Part 21 (2/2)

Disadvantages of 401(k)s Alas, 401(k)s aren't perfect. For one thing, once you put money into a 401(k), you can't easily access the cash if you end up needing it for something else. Except in cases of hards.h.i.+p (see tinyurl.com/401k-hsw), if you pull the cash out before age 59 and a half, you'll be socked not only with taxes, but also a 10% early withdrawal penalty. (On the other hand, you have to begin pulling money out by the time you're 70 and a half, unless you're still working for the company that sponsored the plan.) Also, find out the details of your company's vesting policy. Vesting is the process by which you gain ”owners.h.i.+p” of any contributions your company makes to your 401(k) (as with an employer match). You always own the money you've put into the plan yourself, but you only gradually gain owners.h.i.+p of your company's contributions. You might own none of them during the first year you partic.i.p.ate, for example, 20% the second year, and so on. If you leave the company before you're fully vested, you won't get 100% of the money they contributed. Check with your company's HR department to learn more.

But the biggest problem with 401(k)s is that they often offer only limited investment options. The firm that manages your company's retirement accounts probably gives you a small menu of mutual funds from which to choose. Your challenge is to find the one best suited to your needs (which, as you learned in the last chapter, is likely to be the lowest-cost fund; favor index funds, if possible).

If your company's 401(k) plan is lousy (it has high fees and poor selection, say), move the money into an IRA (Learning to Love Roth IRAs) when you leave the company. But no matter how bad the plan, it's probably not bad enough to pa.s.s on the employer match. For more info on how to deal with a bad 401(k) plan, read this article from Money magazine: tinyurl.com/bad401k.

Every company's 401(k) plan is different. Your best bet is to read up on how yours works and do what you can to make the most of it. And whether or not your company offers a 401(k), you should definitely take a look at the investor's best friend: Roth IRAs.

TipAt some point, you may want to s.h.i.+ft money from one retirement account to another, like moving the money in a 401(k) from your old job to a Roth IRA. (The technical way to say this is that you want to roll over your 401(k).) Be warned: These moves can be tricky. The IRS has a handy chart that shows which accounts can roll over into other accounts: tinyurl.com/IRS-ropdf. For more info, read the Get Rich Slowly article at tinyurl.com/GRS-401kmove and contact a financial planner (see and contact a financial planner (see How to open a Roth IRA account How to open a Roth IRA account).

Learning to Love Roth IRAs Even if your company doesn't offer a retirement plan, you can still save for the future. One of the best ways to do so is with a Roth IRA.

An IRA is an individual retirement arrangement, a retirement plan that gives you tax advantages when saving for retirement. There are two types of IRAs: - With a traditional IRA (first introduced in 1975), the money you put in is typically tax deductible, but the money you pull out at retirement will be taxed at the then-current rate.

- With a Roth IRA (first introduced in 1997), you contribute after-tax dollars, but when you retire, you don't have to pay taxes on the returns the money earned. (These IRAs get their name from Delaware senator William Roth, who helped pa.s.s the law that created them.) In other words, money in a traditional IRA is taxed when you withdraw it, but the money in a Roth IRA is taxed before you contribute it. (For more on the difference between Roth IRAs and traditional IRAs, see the box on Extreme Retirement Saving Extreme Retirement Saving.) You make investments in an IRA through an individual retirement account. Many folks use the term ”IRA” interchangeably to refer to both individual retirement arrangements and individual retirement accounts, but there are some important differences. You have just one Roth IRA, for example, but you can have many Roth IRA accounts. That is, you can have a Roth IRA account at your credit union and one with your mutual fund company, but they're both part of the same IRA. (It's kind of like how this page and the last one are both part of the same book.) One important thing to realize is that an IRA isn't itself an investment-it's a place to put investments. When you open an IRA account, it's like an empty bucket just waiting to be filled. The things you put into your IRA bucket are investments. You might, for example, buy stocks to put into your bucket, or maybe bonds. Some people use their IRA accounts to buy investment real estate, and some simply let their cash sit there, earning interest in CDs, just as it would if it were deposited in the bank down the street (which may actually be where they keep their IRA account!).

