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

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[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?]

* * *
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:

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


2008-tax-makeover-cover-medium.jpg

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48 Comments

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  1. Speaking of taxes, and the retirement contribution, take a look at the Saver’s Tax Credit:
    http://www.irs.gov/pub/irs-pdf/f8880.pdf

  2. I have a question for Todd. How can one open a Roth IRA account *TODAY* if we don’t have a ton of cash laying around?

    I read the post and it sounded as if I could get started with roughly $50 at T. Rowe Price. However in going through the motions to get it setup on their site it sounds as if I need at least $1,000 to even open a Roth IRA with them.

    Am I missing something? How can one “open an account today” for less..? This has been a major hold up in me getting a Roth open–I know I want one. Hell I’ve wanted to open one for years once I learned the benefits but I never was able to amass the $3,000, or even $1,000 needed to get started.

    I guess that’s part of the problem, a lack of ability to save, but if there was an option to “open the door” for $50 and keep pinging at it with $100 a week that’d be a much kinder solution to getting me on the track of Roth IRA goodness…

  3. I thought I read somewhere that the max for Roth IRA investing in 2007 was $4,000. Was that incorrect?

  4. That’s what I get for not reading the fine print. I do believe I’ve found the $50 option.

    From T. Rowe’s site:
    The Automatic Asset Builder (AAB) service enables you to systematically invest money from your bank account on the same day each month. For example, you may invest a minimum of $50 into a fund account each month from your bank account.

    The minimum initial investment requirement to open an account is WAIVED if you choose to fund the account by Electronic Funds Transfer (EFT) with Automatic Asset Builder (AAB) service.

  5. Great advice, but why go overboard with the promises? “Assuming an 11% return” is pretty absurd. Why not pick a more reasonable number that has a higher chance of being correct? Also, did I read it correctly that this article is suggesting NOT paying off your credit cards??? “And for sure, the minimum payment to Visa could be put to better use! “

  6. What sensationalism. Yes, the 2007 limit is $4000. Always pay down your credit cards first. 11% is ridiculous over 30 or 40 years. Try something closer for 7% for honesty. Yes, I’ve maxed my ROTH for 2007 and you have until April 15th to do so. The 2008 limit is $5000. … I would have expected better ‘facts’ from an ‘expert’.

  7. “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 ”

    There are some—-what? He stopped midsentence here.

    Does he mean there are some limitations? if so, what?

    Proof read!!

  8. @Jared: I agree… 11% is overly optimistic. 9% is *more* realistic but even then, that’s “keeping fingers crossed” type stuff. The figures in that table are very misleading, in regards to telling people what they should expect.

    In reality, if I save for 30 years (I’m 31 now) @ $4k a year with a 9% return, I’m only looking at ~$600k. Even at 11%, it only climbs to ~$895k.

    Don’t get me wrong… the IRA is a wonderful savings tool and EVERYONE should invest in one, but let’s be realistic with our numbers when giving advise please.

    As always, do your homework and research before choosing your savings tools.

  9. Ok Guys – Sorry about the typo:

    2007 Roth contribution limit is $4000.
    2008 Roth contribution limit is $5000.

    Let me clear up the bad info on T Rowe Price:

    I just called T Rowe Price to triple check – $50 is the minimum to get started in a Roth.

  10. Actually, the retirement option to consider when doing your taxes is NOT the Roth since it has no bearing (when you are on the younger, still contributing side) on your taxes. Run your numbers for your taxes, then figure out how much you can contribute to a traditional IRA for the previous tax year, this is an “above the line deduction” and will decrease the amount you owe or even give you a refund…which you then should contribute to your Roth IRA with. The IRS actually gives you a break for saving for your retirement with this deduction, not the Roth.

  11. Please fact-check. It is REALLY easy to find the average return of a S&P 500 index fund – in fact, if you search “average return S&P 500″ you get this page:

    http://www.moneychimp.com/features/market_cagr.htm

    If you use 1950 as your starting point, the annual return is 8.66% over time, NOT 11%!! This is SO EASY to check that I would expect a “financial advisor” to check it.

    Index funds are recommended for those who don’t want to manage their portfolio, so if you’re going to recommend investing in index funds, get your facts straight.

    Also, as others have pointed out, the Roth IRA limit is wrong and should be corrected.

    Ramit, I really love your blog, but this post is overblown and could actually damage those who try to follow its advice.

