Planning for your retirement: Traditional IRA vs Roth IRA vs 401k

Hi all,

I have been meaning to write this post for a couple of weeks now, but just haven't had the time. The idea came from a friend of mine (shout out to Mike!) who thought it would be helpful to learn a little bit more about the differences between Traditional and Roth IRA accounts. I'm going to do you one better and throw 401k's into the mix!

I want to try and keep this as simple as possible, so I'm going to start by describing the Traditional IRA account, and then use that as a basis for comparison to explain the differences with the other types of retirement accounts.

Traditional IRA:
The idea behind the Traditional IRA account is that a person can contribute money on a deferred tax basis each year. A deferred tax basis means that, although you will eventually have to pay taxes on this money, you won't have to pay them now. The money stays in the account until your retirement, during which time it has hopefully been growing. When it is time, the money is taxed as it is withdrawn from the IRA account. Here are some KEY bullets to help further explain:

• You can only contribute a maximum of some specified amount each year. This number is constantly changing but, in 2013, it was a maximum of $5500 ($6500 for people over the age of 50).
• Once money is contributed to the account, it cannot be cashed out until age 59.5, or else you will be charged a 10% penalty fee plus taxes. 
• While you cannot cash out before 59.5, you can use the contributed funds to buy and sell investments (stocks, bonds, mutual funds, etc.) within the IRA. This is how you can potentially grow your retirement savings!
• While in the IRA account, you will not need to pay any capital gains taxes on investment gains. 
• At age 59.5, you will be eligible to withdraw your savings from the IRA without paying any penalties. The money withdrawn will be taxed based on your current tax bracket. Typically, you will be in a lower tax bracket after retirement due to a decrease in income. This is so important!!!! It means that you could potentially be paying taxes on your savings at a lower rate than you would have at the time when you contributed those funds during the peak of your career. 

Phew! Okay so that is the gist of the Traditional IRA. Now lets use this basic understanding to help shed some light on the other options out there.

Roth IRA:

The Roth IRA account is very similar to the Traditional IRA. Here are the key differences:

• Roth contributions (same maximum of $5500 in 2013) are made AFTER tax, and are thus NOT tax deferred.
• Once contributed, you can withdraw money from a Roth IRA without paying any penalty fees like you would under a Traditional plan. 
• Money generated within the plan (such as interest or stock growth) is NEVER TAXED. With a traditional IRA, money is contributed before taxes, grows throughout your career, and then both the amount you contributed, plus any growth, is taxed when withdrawn. With a Roth IRA, money is taxed when earned, then contributed, and then never taxed again. 

And that's pretty much it! Biggest difference is the timing of when taxes are paid. 

401k Plans:

401k plans are also very similar to Traditional IRA accounts. Money is contributed on a deferred tax basis, it grows throughout your career untaxed (no capital gains taxes), and then it can be withdrawn after age 59.5 at which time it will be taxed based on your current tax bracket during retirement. Here are the big differences (there are a number of big ones so stick with me here!):

• 401k's have a higher maximum contribution (in 2013, the max was $17,500 per year, as opposed to the $5500 max for IRA's). This means that you have the potential to save even more money for your retirement.
• These plans are organized BY YOUR EMPLOYER, which has a couple of different ramifications:
• The employer will often match a percentage of the employee's contribution. Meaning, if you contribute $17,500 in 2013, your company may also contribute an additional percentage of that $17,500. 
• The employer can specify (read: limit) the investments available to the employee to build and grow their savings. For some people, this could be a really positive thing. For those of you that are really confident in your trading abilities, it may feel a little invasive.
• Contributions come directly from your paycheck. With an IRA account, you are taxed on your income. Then you deposit a portion of that money into the IRA, and you subsequently receive a tax credit on the amount contributed (thus "tax deferred"). With the 401k, you are saved the trouble, as the contributions come out of your paycheck before income is taxed. 
• Finally, you have the ability to BORROW MONEY from your 401k prior to age 59.5. You will still be charged a fee on the money withdrawn; however you will pay this fee in interest TO YOURSELF. You essentially borrow the money from your own retirement plan, and then pay it back with interest. 

