1 Million Dollars

Saturday, April 3, 2010

Investing/Retirement Saving

I know that when you are in school and right after the last thing you have is money to invest for retirement which is 30/40 years a way. But as you get older you will have more bills to pay and the sooner you put money away for retirement the less you have to put away.

There are a few ways to save for retirement, you can put money in tax deferred accounts, tax advantage accounts or taxable accounts. This may sound complicated but really it is not, tax deferred is when you don't have to pay tax on it when you put it in a pay it when you take it out. The types of tax deferred accounts are traditional IRA, SEP-IRA, 403b or 401k. The 403b or 401k are the same type of account but a 403b is for government workers and 401k is for the rest of us.

A traditional IRA allows a employed person or a stay at home spouse to deposit $5000 pre-tax per year into an account. If you are over 50 you can deposit an additional $1000 each year. These accounts are through your bank or broker, not your employer, however you may not put in more that you have earned from work. The best places in my opinion to but a IRA are T Rowe Price, Fidelity, and Vanguard, all of which have websites that you can use to open an account. The benfit of T Rowe Price is you can open an account for $1000 or $50/month, the downside is that they will charge you a fee of $10/year if you have an account with less that $5000 in it. Fidelity allows you to start an account with $200/month or $2500, the downside is if your account gets less that $2000 for any reason you will get a fee. Vanguard only allows you to open accounts with $3000 or more, however they normally have the lowest fees so a lot of people like them. Keep in mind these minimums are per fund, not per account, therefore most people go with a target date fund instead of having a bunch of funds. We will go over target date funds and others in a later article.

A SEP-IRA is a bit weird even for the government. SEP-IRA are IRAs for the self employed and their employees. Basically within a SEP-IRA 25% of the employees wages up to a cap ($49,000 is the cap for 2009) and the employee or employer can contribute the money to the SEP-IRA. For the owner is gets a little more complicated, it is 18.587045% of net profit also up to a cap. SEP contribution limits are computed, not from net profit, but from net profit adjusted for the deduction for self-employment tax. This is half the 15.3% FICA tax, levied on net earnings, which are 92.35% of net profit. Thus adjusted net profit (net profit minus deduction for self-employment tax) is 92.935225% of net profit. And 20% (the max percent for the owner) of that would be the 18.587045% number. After that 401k and 403b will be a snap to understand.

You can put $16,500 of pre-tax money in 401k or 403b per year, if you are under 50, if you are over 50 you can put another $5000 in pre-tax money in the account each year. The amount you can deposit can go up with inflation and is announced every year.
Next post will continue with the other types of accounts.

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