Retirement Investing Crash Course : IRAs

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.

What Does a Pay Stub Look Like?

How Much Do You Really Get From Your Paycheck?

What does a real world pay stub look like? When I finally started getting real paychecks, I was initially let down. I had very naively divided my salary by 24 pay periods and imagined all the cool stuff I was going to buy.

Reality is a bit of a letdown sometimes. I actually only end up with a little over half of my salary coming to me.

So, without further ado, here's my current pay stub (with certain data blanked out!)


Green is income, red is expenses.

At the top left, Salary is the amount I supposedly get each pay period (every two weeks). It works out to be about $50,000 per year.

At the bottom left is the amount that gets deposited into my bank account every two weeks.

43% of my salary doesn't end up in my pocket!

It would be difficult to argue with the taxes portion of the paycheck, but let's take a closer look at the section titled "Deductions From Gross" and "Non-taxable Company Items".

Deductions from Gross

Deductions from Gross are voluntary amounts I choose to have taken out of my paycheck. As much as it stinks to get that much less cash, there are good reasons to get those amounts removed.

Less Taxes:
These deductions are taken out before taxes are calculated. It appears that the taxes are about 15% of the taxable amount. If this is correct, then I pay about $100 less in taxes each pay period by deducting these amounts from my gross paycheck.

What are these accounts though?

Health Insurance - Employee:
This is a medical 'flex spend' or 'cafeteria plan' expense. We estimated how much we were going to spend on medical costs this year, and are having that amount removed from my pay over the course of the year. This account can be used for dental work, eye doctor visits and glasses, birth and related expenses etc. Since we knew we'd be having a c-section baby this year, we knew at least how much we'd be spending.

FSA:
This Flex Spend Account is for child care. Since I'm at work and my wife is at school, we needed someone to watch our kids for part of the day most days of the week. With this account we can pay for child care from our pre-tax money.

401(k):
We are currently putting in 15% of my gross salary into our 401(k). We'd like to retire well, so we've got to make sacrifices now.

Even though these deductions don't come home with me, two of the three are or will be used by me during this year.

Non-taxable Company Items

This is the section which shows non-salary benefits that the company is providing. It appears that they company is paying $306.07 per pay period for insurance for my family.

They match 100% of my 401(k) contributions, up to 3% of my salary. It's true then that I am not being matched completely with my 401(k) donations, but at least it's something.

Take Home Per Year

In all my excited imagining about how to spend my money, it turns out that I should have been thinking about taking home just less than $30,000 per year instead of the $50,000 gross salary figure.

So, if you just barely landed that dream job with the huge salary, don't make too many plans till you carefully review what you're actually bringing home each month.