Roth IRA?

Discussion in 'After Hours Lounge (Off Topic)' started by JohnE, Oct 2, 2003.

  1. JohnE

    JohnE Supporting Actor

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    Could anyone explain how these work and the best way to get myself started? After doing everything wrong through my 20's, I'm finally getting my financial situation under control and have started to think about investing for the future.

    I took a financial class ages ago and remember one of the things the Professor emphasized was to not waste time on a saving account and instead begin investing in a Roth IRA. I don't remember much else about it except her showing a timeline of a Roth IRA earning 10% over it's lifetime turning into a hell of a lot of money.

    Any advice? Thanks.
     
  2. Joe Szott

    Joe Szott Screenwriter

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    John,

    The key to the Roth IRA is pretty similar to a 401k type plan: tax free savings. The difference is that the 401k uses a tax deferred approach and the Roth is a pre-taxed approach.

    Here's how a 401k works: You put in a certain amount of money before you pay taxes on it. That money grows tax free for XX years compounding interest on interest and then when you are 70 you start getting it back. When you get it back, you pay taxes on all that accrued interest, so it is considered tax deferred.

    Now the Roth is a little different. First, you pay your taxes on the money just like normal. Then you place this already taxed money into a Roth IRA where it basically grows tax free for XX years with compounded interest just like the 401k. The difference is when you start pulling it out after you are 59 (I think that's the age), you don't pay any taxes on any of it. Once it emerges from the fund, it is 100% tax-free. Also, there is no date when you must start taking Roth distributions (unlike a 401k), so if you don't need the money until you are 95, just leave it in there to grow until you are 95.

    I won't go throught he math here, but basically over the course of 30 years or so, the pre-taxed Roth makes more money than the tax-defferred 401k. Not a ton more, but more. But...

    The reason lots of folks use 401k programs is that (like me) the company you work for will smetimes match your contributions to a certain amount. For example, I put away 6% into the 401k and the company matches 1/2% for every % I do up to 6% (so they give me an extra 3%.) So by putting away 6% of my paycheck, I effectively get 9% in a retirement program. Then I take extra money every year and put it into my own separate Roth IRA account (because as explained above Roth has some long term advantages.)

    The best thing to do is to find a financial advisor to help you understand all this and find a program that is right for you. American Express provides this service fairly well, I have used them and been happy in the past. Also, if you are a do-it-yourself type, check out www.vanguard.com, that's where I have more Roth program and they are very friendly for the Joe Schmo investors like us.
     
  3. JohnE

    JohnE Supporting Actor

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    Thanks Joe. After spending years spending all my money actually trying to figure out how to save and invest it best is a lot more confusing than I was expecting.:b

    Oh well, I guess I needed to learn sometime.
     
  4. Scott Merryfield

    Scott Merryfield Executive Producer

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    Most financial advisors will suggest fully funding your 401k plan before funding a Roth IRA (if you cannot afford to do both). As Joe points out, it helps you more tax-wise right now, when chances are you will be in a higher tax bracket then when you are retired. Individual circumstances do vary, though. Also, you should always contribute at least enough money to a 401k to get the maximum match from your employer (or else you are just throwing away income).

    I think the maximum annual 401k contributions are $11,000 this year (not including employer matches). The maximum annual Roth IRA contribution is $3,000.
     
  5. JohnE

    JohnE Supporting Actor

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    After putting together a budget for the year, I figured I will have only about $2500 this year and probably the same over the next couple of years to save. Though I'm sure that will go up over time. Also my employer dosen't match, so is a 401K still the best option?

    I really do appreciate the feedback. I just really had no idea until recently what a maze investing was.
     
  6. DaveF

    DaveF Moderator
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    Something not mentioned is the Roth IRA is a newer variation on the now-traditional IRA. The traditional IRA is, like the 401k, tax-deferred. Contributions are tax-deductible for the year they are made, and taxes are paid with the funds are withdrawn at age 69 or whatever. But the IRA contributions are only deductible if you make less than some specified gross income. The Federal tax forms have that information.

     
  7. Chris Lockwood

    Chris Lockwood Producer

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    > The maximum annual Roth IRA contribution is $3,000.

    It goes up in future years, to a max of $5000, I think.

    Also, you can have both a Roth & a traditional IRA, but the max is the total for both. If you make too much to deduct the traditional contribution, it only makes sense to go with a Roth that year. If you have a future year where your income is below the limit, you can convert a traditional to a Roth by paying the taxes on it that year. (Just don't pay the taxes from the IRA funds to avoid cutting down your nest egg.)
     
  8. Keith Mickunas

    Keith Mickunas Cinematographer

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    John, I'd recommend the 401k even without the match. First, it's easier to do, your employer already has the stuff in place. They'll have a variety of funds you can put the money into, so it'll help give you a bit of knowledge how those investments work. Second, it comes right out of your paycheck before taxes. Thus if you put $500 from every check in, your take home is only reduced by $400 or thereabouts. Having it come out of your paycheck makes it easier to keep doing it. If you decide to only do an IRA, you have to keep yourself doing it on a regular basis.

    One of the advantages of IRAs (Roth or traditional) is that you get more control over where the money goes. For instance with my rollover IRA (a traditional IRA consisting of funds transferred in from my previous employers' 401ks) which I have set up at TD Waterhouse I can trade stocks, or invest in thousands of mutual funds. So if I know what I'm doing, or just get lucky, I got more options to grow that money.
     
