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“You have two choices! You can work for your money, or you can have your money work for you!”.
For most this is easier said then done. I created this site to help others with their path to financial freedom. I hope to do this by proving useful tools, resources, and personal experiences. Click Here To Continue Reading...
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Want to get started down the right retirement road?
One of the best things you can do today to improve your chances of a comfortable retirement is to open a Roth IRA and start contributing regularly (automatically, if you can) to a diverse set of investments.
The Roth IRA is not an investment though, like a stock or bond. A Roth IRA is simply an account within which you can hold your investments. Why would you want to hold your investments in this account versus just buying them straight up? The answer is simple: fewer taxes.
Roth IRA Definition Basics
The Roth Individual Retirement Account (or IRA) was created in the late 90s to provide a tax break and encourage you to save money for your own retirement.
The main difference between the Roth IRA and other tax-related retirement accounts (like the 401K or traditional IRA), which allow you to avoid tax on contributions, is that the Roth allows you to avoid taxes when the money is withdrawn in retirement.
If saving a lot of money on taxes sounds like a good idea to you, then a Roth IRA is going to serve you well. Picture yourself with a healthy Roth IRA account in retirement. Now see yourself taking money from that account each month to cover your living expenses, securing lower life insurance rates, and what ever else you need. Now see yourself not paying any tax on those withdrawals. Nice, right?
Another difference between the Roth IRA and the 401K is your ability to control the investments. With your company 401K you’re pretty much stuck with the investments that your administrator will offer you. On the contrary, you can open a Roth IRA where ever you like, and it can contain just about every investment type under the sun.
Not everyone can participate in this type of account though. To be able to contribute your adjusted gross income (check your latest tax return) must be less than $135,000 if you file your taxes individually or $199,000 if you file with your spouse as a couple. FYI – Those are 2018 numbers. Be sure to check the latest numbers.
Roth IRA Annual Contribution Limits
Additionally, you can’t just throw a bunch of money into this account all at once. Contributing too much will trigger an excess contribution tax and penalty.
For some reason the government felt the need to force you to slow-play your savings efforts. Right now (2018) you can contribute up to $5,500 each year to your Roth IRA. Like the income limit above, this changes periodically so pay attention to dates. Also, there is a “catch-up” rule that allows folks 50 and older to contribute an extra $1,000 each year.
Where to Open a Roth IRA
Most banks and large financial institutions will offer Roth IRAs. I typically don’t advise this route as not only are the accounts typically restrictive, some come with administrative fees. Just stay away from the banks when it comes to your retirement accounts.
You could also open a Roth IRA with a mutual fund company like Vanguard. Keep in mind that these companies typically have minimum contribution limits in the thousands. Also, they only offer their investments. So for instance, you couldn’t have a Roth IRA with Vanguard and invest in individual stocks. Not necessarily a bad thing. Just a difference.
If you have a small amount to begin investing, you may want to start with a discount online stock broker like OptionsHouse or Zecco. They have no-fee IRAs with very low minimums, if any.
I could go on an on about why the Roth is a good retirement account, but I think you’ve got the basics down now. There’s no reason not to own one really. All that’s left to do is figure out what investments you actually want inside your account. We’ll leave that lesson for another time.
It’s good to invest for retirement.
It’s even better to invest for retirement if you can also pay less in taxes during the process. That’s what the traditional and Roth IRA provide. They allow you to pay fewer taxes. But they have a few differences, which I will explain below.
The federal government has decided to encourage you to do your own saving for retirement. You see, back in the good ole days, everyone either had a pension from their employer, or they just worked until they died. Only the rich were investing in the stock market.
In the modern era of investing, the pension started to go away. Thus, the government started feeling pressure to take care of older citizens. Because social security isn’t supposed to be a complete answer to your retirement needs, and because Americans started living longer, they needed a solution. They needed something to encourage do-it-yourself investing.
Along came ERISA and the traditional IRA in 1974. The traditional IRA is a retirement account in which the contributions you make to that account are tax-deductible. In other words, if you contribute $1,000 to a traditional IRA, you will be able to reduce your taxable income for the year by $1,000. Depending on your tax bracket, this could mean up to $250 in tax savings. All that just for saving for your retirement.
Over the years, the traditional IRA has seen come changes. We now have limits to the amount that you can contribute each year towards your IRA. Also, if you participate in an employer sponsored plan, like a 401K, you will not typically be able to invest tax-deductible dollars into a traditional IRA. Additionally, if you make over a certain amount each year, you will not be able to contribute tax-deductible dollars to your account.
When you pull money out of your traditional IRA (called a distribution), you will have to pay taxes on the money. So even though you skipped the taxes on the way end, you will make it up in retirement. Your contributions and earnings from those contributions will be taxed when you pull them out.
