Tuesday, August 12, 2008

Monday's Personal Finance Carnival

Being new to this whole blogging thing I entered the post on IRA's in a personal finance carnival being held on Monday. From what I understand the host blog reads through the submissions and chooses a few to post on their blog. The carnival is being held at Everyday Finance (http://everydayfinance.blogspot.com/) so go check it out (and wish me luck).

Quote

I forgot to supply a quote with my last post and I just came across this...

"The 19th century belonged to England, the 20th century belonged to the US, and the 21st century belongs to China. Invest accordingly.

-Warren Buffet at the Ben Graham Center for Value Investing

Monday, August 11, 2008

The LD on IRA's

My deepest apologies for not making a legitimate post in the last few weeks. Last night I was at a bar with a few friends and the topic of IRA's came up. A friend of mine had just opened a traditional IRA and didn't know the difference between what he had opened and a Roth. There is a BIG difference...

IRA = Individual Retirement Account

Traditional IRA - A traditional IRA is like any other account you would open at a bank or brokerage that allows you to invest your money with the exception that it is earmarked for the individuals retirement. The largest and most important detail to know about the traditional IRA is that ALL deposits are made with PRE-TAX dollars. Thus, you can itemize your contributions to your traditional IRA and do not have to pay taxes on the contribution. HOWEVER, when you retire (after age 59.5) any withdrawals made from the account are taxed at the rate corresponding with your most recent income.

EXAMPLE - You graduate from college (age 22) and your salary is $30,000 thus falling into the 15% tax bracket. You contribute $4,000 a year with pretax dollars. When you decide to retire at age 62, your salary is now $100,000 placing you in the 28% tax bracket. You have accumulated approximately $350,000 in your traditional IRA and when you withdraw it, you will be taxed 28%-35% and your retirement nest egg will be squandered to $240,000 by the federal government. (In layman's terms: this sucks.)

Roth IRA - For the sake of simplicity, the Roth works exactly like a traditional IRA with the EXCEPTION OF HOW THE FUNDS ARE TAXED. With a Roth, you make contributions to the account with AFTER-TAX dollars. At retirement, you can withdraw the entire balance of the account TAX-FREE.

EXAMPLE - You graduate from college (age 22) and your salary is $30,000 thus falling into the 15% tax bracket. You contribute $4,000 a year with post-tax dollars (so about $3,400). When you decide to retire at age 62, your salary is now $100,000 placing you in the 28% tax bracket. You have accumulated approximately $300,000 in your traditional IRA and when you withdraw it, you will pay NO TAXES on the balance. The federal government has already taken their cut, but it was when you were paying about HALF THE TAXES. (In layman's terms: this is a beautiful thing.)

Retirement Funds with traditional IRA - $240,000
Retirement Funds with a Roth IRA - $300,000
Net Gain - $60,000

Keep in mind this is an extremely basic explanation. The lesson to extrapolate from this post is if you are younger than 30, and still have many years to reach your salary ceiling, a Roth IRA is a RIDICULOUSLY good opportunity. The example above remains very simple, the difference between the two accounts could potentially be more than $500,000 depending on your income.

Go to your bank. Go to your broker. Open a Roth IRA.
(and don't pay a yearly maintenance fee)