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Why a Roth and a taxable account are a young saver’s best friend

Wood chair on beach
KJ: We recently wrote about: Financial independence: a new concept in lifestyle retirement planning, but how do you know where to save and how to save to reach financial independence? Especially if you are a young saver, some of the retirement account types might restrict you too much on how and when you can ultimately use the funds.

Only saving to a pre-tax account can cause you to lose flexibility
If you save ONLY to traditional retirement vehicles like a regular pre-tax 401(k), traditional pre-tax IRA, Simplified Employee Pension (SEP), etc. then you might find that you have the savings and ability to be financially independent, but you may not have the ability to live off of the money and withdraw funds from these account types before age 59 1/2 without incurring significant taxes or penalties. So, how do you build flexibility into your lifestyle so you can more quickly reach – and realize – financial independence, whether that is at age 35, 40, 50, or 55?

Save to Roth accounts
Roth accounts currently have a very nifty feature for young accumulators. If you were to ever need to withdraw funds from the account(s) before turning age 59 1/2, then you CAN withdraw some funds without taxes OR penalties. In fact, any withdrawals are treated as first coming from whatever money you put in before dipping into any earnings on the account. To illustrate, if you collectively had put $50,000 into a Roth account, and the account is now worth $75,000, then the first $50,000 you withdraw would be tax-free return of your capital contributed (read no taxes or penalties). If you began to dip into the remaining $25,000 before age 59 1/2, then you would of course have to pay hefty taxes and penalties.

Overall, it still builds a lot of flexibility in your plans to reach financial independence because your first dollar withdrawals are tax-free and can further push you closer to the 59 1/2 age where you would then be able to take remaining funds out without taxes or penalties.

Contrast this with regular 401(k) accounts or Traditional IRAs where any funds withdrawn would trigger income taxes as well as penalties if removed before age 59 1/2. Even after age 59 1/2 you still have to pay income taxes on withdrawals from a Traditional IRA, but at least you avoid the penalty!

For a Roth account, as long as your income is below a certain level (approximately $180,000 for married couples in 2014 ), then you can save up to $5,500 per person for a Roth IRA (with an extra $1,000 if you’re over age 50). If that’s not an option, save to your employer’s Roth 401(k) feature if they have it since that could allow you to save up to $17,500 each year (and an extra $5,500 if you’re over age 50). If that’s still not an option, look at the regular investment account outlined below.

Save to a regular investment account
Lots of people think that once they save to their 401(k) or 403(b) and/or an IRA that they can no longer save for retirement. This is NOT TRUE! Sure, you may not have any more specifically tax-advantaged ways to save for retirement, but you can still be setting money aside for retirement in what is called a regular, investment/brokerage account. With an investment account, you pay income taxes in the current year on certain gains and income generated, but you still have the ability to focus on more long-term growth strategies to keep the investments and account with some tax-efficiency.

Contributions are limitless. Seriously. There are not any maximum contributions (or distributions for that matter!) on what you can save to a regular investment account. If you get to the point where you’re bankrolling $100,000 per year in extra income (would be nice wouldn’t it!), then you could be setting it all aside in a regular investment account. The more quickly you set aside money, the sooner you will be able to reach financial independence. Plus, you can use the funds whenever and however you would like. Save enough to reach financial independence at age 45? Not a problem! Money you withdraw does not have penalties. Sure, if you sold an investment to be able to make a withdrawal you could have some gains or tax implications but generally much less so than a regular pre-tax account, AND there aren’t any IRS penalties.

No age restriction. Yep, you read that right. There are no age restrictions to when you can access the money or time waiting periods. You don’t have to keep the money in the account for even a year, and you can withdraw at age 25, 30, 40, 50, etc. as needed to fund your goals.

Talk about ultimate flexibility! So, even though the funds don’t grow as tax efficiently as they would in a pre-tax IRA, 401(k), 403(b), or a Roth IRA, you ultimately have 100% control of when and how you use the funds without Uncle Sam getting involved.