Lastly, you should know that there are penalties if you pull money out of your traditional IRA before you retire, and there are also required minimum distributions you must make starting in retirement. The traditional IRA has a lot of restrictions, but it’s the best place to save for retirement for those without a 401K who are looking for an instant tax deduction.
That brings us to the Roth IRA. The Roth IRA was created by the in Tax Act of 1997, which was authored by William V. Roth, Jr., a Senator from Delaware. The Roth IRA was aimed at helping people save outside of their employer 401Ks.
You contribute after-tax dollars to a Roth IRA, but when it’s time to withdraw those funds in retirement, you can do so tax-free. Nice, right? Just like the traditional IRA, the Roth has income limits and contribution limits you must deal with. See more at the Roth IRA explained.
Other than that, there’s not much downside. Since the funds are after-tax (meaning you’ve already paid taxes on them), you have a lot more flexibility. You can withdraw your contributions without many limits and you can withdraw them in retirement any time you want. No required minimum distributions.
Traditional IRA vs Roth IRA
A good thing to keep in mind is that if you qualify for both accounts you can certainly contribute to both. There’s no rule saying you can’t. Keep in mind that if you do, you need to watch your contribution limits as those will be spread across both accounts.
The traditional IRA and Roth IRA are both excellent tools to help you get started with your retirement savings effort. It’s more important to get started with something than stopping down because you are stuck deciding which one of these is the best.
As a quick rule of thumb, I like to tell people that if you don’t have a company 401K, then consider the traditional IRA if you want to see some savings to your high tax bill. If you do have a company 401K, then just go with a Roth IRA to do all of your extra investing. That’s what I do.
Once you decide which account to use, you can start thinking about what to put inside your IRA. Good luck.
Can you contribute to a Roth IRA and 401k? Yes, you can contribute to a Roth IRA and 401K at the same time.
In this post I’ll share my experience of simultaneously contributing to a Roth IRA and 401K, as well as the requirements you’ll need to meet in order to do the same.
When it’s time to get serious about your retirement, it’s not a stretch to imagine you might start thinking beyond your 401K. If you have a 401K at work, that’s great. Your employer cares about you and your ability to support yourself in retirement. If your employer is offering a matching contribution, well, you’ve struck gold. That’s free money. The next logical step is to consider a Roth IRA.
Before you consider a Roth IRA, you should be fully taking advantage of your company 401K. By that I mean contributing enough annual dollars to get the full match that the company offers. It’s likely that you are already doing that so let’s dive into the next step of also investing in a Roth IRA.
As a side note, if you don’t have a 401K, then consider reviewing the Difference Between Roth IRA and Traditional IRA.
Difference Between 401K and Roth IRA
Remember that the Roth IRA and 401K are just accounts where you keep your investments. They aren’t actual investments. They are just the account (or vehicle, as some put it) where the money is held. These accounts are great because they get special tax treatment.
You are able to contribute pre-tax dollars to a 401K. This means that no tax is taken from your money that is placed into the 401K. If you earn a dollar and put it in your 401K, you pay $0 in taxes on that dollar. If you earn another dollar and put it in your checking account instead, you have to pay taxes on that money.
There is a limit to your contribution though. It changes every year usually, but right now you can contribute $18,500 (2018) to your 401K.
You can’t contribute pre-tax dollars to a Roth IRA. You can only contribute dollars that have been taxed already. However, unlike a 401K, when you distribute that money to yourself in retirement, you don’t have to pay a tax. Nice, huh? For more on this account see the Roth IRA Explained.
401K and Roth IRA
Because the Roth IRA and 401K have opposite tax treatments, the IRS allows you to contribute to both at the same time. The only thing you have to worry about is the income limitation set on the Roth IRA. Your ability to contribute to a Roth IRA starts to “phase out” at $189,000 (2018) for those who file “married filing jointly”.
Here’s a strategy I follow. To contribute to both of these accounts, just make sure you start with contributions to the 401K to get the match. Then, switch to contributing to the Roth IRA. Once that is maxed out for the year ($5,500 for 2018), then you can go back to the 401K until you reach your annual limit there.
I did that for the tax years 2016 through 2017 and saw significant increased in my tax-advantaged retirement investing accounts. Not to mention, I have two different account with different distribution rules. So now I can consider things like using my Roth IRA for a down payment.
How about you, do you contribute to a Roth IRA and 401K at the same time?
Whether you’ve done a formal budget or not, what if it’s clear to you that you’re on a financial path that’s unsustainable? What should you do? Well, you’d better do something, because your financial freedom is at stake.
What is Financial Freedom?
