While I can keep my 401(k) where it's at if I want, I still need to set up a retirement account for my new job. This is the start of a three part series on retirement investing.
In this series I will cover
- IRAs, what are they and what is the difference between a Roth IRA and a traditional IRA
- A comparison of the major companies where you can keep your IRA
- An overview and comparison of investing styles
Please Note: I am not a trained financial expert. I'm not even an un-trained financial expert. I am a computer programmer who suddenly has a salary and a realization that I need to get my money in order. Please talk to a financial adviser or at least get a second opinion before following any of this information.
What Is an IRA and How Does It Work
Like many people, I knew that IRAs are a good way to save for retirement. Also like many people, I didn't know the details of how they worked, or how to make them work for me.
For the 2008 tax year you can contribute up to $5,000 to your IRA, unless you're making a huge amount of money. If you are making enough to be disqualified from IRA contributions, I'm not really sure why you're reading this...go pay for an financial planner already.
An IRA is an "Individual Retirement Account". You put money in and then choose how to invest it. Where you have your IRA account will determine what you can invest in (eg. Vanguard's options are different than Fidelities, etc.). Some options may include money markets, CDs, Stocks, Bonds, Mutual funds and Index funds.
Roth IRA vs. Traditional IRA
Contributions to a traditional IRA are made with pre-tax dollars. You have to pay tax when you pull the money out at retirement. With few exceptions, you cannot take money out of your Traditional IRA until retirement time.
Contributions to a Roth IRA are made with taxed money. You do not have to pay taxes when you pull the money out, including on the earnings. You can take out the amount that you have contributed at any time for any reason without penalty.
Proponents of Traditional IRAs often say that they don't trust the government to keep Roth IRAs tax free until retirement, they would rather get the tax deduction now. Proponents of Roth IRAs will counter than if the government tried this they would need to grandfather in all existing Roth IRAs. I think that the government would simply phase out the Roth IRA program if they decided they wanted to change it...but our government can be an unpredictable beast.
The real guessing you have to do when deciding which IRA to use to maximize your returns is what your tax bracket will be when you retire compared to what it is now.
If you will be in a higher tax bracket when you retire a Roth IRA may save you on taxes. If you are in a higher tax bracket now, then you may want the tax reduction now.
I personally think that when I retire I will be in a higher tax bracket. I think that a combination of inflation and career progression will have me withdrawing more per year when I retire than I am making now.
On Monday, a comparison of some of the major companies which will help you manage your IRA accounts.