A IRA is like meeting someone on Tinder, at a bar, or your sisters wedding. Its special and fun but you don’t know if you are going to keep it around, you know that the memory is going to last forever though and you enjoy it while you can. Ok, so it’s not as much fun as the example but you have to admit this is a great opening line!
Seriously though, a IRA is a great investment tool and can really help you get ahead in life while also building a future. It is a incredibly diversified investment option that also allows access to your funds if you need it. As with all retirement plans though, it is important to understand exactly what you are investing in.
A IRA: Stands for Individual Retirement Account, it is accessible through a variety of employers, although they might roll it into a Roth 401 K, and financial organizations. Like the 401 K (See my previous blog to catch up!) you contribute the amount you can afford into it and then that contribution is matched or at least a portion of it is, again this is based on the services your employer offers. However, one very important thing separates the IRA from a traditional 401 K.
A IRA is usually deducted from post/after tax income if using an employer: This means that instead of taking a contribution out before taxes it is taken out after taxes have been paid. This usually means that your gross income is less than it would be with a 401 K. However, this also means that when you go to withdraw your funds no taxes are paid, the money you withdraw is exactly what you get!
Another huge difference between a IRA and a 401 K is the amount of time before you can withdraw. The 401 K cant be withdrawn from until you are 59 1/2 (Seriously, if you don’t know this you didn’t read the previous blog, go back, read it, and start following me so you can keep up!) but the IRA can be withdrawn from for several different reasons over different periods of time. To fully understand the money you can and cant withdraw I will break it down into 3 different categories.
Your Contributions: Your contributions to a IRA can be withdrawn at any time, with no penalties. This is a great way to get access to money if you have an emergency and need funds right away. It should not be used as an emergency fund, money should be set aside separately for that, but it is still nice to know that you have access to money if you need it. This is especially nice if you are younger and a long way from retirement.
Your Employers Contributions: These are usually given under the Roth 401 K and are locked up until you hit the 59 1/2 year mark, however, these funds can be withdrawn to buy a home for the first time, end up with a disability, or other circumstances that would allow you access. (Sorry guys, random trips to Vegas do not qualify). If you are nearing the age of 59 1/2 you also need to make sure that your contributions have had a 5 year vesting cycle before withdrawing.
The Interest Generated: This one is very cut and dry, while the previous 2 allow you to access your money with relative ease this one must not be withdrawn until you are 59 1/2 years of age. This includes all interest, whether it is from your contributions or the employers. Any withdrawal early is usually penalized at 10%, yikes!!
So, as an example, lets say you are 25 years old and invest $100 each week to your Roth IRA/401 K, you do this constantly for 5 years and your company matches the 5%. Lets say that overall the account has generated 5% interest (This is for the 5 years, compounding is not used in an effort to simplify and because math is not this bloggers strongest area). On your 30th birthday, your Roth would look something like this:
Amount you Contributed: $24,000 /Employer Amount Vested: $24,000 /Interest Earned: $2,400.
Great job!! You have put away a lot of money and that hard work is paying off! However, that Tinder relationship has turned to love, which has lead to marriage and now the wife/husband wants a little house to raise a family, after looking at your Roth IRA you realize that you can probably have all of your employer contributions paid out as this is allowed for first time home buyers and usually after a 5 year vesting period. You are super excited to see that you can easily withdraw the $24,000 for a down payment on the home and still have $26,400 towards retirement! This is the true beauty of a Roth IRA/ 401 K in my opinion, it allows you to not only build a future, but also build a retirement at the same time.
Other factors of the Roth IRA and traditional IRA are the tax breaks and retirement taxable income. In a lot of states, contribution to a IRA can be used as a tax deduction. This means that if you contributed $500 into your IRA, you literally could get a tax deduction of $500, this is literally free cash in your pocket!! (unless you haven’t been paying your student loans, seriously those are no joke). Its also a great plan if you are young and at a lower tax bracket during contribution. Remember, taxes have already been paid so you can’t be taxed again (Income from interest is still taxable). So if you contributed when you were paying 20% in taxes but withdraw when you are in the 45% tax bracket you can feel like you beat the system!! Until you see your most recent pay stub at least.
So readers, what do you guys do? Do you use the 401 K or Roth IRA/401K? Do you mix them up or max one out before working on maxing the other? What companies have the best matches? Feel free to subscribe and comment!!