Especially for the young accumulator that is really building their portfolio for long-term success, this type of account will ultimately help you build the flexibility you need to reach financial independence at an accelerated rate.

So, are you convinced yet? What’s stopping you from opening and saving to a Roth or regular investment account?

    Are you taking advantage of an employer 401(k) or 403(b) Roth?
    Do you have a taxable investment account for long-term growth?
    Share with us what is stopping you from building more flexibility into your savings goals.

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Why a Roth and a taxable account are a young saver's best friend is copyrighted by TheSimpleMoneyBlog.com without consent to republish.

Some of the links in the post above may be affiliate links. This means if you click on the link and purchase the item, we will receive an affiliate commission. We feel strongly about only recommending products or services we use personally and/or believe will add value to you, our readers. Read more about our commitment to providing quality product recommendations.

Financial independence: a new concept in lifestyle retirement planning

Sea Wave on Beach
KJ: One of the biggest topics in the media today is retirement. With thousands of baby boomers reaching the official retirement age each day, it’s all a lot of us think or talk about. How do you get there, how much do you need? What happens when you get there, and why is it called “retirement?” What’s so great about that point in time? Especially for us young savers, the normal retirement age could be DECADES (20, 30, 40 years) away, so what can you do now to really help you get on track and realize this flexibility sooner? Few people want to completely sacrifice today (and every year thereafter) until you get to retirement and can “live the good life.” It’s important to have periodic milestones along the way to celebrate life and youth.

Throw out the concept of retirement
I’m starting to get a little tired of the word retirement. It seems to imply that you’ll work all your life – tirelessly – to get to some point in the future where you can stay home, play computer games, and eat Cheetos until your heart is content. Or, maybe it means laying on a beach sipping piña coladas without a worry in the world. Sure, that sounds like fun for a period of time, but why wait until retirement to do any of that?

Many people who get to retirement realize it isn’t what they thought it would be. After all, what are you going to do to stay active (and not just turn into a vegetable on the couch!)? You may quickly realize you would like to spend time doing something meaningful by taking on a part-time job, another full-time job, or volunteering for a cause that is closest to your heart.

Instead, reach for financial independence
Financial independence is a very similar concept to retirement, and it’s my preferred term for what people are doing to try and accomplish this “lay on a beach and sip drinks” utopia.

What financial independence means is not so much not working at all, but rather the concept of working because you want to and not because you have to and need the income. Maybe your savings numbers are much the same as the traditional concept of retirement, but look to get to a point where you can live off of your savings and investments indefinitely. There are lots of studies designed to help you figure out what that number could be, so work with an advisor to help understand what it really means and what you need to save.

Even though 60 is the new 50, sacrificing it all today for that one point in time seems ludicrous. Set goals for you and your family and include some fun checkpoints along the way. Maybe it’s reaching a net worth of $100,000, $250,000, $333,000, $500,000, $1,000,000, etc. Even though these numbers can just be figures on a page, it can help you learn to celebrate what you’ve accomplished. Crack open the bottle of champagne, go to a fancy restaurant with your significant other, or take a nice trip.

How financial independence is different than retirement
It helps bring the concept of retirement into perspective for younger generations. By understanding where you are heading and what you need to do to get there, you can make the changes today to get you on the right track.

Financial independence helps bring the concept of retirement to what you can actually do today that can have an impact. Saving blindly to a 401(k) just *hoping* to get to retirement decades from now can often be very burdensome and unfulfilling. So, put it in terms of what you spend today. Looking at it from the perspective of working because you want to and not because you have to may mean to make a few different career or lifestyle choices to more quickly build flexibility in your life. The lower you keep your expenses, the lesser amount you need to sustain your lifestyle, and the quicker you can get to financial independence. If you get raises or bonuses, use it to sock more money away and get ahead – not use it for that expensive car or to subsidize the cost of a pricey home!

