Saving

Individual Retirement Account (IRA)

 

Basics

We all want to retire comfortably and live the good life.  And we all need money to do so.  An IRA (Individual Retirement Account) is one way to help us get there.  An IRA is designed to help individuals save for retirement by giving them various savings plans.  People try to put in the maximum annual amount they can to increase their savings and to grow their account, using compound interest.  IRA funds can be invested in stocks, bonds, CDs, and various kinds of funds.  Make sure to keep your eye on your account, because based on the economy, your age and needs, you might want to change how your money is invested and the kind of risks you wish to take.  Again, read the fine print; there are penalties for early withdrawals.


Qualifications

In order to qualify for an IRA you must have a job.  This can be a part-time or a by-the-hour contract job such as babysitting, lawn mowing or snow removal.  Your income must be reported to the Government.  Your employer should provide a W-4 form which shows your tax withholding, or a W-2, which shows how much you earned during the year.  Or you can just file a regular tax return if your income is less than $4,400.  This way the Government has a record of your having a job.  Even if you don’t earn enough money to pay taxes, you can at least prove you had a job.  But you MUST file.

If you do earn money, report it to the Government, and are willing to put your money away for a very long time, than look into IRAs.  Let’s see what $1,000 gets you.

Example:  At 18 you open a Roth IRA (see below) account with $1,000, and each year you put in $1,000.  You expect to retire at age 70 and your life expectancy is 90.  Furthermore, let’s say you expect your annual return on your Roth IRA to be 8.0%.  When you retire, your IRA fund balance will be $726,031.55.  Your annual income from your Roth IRA would be $73,947.92, Tax Free!  Not bad for putting in only $1,000 a year!

Although the desire for an IRA seems long range for most of us, some of you may qualify, and wish to establish an IRA now.  You can invest in an IRA for minors if you are less than 18 years-old.

The Government limits how much you can put into an IRA.  You can put in any amount from a few hundred dollars to the maximum; check with your IRA provider.  The government has always put a set amount, for example $5,000 for individuals 49 and under.  Starting in 2010 they will take that amount and adjust it for inflation.  Let us say inflation (the price of goods and services based on the consumer price index (CPI) (see Economic Indicators & Other Causes That Can Affect Stock Prices Other Than Company News), goes up 2%.  Then in 2010 your maximum contribution amount would be $5,100 ($5000 x 1.2%)

 

MAXIMUM IRA CONTRIBTUION:
BASED ON AGE FOR 2009 & 2010
YEAR AGE 49 & Below Age 50 & Above
2009 $5,000 $6,000
2010 Indexed to Inflation Indexed to Inflation

 

 

Types Of IRAs

Traditional IRA:...you receive a tax break up-front, when you put the money in.  With a traditional IRA you put in "pre-tax" dollars, which means your contribution gets deducted from your current taxable income (which equates to a savings up-front).  Let’s say you earn $25,000, and put $5,000 into a traditional IRA.  That means your reported income is now $20,000, which might lower your income bracket and save tax dollars right away.  Your IRA money then goes to work.  All the money (the money you invest and the money you might earn (capital gains), is tax-deferred.  This means it is not taxed until you take the money out (once you are retired which is many, many years ahead, BUT PLAN NOW!).  The money you withdraw will be taxed at the income level you are earning when you retire.  You must, however, start taking withdrawals once you reach 70½ years old.



ROTH IRA… you receive a tax break on the back end, when you take money out.  With this type of IRA you put in “after-tax” dollars, which means you pay all your taxes right away on all the money you invest.  But all the money you invest, and the money you make, will be tax-free when you retire.  Furthermore, you don’t have to make the required minimum withdrawals when you turn 70½, you can let your money continue to grow.  Using the same example, if you earn $25,000, and make a $5,000 contribution to a Roth IRA, you pay taxes on the total $25,000.  If you have socked away $100,000 and with a smart investment it grows to $500,000, that $400,000 profit is yours to keep.  No taxes due to Uncle Sam, i.e., the government.  Note: If you have held your Roth IRA for five years, you pay no taxes once you reach 59½.

IRA For A MINOR…is for those who are under 18 who have earned income and reported it to the IRS.  You can invest the equivalent of your annual earnings up to $2,000 a year, in the Roth IRA. Remember you must have a job and file a tax return.  Your parent(s) must open a custodial account.  Your parent(s) will control the account until you reach the age of majority, which in most States in 18.  Hey, if you are really in good with your parent(s)/grandparent(s), and they can afford it, the Roth money does not have to come directly from your paycheck, it can come from them.  Any adult can contribute an equal amount that you earn, or up to $5,000 for 2009 (see above) into your Roth IRA.

 

Other Retirement Plans

Since savings for retirement is not your number one priority as a teen, I am just going to briefly mention a few other ways to put money aside that you might hear about.
  • 401K:  This is a plan where employees elect to contribute pre-tax dollars to a qualified tax-deferred retirement plan.  This is instead of collecting a part of your paycheck or bonus.  If for example you made $30,000 and decided to put $2,000 (this money is also called a “contribution”) in a 401K plan.  You would only pay taxes on $28,000.  And you are only taxed when you withdraw the money.  Some employers even match their employees’ contribution.
  • Keogh Plan:  This is a plan for people who are either self-employed or work for an unincorporated business.  Again your contributions are tax deferred until you withdraw them.  You can withdraw the funds starting at age 591/2, and no later than age 70 ½.
  • Annuity:  There are all sorts of forms of annuities (for example fixed and variable) sold by life-insurance companies.  This is another way to save.  You receive a fixed or variable payment after you retire for life.  However, commissions (the fee you pay to an insurance broker) must be paid, which means you have extra expenses.  Furthermore, you may want to check on the financial long-range health of the insurance company(s) you are investing in.