At the beginning of the year, Johnny did a few posts on the dirty details of the Roth IRA. Those posts, condensed? We’re big, big fans of Roth. We maxed out our Roth IRA last year, we’ve maxed it out this year (using our tax return from Uncle Sam), and we plan to max it out each and every year. In short, we are on the Roth train.
And here’s why.
First, we love everything about Roths: no taxes on withdrawal, penalty-free withdrawals on principal, and, of course, the compound interest. Thanks to the penalty-free withdrawals on principal, we’ve started using our Roth as an emergency fund, as many of you have said. But most importantly, we really like what a yearly maxed-out Roth means for our retirement.
So let’s talk numbers. Because who doesn’t love a little math? (raising my hand)
In our rough calculations, we need between $1.5 and $3 million saved for retirement, which is a pretty large margin. Rough calculations, remember? We’ll do a post in the near future where we do more specific calculations of exactly what we need for retirement. But we’ll stick with those numbers for now.
So far we’ve contributed $22,000 to our Roth ($5,500 for each of us for two years). And we plan to retire in 37 years. So if we put $11,000 in each year, we’ll have contributed a total of $429,000 over the next 37 years.
So where will that $429,000 be in 37 years, once the money babies have had their way with it?
Well, let’s start with a very conservative scenario where the money only gains an average of 4% interest. Once again, very conservative. That $400,000 will have grown to $1 million bones!
But now let’s talk about another likely scenario. Let’s say the money gains an average of 8% interest. That $400k will have grown to $2.79 million!
Pretty amazing, right? Obviously, it’s choosing smart investments that will make us money, not the Roth itself.
It just sounds so simple: If you save $11,000 a year, you’ll be set for retirement. Obviously, setting aside $11,000 a year might not be attainable for everyone, and it’s a huge stretch for us. But it seems worthy of trying. This also doesn’t take into account our employer-sponsored retirement plans, which we hope we’ll continue to have access to and contribute to as well.
And for all you youngins who are pushing off saving for retirement and rolling your eyes at our obsession with money making money babies, we’ve got an incredible chart for you on the power of compound interest, by the folks at JP Morgan Asset Management.
This chart represents compound interest at an average growth rate of 7%. Do you see where Chris ends up?! So even if you can just put away $5,000 a year, start now!
So, you on the Roth train yet? At the very least, you on the retirement train yet?
As a Canadian I have 2 tax sheltered savings option. An RRSP that is a good tax deduction in the year you make it but you are taxed on the money when you remove it. or a TFSA for which you do not receive a tax deductions for deposits but you can remove it, without penalty, at any time and you are not taxed on any earnings the money earns.
The goal is to avoid taxes upon retirement. If I had a good pension and was going to be a middle to higher income senior then I would add to my TFSA. I will be a lower income senior so I concentrate on the RRSP. I get good tax deductions which lead to a tax refund which I can reinvest but I will be taxed at a lower rate when I withdraw in the future so I am not worried about that.
-11Celsius and convinced winter may never end in my part of Canada
Sounds about the same as our 401k/403b/IRAs (taxed upon withdrawal) and Roth IRAs (already taxed). That’s a smart plan. We think we’ll likely be in a higher bracket come retirement, hence the Roth focus. BUT, we’re still contributing to our employer-sponsored 401k/403bs to hedge our bets, just in case we find ourselves in a lower tax bracket than we anticipated.
-11 C! You need to put aside some dough and get yourself to a beach stat!
I have a ROTH, but I don’t max it. I use it as a way of tax diversification for the future. I tend to investment a good amount in my 401k since my choices are pretty low fee. I then put some money into my ROTH. Other than that I put a good amount into my taxable account. In the end all that matters is someone is saving and saving now, not tomorrow, not the next day, but now.
I think we mentioned it, but you bring up an important point — diversification extends to retirement options, too. We’re fairly confident we’ll be in a higher tax bracket come retirement, but we’re hedging our bets by maxing out our employer match 401k/403b contributions.