Cut your expenses for the next five years
Maybe this means cutting your expenses for the next five years, so you can take a year or two sabbatical to travel or spend more time with family. Stopping work on a whim would be ill-advised, so planning ahead to have this type of flexibility is important.

Think ahead for your five year future. Maybe you’re a two income household and are looking to start a family in the near term. What is life going to be like when you lose one income? Will it be temporarily for a few weeks, months, or years? Thinking about this ahead of time will allow you to plan ahead and save for those contingencies. Instead of a 3-6 month emergency fund, maybe it’s a 12-24 month fund you need!

Save more, spend less
To me, the concept of saving 5-10% of your income will take you forever to get to financial independence. If you have children and education goals and/or goals to get to financial independence quickly, saving 10-30% of your income isn’t unheard of.

If you found that saving an extra 5-10% of your income could shave off years of your goal for financial independence and allow you sooner flexibility to take a sabbatical, European trip, or Bahamian beach vacation for weeks, would you do it? We sure would!

    What does financial independence look like for you and your family?
    What are you doing to ensure your success in reaching financial independence?
    Share with us what your goals are to get to financial independence.

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Financial independence: a new concept in lifestyle retirement planning is copyrighted by TheSimpleMoneyBlog.com without consent to republish.

Some of the links in the post above may be affiliate links. This means if you click on the link and purchase the item, we will receive an affiliate commission. We feel strongly about only recommending products or services we use personally and/or believe will add value to you, our readers. Read more about our commitment to providing quality product recommendations.

Smart 401k planning must knows

Heart monitor on piggy bankKJ: We recently came across a quick 401(k) article talking about 7 ways to avoid a 401(k) disaster. In my opinion, there’s never too much you can read or understand about your retirement plans, so we’ve created our own set of do’s and don’ts when it comes to common 401(k) mistakes to avoid. We’re not forgetting about those of you who have a 403(b), as this list applies the same to you! Read the full MSN Money 401(k) article here.

Take full advantage of your employer’s match
Mistake #1. Don’t leave money on the table. Even if you think you can’t possibly save money because your cash flow is too tight, chances are you actually can come up with a solution. Even if it’s an extra $50 or $100 per month, that can make a huge difference in getting you on track for your goals. You may not be able to make a change in one area to come up with the extra $50-100, but maybe you can adjust a few categories. Cut out that movie channel package, get a cheaper electricity provider, cut out dining out once per week (this alone could save most couples $120 per month), or shop around for some deals and coupons before you make a purchase. Stop making excuses, and do whatever it takes to at least get your full employer match!

Take advantage of the 401(k) Roth feature
Sure, not every firm has this, but more and more companies are offering it nowadays. If you’re young, in a low tax bracket, and have a LONG time until you retire, then not participating in the Roth feature of your account is a big no-no. You pay taxes on the money this year (i.e. you can’t deduct your contributions like you can for a traditional pre-tax 401(k)), but money withdrawn in retirement is tax-free! Huge win for us young savers.

Know your fees
All investing involves not only risk but also fees, so be aware of what you’re getting charged. New regulations enacted in 2012 require your 401(k) plan to provide detailed fee expense information. Not all fees may be paid by you, but it’s important to know what they are. In addition to administrative and record-keeping fees, there are also mutual fund fees (commonly known as an “expense ratio”). Each mutual fund is different, and various strategies have differing amounts of fees. However, just because a fee is higher than another fund, doesn’t mean it is not appropriate. Large company domestic stocks are usually lower in expenses compared to an international stock strategy, so know the differences and make sure you’re comparing apples to apples.

Know your investment options
Pay attention to the options you have to invest in. Much like you probably shop around for the best retailer when making a purchase, do your research to make sure you are picking the right funds for your goals and risk appetite. If you aren’t prepared to analyze all the factors in making an investment decision, then hire out proper counsel!

Diversify your investments
Just because yesterday’s top performer did well, doesn’t mean it will be tomorrow’s best performer. The purpose of diversification is to build a more stable portfolio over time, so some funds will underperform while others outperform in different market conditions. As we’ve seen twice over the last 13 years, stock markets (or real estate) don’t always go up! It’s part of the cyclicality of markets, and knowing that is half the battle.