Money is a form of freedom because it provides you with the ability to make choices with respect to things that have a financial cost. Financial freedom is measured in dollars, so the more money you have the more financial freedom you have. Spending money is an expression of your financial freedom and, paradoxically, each time you do you actually reduce the amount of freedom that you have, because spending money on one thing deprives you of the ability to spend it on something else.
For example, let’s say that you have $100 that you’re completely free to use; you don’t need it for housing, food, transportation, or any other living expenses. In short, you have $100 of pure financial freedom to do with as you wish. If you save it you continue to maintain that freedom, and it will even grow over time as your $100 earns interest. If, however, you choose to spend it on something then you’re free to do so, but once you make that choice then you’re no longer free to buy anything else.
The Myth of Unlimited Financial Freedom
There are varying degrees of financial freedom. On one extreme end of the scale is unlimited financial freedom. Unlimited financial freedom is the ability to do or to buy anything that costs money. Nobody in the history of the world has ever had unlimited financial freedom. The Pharaohs, the Khans and the Caesars didn’t have it anciently and, despite the many billions certain people have amassed in our time, nobody has it now. In fact, nobody is even remotely close. The bottom line is that even the richest of the rich have financial limitations. Thus unlimited financial freedom is a mythical goal that can never be achieved, so you can go ahead and scratch it from your life’s “to do” list.
Since unlimited financial freedom is unattainable then I recommend that you strive for financial security. You achieve a state of financial security when you can comfortably meet both your needs and all of your reasonable wants without having to work and without going into any kind of debt. Financial security is what most people visualize when they think about the ideal form of retirement. Again, it’s the ability to do what(within reason), when you want, without having to worry about money.
Having a true understanding of the concept of financial security is vitally important, because you’ll never be able to obtain it (much less be able to appreciate it) if you don’t even know what it is! And how might you not recognize financial security even if you obtained it? The reason is because “financial freedom” is such a heavily cited yet rarely defined goal in personal finance guides and literature that it’s easy to misunderstand what the term really means. Again, if taken literally, one can easily be led to believe that financial freedom is the ability to do anything that costs money. But remember, that’s the definition of unlimited financial freedom, which you just learned is an unobtainable goal!
Does that mean that all personal finance literature that uses the term “financial freedom” is wrong? Of course not! It’s just important to remember that whenever you encounter the term “financial freedom” you should interpret it in your mind as “financial security.” If you do that then things you read on personal finance and money management will make a lot more sense. Having said that, know that I myself will sometimes use the term “financial freedom” as a substitute for “financial security” in my own writing because in the context of certain discussions the idea of freedom actually conveys more meaning. But again, to have the right understanding and expectations, in the context of money it’s always important to interpret financial freedom to mean the ability to do what you want within reason (as opposed to doing anything you want), when you want, without having to worry about money.
Achieving a state of financial security is an ambitious goal that could take you many years of wisely applied learning and sustained effort to achieve. Fortunately along the way there is another worthwhile and satisfying goal to strive for: financial stability. You achieve a state of financial stability when you can comfortably meet all of your needs and some of your reasonable wants without going into any kind of debt.
Those who achieve financially stability are generally thought of as “getting ahead.” What exactly does that mean? It means you reach a point where you consistently spend less than you earn, and by doing so you generate what’s commonly referred to as “discretionary income.” Discretionary income is what’s left to save or spend after you have met all of your financial obligations. For example, in a typical month if you have income of $4,000 and your standard monthly expenses are $3,500 (housing, transportation, food, etc.) then you would have $500 of discretionary income ($4,000 – $3,500 = $500). Granted you can’t walk away from your job just because you’ve achieved a state of financial stability. After all, using the previous example, you can’t exactly retire to an island paradise on $500. But that aside, financial stability is a nice place to be because it means:
- You can comfortably meet all of your needs.
- You can meet some of your reasonable wants.
- You can put some money in an emergency fund and/or investments with an eye towards eventually achieving financial security.
- You can weather financial disruptions without undue stress (precisely because you have set aside some money to deal with such situations).
Financial instability is a state where you have just enough income to meet your needs, along with perhaps a few meager wants. In other words, you’re barely scraping by living at the subsistence level, right on the edge of your income. Here are some signs that you’re financially unstable.
- You feel a substantially heightened degree of stress if anything out of the ordinary happens that might cost money.
- You can’t take advantage of good deals and opportunities even though you would like to because you don’t feel like you have enough extra money to do so.
- Long periods of time can go by as you wait to be in a position to do or buy even modest wants (with higher level wants being out of the question).
Do you see the pattern? Remember, financial freedom is the ability to make choices with respect to things that cost money, but when you’re financially unstable you have very little of such freedom. It’s hard to be happy on a day-to-day basis in such a condition, because so much of your money is tied up just keeping your head above water that there’s little to nothing left to do anything satisfying or enjoyable.
