How to Prepare for Retirement

These days, there are a variety of ways to save money for retirement. Some examples are the Roth IRA, Traditional IRA, 401k, a regular brokerage account, and running your own business.

Roth IRA –

The Roth allows anyone with an earned income to stash away a maximum of five thousand per year into a tax free account. Of course, if your earned income is only two thousand dollars, then you can only contribute two thousand dollars to your Roth IRA for the year. A Roth IRA is extremely useful for someone who wants to invest in high dividend stocks, funds; etc. The Roth allows your interest to compound tax free, which will dramatically increase your investment’s capital over time.

It’s also nice that you have the option to pick your own stocks or funds if you wish. Another advantage is that unlike the Traditional IRA, you don’t have to start withdrawing your balance when you turn seventy and a half.

Another reason to utilize a Roth is that you can withdraw all of your contributions without penalty. However, don’t withdraw the earnings or you will pay a fine. So if you’re in a cash crisis, your Roth can help bail you out. You can also deduct a portion of your Roth to help with the purchase of a home.

The disadvantage to the Roth is that you’re limited to five thousand per year to invest. It should also be noted that the amount you can contribute to your Roth will increase in the future. This allows your money to keep pace with inflation.

If you make too much money, then you can’t contribute to a Roth. Once your salary passes ninety-five thousand or so dollars in a given year, the amount you can contribute starts to decrease.

Traditional IRA –

A Traditional IRA also has contribution limits of five thousand per year, but allows you to sometimes deduct the amount you contribute on your taxes at the end of the year. Unfortunately, you will still have to pay taxes on this when you start withdrawing from it in your retirement years.

Also, as I mentioned above, you will have to start withdrawing from your balance when you turn seventy and a half. Of course, the government could always change the rules a bit and up the withdrawing age to seventy-three or so. There is no way to be certain. Fortunately your interest will still compound, so it’s still a useful way to save some money for retirement.

The 401K –

The main advantage to this type of retirement account is that you can contribute up to fifteen thousand per year (twenty thousand if you’re over fifty). That’s a lot of money to contribute.

If you have a job that pays really well, then by all means contribute to the 401k. Most companies will also match you for whatever you contribute to your 401k; it just depends on the company you work for. Some companies will match you two percent and some might match seven percent and so on. Unfortunately, mutual funds are the only types of investments that you can choose from, though.

So with the 401k, you can’t choose individual stocks. However, if you dislike choosing your own individual stocks or funds then the 401k may be perfect for you.

You will still be taxed on the contributions when you start withdrawing from them in your retirement years. There is also something new called a Roth 401k. It’s basically the same thing as a Roth IRA with the exception being that you can contribute fifteen thousand instead of just four thousand dollars. You’re still stuck with just being able to pick mutual funds, though. But your money compounds tax free like the Roth IRA. And again, the limitation of fifteen thousand per year will likely increase as time progresses due to inflation.

Normal Brokerage Account –

What about a normal brokerage account? A regular brokerage account is nice, but you will have to pay taxes on the dividends. If you buy a stock, and sell it for a profit then you will have to pay taxes on that too.

You don’t have to have earned income to open a brokerage account, though. And you can choose whatever type of investments you like to pick. Of course, if you choose a stock that doesn’t pay a dividend then you will not have to worry about paying taxes on the dividends.

Let’s say you buy a hundred shares of a non-dividend paying stock that is worth ten dollars per share. Say that you spend a thousand dollars on this stock. This stock then jumps to fifty dollars a share and splits five times over the course of three years. Before taxes, this could net you a hundred and sixty thousand dollars of profit.

You will not have to pay tax on this type of investment until you cash in the stock (you don’t pay tax on stock splits). Also, the longer you hold a stock the less you will pay in taxes. So while you may not have the advantage of compound interest, a regular brokerage account is a good way to save.

What About a Business?

A business? When you’re older you will not be as spry as you once were, but you can still run a business. For example, you could write articles or maybe a novel. The type of business you start isn’t really important. The passive income that you generate from it is what really matters.

Probably the best way to prepare for retirement is to combine all of the above ideas. Remember, thanks to inflation, thirty to forty years from now everything will be more expensive. Why? Because of inflation. At even just three percent per year, inflation can do a lot of damage to your retirement plans. Especially, if you have a long way to go (like forty years).

And then, depending on the type of retirement account you have, you may or may not have to pay taxes on your withdrawals. So if you plan on retiring in thirty to forty years, you should probably have a lot of money stashed away. Or a successful business or two. Or both.

Retiring well means saving and investing wisely. And a successful business never hurts anything. If retirement is a long way off for you, just remember that inflation is your number one enemy. And this enemy is never going away.