An important component of this aspect is periodically watching how your investments are positioned. If you own a fund that is considered an “asset allocator” (meaning it could be invested in stocks, bonds, cash, etc.) or target date fund, then it’s important to watch what they do in conjunction with your other investments. Digging into the numbers may help you realize you’re either way LESS or way MORE positioned in one area – too much Europe, too much U.S. small cap?…

Know your retirement needs
Chances are you may not be equipped to know realistically what you need to have for retirement (is it $500,000, $1,000,000, or $5,000,000 – all entirely contingent upon what your expenses are). Work with a knowledgable advisor to help you navigate not only how to position your portfolio, but also what milestones you’re trying to reach for. If you don’t know where your “financial independence” ship is headed, how can you ever expect to know when you’re there?

Use your account for retirement purposes ONLY
While there are a few IRS tax provisions to allow you to avoid penalties for withdrawals prior to retirement (or at the earliest of age 59 1/2 as set by the IRS), using your retirement funds for non-retirement purposes can be disastrous. Don’t dip into the account before it’s time. You may not even realize the compounding effect of the $1,000 or $5,000 you “need” now and what that could do for your long-term retirement plan!

    Are you maximizing your 401(k) or 403(b) contributions?
    What would motivate you to take advantage of the employer match?
    Is there anything you would add to this list?

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Smart 401k planning must knows is copyrighted by TheSimpleMoneyBlog.com without consent to republish.

Some of the links in the post above may be affiliate links. This means if you click on the link and purchase the item, we will receive an affiliate commission. We feel strongly about only recommending products or services we use personally and/or believe will add value to you, our readers. Read more about our commitment to providing quality product recommendations.

A target to aim for: what do I need to save for retirement?

KJ: One of the commercials that Fidelity had running a few years ago had a green arrow with a number above each person. The magic number was the amount of money that person needed to have socked away for retirement. But, how did they calculate how much a person needs for retirement? What factors should you think about as your family plans for your future? Well, there have been numerous research studies over the years about a little thing called the ‘safe withdrawal rate.’ This is the percentage of your savings/investments that you could “reasonably” expect to withdraw over a long period of time while letting your savings continue to grow. I.e., it is the amount of income you and your family could plan to live off of in retirement. And, this is such a little understood concept of personal finance that it’s why people who win the lotto or sports players with HUGE signing contracts end up dead broke after spending all of their money.

And, if you do not have a barometer for what amount you need to save in order to retire, there’s slim chance that you can get there successfully. Do you need to have $500,000, $1,000,000, or $5,000,000+? The answer: it depends.

Success On Dartboard Showing Accomplished Progress

Looking at the math
While it is entirely dependent on your age in retirement, expense levels, and other factors, some suggest the safe withdrawal rate is anywhere between 3.5% and 4.5% of your savings. To illustrate this point, if you and your family had annual living expenses of $50,000 per year, you may need anywhere from $1,100,000 – $1,450,000 ($1,100,000 X 0.045 = $50,000) in savings to be able to maintain the purchasing power of your dollars over time while you took your $50,000 per year out of the account. I.e., in a “normal” year (whatever that is!) you could earn some return on your money, take your money out for your living expenses, yet still end up with the same amount of money as you started the year (accounting for the little thing called inflation, that is).

Fortunately, there are income sources like Social Security that may help reduce the overall amount you need to save, so the true amount you may need to accumulate in your savings could be MUCH lower. So, are you on track? One of our prior posts highlighted the milestones you could aim for based on your salary and age. Check it out here.

Other things to consider as you plan:
What does retirement mean after all? – Is it living on a beach, traveling around to play golf at all of the amazing courses around the world, or spending time at home with your family? Each of these has very different implications for what you would need to save and how your savings may need to keep up with your expenses. Thinking about it before-hand means you won’t be spending your days at home stuck to the computer wondering what you’re supposed to be doing with your time!

