I have a really smart husband. Smarter than I deserve, I think. But I’ll take his intelligence and knowledge as a blessing, because that’s what it’s been – particularly financially!
One thing that Jeff did after he got a “real job” was to start investing in a 401(k) AND a Roth IRA. I didn’t. I did the 401(k) thing. Mostly because my employer made it easy – “just sign here!”, so I did it. A Roth IRA though takes a little bit of work, so I never did. It takes work because
- You have to learn about them (they aren’t nearly as popular as 401(k)s) and
- You have to seek out some place to set one up
Now that we’re married, I have a Roth IRA in my name and he has one in his. (Roth IRAs are only in one person’s name so each having a Roth IRA isn’t a way of not sharing money – it’s just how those are done.)
Today, I’ll talk briefly about what a Roth IRA is and why you want one.
High Level Details:
- Think of it like a post-tax 401(k). You put money into it from your paycheck, after you’ve paid taxes.
- You can take the money you’ve put in at any time without paying taxes on it.
- So, you put in $50,000 over 20 years and if you earn another $25,000 on it, you can take out $50,000 tax-free.
- It’s basically a holder of money that you want to save or invest.
- Think of it as putting money into an envelope and inside that envelope are other envelopes that hold money.
- Some are savings accounts.
- Some are stocks.
- Some are mutual funds.
- You can put in $5,000 a year. (For 2011)
- According to the IRS, you can participate if:
- You’re single and make less than $120,000/year (for 2011).
- You’re married and make less than $176,000/year (for 2011).
- You can take money out to buy a first home, making it a decent way of saving for a house. (Some financial people recommend this; some don’t.)
Why you need to do this NOW:
Let’s say you’re 25 years old. And you put in $200/month for 10 years. Just 10 years and just $200/month.
Let’s assume you get 5% return (a pretty low return – could be more!).
At age 65, the $24,000 you put in is now worth $139,000.
The only difference between this and scenario 1 is that you’re starting 10 years later. Let’s say you’re 35 and now you put in $200/month for 10 years.
At age 65, the $24,000 you put in is now worth $84,500.
That’s $54,500 less just because you started 10 years later.
You can see an investment calculator here from Dave Ramsey.
My brother (another genuis – and a CPA!) corrected something I had said earlier — your Roth IRA income is probably not taxable income – depending on when you withdraw it. Accordingn to rothira.com:
Whether or not your withdrawal from a Roth IRA is taxes depends on a few factors.
- when the withdrawal was made
- whether the withdrawal was from contributions alone or if it included earnings
- what purpose the withdrawal was made for
Withdrawals made after age 59 and 1/2 are normal retirement withdrawals and are not taxed. You paid tax on that income when you first contributed to the Roth IRA.
If the withdrawal is made before age 59 and 1/2 and is only up to the amount that has been contributed to the Roth IRA then no income tax is charged. Withdrawals of contributions are tax-free.
If the withdrawal was made before age 59 and 1/2 and includes amounts above what you contributed (your investment earnings) then you may have to pay tax. There are certain situations where the IRS will allow you to withdraw without penalty. Funds can be withdrawn for higher education expenses or to buy a home. Certain hardship circumstances such as permanent disability also allow funds to be withdrawn tax and penalty free.