Six years ago, I distinctly remember a loan advisor telling all of us soon-to-be student debtors to start investing in a Roth IRA that day. I punch myself in the face everyday as penance for not heeding his advice sooner.
Are you also maxing out your pre-tax accounts such as 401k? If yes your math would be even more impressive… If not it would be interesting to hear why?
We’re maxing out our pre-tax employer match, in addition to a few extra percentage points that Joanna’s employer kicks in to her 403b. So while it’s not quite as substantial as our Roth contributions, we make sure to take the free employer match cash while also diversifying our retirement investments. As mentioned in the comments above, we’re betting on being in a higher tax bracket come retirement, hence the preference for Mr. Roth.
Your approach makes sense if you plan on being in a higher tax bracket in your retirement than the one you are in now while working full time. We are taking a different approach and maxing out pre-tax accounts first since I seriously doubt we will be making more money in retirement than we do now. This allows us to contribute more early on due to tax savings i.e. front-loading. There is also an option of converting our pre-tax savings to Roth as soon as we are FI and can reduce our earned income to the level where we qualify to do it over several years. That seems very attractive to me as we can invest pre-tax now and then convert the savings to Roth later and never pay taxes.
Yep. I anticipate us being in a lower tax bracket in retirement as well as having some low income years before then. It makes way more sense for us to contribute pretax now and convert it to a Roth later.
I just read this fact this morning from a Dave Ramsey article: 57% of workers have less than $25,000 saved for retirement.
(found at: http://www.daveramsey.com/blog/retirement-doing-it-wrong).
Can you believe that?! That shocks me…and I’m thankful it shocks me. I’ve exceeded that and I’m 29….I cant imagine the terror I’d feel of being close to retirement with so little saved. (No pension for me, so far!)
Anyway, I am a Dave Ramsey fan, and I am at the point where I am debt-free and building my emergency fund . As a single 29 year old, I calculated based on my costs, my 6 month savings fund should be $12,000. For now, I’m building that in a basic savings account.
Additionally, I max out my Roth IRA (opened towards the end of 2013, yay!) by putting in $458/month.
So you guys use your Roth as your retirement AND/OR your emergency fund? That’s interesting to me… I never really thought as having my emergency fund invested in a Roth…I guess because I’m afraid I’d lose it, an emergency would occur…. I always pictured my emergency fund in a safe savings account and separately having my retirement money untouchable in a Roth IRA and my 403b.
Wouldnt it be tough (emotionally) for you to pull money from the Roth knowing all it COULD earn if only you didn’t take it out? I guess that’s why you’d only have it for true emergencies…
Hmmm makes me rethink if I should just build my emergency fund in my Roth by maxing it out, and do retirement contributions to my 403b, and not save in a savings account at all….
Do you guys use regular savings accounts for anything? Like when saving for your house fund, where do you save that in?
Prompted a lot of questions for me!!!
In my opinion using a Roth IRA as your emergency fund is hopefully a short term solution (just a few years). The ideal is getting to the point where you can max out your IRA and other tax advantaged offerings every year, and then still have some left over to build that emergency fund in a cash account. Until that point is reached, might as well use the Roth and not miss out on the opportunity. If you don’t have an emergency, it stays and (hopefully) grows; if you do have one, you pull it out and use it. Yes, there is investment risk involved, so keep that in mind when choosing investments.
Ughhh, that DR stat is shocking. But to tell you the truth, our generation has not been helped at all in financial education. While it should be our responsibility to take the bull by the horns and figure it out, it’s no easy task to find easy-to-digest info to help one plan financially.
TT hit the nail on the head. While we’ve effectively moved our 6-month emergency fund over to our Roth IRA now, we still have a nice cushion in our standard savings account should we need the money in a pinch. Maybe a more measured approach would make sense where half of your emergency fund contributions go to your Roth and the other half to your savings account, just to give you peace of mind and immediate liquidity should your investments go sour when you have an emergency.
We’re currently keeping our future home mortgage savings in a money market account. We’d love to put that cash into a rolling CD, but the ratess are so abysmal right now that we’re not missing out on much with our almost-1% money market.
