Time is money. You've heard that old saying. But when it comes to investment, the better way to say it is: Time leverages money. Especially when you don't have to pay taxes on the money you earn.
That's the tempting incentive behind Roth IRAs. And millennials are gaining a new appreciation of that simple truth when it comes to saving for retirement, according to a new study from T. Rowe Price. The study shows that investors under 34 years of age have over eight times more money in Roth IRAs than traditional IRAs.
(For those unfamiliar with the rules, you don't get a current tax deduction for your contribution to a Roth IRA, as you would with a traditional IRA. But the government promises that all the gains will come out tax-free when you retire! It's such a good deal that there are income restrictions on who may contribute -- only singles with incomes under $114,000 and married couples filing joint returns with income under $181,000 can take full advantage of a Roth contribution.)
So give the millennials some real credit for understanding not only the value of regular retirement saving, but the importance of avoiding taxes in the future. After all, given our huge deficits and promises of payments to the aging baby boom generation, it's reasonable to assume that tax rates might be much higher when millennials finally retire.
That wasn't the case twenty five years ago, when most boomers started thinking about retirement. Back then, it was assumed that when you retired you'd be in a lower tax bracket. And that was before so many programs, including Social Security benefits Medicare Part B premiums, were impacted by taxable income. Now every bit of taxable income may count against you, not to mention the possibility of rising tax rates.
Compounding Time and Money
There are two good reasons for younger people to opt for the Roth version of the IRA. First, they're likely to be in a lower income tax bracket when they contribute, so the deduction isn't as valuable. But even more importantly, they have a much longer time to make that tax-free money grow. And that's not just a guesstimate.
Here's an example from the study, which assumes investors retired at age 65 and contributed $1,000 to a Roth vs Traditional IRA at various ages. Each is in the 25 percent tax bracket at the time of their IRA contribution. And to make things fair, the $250 tax deduction from the traditional IRA is not spent, but invested in a separate account.
The study also assumes a 7 percent annual return for each of the accounts (as well as that separate taxable account for the $250 annual savings from the deduction). Then during retirement, when most investors become more conservative, the return drops to 6 percent.
Withdrawals are taken over a 30-year retirement. And how is that retirement lifestyle enhanced for the Roth investor?
That 25 year old who used a Roth and stays in the same tax bracket in retirement would have nearly 20 percent more spendable income in retirement than the worker who used a traditional IRA. That is a significant difference; just ask any retiree if he or she could use 20 percent more income!
There are some other benefits to Roth IRAs. If you've managed to save a lot for retirement, you might not want to withdraw from your IRA, instead passing it on to your heirs. Traditional IRAs have required minimum withdrawal rates after age 70-1/2. But there is no such requirement for a Roth.
And here's another secret about Roth IRAs that I hesitate to publicize. While an IRA is meant to be untouched until retirement, if urgent circumstances require a withdrawal from a traditional IRA before age 59-1/2, you'll face a 10 percent penalty, plus taxes. Not so with a Roth, where you can withdraw the contribution portion of your account without penalty or taxes.
The New IRA Season
We tend to stop thinking about Individual Retirement Accounts after April 15th. But that's a huge mistake. The T. Rowe Price survey also shows that those who make their contributions on a monthly basis throughout the year far outperformed those who waited until tax-time to make a lump sum contribution.
In fact, using rolling 10-year periods of real S&P 500 stock returns, the monthly contributor generated a larger account balance in 98 percent of those time periods. And the best performance of all was generated by those who made their annual contribution early in the year. In the study, the "early investor" outperformed the monthly investor in 91 percent of the 10-year periods studied!
That means now is the time to be making this year's IRA contribution - not 11 months from now!
You can contact any mutual fund company or broker to open an IRA in a low-cost, diversified stock market portfolio. T. Rowe Price will let you open an IRA with a minimum investment of $1,000, setting up an automatic contribution of $100 per month or more. The same minimums apply with most no-commission (no-load) mutual fund companies.
But if you're just getting started, don't let the high entry price deter you from starting an IRA. At www.Sharebuilder.com, there is no minimum amount required to open an IRA, although you will pay a $6.95 fee for each investment.
No matter where you open that IRA, you'll get an opportunity to invest in a diverse portfolio of America's best companies, reinvesting dividends along the way, either through a mutual fund or Exchange traded fund (ETF).
Once you get started with an IRA account and automatic monthly contributions, you'll be amazed at how easy is to get your money working for you as hard as you worked for it! And that's The Savage Truth.
Where do you see most RVs? Parked in their owner's driveways for 11 months a year. So instead of rushing out to buy one for $100,000, check out renting it instead. We're told a pretty nice Airstream that sleeps six will set you back $2,000 per week. In general, the rule of thumb has always been to own what appreciates and lease what depreciates. Do you really want to walk past the behemoth in the driveway five times a day knowing it devalues a little more each month with age? And don't forget about the other costs of RV ownership: insurance, maintenance, storage off-site when you tire of it as a lawn decoration.
Our favorite places to shop are thrift stores near retirement communities. Golf clubs and golf carts show up frequently in these shops at a fraction of their original cost. We also comb the classifieds of the retirement community newsletters for gently used cars; you can find some gems with low mileage.
To state the obvious, you can always rent a boat for a day of sailing or a weekend at sea. You also let your boat-owning friends know that you're "thinking" of buying one and ask if they would mind taking you out for the day? Most boat owners love to show off their toys. And you can become the guests they always invite back by going a little overboard with the food and drink you bring. Boat owners we know say the guests they like the most are the ones who stick around long enough after the sail to help clean up and secure the vessel.
Offer your guest room to out-of-town visitors and you'll feel better asking to use theirs. Use a home-swapping service when you visit new places. Trade your plumbing skills with the house-painter's. You sew and your neighbor bakes like a pro; order up a birthday cake and offer to take up a few hems. The one commodity that retirement gives everyone is time. Barter it for the lifestyle you want.
Public libraries rent out not only books and movies, but they also run lots of free programs including lectures. Parks hold concerts in the summer for free. Colleges frequently allow those 55+ to audit classes for free; you won't earn credits toward a degree, but you will learn some new things.
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