    -Erica

  12. Todd should recommend “target date” funds (available at both Vanguard and T. Rowe Price), which automatically adjust their asset allocation to be age-appropriate for the fund’s investors. A beginning investor is well served to put 100% of their long-term money in such a fund.

  13. Sensationalism – maybe not. There are many opinions on returns – everyone has one. They are simply opinions based on past performance, which may or may not hold true. Including mine. Let me share some references on the 11%.

    The S&P 500 is only one measure of the historical average. Here is data on a more diversified portfolio over the last 80 years.

    http://www.ifa.com/portfolios/index.asp#RiskReturnTable

    See the last column for the returns. Maybe you are not comfortable with 100% stocks – I’m fine with that. For those who don’t want to click the link – the average is 11.66% from 1928 to 2007 for a diversified portfolio. 9.9% for the S&P500. Let’s say you wanted a “balanced portfolio” of 60% stock – 40% bond, the return was 9.54%.

    I am also in the school that value stocks and small stocks can boost your return over the long term. Jeremy Siegal’s book, “Stocks for the Long Haul” also outlines the premium historical return of value and dividend paying stocks (even higher than the 11% giving some heartburn). See http://www.amazon.com/Stocks-Long-Run-Jeremy-Siegel/dp/0071494707/ref=pd_bbs_sr_1?ie=UTF8&s=books&qid=1204044846&sr=8-1

    I also invest in several mutual funds with 12%+ over decades. That is why I believe that 11% is possible.

    At the end of the day, you have to choose a number for planning purposes. Maybe you are not comfy with 11%. Use 8 or 9 or whatever and adjust your plan accordingly to make it more conservative. Just get started and adjust as time goes on. Be ultra conservative and save even more if you are uneasy.

    One other response – Emily: I agree, 2007 contributions into a Roth does not lower your current income taxes, but you lose the window opportunity to contribute for 2007 once you file you taxes. That is why I recommend you do not file your taxes until you make a 2007 Roth contribution.

  14. Wow, this article was quite sensationalist. I agree with Todd’s ideas for having an automatic withdrawal from your checking account each month, but he’s not taking into account paying off those high-interest credit cards.

    11%?!? I think he pulled that number out of his a$$. I wish I could get 11% over the next 35-40 years, but that’s not going to happen. 6%-7% is a much more conservative, wise amount.

    So far I’m really not impressed with this guest poster. While reading this post, I felt like I was reading one of those GET RICH QUIK [sic] websites/books that have no basis in reality.

    Also, I have read that Roth IRA’s while nice in theory, can be changed by Congress at any time. This means that Congress can change the rules on Roth IRA’s to be essentially the same as Traditional IRA’s. I would rather take the immediate tax savings that Traditional IRA’s offer, and pay taxes during retirement. Call me crazy, but immediate tax breaks are better than supposed future tax breaks.

  15. Good article, but very sensational. I hope the tone and realism improves in the future out of respect for the sort of readers Ramit attracts. Regardless, I forwarded it to my g/f to convince her to open a Roth (I already have one).

  16. [...] I am a subscriber to “I will Teach you to be Rich” Blog and today he had a guest blogger write an article that explains it really quite well. Click Here to Read it. [...]

  17. Guys — I take your point on the sensationalism of the article. The mistaken Roth IRA limit was inexcusable (that’s been corrected above). In terms of sensationalism, Todd is a first-time blogger so cut him some slack. We just chatted and he’ll tone down the sensationalism on the next posts.

    Also, notice how interesting it is that a lot of people seem to be focusing on the investment returns part of the article (a minor point). Don’t be like other people who nitpick one teeny point and miss the broad message.

    The bottom line is, whether you get 9% or 11% or 4,000%, most people are not investing at all.

  18. Todd needs to lay off the ‘dew.

    But I agree with a general point he is making: Roth IRAs have a lot of benefits. And for those in jobs that are likely to push them over the income threshold the time to invest in a Roth IRA is now. (Although there will be an opportunity to convert an IRA into a Roth IRA, regardless of your income level, in 2010 if current rules remain unchanged. Some analysis of the pros and cons of doing that would be interesting to see.)

  19. A question:

    I’ve been meaning to open a Roth, but honestly I just forgot. I filed my taxes literally an hour ago.

    I’d like to open one for 2007. I have the cash… what should I do?

  20. This is Todd, the author of the article.

    Great question. I would pick up the phone NOW and call TurboTax – you might be able to catch it before it goes to the IRS.

