Guest post: Read this before you file your income taxes!

February 26 49 Comments latest by FD » Blog Archive » Personal Finance, Part 13 Unemployment Risk26 Feb 2008 by D…

[Update: Roth IRA amounts corrected below.]

[From Ramit: Since tax season is here, I wanted to write something about the tax issues we face. But since I’m not an expert, I’ve typically turned to guest posters to help. Last year, David Bergstein answered your tax questions.

This year, I’ve invited Todd Doerr to guest-post for the next three days. Over the next 3 days, he’ll write about taxes for three situations: people in their twenties, college students (I know you’re lazy so you can just point your parents to the article to do all the work), and recently married couples. And on Friday, after the three posts, I’ll announce something pretty cool.

I like this post below because Todd points out that if you’re already saving, why not take a small extra step to dramatically increase your returns?]

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Guest post by Todd Doerr

Stop. Turn off your ipod. Turn off your phone.

This one post will help you win with money – guaranteed – if you take ACTION. If you are in your 20’s or 30’s, this is going to rock your world.

I coach many individuals and families in my financial coaching practice – they pay me to help them quickly get out of debt and build wealth. Hopefully you are already saving some each month towards retirement. Why not spend an hour to setup a simple, automatic wealth building plan that will double your return?

I’m amazed that only 31% of Generation Y workers (born 1978 or later) are saving for retirement in their 401k, according to Hewitt Associates. You can be light years ahead of your friends if you follow the coaching advice that follows. It will only take an hour of your time – your friends will be amazed!

Let’s dive in - stay with me!

Let me go ahead and spell out the entire purpose of this post:

The Roth IRA is one of your most important wealth building tools. Maybe even the most important. If you consistently invest in your Roth IRA during your working years, you will build substantial wealth.

OK. Maybe it was a little heavy, but I want to get your focused attention for a few minutes. Let’s cover the basics first.

The Nuts and Bolts of the Roth IRA

Here are some of the common questions that I get about the Roth IRA:

Q: Why should I care about a Roth IRA?

A: The short answer: You don’t want to work the rest of your life. Using a Roth IRA consistently, in addition to your 401k, will make you very rich and will change your life. I would argue that if you save aggressively in a Roth IRA, you will open up new options and freedoms in life that you cannot fathom today.

Q: What is a Roth IRA?

A: A Roth IRA is simply a retirement savings account offering amazing “back-end” tax breaks when you take money out at retirement age (59½ years and older). The Roth is a “bucket” – you fill that bucket with good conservative mutual funds (I don’t recommend individual stocks).

Q: How hard is it to setup?

A: 1 Hour – I’m dead serious. I’ll cover the specifics later in this article.

Q: What are some specific benefits?

A: You can withdraw funds without taxes or penalties once you’ve reached age 59½ and held the funds in the Roth for five tax years after the year you make your first contribution. Here’s an example. Let’s say that you worked your buns off for 30 years and had $1 Million dollars in your Roth. When you retire at age 59½ years (or older), you can take out the $1 Million TAX-FREE. It also grows TAX-FREE each year during your career. Don’t think you can save $1 Million? Keep reading on.

Q: What are the limits on a Roth IRA?

A: You can contribute $5000 annually to a Roth ($10,000 for married couples), whether you participate in an employer plan (like 401k) or not, if your AGI (line 37 on Form 1040) is less than $116,000 (joint filers, $169,000).

Q: Anything else I should know about it?

A: You can withdraw your contributions penalty-free should you need them for an emergency. You can contribute at any age as long as you have earned income. There are some

A Sweet Retirement

OK. Onto the cool stuff. Go ahead – take a peek. Wow.

The tables below show what you could have in your Roth IRA if you invested monthly or annually during your career. These numbers assume you invested in a diversified, conservative set of mutual funds that could average 11% annually (stock market has averaged over 11% for over many decades).

You must really like that $400 car payment! Or, maybe the gym membership isn’t looking so fiscally fit anymore. And for sure, the minimum payment to Visa could be put to better use! Maybe the $200 per month for eating out is not so appetizing.

Here are some specific and exciting ways to boost your savings plan.

• $100 - $200 - $300 - $400 per month of savings: Go through your budget and find the “luxury” items – you will be amazed when you cut a little here and there. These things add up. My favorites include: driving a used car and dropping the fat car payment, drop the premium cable channels, cut back on the cell phone plan or drop your land line at home, selling the cat (just kidding!), bring your lunch to work except 1 day per week, drop the gym membership, take basic vitamins instead of $100 per month, only buy clothes that are mega-bargains, cancel subscriptions that you don’t really have time to read – the list goes on. You won’t miss these and will truly enjoy knowing you have a plan to win with your money. Get yourself motivated and start making changes now!
• $200+ per month of savings: Work a part-time job to speed up your progress. Ask your employer for overtime opportunities. Provide a tutoring service. Deliver pizzas (you can make $750/mo doing that). Mow yards or provide handyman services. Start a pet sitting business. Get creative. Get your real estate license. Write software on the side. Don’t analyze this too much – just go for it. If you don’t like your first part-time job – just find another one. This is not a FOREVER job.

Anyone in America with a decent income can win! The key is to start TODAY and not hesitate. Set your goal and don’t stop until you reach it - $100 - $200 - $300 - $400!

Annual amount – Assuming 11% return

Yearly Contribution	30 years of saving	40 years of saving
$1000	$220,913	$645,826
$2000	$441,826	$1,291,653
$3000	$662,739	$1,937,480
$4000	$883,652	$2,583,307
$5000	$1,104,565	$3,229,134

Monthly Investing Results – Assuming 11% return

Monthly Contribution	30 years of saving	40 years of saving
$100	$283,022	$867,895
$200	$566,045	$1,735,791
$300	$849,068	$2,603,687
$400	$1,132,090	$3,471,582

My

Simple Way

To Get Started in less than 1 hour

STEP ONE: Don’t file your taxes yet. The good news: You can still make a “2007” contribution if you open a Roth IRA before you file your income tax return.

