Roth". I hope I gotcha thinking, and you can read this IRS link to get more information on the rules.
Food for thought ... don't count on getting anything from Social Security! We'll be lucky if there's anything left when we are finally able to get what we contributed for so many years. Ahh, I feel my blood pressure rising on this thought ... I'll just leave it at that!
Hasta luego ... until then. Mid-Life Cruising!
*For those that missed the other posts of this series, check them out below:
- Frugal Fridays - The Rest Stop! Frugal Fridays - The Internet
- Frugal Fridays - Goodwill Frugal Fridays - The Day After
- Frugal Fridays - Happy Hour! Frugal Fridays - A Little Patience
- Frugal Fridays - An Almost Free Vacation! Frugal Fridays - Free Music!
- Frugal Fridays - The Class Room Frugal Fridays - Free Workout Videos!
- Frugal Fridays - Free Corona Frugal Fridays - Bring It!
- Frugal Fridays - Credit Cards!