Financial Challenge – Day 6

In the last challenge we talked about contributing to your 401(k) plan to get the matching funds. Unfortunately, some people don’t have access to a 401(k) fund or their company doesn’t match any contributions to the 401(k) fund. If this happens to be the case, then for most it’s time to move onto the next investment option on our “easy investing” list – opening a Roth IRA account.

The Roth IRA works a bit different than the 401(k) in that you save after-tax dollars instead of pretax dollars. This means that you don’t get a tax deduction the year your contribute to a Roth IRA, but all the earnings grow tax-free and there are no taxes to pay when you withdraw the money (with your 401(k) you have to pay taxes on all the interest earned when you withdraw the money).

You’ll have even more choices with a Roth IRA of what type of instrument(s) you want to invest in than than you do with a 401(k), but the investment strategy should be the same. Even though stocks are more volatile than other investments, for long term growth they are still your best bet. If you have a large chunk of money to begin, you want to diversify that, but for all contributions you make from now the should go into a broad based stock fund.

Roth IRA - time equals money
Roth IRA – Time and Money

In fact, the Roth IRA has a fairly small limit and the goal is to max it out. For 2005, the annual limit for a Roth IRA is $4,000 ($4,500 if you’re over 50). There are some limits which can reduce this amount if you don’t have enough earned income or if you make too much, but most should qualify for the full amount. The reason I used 2005 numbers instead of 2006 numbers is that you can still make contributions toward your 2005 limit until April 15 – if doing so just make sure to indicate that the contribution is for 2005 and not 2006 (the limit for 2006 is $4,000 for those under 50 years old and $5,000 for those over 50 years of age).

Since the limits on the Roth IRA are fairly low, the goal will be to max out this retirement account (and you’re spouses, too, if it applies) each year (that comes to $333 a month – more than our $100 minimum goal, but I think if you truly attempt each of the challenges you’ll find that $100 is a quite conservative number and the $333 is quite doable).

Some people argue that a 401(k) plan is a better investment even without a match than a Roth IRA due to the better protection it affords against creditors. While Federal laws do provide sturdy protection for 401(k) retirement savings from credit card companies, this really is a non issue to us because by the time you begin investing, your credit card debt should already be paid off.

In the time you have set aside for today’s challenge, you should open a Roth IRA account in a stock fund. I personally have mine in a Vanguard S&P 500 Index Fund, but there are many to choose from. If you are just beginning to invest, what you might find is that you don’t have the minimum amount required to open a fund. If that is the case, then you should place your savings into one of the online high interest bank accounts you opened until you reach the minimum required to open the Roth IRA account of your choice.

NOTE: The entire challenge series is what I would do with my money and is merely my opinion. You should do thorough research and seek professional advice and decide to do what is best for you. My Disclaimer

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8 Responses to Financial Challenge – Day 6

  1. mjrube94 says:

    Many mutual fund companies will waive the initial minimum if you agree to a regular investment plan (monthly or quarterly). If you have the $100+ to invest each month, this may be a good option for avoiding the minimum fees. Good luck everyone!

  2. Sarah E. says:

    I don’t if you can answer this question or not, but here goes… The way I understand it you can only contribute to an IRA up to $4000/yr or your amount of earned income if that is smaller, unless you are a non-working spouse. I see myself as a non-working spouse, and I desperately want to contribute $2k to a Roth IRA because I have pushed our AGI below $50k and so my husband qualifies for that credit that will give him 10% back on his first $2000 contributed, and if I did the same, we would have a $400 credit coming on our tax return, making it all the cheaper to invest. However, I quit my job on December 31, 2004 and received my last check in the beginning of 2005 (probably for about $900), so technically in the eyes of the IRS I earned mony this year and will get a W-2. Also, I sold Pampered Chef for a few months last spring and earned a few hundred dollars before expenses. Do you if I will be able to contribute up to $4k as a non-working spouse, or if I will be limited to contributing only up to my total earnings (which weren’t much)?

  3. pfadvice says:

    “I don’t if you can answer this question or not, but here goes… The way I understand it you can only contribute to an IRA up to $4000/yr or your amount of earned income if that is smaller, unless you are a non-working spouse. I see myself as a non-working spouse, and I desperately want to contribute $2k to a Roth IRA because I have pushed our AGI below $50k and so my husband qualifies for that credit that will give him 10% back on his first $2000 contributed, and if I did the same, we would have a $400 credit coming on our tax return, making it all the cheaper to invest. However, I quit my job on December 31, 2004 and received my last check in the beginning of 2005 (probably for about $900), so technically in the eyes of the IRS I earned money this year and will get a W-2. Also, I sold Pampered Chef for a few months last spring and earned a few hundred dollars before expenses. Do you if I will be able to contribute up to $4k as a non-working spouse, or if I will be limited to contributing only up to my total earnings (which weren’t much)?”

    First, I’m not a tax expert so your best bet is to take the question to a tax professional to make sure. I’m not sure what the 10% credit is??? – a Roth IRA doesn’t give a tax break (are you talking about a standard IRA?).

    As for the $900, if it was for work done in December then it likely was included in the W2 you received in 2004 – check to make sure, but just becasue the check arrived in January doesn’t mean it was booked in their records in January. If you had already quit, then that should not be income for 2005 (it should have been reported in 2004)

    As for Pampered Chef, add up your expenses – if they negate your earning then there is no income there.

  4. Sarah E. says:

    Sorry to disagree, but yes, a roth IRA can give some people a tax break – in fact, the best kind, a tax credit called the retirement savings tax credit. Please refer to this link or form 8880: http://www.bankrate.com/brm/itax/tips/20030224b1.asp

    The AGI for married filing jointly must be under $50k, and you can’t be a full-time student to qualify.

  5. pfadvice says:

    “Sorry to disagree, but yes, a roth IRA can give some people a tax break – in fact, the best kind, a tax credit called the retirement savings tax credit. Please refer to this link or form 8880:

    The AGI for married filing jointly must be under $50k, and you can’t be a full-time student to qualify.”

    No need to apologize…as I stated, I’m not a tax expert. You’re correct and you can see the official IRS release at Retirement Savings Contributions Credit

  6. anna says:

    Well, there’s the IRA info… only my 401K ian’r $4000 or more, so I guess that means I need a different option. Maybe just leaving it where it is (loathe as I am to do that), saving up in my ING, and then ‘dumping’ the accumulated savings into the mutual fund until it’s big enough to roll into something safer and more stable? Thinking…

  7. Wilson says:

    One good resource for those of you who aren’t familiar with IRA’s and retirement plans and investing is investopedia:
    http://www.investopedia.com/university/retirementplans/
    They have an excellent series about retirement plans, including Traditional IRA’s, Roth IRA’s, Qualified plans, 403(b), ESA’s etc for those who want a little more information.

    This is a great series, Jeffrey. I particularly like the way you make everything so easy to follow by having people take each step 1 day at a time, with 1 goal in mind that day. Your explanations are clear and to the point as well.

  8. James says:

    Jeff, keep up the good work

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