Even though the ROTH IRA has been around for a few years, it still holds an allure and I am always asked about it. If you qualify, I am a big fan of the ROTH IRA. The ROTH IRA is an individual retirement account with special tax benefits. Your contributions are made with after-tax dollars, they grow tax-deferred but when you start withdrawing the money, it is TAX-FREE. Because it is an account, you can invest in whatever you like (mutual funds, stocks, bonds). As of 2006, you are able to contribute up to $4,000 per year. If you are over 50, you can contribute up to $5,000. This will continue to increase over the next few years.
You can only contribute to or open a ROTH IRA if you make less than $95,000 as a single person or $150,000 as a couple. If you make more than $95,000 the next year, you can't add any more money to your existing ROTH IRA. However, nothing will happen to your existing ROTH IRA. You have to open a Traditional IRA. If you have a year in the future where your income dips below $95,000 you can add to your ROTH IRA again.
You are eligible to start withdrawing money from your ROTH IRA penalty free after age 59 1/2. If you need the money before that, you will be charged a 10% penalty only on ROTH IRA earnings. One of the great benefits about a ROTH IRA is that there is no age where you are required to begin taking withdrawals. With other IRAs and 401ks, you are required to start taking a minimum distribution at age 70 1/2, but there is no age limit with the ROTH IRA. Another great thing about the ROTH IRA is that if the principal has been in the account for at least five years, you don't pay any penalty to take the money out. You also don't pay any penalty if it is used for a first home, qualified education expense or certain hardships.
If you currently have a Traditional IRA and want to convert it to a ROTH IRA, beware, because you will be hit with a tax bill. Make sure you understand the impact of taxes before making this decision. You can transfer your ROTH IRA from one firm to another. As long as it stays in it's ROTH IRA form, you can transfer it as much as you like. In addition, you can change the investments within your ROTH IRA whenever you like as well.
Other than that, a ROTH IRA is the same as a Traditional IRA or 401(k) in that the money grows tax-deferred and is a great retirement savings vehicle. To understand more about what to invest in an IRA or where to open an IRA, see “Making Your IRA Count”.
Making Your IRA Count
Whenever April 15th rolls around, we all get bombarded with ads reminding us to open or fund an IRA. While that is great, you want to make sure you are making the most out of your IRA and having it work for you. It’s so easy to get overwhelmed and not do anything. An IRA is an Individual Retirement Account. This means that once you open the account, you still need to invest the money in the account. There are three main areas you want to focus on:
• Streamline
• Funding the IRA
• Investing in the IRA
Streamline
Chances are you have more than one IRA. Perhaps you opened one at your bank or at your parent’s brokerage firm. Pick one place and consolidate all your IRAs. If they are in the same format (either ROTH or Traditional IRA), they can be consolidated to one IRA. Simplify your life and consolidate them all to a discount brokerage firm (like Fidelity) or a mutual fund company (like T. Rowe Price) or a full-service brokerage firm (like Morgan Stanley).
Funding the IRA
For 2006, you can contribute up to $4,000 and $5,000 if you are over 50. For most of us, this money goes in after taxes. If you are working for a company that has a 401(k) and you are not maximizing your contributions to the 401(k), you should try and do that first before funding your IRA. If you are working for yourself, or work for a company that doesn’t have a retirement plan, you should look at self-employed retirement plans like a SEP IRA. They let you put much more money in and on a pre-tax basis. However, if you have already maximized your contributions to the 401(k) or SEP IRA, then you can fund your IRA. If you don’t have enough to fund the complete IRA, consider setting up an automatic savings to your ROTH or Traditional IRA. This only comes out to $333 a month. Can’t afford that? Then do $100 a month and fund the rest at year-end.
Investing in the IRA
Make sure the mutual funds within your IRA are aligned with your retirement time line (5 or 20 years need different mutual funds). Keep this simple as well by only having 4 or 5 mutual funds and make sure they are completely different! If you have mutual funds within your 401(k) or SEP IRA, make sure you don’t have duplicates. It will make it much easier to do a checkup on an ongoing basis.
• Streamline
• Funding the IRA
• Investing in the IRA
Streamline
Chances are you have more than one IRA. Perhaps you opened one at your bank or at your parent’s brokerage firm. Pick one place and consolidate all your IRAs. If they are in the same format (either ROTH or Traditional IRA), they can be consolidated to one IRA. Simplify your life and consolidate them all to a discount brokerage firm (like Fidelity) or a mutual fund company (like T. Rowe Price) or a full-service brokerage firm (like Morgan Stanley).
Funding the IRA
For 2006, you can contribute up to $4,000 and $5,000 if you are over 50. For most of us, this money goes in after taxes. If you are working for a company that has a 401(k) and you are not maximizing your contributions to the 401(k), you should try and do that first before funding your IRA. If you are working for yourself, or work for a company that doesn’t have a retirement plan, you should look at self-employed retirement plans like a SEP IRA. They let you put much more money in and on a pre-tax basis. However, if you have already maximized your contributions to the 401(k) or SEP IRA, then you can fund your IRA. If you don’t have enough to fund the complete IRA, consider setting up an automatic savings to your ROTH or Traditional IRA. This only comes out to $333 a month. Can’t afford that? Then do $100 a month and fund the rest at year-end.
