Retirement accounts - Roth IRAs, traditional IRAs, 401(k)s – there are a number of different ways to save money for retirement. It's important to know about each of them and their pros and cons as revealed in this presentation.
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What you need to know about retirement accounts
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What You Need To
Know About
Retirement Accounts
If you don't have a retirement
account guess how you'll spend all
those years after age 65? Yes, that's
right. You'll be working.
If you truly want to put the gold in
those golden years you need to have a
retirement account. If you don't have
one, you need to start one. This is true
whether you're in your 20s or your
40s, as it's never too early or too late
to harness the power of compound
interest. (Continued)
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How compound interest works
According to the online encyclopedia Wikipedia, compound interest "arises when
interest is added to the principal of a deposit or loan, so that, from that moment
on, the interest that has been added also earns interest. This addition of interest
to the principal is called compounding.” To put this another way it's how just
about anyone can accumulate enough money to have a nice requirement.
An example of the power of compounding
Here’s an example of the power of compounding. Let's suppose you have $1000
to invest and that you're willing to add $100 a month to it for a period of 20
years. If you were to earn 5% a year, which is fairly modest, you would have
$42,330 at the end of those 20 years. In comparison, if you were to save $100 a
month without compounding, you would have only about $25,000.
The three basic types of retirement accounts
There are a number of different kinds of retirement accounts but if you’re an
employee the three most popular are a traditional IRA, a Roth IRA and a 401(k)
plan. If you work for a nonprofit organization there is the 403(b) and if you’re
self-employed there is the SEP or Simplified Employee Pension.
Here’s how they differ.
Traditional IRA
Anyone can have a traditional IRA (Individual Retirement Arrangement) whether
you're employed or not and whether or not you participate in some other
retirement plan. An IRA can be set up with just about any financial institution
but is most often with a brokerage firm. With a traditional IRA, you can
contribute up to $5500 a year (for now) tax-free. In other words, you can deduct
whatever amount you contribute to your IRA from your income taxes. You can
begin taking withdrawals from an IRA when you
• Turn 65 (or the plan’s normal retirement age, if earlier);
• Participate in the plan for 10 years; or
• Your employer terminates your services
One of the best things about a traditional IRA is that you fund it using before tax
money. The downside is that when you begin withdrawing the money it will be
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taxed as ordinary income at your normal tax rate, which will probably be 25%.
Plus, you must begin withdrawing the money when you reach the age of 70 1/2
whether you want to or not. This will be in the form of what’s called a Required
Minimum Distribution and will be calculated based on how much you have in
your IRA and your age. Of course, you can withdraw more than your Required
Minimum Distribution if you wish.
Roth IRA
Many of the things that are true for a traditional IRA are the same for a Roth IRA.
For example, you can deposit up to $5500 a year in a Roth IRA just as you could
with a traditional IRA. You can also withdraw money the same way as with a
traditional IRA – when you turn 65, have been in the plan for 10 years or your
services are terminated by your employer. However, in terms of taxes a Roth IRA
is the exact opposite of a traditional IRA. You fund it with after-tax dollars but
then when you withdraw the money it is not taxable. Again, you will have to begin
withdrawing the money when you turn 70 1/2 and there will be a Required
Minimum Distribution (RMD). You can take more than your RMD but if you take
less you will be fined by the IRS.
401(k)
Many people call a 401(k) the workingman's best friend. With a 401(k) plan, you
can choose to “defer” some of your salary. Instead of getting that amount in your
paycheck, the deferred money would go into the 401(k) plan sponsored by your
employer. This deferred money generally is not taxed until it is distributed. But
the real beauty of a 401(k) is that in many cases your employer matches your
contributions up to a certain level. While this will vary from employer to
employer, a typical situation is that the employer matches 50% of your
contributions for the first 6% of your salary you contribute, which means it won't
match more than 3% of your total salary. Other companies might elect to provide
a straight match to a certain point. In this case, the employer matches 100% of
your contribution up to a set percentage of your income.
A 401(k) is more generous in that you can contribute up to $12,000 in a year. The
money you contribute is 100% vested because after all it's your money. However,
your employer's contribution may vest over some period of time.
You can borrow from a 401(k) account with certain limitations. If you do elect to
borrow from your account you will be required to pay it back within six months
or the money will be treated as ordinary income and you will be taxed
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accordingly. Since the money is yours you can take it with you if you leave your
employer and then roll it over into another 401(k) plan or into the IRA of your
choice.
The same restrictions apply to a 401(k) as a traditional IRA or Roth IRA. You
must start withdrawing your funds when you reach age 70 1/2, as there will be a
Required Minimum Distribution.
403(b)
This plan is pretty identical to a 401(k) except it's for people who work for
nonprofit organizations. This includes employees of public schools; some colleges
and universities; churches; or charitable organizations that are tax-exempt under
section 501(c)(3) of the IRS code. You can defer up to $16,500 of your annual
salary into a 403(b) plan and you must begin taking your Required Minimum
Distributions when you reach age 70 1/2.
You manage your money
Regardless of which type of retirement account you choose, you will be in charge
of managing it. This means you will decide how to invest the money. If you have
an IRA you can invest in just about anything you choose up to and including real
estate. However, with most 401(k) s your choices will be limited. As an example
of this, if your employer has Fidelity Investments as its fund manager you might
be limited to choosing from among a group of the mutual funds it offers. But the
important thing is to be conservative in your investing. Stocks, bonds, mutual
funds and most other investments go up and down in value. It’s much better to
find investments that return a safe 3% or 5% than to gamble on some high-flying
stock that’s skyrocketing in value but that could crash and burn next year –
wiping out all your hard-earned savings.
Run do not walk
In the event you don't have a retirement account, run do not walk to your HR
department or your local brokerage and get one set up. Make regular
contributions, let the power of compounding work for you and you might even be
able to retire at age 65, move to that island paradise and spend your golden years
basking in the sun. If not, you might find your golden years are not so golden and
you could end up literally working until you drop.
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Does this sound familiar?
• You are tired of worrying about money…
• You are losing sleep due to mounting credit card
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• You are fighting with your partner about the
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• You are living paycheck to paycheck…
• You are falling behind on your debts…
• You are losing hope…
It’s time to talk with National Debt Relief!
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