    Oherwise, you can file an amended return using Form 1040-X with the same schedules you filed with your original return.

    Here are some rules/details on amended returns:
    - You can file an amended return within three years of the original filing date (including extensions), or two years after you pay the tax, whichever is later.
    - If you’ve moved since you filed your original return, file the amended return with the IRS service center where you currently live.
    - If you amend your federal return, don’t forget to amend your state return too.
    - If you’re married and you originally filed separately, you can amend your return to file jointly—but not vice versa.
    - If you filed a joint return, then divorce, you can amend your previousjoint return with respect to your income only.
    Amended returns generally aren’t considered “audit bait” so long as you can support your amendments as conclusively as if you hadreported them with your original return.
    - Your amended return should be complete and thorough. Attach any schedules you would have filed to document your claim with your original return.

  21. Question: Why is there no discussion here of Roth IRA vs. Traditional IRA?

    I’ve seen in the previous comments that many have problems with the 11% figure (and I do, too) so I won’t continue to harp on it. I also understand that just starting is better than debating minutiae while you’re frozen to inactivity.

    But making the wrong choice between a Roth and a Traditional IRA is not debating minutiae; it can cost you a TON of money. Unfortunately, the answer to the question, “Will I be in a higher tax bracket now or when I want to withdraw?” is not easy to answer, but it is too important to completely ignore. Suggesting to readers that a Roth is the only option could cause them to be paying way more in taxes than they should. Personally, I don’t want to contribute any more to Uncle Sam than I have to–I don’t know about you guys.

    Bottom Line: Since it wasn’t mentioned in the article, I think readers should be aware that there are options other than the Roth and if they don’t know about them they should go somewhere reliable to research them. They should have plenty of time to figure out everything they need to know before their taxes are due!

  22. I agree with the above posts. Todd, I think that you offered a little misleading advice by pairing the 11% number with your advice to get a growth and income mutual fund. First, 80% of mutual funds underperform indexes. Second, Target Retirment funds should be the de facto standard for offering a starting place to invest, not a growth and income fund, which averages a much lower return (Vanguard’s TR fund is great if the $3,000 minimum can be made). Third, I am a little scared that you are offering financial advice on how to become a millionaire through generalizations. Ingraining habits of inaccuracy in your clients will only lead them to achieve inaccurate goals. I recommend doing a little more reading on investing/index funds (hang around diehards.org), but until then you are doing a great job of motivating people to save for retirement. Just work on the details.

  23. Is the rule about funding the previous year Roth before filing taxes a new one? How does Vanguard know when I filed my taxes?

    In March of 2007 I contributed to my 2006 Roth, and that was after I filed and got my refund (it was actually my refund that I contributed). I call BS on this rule. I think you have until April 15th, regardless of when you file.

  24. @Todd

    Todd: If you love the Roth IRA so much, why no love for the Roth 401(k)?

    It has a high annual contribution limit; offers employer matching for some lucky individuals; easy to set up through work if offered; same great tax benefits

  25. Just to address the subject line… You don’t have to make 2007 roth ira contributions before filing your 2007 income tax return.

    IRS publication 590 (pdf) says on page 64:

    “You can make contributions to a Roth IRA for a year at any time during the year or by the due date for your return for that year (not including extensions. [...] This means that most people can make contributions for 2007 by April 15, 2008.”

    And on page 58:

    “You do not report Roth IRA contributions on your return.”

  26. I am not from US of A, so this question – why does it have to be a mutual fund.. won’t an ETF do? Costs are also less.

  27. Todd, This is probably a dumb question, but what is the advantage to opening a roth ira before filing your 2007 taxes? Thanks in advance.

  28. What would the benefit be to using an investment house vs. using one’s own bank or (in my case) credit union to mange my Roth IRA?

  29. Note to the next potential IWTYTBR guest poster,

    “RUN AWAY!!!”.

    Geez, people, lighten up. Todd, although your writing style is different than Ramit’s, you provided some good information about the importance of contributing to one’s Roth IRA. Thanks.

  30. Have to agree with other commenters.. there are at least 4 inaccuracies in this article. 1) The already corrected 2007 limit. 2) The supposed requirement to contribute to the IRA prior to filing your taxes and the followup advice to submit a Form 1040-X if you contribute to a Roth IRA after filing taxes — both are WRONG. 3) The assumption that Roth IRAs will always be tax free — when Congress could change this at any time. 4) The claimed 11% return is simply inaccurate and unrealistic. And it is not a minor point — it significantly alters the entire premise of the article that you can become a millionaire by simply contributing to a Roth IRA for 30 years. If the return is 8% instead of 11%, you would have only $616K instead of $1.1 million. And if the return is 5% — the actual rate of return of the DJIA for the past 108 years according to http://www.crestmontresearch.com/pdfs/Stock%20Average.pdf — then you would have only $354K. Next, you have to subtract the affects of inflation, which is not insignificant.