As you might expect after reading the last chapter, smart people mix up the contents of their IRA accounts over time. Their buckets might contain a combination of stocks, mutual funds, bonds, and real estate. (When you start out, your bucket will probably hold just a single investment, and that's fine.) For many people, Roth IRAs are the perfect place to put retirement savings. They're an easy way to contribute to your financial future, and they're such a good deal that it's worth taking an extended look at them.

NoteSome companies offer Roth 401(k)s, which are like a cross between a Roth IRA and a regular 401(k): You put in after-tax dollars so that you can withdraw them tax-free. You can learn more about Roth 401(k)s at tinyurl.com/yh-401k.

Roth IRA rules and requirements There are some restrictions on who can contribute to Roth IRAs. These arrangements are designed to help ordinary working folks to save for retirement by giving them a significant tax break. They're not meant for people with really high incomes.

If your tax filing status is single and you earn more than $105,000 but less than $120,000 in 2010, the amount you can contribute is limited. And if you earn more than $120,000, you can't contribute to a Roth IRA at all. If you're married and filing jointly, your contributions are limited if your household income is more than $167,000 but less than $177,000 in 2010. And if you and your spouse earn more than $177,000, you can't contribute to a Roth IRA at all.

These income limits are based on your modified adjusted gross income. (If you don't know what that is, don't worry about it unless you think you're close to the limit.) Also note that the Roth IRA income limits usually increase every year. A few other important facts: - If you're younger than 50, you can only contribute $5,000 to your Roth IRA in 2010 (if you're 50 or older, you can contribute up to $6,000).TipThese contribution limits increase from time to time to keep up with inflation, so you should check every year to see whether they've gone up.

- To invest in a Roth IRA in any given year, you (or your spouse) need to have earned income; in other words, you can't fund a Roth IRA if all of the money you received that year came from an inheritance.

- You can use a Roth IRA even if you have a 401(k) or other retirement plan.

- You have to make your contributions by the tax deadline each year. For example, you have until April 15, 2011 to make your Roth IRA contributions for 2010. (But it's a good idea to fund your account as early as possible.) - You can convert traditional IRAs to Roth IRAs. There used to be income limits on these conversions, but those limits are gone as of 2010. If you think you might like to convert a traditional IRA to a Roth, contact a financial planner. (The topic is beyond the scope of this book.) - You can withdraw your contributions at any time without penalty. But if you try to withdraw your earnings (the returns on your contributions) before you're 59 and a half, you'll have to pay taxes and a 10% early-withdrawal penalty (except in special circ.u.mstances).

- Lastly-and this is important for many people-you can withdraw up to $10,000 in earnings without penalty to buy your first home, as long as your IRA spans at least 5 tax years. Check out tinyurl.com/mf-irahome for more info. for more info.

There are other arcane guidelines and provisions, but these are the basics. If you want more info, check out Publication 590 at the IRS website (tinyurl.com/IRS-iras) or contact your friendly neighborhood financial planner (see the box on the next page).

On The Money: How to Hire a Financial PlannerIf you don't have the time or knowledge to create a roadmap for your financial future, consider calling in a pro. A financial planner can help you put the pieces of your investment puzzle together in a way that makes sense for your personal goals and values. Even if you do most of the work yourself, you may want to have a planner check things over to make sure your investment plan will work as you intend. Planners can also make recommendations and give advice on how to implement your plan.Before hiring a planner, decide how much help you want or need. Different planners charge different rates, typically based on one of these methods: by the hour (best if you need minimal help), by the project (best if you need help in a specific area), on retainer (best if you want ongoing help), or based on a percentage of the a.s.sets they're managing for you. (Watch out: This last method has a built-in conflict of interest.)The more research you do on your own (like reading this book!) and the more you're willing to do yourself, the less you'll end up paying. Most planners will give a free initial consultation, which will let the two of you get a feel for each other. (Be sure to ask these 10 questions: tinyurl.com/CFP-questions.)As you look for a planner, watch out for potential conflicts of interest. Ask yourself if the recommendations she gives you could somehow benefit her. Those paid by commission tend to be salespeople rather than actual planners. So ask questions, read the fine print, and a.s.sume nothing.It's important to know that the term ”financial planner” isn't regulated-anyone can call themselves that. But Certified Financial Planners (often simply called CFPs) are regulated and have to agree to uphold a set of standards and follow a code of ethics.You can find a CFP using the Financial Planning a.s.sociation's PlannerSearch website (tinyurl.com/FPA-search). The Garrett Planning Network () has a searchable directory of financial planners who charge by the hour. The National a.s.sociation of Personal Financial Advisors (mendations, but look for other options, too. Many banks and credit unions offer IRA accounts (though you'll usually be able to invest only in deposit accounts, like CDs). If you're willing to make some decisions on your own, you can open an IRA account through a discount broker or mutual fund company. There are a lot of good options out there, but you might start your search with these firms: - Fidelity Investments. tinyurl.com/FID-ind, 800-FIDELITY - T. Rowe Price. tinyurl.com/TRP-ind, 800-638-5660 - The Vanguard Group. tinyurl.com/TVG-ind, 800-319-4254 Set aside an hour or two some Sat.u.r.day morning to explore the options over a cup of coffee. With a little research, you should be able to find a company and program that suits your needs. When you're shopping around for a place to open an IRA account, ask the following questions: - Is there a minimum initial investment?