  9. Keith Mickunas

    Keith Mickunas Cinematographer

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  10. Chris Lockwood

    Chris Lockwood Producer

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    > But if I'm not mistaken you can't have a traditional IRA and a 401k.

    Why not? The only rule differences I know of between traditional & Roth IRAs is whether taxes are paid before the money goes in or when it's taken out.

    IRAs & 401k plans have nothing to do with each other, except both are retirement plans. I've had some jobs where there was no 401k, but I've contributed to an IRA every year, 401k or not.

    Contribution limits:
    http://www.ira.com/faq/faq-05.htm
     
  11. DaveF

    DaveF Moderator
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  12. Keith Mickunas

    Keith Mickunas Cinematographer

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    Chris, look at http://www.ira.com/faq/faq-06.htm, what I meant to say is that you can't contribute to both at the same time.

    I believe, but I'm not certain and it doesn't state it clearly there, that if you do a 401k and traditional IRA at the same time, your maximum contribution to both is the same as just having an IRA. When I left my job, I'd contributed about four or five thousand to my 401k for that year already, therefore I'd gone past the limit for an IRA, so I could not open one up. This was in 2000, perhaps things have changed.

    If I'm understanding this correctly, if you put less than $3000 into your 401k, you could put the remaining amount into a traditional IRA. But you can't put $11,000 into a 401k and $3000 into an IRA in the same year.

    Oh wait, I now see that you can contribute money to a traditional IRA that is not tax-deductible. I was not aware of that. I'm not certain why you'd do that instead of a Roth IRA though.
     
  13. Chris Lockwood

    Chris Lockwood Producer

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    Yeah, back a few years ago (1998, I think) you could convert a Roth to a traditional & spread the taxes over 4 years, so I did that. (Just in time for the market crash to wipe out a lot of the gains in the account after I paid the taxes.) But a couple years after that I made too much to contribute to a Roth, so I contributed to the traditional those years. I don't think there's an upper income limit on being able to contribute to a traditional, just on deducting it.

    It's too bad this info isn't more widely known.

    Oh, if you leave a job & want to move your 401k money to an IRA, it has to be a traditional. But you can later convert that account to a Roth- go figure.
     
  14. Joe Szott

    Joe Szott Screenwriter

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    You are right, you can only have one tax deferred plan active at any given time, but the Roth IRA is not tax deferred, it is funded with post tax dollars. So although you can only have one 401k or IRA that you can contribute to in any given year, you can also have a Roth IRA in addition to that tax deferred plan. This is intentional since the Roth was created for people who max out their 401k/IRA contributions but still want to save more for retirement. The Roth is like an "extra" retirement plan available to anyone who earns the money in that year and doesn't make over a certain amount (guessing: $120,000/yr.)

    I remember seeing a breakdown of what equal amounts of money would become in either a 401k or Roth over the long term. Basically, the 401k was better for shorter term timeframes and the Roth was better the longer it sat there. The crossover was around 25-30 years. So for John, the question might be moot as that is about the time until his retirement anyway.

    Don't worry John, if someone as dense as me can understand it, anyone can. There's not that many rules really, but the ramp up sure can feel steep. Read a "Finance for Dummies" book or meet with a financial advisor, they really do help.

    If you want I think I have a copy of Finance for Dummies that I read a few years back. Some of the info might be dated, but if want to pay the shipping I'll mail it to you. I know what it said by heart, don't need it anymore...
     
  15. Chris Lockwood

    Chris Lockwood Producer

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    > I now see that you can contribute money to a traditional IRA that is not tax-deductible. I was not aware of that. I'm not certain why you'd do that instead of a Roth IRA though.

    It would only make sense if you made too much to be eligible for a Roth. Note that if you rollover a trad IRA to a Roth, you only pay taxes on what wasn't already taxed. In other words, say you make $200k this year & put $3000 in a trad IRA. Next year you only make $80k so you rollover that money to a Roth. Since you already paid tax on the $3000, you don't have to pay it again on the rollover. (But if your $3000 grew to $3500 by the time of the rollover, you'd pay tax on that $500 gain.)


    > Chris, look at http://www.ira.com/faq/faq-06.htm

    That page only talks about how much you can deduct. Where does it say anything about contributing to both accounts?

    The IRS doesn't say anything about it on this page:
    http://www.irs.gov/taxtopics/page/0,,id%3D16222,00.html


    > You are right, you can only have one tax deferred plan active at any given time

    Do you have a source for that? Somebody needs to tell the IRS!
     
  16. Keith Mickunas

    Keith Mickunas Cinematographer

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  17. Chris Lockwood

    Chris Lockwood Producer

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    > I'm certain that when I looked into it in 2000, you could not contribute to a 401k and a traditional IRA with pre-tax money

    "pre-tax money"- another way of saying deductible.
     
  18. Keith Mickunas

    Keith Mickunas Cinematographer

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    Sorry Chris, I didn't read close enough. So how do you deal with contributions to an IRA that are after tax?
     
  19. Chris Lockwood

    Chris Lockwood Producer

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    Deal with? I don't follow what you're asking.
     
  20. Keith Mickunas

    Keith Mickunas Cinematographer

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    Aren't things going to be complicated if you have both pre-tax and after-tax money in the same IRA? Or is that not allowed? Or is there something about how taxes are paid on an IRA that it doesn't matter?
     

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