STEP TWO: Open an account TODAY. The sooner you start, the sooner you start the magic of compound interest.

• Find $5000 $4000 (the new 2008 limit is $5000) for your “2007” contribution. If you don’t have $5000$4000 right now, just put in whatever you free money that you have. $500 - $1000 – it doesn’t matter. You must get started!
• Autopilot for 2008. Setup an auto-draft from your checking account each month and have the money invested automatically. It’s too easy to get distracted during the year to write a check each month – set it up once and let it run. Your target amount should be $416 per month ($5000 divided by 12 months). If you have to start small, that’s OK. As you can see, even $100/mo is HUGE at retirement. And don’t forget the next time you get a raise, bump up your monthly investment by even more.
• Open an account at a low-expense, customer friendly mutual fund company. Simply tell them “I would like to open up a new Roth IRA and make a contribution for 2007. I would also like to setup an automatic investment plan each month for 2008 and beyond.” I highly recommend T. Rowe Price and Vanguard as a great place to open a Roth IRA.
  • T Rowe Price. You can start with as little as $50 per month on most mutual funds. Contact them at www.troweprice.com or 1-800-638-5660.
  • Vanguard – They have higher minimums amounts to start, but offers lower annual expenses than most companies. Contact them at www.vanguard.com or 1-877-662-7447.
• Choose a conservative “growth and income” mutual fund or balanced fund to get started. These should be funds you plan to hold for a lifetime. You can diversify later into different flavors and styles of mutual funds. For right now, these will work fine.
• Leave it alone! If you look at the long history of the stock market, 97% of any 5 year timeframe had a positive return. Don’t try to get fancy, time the market, buy individual stocks – stick with the basics. You want your foundation to be strong – don’t tinker with it. Invest and leave it alone.

Retirement Savings Goals

In case you are wondering how much you should save each year for retirement, your overall savings goal should be about 15% of your gross income (most of my clients are in the 10% – 20%), in the following order:

• Fund your employer 401k plan up to your maximum employer’s match.
• Max out your Roth next up to $5000 (or start with a Roth if no company match).
• Finish out the 15% by investing more in your 401k.

Friends, Laziness, and Boosting Returns

OK. You now have a vision for building significant wealth.

But what about your friends? Many of your friends probably don’t get it. Why? Because they haven’t seen that significant wealth is possible for the “average” person with an “average salary”. Share this article with them. I’ve found that it helps to have like-minded friends shooting for a hopeful future.

If you are feeling lazy – you better wake up! I have made it abundantly clear that 1 hour of your time will rock your world. You don’t have to do heavy analysis each month – set up this plan on autopilot and let it run. If you are so lazy that you can’t spend 1 hour on this, then, whew, life is not going to be easy in your later years.

If you are already saving some, you can turbo charge your results by using low-cost mutual funds that I recommend in this article. Using mutual funds that cost 1% less per year than the average mutual fund could boost your total nest egg by nearly 25% over a 30 year time span. Instead of $1,000,000, you could end up with another $250,000 for a total of $1,250,000.

Final Thoughts – Keep it Simple and Automatic

It’s amazing, but you can actually thrive and build wealth with a simple, “boring” diversified portfolio in your retirement accounts. The Roth IRA should be a serious part of most wealth building plans. Open your account today.

Be sure to join us tomorrow. I will be sharing some specific ways to find $1000 Dollars for college expenses.

Blessings,

Todd

Todd Doerr is personal finance coach. He helps his clients to rapidly get out of debt and to build serious wealth. He tells his clients, “It’s not always easy or pretty, but it always works.” You may reach him at todd_doerr@yahoo.com or at www.taxmakeover.com.

[Update]
1. See the two other articles Todd wrote:

• How college students can save their parents tax money
• What to do, tax-wise, if you’re recently engaged or married

2. Then check out his eBook, The 2008 Tax Makeover Guide

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49 Comments latest by FD » Blog Archive » Personal Finance, Part 13 Unemployment Risk26 Feb 2008 by D…

1,031 people respond: How they spent money on Valentine’s Day

February 24 8 Comments latest by William

[Update: Check out Slide #5. It’s hilarious how the percentage of men and women who bought “intimate apparel” is…equal.]

A few days ago, I asked you how much you spent on Valentine’s Day. With 1,031 responses, here’s the analysis (RSS readers, click here to see the slides).

| View | Upload your own

Click for a larger view

See my other survey results about money here.

As usual, thanks to Rob from FindABetterBank (give it a shot and see how your bank compares).

If you have any particular data you want to see in upcoming analyses, leave a comment here with an interesting idea. Dumb ideas will be mocked.

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8 Comments latest by William

Mission accomplished

February 21 8 Comments latest by K

Probably one of my favorite emails ever.

Ramit,

Hello. My name is Kayla and my brother actually sent me your recent entry about college financial aid at Stanford University. I was definitely interested because I know that college is going to be very difficult for me to pay for and, quite honestly, I’m really not looking forward to years of student debt. Anyway, I actually just wanted to thank you. I really never thought about how much scholarship money is probably never even given away. It’s really encouraging to hear that, with just a little effort, I could potentially come out of college with little to no debt at all.

Now, I’m not saying my grades are necessarily perfect, but I have goals. I’m actually planning on going to the University of Iowa as a pre-business major and then going to the Tippie College of Business so your advice, in all senses, is going to really help me out. So, like I said, I’d really like to thank you for opening up my eyes about everything.

Sincerely,
Kayla

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