What’s in this issue?
What are we learning today?
What the real retirement problem is
The Roth IRA - the best retirement tool to solve the problem
How to get started
The real retirement problem
I can’t seem to go a day without hearing about the retirement crisis here in America. As a young-ish person, this hasn’t (until somewhat recently) been something I cared about. “I’ll worry about it when it’s a problem”. Looking back on that viewpoint I feel a little foolish especially when I start to grasp the depth of this issue. The good news is that that are many powerful tools to encourage young people to begin to think about their retirement and I’m going to cover one of them today. But first, let’s look at some numbers.
Forbes ran an article last year highlighting percentages of people who have saved for retirement. I like focusing on this because I think this is the bigger problem as opposed to the amount saved. Yes yes, I know you need to have the proper amount saved but we need to walk before we can run. Here is a chart on the percentage of Americans who HAVE NOT begun their retirement savings.
The Roth IRA
Our government is aware of the problem and has instituted laws to help mitigate the problem. This has led to a time where more financial tools and resources are available than ever before. While it’s generally beneficial, the sheer amount of information is often overwhelming. (That's part of why I write this newsletter; to distill information into actionable insight.) Today I’m highlighting what I consider to be the most important tool to save for retirement, the Roth IRA (individual retirement account/arrangement).
Roth IRAs were established in 1997 from the Taxpayer Relief Act. This “account” is essentially a tax-advantaged way to save for retirement. The idea is that you contribute money you earn, post-tax, to this account and grow it until retirement. When you choose to retire, you can withdraw this money tax-free. The younger you are, the more powerful this tool becomes because it allows more time for your money to compound.
What are the details?
You are able to contribute $6000 per year to a personal Roth IRA and $7000 if you’re age 50 or older. Now, this comes with a few caveats; your income for one. First, you need to actually have the income to contribute; this includes wages, tips, salary, etc. So you need to make money but not too much. If you’re single, your income must be less than $137,000 and $203,000 for married couples. The other caveat, which I don’t think is a caveat at all, is that your money cannot be withdrawn without paying a penalty. There are exceptions to this rule but I’m not going to talk about them because withdrawing money from this account is one of the worst things you can do. I want people to think about the money in this account as the money they won’t see for 30+ years.
Let’s play out a hypothetical situation and look at the results. You got into a career, you’re now 30 years old, have money leftover outside of paying your bills, and beginning to think about the future. You want to max out the contribution of your Roth which means $500 contributed per month. If you contribute $500 a month to a Roth from the time you’re 30 until you’re 60 years old, you would have a grand total of $398,633 when your contributions amounted to $180,000! That’s a decent retirement nest egg which isn’t considering other things like social security (if that even exists when my generation comes time to retire). The chart below depicts this example.
This example has several implied assumptions. It implies a 5% return each year which is conservative and also does not include the extra thousand dollars that can be contributed per year after age 50. This also implies you stop at 60 even though many people work well beyond 60. Adjusting for these and other factors, that number could be considerably larger. When it comes to money, being extremely conservative with projections gives you a lot of room for error. I also like setting the bar low so expectations are always met; I’m kind of a glass half empty person, unfortunately.
Because of the relative “newness” of this product, not nearly as many people have these as should. In 2015, the IRS cited that only 8% of eligible taxpayers contributed to an IRA (there are other types of IRAs but that will be for another day). What’s strange to me is that I seem to run into more young people that have Roth IRAs than older ones. Our older generations have relied heavily on pensions and social security which are dwindling away. Within the last year, I set both my parents up with Roth IRAs and they are already experiencing the benefits of this product.
How do I get started?
The point of this is not to say “You need to open a Roth IRA and begin maxing out immediately”. That may not be feasible for your situation at this present moment. The point of this IS to say that regardless of your age, you should get the process started. When I opened my account, contributing $25 dollars a month was all I could afford. While I wasn’t going to retire on that, the small contribution got me into the mental habit of putting money away and that is where the real value came from.
I’ve set up some links here for brokerages that offer Roth IRAs that are both reputable and safe. The important things to look for in a brokerage are that it’s a big name that has been around for a long time and that is FDIC insured. I would recommend Fidelity mostly because that’s who I use. The experience is user friendly, their support team is knowledgeable and helpful while being available over the phone and online chat, and is a trusted name in the space. Vanguard is arguably one of the longest standing names in this area; I chose Fidelity just because the user experience was much better and the visuals were easier on the eyes. Schwab is also a great option.
The important takeaway is that you begin to think about the future today. Your future self will thank you.
A Few Closing Thoughts
The goal of this newsletter to help people become better financially educated. I believe the best way to do that is to create a community of people that are actively engaged in helping one another and sharing information. Here’s how we can do that:
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I’ll talk with you all next week!