Let the countdown to New Year’s Day begin! While everyone else is distracted by eggnog and gingerbread, I’ll be sharpening my pencils, reviewing my financial figures, and setting goals and resolutions for next year. Huzzah!
The end-of-year LBYM to-do list is long so let’s get started …
First up? Topping off my retirement accounts. I’ve maxed out my 401(k) plan at work, but due to our lower household income in 2018 (yay, er … less money!), I can put the maximum annual contribution into my Roth Individual Retirement Account (IRA). Let’s take a closer look at why you should consider doing the same. Some math ahead—exciting!
Let’s say you have $1,000 saved for retirement and you’d like to invest it so it will grow over time. You put the $1,000 into a regular investment account and it’s just enough to buy one share of this little financial education company called, umm, MYBL (rhymes with bible). Thirty years later, MYBL has grown into a media conglomerate, teaching financial education classes around the world and selling all kinds of branded … cashmere beanies. Or something like that.
That one share of stock is now worth $100,000.
You decide it’s time to sell your one share. If tax rates are the same then as they are now, you will probably pay $14,850—that is, 15% in capital gains tax on your $99,000 investment gain in value. You savvy investor, you! Sure, except that if you had put the $1,000 into a Roth IRA … and bought that same share of MYBL … and sold it 30 years later, you’d pay $0 in tax 🤔.
A few things to note here. The type of account you have is different than the investment you have. Think of a regular investment account and a Roth IRA as two containers that can hold the same liquids (e.g. cash or one share of MYBL), but have different rules about when you can pour that liquid out (i.e. withdraw funds) and how much of that liquid will go to the U.S. Treasury when you do so (i.e. taxes).
That regular investment account is costing you a fair amount in tax. Not only are you charged a capital gains tax when you sell your one share of MYBL, but any income you receive over the years from your ownership stake would also be taxed each year at your regular tax rate. In a Roth IRA? Nope. No taxes.
What are you getting for those taxes you’re paying on that other account? Scale and flexibility. There’s no limit to how much money you can put in a regular investment account while Roth IRA have relatively low annual contribution limits, $5,500 in 2018. Because the “R” in IRA stands for retirement, you also generally can’t withdraw any earnings from a Roth IRA until you’re 59 ½. If you do so before then, unless the withdrawal is for one of a handful of reasons, you could be charged taxes and penalties on the earnings. You’ll always be able to take out the amount you originally contributed ($1,000 in the case of MYBL) … but after a few decades, hopefully it’s your earnings that represent the bulk of the account.
So if you can—wait. Think about it this way … your money’s growing and by the time you’re taking money out, it’s all Senior Discounts all the time. More moolah and everything costs less.
Man, I can’t wait.