Expanding life expectancies
Life expectancies are not decreasing, but in fact have continued to increase significantly over the past century, so planning ahead by thinking about how long your savings could last you for the next 20, 30, or 40 years could be the difference between a well laid plan and a complete flop.

Your comfort levels for investments
Who would have thought this would come into play, but it really is an important one – especially when planning for a VERY long time horizon! If you’re not comfortable taking on a certain level of investment risk, you may have to save up more than your friend by shooting closer to the 3.5% target instead of 4.5%, so you can remain more conservative with your savings. Whatever your preferences, talk to your significant other (and an advisor as well) to get a feel for what you are and are not comfortable with when talking about your savings. If you find the stress of stock markets keep you up at night, then maybe you could be more conservative in your strategy. However, with that approach, you may find yourself needing to set aside more savings each month. It’s a bit of a trade-off, but it’s important to discuss before you find yourself making a reactive decision later!

    How do you calculate what you are aiming for?
    What do you do to determine how much money you need for retirement?
    Tell us your retirement success plans.

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A target to aim for: what do I need to save for retirement? is copyrighted by TheSimpleMoneyBlog.com without consent to republish.

Some of the links in the post above may be affiliate links. This means if you click on the link and purchase the item, we will receive an affiliate commission. We feel strongly about only recommending products or services we use personally and/or believe will add value to you, our readers. Read more about our commitment to providing quality product recommendations.

State of the union: what is MyRA? Success or failure? What we know now.

State of the Union #myRA My Retirement AccountKJ: So without getting into any of the politics from the State of the Union, we wanted to bring a quick summary about what this new myRA account is all about (i.e. with many wondering if myRA is a new account, if it’s like a Traditional IRA, or is myRA more like a Roth IRA?…all things we hope to clarify in this post). While there are a lot of details to be ironed out, the program is designed to be made available in 2015 with some early adopters starting the program in late 2014. There are quite a few good articles out there, but here is the Whitehouse.gov press release with some additional reading. Here is what you should know now:

What it is:
(1) Another confusing acronym that sounds eerily similar when pronounced to the already existing IRA. Wait, are you saying myRA, my IRA, or just IRA? Are you saying Myra (as in the person – a mistake a number of people have made on Twitter putting @myra instead of #myRA – oops!) or my RA (as in rheumatoid arthritis or residential adviser – college dorm term). All-in-all, just a bad name choice in my opinion.
(2) A Roth IRA equivalent – The participant does not get any tax advantages today for contributing to the account today (it is “after-tax” money meaning you don’t take any current year tax deductions for what you put into the account), but it grows tax-exempt, just like a Roth IRA. Plus, an account owner can roll the funds over to a Roth IRA at a financial institution (and will be required to do so after they have accumulated $15,000 or have been invested for 30 years) at any time.
(3) Your own savings. It’s not a plan or account that the employer controls or has any say in. Really, their only involvement is to process payroll deductions and then send the funds to the Treasury for deposit into your myRA. Plus, if you leave your employer, the account is yours to take with and do what you want – and fund it again with your new employer. Thus, it has a lot of the portability benefits that a Traditional IRA or Roth IRA has.
(4) Your myRA contributions are protected from investment loss. Guaranteed by the Treasury, and the same “G” – government securities – investment option in the Thrift Savings Plan (TSP) for government employees in their workplace retirement programs, it will not lose principal. Check out the TSP website on historical performance for more on this fund.
(5) A way to help those save for retirement who don’t have a workplace retirement option available. However, just because you don’t have a workplace 401(k), does’t mean you have NO options on saving for retirement. See our post on how to save for retirement if you don’t have a 401(k) for some further reading.
(6) There are no tax penalties for taking a withdrawal. Much like a Roth IRA, for money you put into the account, you don’t have a penalty or taxes owed on money distributed. However, there are likely to be restrictions (much like a Roth IRA) for earnings in the account if withdrawn before a certain age and an exception doesn’t apply (read, taxes and penalties could apply to the earnings).