If you ever reach a state of financial instability, and especially if you’re there for a long period of time, it can be tempting to compensate for your lack of discretionary income by turning to credit cards or other forms or borrowing to finance purchases for things that you want. While that may feel satisfying in the short term, it’s just an illusion. As time goes on the finance charges associated with your debts will mount, pushing you closer and closer to the brink of the worst state of all: financial bondage.
If financial instability represents a state where you have lost the ability to make choices with respect to things that cost money, financial bondage is a state where others actually have control over you. In other words, you not only lose the ability to act financially, but you’re subject to being acted upon in ways that are beyond your control. Following are some examples of things that can happen to you when you’re in financial bondage, whether you want them to or not.
- You can be forced out of your home due to foreclosure (or you can be evicted from your apartment).
- You vehicle can be repossessed.
- Your wages can be garnished (which means they’re taken out of your paycheck before they ever even hit your bank account).
- Your electricity, phone, Internet connection, gas and water can all be shut off.
It can be severely debilitating mentally, physically and emotionally to be in a state of financial bondage, but don’t give up hope! If you combine the knowledge you gain from this website with other good resources and work hard to intelligently apply the things you have learned, I am confident that you can progressively gain more freedom until you find your feet financially…and then you can build from there.
Why Does Overdraft Protection Work a Little Bit Differently for Checks and Debit Cards?
It’s important to understand that there are important differences in paying for something with a check vs. a debit card as far as overdraft protection is concerned. Think about it. As a purchaser, when you pay with a check you get what you want right away, but the seller has to wait for a period of time in order for your check to clear. On the other hand, when you pay for something with a debit card the transaction goes differently. First your debit card is run through a payment processor and then, after a little bit of a wait, your purchase is either approved or denied. And it’s that difference –the speed at which checks (slower) and a debit cards (faster) can be validated – which is the reason overdraft protection is just a little bit different for check and debit card transactions.
Savings Account and Credit Card Overdraft Protection Works the Same for Check and Debit Cards
Before explaining the differences in how overdraft protection works for checks and debit cards let me first explain how they are the same. If you overdraw your account on a debit card purchase and you DO have savings or checking account overdraft protection then you should generally be able to make your purchase without too much hassle; the necessary money will be transferred to your checking account to cover the shortfall in the same manner as if you had overdrawn the account by writing a check. Read about How to Use a Credit Card Effectively.
Something Different: Automatic Debit Card Overdraft Protection
Prior to August 15, 2010 if you overdrew your account as a result of a debit card transaction then your bank could automatically charge you a substantial overdraft fee of approximately $27 per transaction. For example, if for whatever reason you didn’t realize that you had no money left in your checking account and you made 3 separate purchases of $5 apiece using a debit card then your errands could end up costing you a whopping $96 (3 purchases at $5 apiece plus 3 bank fees at $27 apiece)! But now, based on the new regulations, your bank can no longer automatically hit you for overdraft charges related to debit card purchases unless you affirmatively sign up for the program.
To illustrate how this works, let’s say that you did NOT have savings account, credit card, OR the automatic debit card overdraft protection. What would happen if you attempted to buy something with a debit card for more money that you had in your account? The seller would run your card through a payment processor and, after a brief wait, your card would be denied. Perhaps you might find that a little embarrassing if you were making the purchase in person rather than online, but at least you would be spared a far more expensive alternative.
And what is that expensive alternative? If you had signed up for automatic debit card overdraft protection (or whatever your bank might call it) and you had made the purchase described above then the good news is that it would be approved even though you didn’t have enough money in your account to cover it, but the bad news is that you would be subject to the $27 overdraft fee. That’s enough money to hurt any regular person! As a result, I recommend that you cancel, resist, turn down, or otherwise opt out of automatic overdraft protection and instead utilize the much less expensive alternatives of saving account or credit card overdraft protection.
How Do You Cancel Automatic Debit Card Overdraft Protection if You Already Have it?
If you have any question in your mind about whether or not you have automatic debit card overdraft protection (as opposed to savings account or credit card overdraft protection) then contact a customer service representative from your bank to find out for sure. Now if you do indeed have automatic debit card overdraft protection then, again, I recommend that you opt out of it. If the bank’s customer service representative cannot help you do that, or they are not giving you information that’s sufficiently clear enough to enable you to make informed financial decisions, then consider taking your business to a competing bank that will.
A Reminder on How all of This Relates to Overdrawing an Account by Bouncing a Check?
I want to again emphasize that the August 15thregulations relate to automatic debit card overdraft protection. In other words, while banks can no longer automatically charge you fees for overdrawing your account as a result of debit card transactions, they can still automatically charge you for bouncing checks. As a result, regardless of whether you generally use a debit card or checks to make purchases and pay bills, I highly encourage you to get savings or credit card overdraft protection.