I’ve heard this is something I should get or setup but don’t really know what is it.
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An IRA is a retirement fund you put pre-tax money into and when you retire you pay tax on the money you take out.
A Roth IRA is a retirement fund you put post-tax money in and when you retire you don’t pay tax on the money you take out.
Let’s say you put $100 into a Roth IRA. 30 years later it’s worth $10,000 and you take it out of your Roth IRA and put it into your bank account.
The tax bill from the IRS on that gain of $9,900?
$0.
That’s the power of a Roth IRA. You don’t pay taxes on the gains you get. With a Traditional IRA, you’d pay taxes on that $9,900.
Government allows you to put $6500 into a Roth IRA. You can buy stocks, bonds, ETF, REITS, etc (trade options, not recommended for those still learning how it works).
When I was getting started, I thought of it like a sandbox. You can manage it however you feel comfortable, and the government does not tax income once it’s in the sandbox (assuming the ‘sand’ leaves/money withdrawn at age-based terms).
First understand that a savings account is where you put money into the bank and they hold it for you, adding interest based on the current prime rate as set by the government. Right now it’s at like 4%, meaning this year, for every $100 in your account, the bank adds another $4 (33¢ per month). The government will take a portion of that $4 back at tax time; the actual amount they take depends on your total income.
A savings account is better than stuffing cash in a mattress, but your money grows very slowly, and doesn’t really keep up with inflation (rising cost of living). Nevertheless, it does keep going up, if you don’t touch it.
There’s a special kind of savings account called a CD (certificate of deposit, not compact disc), where you deposit a standard amount and get slightly higher interest rates, but you have to keep the money in there for a certain amount of time or they make you pay a big penalty.
A Roth IRA is a sorta like that, but it’s a personal retirement *investment* account. Like a savings account, you deposit your already-taxed cash into it at your convenience. There are limits on how much you can put in and take out, and when. Also, there’s no interest. Instead, to make it grow, you convert most of the money into investments (e.g. stocks in the stock market), which you are free to choose, but which you don’t get to actually keep.
As far as you’re concerned, your account then contains a certain amount of money, which is not the cash “principal” you put into it, but rather just the value of the investments. So the amount of money in your account generally rises and falls with the stock market and the overall economy.
It’s risky. A broker can help you tailor your portfolio according to how much risk you’re willing to take, but no portfolio is totally recession-proof. That said, the idea is you just keep adding to it, and you ride out the dips in the economy, and hopefully when you’re old, you’ll end up with a nice profit. Most people get like 7% to 10%. That means for every $100 they put in, they ended up with an extra $7 to $10 of “free money”.
I wouldn’t say having a Roth IRA is something you “should” have. But having *some* kind of retirement savings is generally considered a good idea.
It is a way of contributing post tax money to an IRA (individual retirement account) so you don’t have to pay tax on it when you draw on it. So, you have to wonder, can I afford the tax *now* or can I afford the tax *later*, for many people it is easier to afford it now. However, if you make too much money you can’t contribute at all, you are stuck with a traditional IRA or buying bonds or whatever.
Having a sensible tax strategy for retirement is one of the best things you can do besides doing the saving in the first place.
When it comes to retirement savings you probably want to tax advantage and take free money. So step 1 is to determine whether your employer offers a 401(K) match. What I mean by free money is if you are like me, Mr. Employer will match up to 6% of my salary. So I get the most free money by contributing no less than 6%. Plus, that 6% reduces my overall taxable income, so it might be worth my while to put in even more up to $22,500 a year if you are under 50 and $30,000 if you are over 50.
Once you have that sorted out, you can talk IRAs, again, your employer probably offers a traditional IRA and they may even match into that. I had an employer kick in up to 3% in a 457 plan (an IRA but for government employees) *in addition* to the match on the 401(K). So that is your next option, again, it is pre-tax money so you get to reduce your taxable income. AND, you get 3% free…
Once you have exhausted those opportunities, check to see if your employer offers a deferred compensation plan or stock buy plan. Those aren’t expressly retirement accounts, but they are more flexible because you can use the money anytime and for any reason you see fit. A deferred compensation plan is like an IRA without penalty for early withdrawal. You still invest the money, it is still pre tax (so when you take it out in 5 years you have to pay tax on it), but *you* choose when you want to take it.
Once you have done all that, then I might consider a Roth (if you qualify) if you regularly come into amounts of money (bonuses, side jobs, no debt to pay, etc) that you don’t mind waiting for. Personally, and I am only speaking about my experience and my thoughts, I am not an investment advisor, once you tap out all of your potential employer options and you *still* have money left over…I chose to simply invest post tax money in a normal retail account. Saving for retirement is important, but so is saving for your kid’s college fund or whatever else you might want to do 20 years down the road but before you plan on retiring. I know people who paid for their children’s college primarily on the dividends of their investment accounts. These people are not Warren Buffet, they have professional salaries and they simply reinvested dividends and over the course of 18-20 years those can add up.
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