- What sorts of fees will they charge on your account?

- Can I make automatic contributions?TipMaking regular automatic investments to a Roth IRA account is a fantastic way to build wealth. Most brokers and mutual-fund companies provide some sort of program that'll pull money from your bank account every month. If you make this a habit, you won't even notice the money is missing; it'll be a regular expense in your monthly budget. Do this and you'll put yourself far ahead of your peers.

- What investment options will I have? Can I invest in index funds?

- Will I be able to download statements?

Search for a company that suits your needs. But don't fret about finding the perfect match-find a good match, and then get your IRA account in motion. You can move your money to a new IRA account if the first company you choose isn't a good fit.

Once you pick a place to open your IRA account, it's time to fill out the application. Some firms want you to download forms, and then mail or fax them back, but most companies provide online applications. To complete the application, you'll need your Social Security number, bank account info (so you can transfer funds), info about your current employer, money in a bank account (depending on where you open your IRA account, you might need anywhere from $25 to $3,000), and about half an hour of free time.

When you've gathered all that info, you're ready to fill out the paperwork. You'll probably have to answer some simple questions about your investment plans and goals. Once you complete the application, they'll ask you to transfer money to your new Roth IRA account. (This money will probably earn interest until you choose an investment.) That's all there is to it!

Frequently Asked Question: Roth IRAs Versus. Traditional IRAsHow do I choose between a Roth and a traditional IRA?As great as Roth IRAs are, they're not for everyone. The general rule of thumb is that you should go with a traditional IRA if you need the immediate tax deduction (see Roth IRA rules and requirements Roth IRA rules and requirements) or if you're likely to be in a lower tax bracket when you retire than you're in now. (Both of these are more likely if you make a lot of money, in which case you might not qualify for a Roth IRA anyhow [see Roth IRA rules and requirements Roth IRA rules and requirements]).There are many subtle differences between the two types of arrangements that affect people in or near retirement. You read about some of these details earlier in this chapter, but to save you from having to do a point-by-point comparison, here are the most important considerations for the majority of folks: - Both types of IRAs have the same contribution limits. The current limit is $5,000 a year, or $6,000 a year if you're 50 or older.

- Roth IRAs have income limits; traditional IRAs don't. For the 2010 tax year, single filers have to make less than $105,000 to be allowed to fully fund their Roth IRAs; for joint filers, it's less than $167,000. (Traditional IRAs have income limits on deductibility in certain cases; see tinyurl.com/ira-deduct for details.) for details.) - The two types of arrangements have different tax advantages. You typically fund a traditional IRA with pre-tax dollars, so you pay taxes when you withdraw the money. The money you put into a Roth IRA has already been taxed so it grows tax-free and you don't have to pay taxes when you withdraw it.

- You have to take yearly distributions from a traditional IRA (and pay taxes on them) when you're over 70 and a half. As with a 401(k), the IRS says you have to take a certain minimum amount out of your traditional IRA every year once you reach a certain age. There's no required minimum distribution for Roth IRAs.