Who it is for:
(1) It’s touted to be for anyone who doesn’t have a workplace retirement account they can save for. Well, not EVERYONE would be eligible. It is designed to be a retirement plan that you can contribute to at work through payroll deductions, but the employer has to actually offer it as an option when processing payroll. At the current time, it sounds like it could be in addition to a 401(k), instead of a 401(k), or instead of another workplace retirement account. So, while it could be available for all, there currently isn’t a mandate that employers actually offer it as an option.
(2) Couples making less than $191,000 per year (and a lower threshold for single tax filers at $129,000 per year). It doesn’t quite say that this is when the phase-out begins (or ends) for being able to make contributions, but it sounds quite similar to the maximum income to be able to contribute to a Roth IRA for married couples.
(3) Those looking to start saving for retirement with very little money each paycheck. With contributions as low as $5 per paycheck, and minimum investments of $25, it is arguably both approachable and affordable for all families.

What are my thoughts?
(1) While a guarantee against loss of principal sounds (in theory) like a good option compared to the volatility you see in a private investment strategy (think bonds, stocks, etc.), at what long-term savings cost is this guarantee? Even just earning an extra 0.5% or 1% on your money over the long-term (though subject to periodic market swings) would equal THOUSANDS of dollars of extra retirement money. The key is holding your ground and staying invested and not panicking at the bottom of the markets. Markets fluctuate quite regularly (anyone look at their statements from January?), so learning this early in your investing career can equip you to focus long-term (i.e. 5, 10, 15, 20 years).
(2) Depending on someone’s income, it could be an interesting opportunity to get some additional funds into the myRA, then roll over to a Roth IRA, so you can ultimately get more funds in the great account that is a Roth IRA. Note that this could be severely limited pending further discussions on whether contributions to the myRA are the same limits subject to Traditional and Roth IRAs, so those maximizing their existing Roth IRAs may not be able to contribute anything to the new myRA.
(3) How can a maximum account value of $15,000 with the new myRA be enough to help America’s retirement problem? Assuming you spent the money in one year (not to mention trying to LIVE off of the account on an ongoing basis), that’s barely enough funds to provide for one year of income at the Federal poverty level, yet it’s the maximum you can save in the account? Sure you can roll the funds over to a Roth IRA above this threshold (then the sky is the limit on your account value), but what kind of cap is $15,000?
(4) It can be a good way to get people to START to think about saving for retirement and saving for their future at even a low threshold.
(5) Why do we need another account? Can’t there be solutions to enhance existing options? Is it me, or are there just too many account types out there: Traditional IRA (wait, is a portion deductible or non-deductible?), Roth IRA, SEP IRA, SARSEP IRA, SIMPLE IRA, HSA, MSA, FSA, 401(k), 403(b), TSP, TRS, 457, PSP, checking account, savings account, trusts, credit cards…anything I’m missing?

What is still to be determined:
(1) What are the exact income limitations, and is there a phase-out?
(2) How much can you actually contribute each year?
(3) How does the contribution impact your total contributions to Traditional IRAs/Roth IRAs (up to $5,500 per person for 2013 and 2014) and other retirement accounts? Will it be a new type and completely separate contribution limits or will it combine with your existing IRA limits?
(3) What is the process for when you have had the account for 30 years or when the balance reaches $15,000 and must be rolled over to a private retirement account (i.e. Roth IRA)?
(4) Will this become a requirement for employers to offer at some point?

    What have you read about the new myRA?
    Will you be keeping up with this new account type?
    What would motivate you to contribute to this new account?

State of the union speech: what is MyRA? Success or failure? What we know now. is copyrighted by TheSimpleMoneyBlog.com without consent to republish.

Some of the links in the post above may be affiliate links. This means if you click on the link and purchase the item, we will receive an affiliate commission. We feel strongly about only recommending products or services we use personally and/or believe will add value to you, our readers. Read more about our commitment to providing quality product recommendations.

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