I love this graph, it always amazes me how important those first 10 years are. If you work hard to save early and often, you’ll be able to coast once kids, schooling, and housing start taking up more of your budget.
Makes me wish I had taken some of that measly money I earned when I worked at Jamba Juice as a teenager and thrown it into a Roth IRA.
Like your other reader, Jane Savers, I too am a Canadian and so contribute to both RRSP and TFSA plans for both my wife and myself. These compare to your American ROTH IRA and 401(K) plans. Over the years we’ve been fortunate in being able to max out our contribution room in our plans.
Early in my career, while my wife was not employed for some years (but still hard at work looking after our 2 kids when they were younger), we did one more thing – in additional to my wife contributing to her own personal RRSP, we also set up a “spousal” RRSP for her, where I contributed some of my annual RRSP contribution money into her spousal plan and the remainder into my personal RRSP. Without going into a lot of boring detail here, I did it as a way to eventually accomplish income splitting (since I was annually making more $$ than she was). And the reason for income splitting? As a significant tax saving measure when the time comes when we are obliged to withdraw annual minimum amounts each year from these RRSP plans and pay tax on the funds – but at a lower tax rate.
So Joanna, if your annual income is quite a bit less than Johnny’s then you guys might want to investigate if there are ways to income split your annual Roth IRA contributions between yourselves for eventual tax saving purposes.
Great tip, Rob. I know that there are spousal IRA options, so we’ll definitely consider this as Joanna prepares to leave the workforce sometime in the next few years. Thanks for the heads up.
Such a great post! My husband and I are great fans of the Roth as well 🙂 It’s so amazing to see how contributions like the ones you’re making can really go a long way towards building the type of retirement you want to have. We are planning on retiring in less than 10 years so that we can travel the world. The Roth will go a long way towards funding the life we wanna live after we hit the 59 1/2 marker. We plan on cashing in our Roths and 401-K at that time. 🙂
Such an inspiring post – I wish everyone would take the time to look at this so that they can get educated on what amazing things compound interest can do!!
I’ll have what you two are drinking! Bring on early retirement! While we’re likely quite a few years behind your awesome progress, it’s great to hear your goals and progress toward making them happen. Congrats!
Great post. I would still encourage considering the tax advantaged traditional IRA in cases where your income qualifies you to deduct the amount from your adjusted gross income (AGI). There are penalty free withdrawal exceptions with this type of account too if you are considering it to double as an emergency fund but the ROTH would provide greater flexibility. There are also opportunities to convert it to ROTH later on tax free or for very little taxes.
Perhaps get the best of both worlds by putting “enough” contributions in the ROTH to feel safe for emergencies then enjoy the tax benefits of a traditional IRA for as long as you are under the income restriction. In any case, significant retirement savings is the strategy of choice for most households who eventually reach financial independence.
Good call. I almost pulled the trigger on also contributing to a traditional IRA last year for tax savings, but our 401k/403b contributions had already helped out a bit in the regard and we opted to put that money toward the Roth instead.
I’m interested in the IRA to Roth IRA rollover with little to no taxes. Do tell.
I would read the entire Mad Fientist site but this article in particular:
The bottom line is that the tax system favors people with high assets but show low “ordinary” incomes. You can play around with it yourself with a tax calculator:
Converting from Traditional to ROTH would count as ordinary taxable income. But, with a combination of exemptions, deductions, credits, and income type you could convert a significant amount of money and pay $0 tax. If you simply stay in the 10% or 15% tax bracket, qualified dividends and long term capital gains are taxed at 0%. I just put in $60,000 earned from long term capital gains and dividends plus $40,000 converted from traditional to ROTH in the calculator for my family of 5 and still returned that I would receive a refund. At retirement, your income becomes simply a function of your living expenses. If we can live on less than $60,000 then we could convert more to ROTH and stay under the tax requirement.
That conversion is then counted as ALL contribution and can be accessed without penalty before age 59.5 as long as it remains untouched for 5 years after conversion. Usually people set up conversion ladders so that after 5 years they will have access to new money each year before traditional retirement age.