- You can withdraw your contributions (but not earnings) from a Roth IRA anytime without paying penalties. Traditional IRAs don't give you this option.

If you don't know which option to choose, you're likely best off using a Roth IRA. For more info, check out the Roth IRA vs. traditional IRA calculator at CCH Incorporated (tinyurl.com/ira-calc) or talk to a financial adviser (How to open a Roth IRA account).

Extreme Retirement Saving If you've already put enough into your 401(k) to get the full employer match and you've maxed out your Roth IRA, congratulations-you're in great shape! What you do after this depends on your priorities.

If you think you need to save more for retirement, then pump up your 401(k) as far as you can. In 2010, you can contribute up to $16,500, including your employer match. If you're 50 or older, you can contribute up to $22,000.

You might also consider accelerating your mortgage payments (see Should you prepay your mortgage? Should you prepay your mortgage?); many retirees find that owning their home free and clear gives them tremendous peace of mind. A final option is to use targeted savings accounts (Targeted Savings Accounts) to pursue other goals. These are all great options, and Super Savers can't go wrong by pursuing any-or all-of them. They'll each put you that much closer to retirement.

Early Retirement and Other Dreams For most of us, a job is a necessary evil. Many folks dream of retiring early-finding a way to leave the workplace in their 40s or 50s instead of sticking it out until age 65 (or older). In fact, the 2009 EBRI Retirement Confidence Survey (A Better Way) found that 18% of retirees left the workforce before age 55 (and another 17% retired before they turned 60).

Early retirement is a fantastic goal, but it's tough to do because of four main obstacles. When you retire early: - You have less time to earn money. If you start working at 20 and retire at 65, you have 45 income-producing years. But if you retire at 45 instead, you only have 25 income-producing years to achieve the same results.

- Your investments have less time to compound. As you learned on The Power of Compounding The Power of Compounding, the longer you go without touching your savings, the more you benefit from the power of compounding.

- You'll be drawing on your savings for longer. The average American will live to be nearly 80. So if you retire at 65, your savings will probably need to last only 1020 years; but if you retire at 45, your savings may have to support you for 3040 years.

- You won't have some of the traditional perks of retirement (at least not right away). If you retire young, you won't be able to draw on Social Security or Medicare for many years. You'll also face penalties if you want to tap your retirement accounts before you reach the minimum age requirements.

In short, if you retire early, you'll have less money saved and it'll have to last longer than if you waited. Even if you stay healthy and the economy cooperates, that's asking a lot.

That's not to say you shouldn't plan to retire early. It's a laudable goal (and one I've set for myself). If you're serious about doing it, you need to be extra diligent about living frugally now so you can save as much as possible for the future.

After Philip Greenspun retired in 2001 at the age of 37, he wrote an article about some of the joys, challenges, and practical aspects of his decision: tinyurl.com/PG-retired. And at MSN Money, Liz Pulliam Weston profiled people who retired early. In one article (tinyurl.com/rb50-one), Weston looks at what it takes to retire by age 50. In another (tinyurl.com/rb50-two), she shares how three couples made this dream a reality.

To learn more about early retirement, check out the Early Retirement Forum (e from some sort of work. In Work Less, Live More Work Less, Live More, Bob Clyatt explains the advantages of this option: With a modest income from part-time work, early semi-retirees may not have to face the dramatic downs.h.i.+fting in spending and lifestyle that so often confronts those who live only on savings or pensions. And semi-retirees learn that a reasonable amount of work, even unpaid work, keeps them energized, contributing, and sharp.

Though semi-retirement is more realistic than early retirement, it's still not for the faint of heart. You have to be dedicated and work hard to make it happen. Semi-retirement typically involves: - Ample savings. Semi-retirees plan far in advance, acc.u.mulating a large nest egg before they make the leap.

- Modest living. Semi-retirees tend to be frugal and use techniques like those in Chapter5 Chapter5.

- Ongoing work. Though semi-retirees aren't employed full time, they do keep working for a number of reasons: The added income means they don't have to draw down their retirement savings as quickly as they would otherwise, and the work lets them spend time with people while doing something worthwhile.NoteAccording to the EBRI Retirement Confidence Survey, one-third of retirees worked for pay in 2009.

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