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This is the a piece in a 8 part series on getting your financial house in order. Here are the rest of the posts. Please read them sequentially and hopefully it will help you on your path to financial independence.
- Setting up a budget/expense report: Ever wonder what should be included in a budget? We cover what you may want to consider. You can also sign up for our email list and download our free Budget crushing tool!
- Determining net worth: Do you know how to calculate your net worth? We discuss how to do it and if things like your home or cars should be included? Check it out to see what I do.
- Get you some insurance: Here we discuss what insurance you need for your family? Is an umbrella policy really necessary?
- Setting up a will or living trust and What to place in a living trust: How do you protect your family with a living trust? Why would you want one and how much will this cost? How do you do it? Check out these posts to figure it out.
- Max out the 401K, 403b, 457, or Government TSP: Ever wonder what these different accounts are? How much can you put into one versus the other? Is a Traditional or Roth plan right for you?
- Start an IRA: What is an IRA? Should you have one? How do you do a backdoor Roth?
- Pay down debt: As Dave Ramsey says, debt is bad. Still which debt should you pay down first and when can you consider paying down debt versus investing.
- Start tax advantaged accounts: Once you have done the above, what is the next thing to do with your money?
Start an IRA
IRA or Individual Retirement Accounts. The initial answer by the US government to the disappearing pension systems in our society. This is something we need to think about as an IRA is a great way to save money for retirement. So here we cover some of the basics.
I was not savvy enough to contribute to an IRA account until 2014 but have been doing so for myself and my spouse since 2014. It is in addition to my employer 401K account and something to invest in after hitting the employer match and paying off high interest debts as discussed in getting your house in order.
This is a summary from a Forbes article found here:
The IRA established in 1974 (401K’s would not come into play until 1980) when Congress passed the Employee Retirement Income Security Act. In the beginning, an employee could put $1,500 in an IRA account. This grew tax deferred (not taxed until a withdrawal was made). Initially only individuals not covered by employee retirement plans could make contributions.
With the Reagan administration (1981) and the limit was increased to $2,000. The Reagan administration allowed for nonworking spouses to contribute $250 a year. Everyone received a tax deduction for contributions until 1986. Then tax deductions were taken away from high earners. There were more changes over the years getting us to our current limit of $5,500.
The next big change came in 1997, when the Roth IRA was created by Senator Roth. This allowed for after-tax contributions, allowing money in the account to grow tax free. Limits on this increased over the years and in 2001 an extra $1,000 catch-up contribution was allowed for those over 50 years old.
A traditional IRA is one where money is placed into the account. The money grows without being taxed. Once taken out the money is taxed at the current income bracket. By not taxing the money as it grows, the money grows faster without a “tax drag”.
- Money put in today is completely tax deductible if income is below $99,000 if filing married/jointly ($62,000 if filing single).
- The money is partially tax deductible if income is between $99,000 and $119,000 filing married/jointly ($62,000 to 72,000 if filing single).
- The money is not deductible if income is above $119,000 filing married/jointly ($72,000 filing single).
- Contributions can occur until 70 years old.
- There are no income limits
- Withdrawing of the money can start after 59.5 years of age without penalty.
- Money has to be withdrawn starting at 70.5 years of age.
- If money is removed before 59.5 years old there will be a 10% penalty.
- The current contribution limits for a traditional IRA is $5,500 unless over 50 years old, then it is $6,500.
A Roth IRA is where after-tax dollars are placed into an IRA account and grow tax free. Once the money is taken out there are no further taxes.
- Contributions can be made at any age,
- Withdrawing money can begin at 59.5 years of age.
- There is no mandatory age where money must be taken out.
- Money removed before 59.5 years old will have a 10% penalty and a tax on the earnings.
- The current maximum contribution is $5,500 a year unless over 50 year of age, then there is the $1,000 catch up to also contribute.
Annual modified adjusted gross income is a limit to the use of Roth IRAs.
- In 2017, as a married/joint filer the modified adjusted gross income needs to be below $186,000 ($118,000 for single filers).
- If married/joint income is between $186,000 to $196,000 ($118,000 and $133,00 for single filers) you can make partial contributions.
- If income is more than $196,000 for married filers ($133,000 for single filers) then technically you can not contribute to a Roth IRA.
- There is a work around for this, however, called a backdoor Roth IRA which has been discussed at length by the White Coat Investor and what I personally do.
When to make contributions and other points
- Contribution can be made for the year up until tax day. For 2016 contributions you have until April 18th, 2017 to make the contribution and claim it on your 2016 taxes. You can also make contributions on the first day of the new year. For 2017 contribution money can go in on January 1st, 2017.
- The tax deductions, if you qualify, are above the line and have nothing to do with whether you standardize or itemize the deductions.
How do you set up an account
Consider going to Vanguard, Fidelity, or some other index fund company and set up an account with them. It is relatively easy with good tutorials on the way. Then pick your index fund or mix of funds as I discussed here.
I hope this has been helpful. Any other thoughts?
Also published on Medium.