    401Ks, for those who have the option, are probably the better choice. The money is pre-tax, which means you are saving tax dollars today, not 30 years from now. And most employers match at least part of your contribution, giving you free money that can really add up over time.

  31. Thanks for the great tips Todd. I also appreciate that it was short and simple, I may not have read it had it not been. Now I feel motivated. I need to get my butt in gear more when it comes to investing and saving.

  32. Some food for thought. If you can’t contribute the max to a Roth IRA, then imagine using a Traditional 401k for the same amount AND contributing the current tax savings. This results in more being saved sooner, allowing compounding to work its magic. Most calculations do a straight up $1000 to the Roth and $1000 to the Traditional when comparing the two, which assumes the current year tax savings are not invested (I used $1000 as an example). This is something to consider when deciding between the two. I have access to both a Roth and Traditional 401k and have decided to contribute a higher percentage to the traditional than I would the Roth. Also, current tax breaks are more certain than a tax break in 40 years as someone else mentioned. Just think about it, there is no silver bullet. And getting started is important but make sure that what you get started with is right for you.

  33. A great point that this article illustrates to the readers is the power of compounding. You may not agree with the 11% annual return figure, but it’s hard to argue with the insane difference you get when investing for 40 years instead of 30 years (i.e. the difference between starting at 23 years old and starting at 33 years old).

    From the table above:
    $5k/yr for 30 years @ 11% = $1,104,565 (@ 7% = $505,365)
    $5k/yr for 40 years @ 11% = $3,229,134 (@ 7% = $1,068,048)

    2-3 times more money at retirement!!! And it didn’t take perfect asset allocation or being the smartest person in the room or having a finance degree or anything else–all it took was $50,000 and a little foresight. ($5k x 10 years = $50,000).

    They should print these figures on every fake diploma they hand out at college graduations to remind new grads that planning for their retirement starts immediately, whether they want it to or not.

  34. Todd I didn’t mean to be so negative before. It’s just that I plan to contribute to my 2007 Roth this year and I’ve already filed, so I was alarmed.

    I like the sensational style because it gets lazy people motivated and its fun to read.

    People do have a point about congress changing the laws though but what they haven’t voiced is taxes may (most certainly will) be a lot higher in the future than now. If you look at recent history, US taxes were much higher in the 80′s than now. Baby boomers will implode Social Security in the next 20 years and guess where the money will come from? I’d rather pay taxes now when they’re low than in the future when they are likely to be higher.

    I think the best solution is both Roth and 401k and widthdraw from both at retirement because then your taxable portion will be small. Remember that everyone gets a standard deduction on their taxes so that much 401k widthdrawal each year is tax free anyway.

    You mentioned you lie both 401k and Roth but not for the reasons I’ve brought up.

  35. I agree that the article had a couple mistakes and questionable calls, as others have pointed out and beaten to death. However, I also feel the article achieved its purpose in clearly and enthusiastically illustrating the advantages of a Roth IRA and exactly what we should do to take advantage. I would refer my friends to this article if I ever needed to give them a quick “why you should open a Roth IRA now” rundown. Pretty good for a first blog post. Just remember to CHECK YOUR FACTS, DUMB***!! }:oO
    :oP :o)

  36. Great article. Pretty much solidified what I was leaning towards doing anyways. I have a 401k currently and my employer contributes 11% of my salary towards the plan without me even putting ANY money towards it. Which is nice. Although they do no contribution matching. That 11% is all you get whether you put in any money or not. I was teetering on the edge of whether to just put money into the 401k or start a Roth. But learning that you can start a Roth cheaply, really sells me on the idea that I can do both. As for the “11%” return figure figure, I think people read a bit too much into that. Since when have you taken to heart any speculated investment return rates without further research? I think the point was driven home. INVEST NOW. :)

  37. hmm according to my calculation there is only one big if. the numbers in the table are not simple future value of annuity, but future value of annuity DUE, and the difference is significant, as it is assumed that you invest your money at the beginning of each investment period. so if you invest 5,000 at 11%, at the end of the year, after 30 years you will have only $995,104.39, whihc is not as pretty a number as 1.1 mil.