So, it was put in pre-tax, grew tax free, converted (over time) tax free, and then became tax free forever as ROTH contributions and earnings. Plus it can be withdrawn prior to retirement age.
Interesting stuff. Thanks for the reads.
Love the Roth! I just finished maxing it out for 2013, things will get more complicated for 2014 (M and I will be married and he’s a commission employee, so we won’t know until year end if we can contribute regular or have to do back-door contributions).
I will agree traditional IRAs are worth considering if you’re able to duduct them, but as long as you’re contributing a good chunk to a 401(k) pre-tax I feel like a Roth is a good balance between tax savings now (401) and later (Roth). Plus it has the flexibility of taking out contributions early, for emergency purposes or for retiring-before-59.5 purposes if your money babies are particularly productive ;).
And this may have been asked before I started reading, but what’s with Levar Burton? Was there something malicious about Reading Rainbow I didn’t catch as a kid?
We’ll take a closer look at the traditional IRA next year and see what our 401k/403b contributions tally up to. It’s definitely worth hedging any retirement tax bracket bets since who knows where we’ll be and where tax rates will be at that point. Thanks for the heads up.
So here’s the deal with LeVar: he’s awesome. He’s so awesome, in fact, that if he ever did visit our blog and comment, the whole Internet as we know it would explode. And since that would be a terrible thing, we ask him to keep his awesomeness to himself. 🙂
I was one of those youngins’ rolling my eyes years ago when an employer was explaining saving for retirement at an early age. Did I listen? No! Now I’m trying to play catch up and it’s not easy! I’m still not on the IRA train, but I’m on the retirement train in the form of mutual funds and a pension. IRA is my next step.
Still super jealous of that pension. Nice job landing a job that still offers one of those unicorns. And congrats on being on the retirement train, no matter the investment vehicle.
Due to crappy circumstances our savings was recently depleted. I am a 30 year old stay at home mom, always have been. Since I’ve never had a full time job and am just starting a new job – PT for now – no benefits of any kind, as we build it back up again where would you recommend putting our first chunk of change? Let’s use $5,000 for conversation’s sake. It is so hard to know where to even begin when you don’t have an employer to help guide you.
Sorry to hear that, Emily. No matter the circumstances, that’s a major bummer. I would definitely start by building your emergency fund back up. Don’t do anything else until you have a new safety net. As we referenced above, a Roth IRA could potentially serve as an emergency fund vehicle (since you can always pull the principle out without penalty), but if you’re afraid of future volatility with your finances/careers, it would make a lot more sense to save it in a money market account at your bank.
The bottom line is, don’t be too too concerned about what you’re doing with your savings — just focus on saving. If you’re saving period, you’re on the right track. Shoot us an email if you have any other questions. And best of luck!
Great post, thank you. This year our plan is to max out my Roth IRA contribution, up my husband’s 401k contribution (we already do a few % above the employer match), then take additional savings and contribute to the kid’s college/future fund and our mutual fund investments. This year is tricky because we are house hunting and expecting another baby in May- 2 big life events that obviously have a large impact on finances!
Woah, HUGE life events on the horizon! Congrats on all of them! And congrats on keeping your eye on the prize of tax-advantaged investing. It sounds like a tall order, but you guys sound like you’ve got it in ya. Virtual high five!
We’re still paying off significant debt but are looking to fund more to Roth IRAs for an emergency fund. Is there a limit to principal take out so long as there’s enough principal in the account?
Whatever you put in, you can take out. Your Roth IRA provider/brokerage might have account minimums, but otherwise, you should be able to keep your earnings in the Roth IRA. Realize, though, that if you take out more than the yearly max of $5,500, it might take you a few years to replace what you took out. And that really hurts the effects of compounding interest.
I’m looking forward to being able to max out our Roth IRAs once our debt is gone. For now, I deposit around $100 a month into my account. Roths rock — when I had a traditional employer, I had a Roth 401(k) as well!
I’m still not totally convinced Roth IRAs weren’t named after David Lee Roth for the amount of rocking they do.
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