Investing in the IRA
Make sure the mutual funds within your IRA are aligned with your retirement time line (5 or 20 years need different mutual funds). Keep this simple as well by only having 4 or 5 mutual funds and make sure they are completely different! If you have mutual funds within your 401(k) or SEP IRA, make sure you don’t have duplicates. It will make it much easier to do a checkup on an ongoing basis.
Demystifying Mutual Funds
Mutual funds are an essential part of your personal finances. They are the fuel of your retirement plan, can help you buy a house and the easiest way to take advantage of the stock market. If you don’t have any money saved, you can still start investing in mutual funds immediately. With over 12,000 mutual funds in the marketplace, they can definitely be overwhelming!
A mutual fund is a group of stocks or bonds (and sometimes both). When you buy shares in a mutual fund, you are buying equity in all of its holdings. The rule of thumb is that if you have less than $75,000 to invest, you should stick to mutual funds to be properly diversified. For a small management fee (more on this later), you get a qualified money manager to manage your money. Mutual funds are much easier than individual stocks and bonds to monitor and determine how your investments are performing. Plus, if you don't have a lot of money, you can start investing in mutual funds for as little as $50 per month!
Because there are so many mutual funds out there, it can be overwhelming on where to begin and how to select a mutual fund that is right for you. The first place to start is to determine what your needs are. Do you want the investment for the short-term (less than 3 years) or mid-term (5-7 years) or long-term (10 years or longer) – like retirement? This will help you decide what kinds of mutual funds you should buy. You want to make sure you are properly diversified which means you are spreading your risk among different types of mutual funds.
If you are investing for the short-term, you should stick with relatively safer Money-Market Funds. For the Mid-Term and Long-Term, you want to build a portfolio with a combination of Large-Cap Growth, Large-Cap Value, Small or Mid-Cap, International and Bonds. The percentage you want in each of these categories depends on your age, time horizon and risk level. If you don't have any investments and only a small amount to invest, a great mutual fund to choose is a Balanced Fund (also called a Domestic Hybrid or Moderate Allocation). This is one mutual fund that combines stocks and bonds. There is also the Target or Lifestyle Mutual Funds. You pick the mutual fund according to the date that you want to retire (ex: 2030) and it will combine all the investments you need for a diversified portfolio. I call it One-Stop Shopping.
You have three main choices from where to buy a mutual fund. You can go to a mutual fund company, such as Vanguard or T. Rowe Price and pick five mutual fund styles such as: Large-Cap Growth, Large-Cap Value, Small or Mid-Cap, International and Bonds. Or, you can go to a mutual fund supermarket such as Fidelity or Schwab. There is a lot to pick from here, which can also be overwhelming. Lastly, you can go through a broker. The broker usually suggests which mutual fund to buy. Just be careful because this is the most expensive route and the broker might be "pushing" a certain fund based on the commission he or she gets paid.
A mutual fund is a group of stocks or bonds (and sometimes both). When you buy shares in a mutual fund, you are buying equity in all of its holdings. The rule of thumb is that if you have less than $75,000 to invest, you should stick to mutual funds to be properly diversified. For a small management fee (more on this later), you get a qualified money manager to manage your money. Mutual funds are much easier than individual stocks and bonds to monitor and determine how your investments are performing. Plus, if you don't have a lot of money, you can start investing in mutual funds for as little as $50 per month!
Because there are so many mutual funds out there, it can be overwhelming on where to begin and how to select a mutual fund that is right for you. The first place to start is to determine what your needs are. Do you want the investment for the short-term (less than 3 years) or mid-term (5-7 years) or long-term (10 years or longer) – like retirement? This will help you decide what kinds of mutual funds you should buy. You want to make sure you are properly diversified which means you are spreading your risk among different types of mutual funds.
If you are investing for the short-term, you should stick with relatively safer Money-Market Funds. For the Mid-Term and Long-Term, you want to build a portfolio with a combination of Large-Cap Growth, Large-Cap Value, Small or Mid-Cap, International and Bonds. The percentage you want in each of these categories depends on your age, time horizon and risk level. If you don't have any investments and only a small amount to invest, a great mutual fund to choose is a Balanced Fund (also called a Domestic Hybrid or Moderate Allocation). This is one mutual fund that combines stocks and bonds. There is also the Target or Lifestyle Mutual Funds. You pick the mutual fund according to the date that you want to retire (ex: 2030) and it will combine all the investments you need for a diversified portfolio. I call it One-Stop Shopping.
You have three main choices from where to buy a mutual fund. You can go to a mutual fund company, such as Vanguard or T. Rowe Price and pick five mutual fund styles such as: Large-Cap Growth, Large-Cap Value, Small or Mid-Cap, International and Bonds. Or, you can go to a mutual fund supermarket such as Fidelity or Schwab. There is a lot to pick from here, which can also be overwhelming. Lastly, you can go through a broker. The broker usually suggests which mutual fund to buy. Just be careful because this is the most expensive route and the broker might be "pushing" a certain fund based on the commission he or she gets paid.
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