  38. Another correction to the article:

    Q: What are the limits on a Roth IRA?

    A: You can contribute $5,000 (2008) 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).

    Actually, you can only contribute the max up to $101,000 (2008 figure) and it gets phased out by the $116,000 amount.

    BTW, if you’re only able to contribute a few thousand to your retirement savings, then anything with a match is your best bet. After that it’s probably the Roth. However, the real goal is to have multiple investments with varying tax considerations so that even if Congress changes the tax law you’ll have some “diversification” in place.

    Oh, and due to the fact that gains on the Roth are not taxable, your most aggressive funds should go into a Roth account while more conservative investments (or just not the most aggressive stuff) belong in other retirement or non-retirement accounts.

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  40. One thing I am wondering is if it would be better to: Match 401k up to company match, then max out Roth IRA, THEN max out Traditional IRA, then finally max out 401K? That way you have more investment options then what you are locked into with your 401K. But where I am not sure is, does the compound interest from a 401K make it a better choice then putting money into a Traditional IRA first? (Assuming you are at least putting in the company match amount)

  41. [...] Ramit: Today is Todd Doerr’s 3rd and final guest post. Earlier this week, he wrote about what to do before you file your taxes this year, and how college students can save their parents [...]

  42. Brian,

    I believe the Federal limits cover both Roth and traditional IRAs at the same time. So the traditional order would be: 401k to the company match, fully fund the Roth IRA, finish funding the 401k.

    However, there are several different ideas on that. The best example I saw recently was this:

    http://finance.yahoo.com/focus-retirement/article/104486/Protecting-Your-Retirement-No-Matter-Who's-President?mod=retirement-preparation

    Basically, what this says is that the traditional IRA/401k option has a lower (or is that different?) level of risk than the Roth. If you assume that the federal government with both raise taxes and continue funding its activities using the income tax, this product works very well. However, if the government decides to change the code to a flat tax or sales tax (something Republican candidates have been proposing for decades) you are out of luck when you go to withdraw funds from the Roth. Of course, Uncle Sam could make a law at any time giving himself the ability to tax money in your Roth.

    I also think that your guest writer forgot to mention inflation in his article. Most people do. Listen up everyone: $1M today is worth *alot* more than $1M 40 years from now. I would really like to see someone write an article about saving with goals using today’s dollars.

    Finally, a point brought up in Jim Cramer’s latest book (did I just discredit myself there?): Retirement saving is necessary, but what about saving for other things you would like to do. Like starting your own business (a topic covered often here) or taking some soft of major vacation? Perhaps saving for a reasonable down payment on a home (if that makes sense)? I rarely see anything like that in these types of articles.

  43. Vanguard has a traditional vs Roth IRA guide… https://personal.vanguard.com/us/planningeducation/retirement/PEdRetInvTradRothIRAsContent.jsp?From=RetTestA1

    I also JUST filed my taxes and am relieved to hear that I can still contribute for 2007. I had thought, the calendar says 2008, I guess I missed the window of opportunity for 2007. I’m sure people such as myself would appreciate this correction made in the article, or at least higher in the comments (I know you can do it Ramit). I tried to contact the efile company I used and went and downloaded the 1040X form before reading on.

  44. I’m nineteen and I just opened a Roth IRA, right before filing taxes, at Zecco instead of Vanguard or T. Rowe Price. I used Zecco because it
    1. Has no minimum to open
    2. The annual fee is only $30 instead of $50
    3. You get 10 FREE stock trades per month!!! Zecco is one of the only brokerages that offers free stock trades.

    Zecco.com. If a nineteen year old could do it in 15 minutes, you can do it too =)

  45. Todd,

    I am opening an account in Vanguard but there are so many choices for funds. You say that you suggest investing in certain funds in your article but they aren’t listed anywhere. Do you have any funds that you recommend/ I’m 26 and plan on maxing this out for as long as possible so I can really ramp up my savings. Thanks!

  46. The timing of this article is perfect for me…
    I’m new to investing (but old pro on saving) and I thought that we’ve missed opening a Roth IRA for y2K7.
    It’s great to know (and I’m acting on it…) that I can add money to my not-yet-opened Roth IRA for y 2007 up to the limit of 4000 per person (more for married couples).

    Thanks for making me rich(er) today. Especially if I live to see the money in 30 years :)