Okay, so that is pretty much it. Couple quick notes: 401k's also come in the "Roth" variety. They are less common (a relatively new option), and are different from Traditional 401k's in the same ways that Roth IRA's are different from Traditional IRA's. In general, the 401k tends to be the more attractive option (higher contribution maximums, employee matching, ability to borrow); however, some people would prefer the IRA options simply for the freedom to invest in whatever they choose (as opposed to the limited options of an employer organized 401k).

Now, I think that was a pretty decent description of some of the key differences between the big retirement plan options out there, if I do say so myself. Having said that, simple descriptions will not (or at least, should not) be sufficient to make an investment decision. To help those of you faced with this issue, I have included several fantastic videos below, compliments of the Khan Academy. They really break down the nuances between the three big options, and demonstrate how they would affect your savings in practice. When I first signed my job offer and began taking a look at the big boy decisions I would soon need to make, I turned to Khan Academy to help clarify my options.

I hope you have all found this helpful! Let me know your thoughts.

Traditional IRA:

Roth IRA:

401k:

Making the most out of your debt: Credit card reward points!

For many people, relying on credit is just a fact of life. I wish I could sit here and tell you that I have the luxury of only using my credit cards in order to build up my credit profile; however, that is simply not the case. Every once in awhile an expense (whether big or small) will unexpectedly pop up into my life, and I will be caught without any free cash flow to cover it at that moment. It is times like these that I am so thankful to have my credit cards to get me out of a bind. In some of these situations paying a little bit of interest is by far preferable to foregoing payment on that unexpected expense, or missing out on a great opportunity (ie: your car breaks down and if you do not pay to fix it you will have no way to get to work; or, you win free concert tickets but need to pay for transportation). 

One of the best ways to make myself feel better after a big credit card purchase is by taking a look at my statement, and seeing all of the great rewards points that I have accrued. It can really help to take away the sting of an upcoming interest expense! If you are able to get your score into the good and excellent ranges (see my post on credit scores), you will be eligible for some of the top credit cards available, and it's these cards that will provide the best rewards packages to cardholders. 

To demonstrate this concept, I will share a personal story: At the end of the Spring 2013 semester, I realized that, because the accounting department completely screwed me, I would have to pay for an online class that, had things worked out as originally planned, would have been paid for by my graduate assistantship at Lehigh. There was no good time in the upcoming Fall semester to take the class, so I absolutely had to enroll over the summer, and with such short notice, I didn't have the $2000 in cash to fork over for tuition. 

After taking a good look at my finances I decided that I could reasonably (and responsibly!) open up a new credit card to use to pay my tuition. I did a lot of research, and in the end settled on a card that I had been pre-approved for. It was the Citi Thank You Preferred card which, at the time, was offering 20,000 bonus "ThankYou Points" after $1500 in card purchases within 3 months of account opening. 

Here's where the story gets really awesome: 20,000 bonus points translated into a value of $200 worth of gift cards. By paying my tuition with the card (and thus spending more than $1500 in the first three months), I received my 20k bonus points. And due to the point structure on the card, I also received an additional point for every dollar spent on the card. When all was said and done, I paid for my tuition (an expense that I absolutely had to incur. I needed to take that class!) without accruing any interest because of a 0% intro apr feature, and I was rewarded with approximately $250 in gift cards (to stores that I got to chose amongst many options such as: Bloomingdales, Nordstrom, Brooks Bros, iTunes, etc). It was a total win-win!!!

There are a number of considerations when choosing a rewards card. Check out the video below, or this blog post, to learn about the three big categories of rewards programs: points, miles, and cash back. Another awesome resource when trying to pick a new credit card is creditcards.com. Here you will be able to search through available cards in a number of ways, such as: by type of card (low interest, balance transfers, 0% apr, rewards program, etc.), or by credit quality (excellent, good, fair, bad, or no credit at all). 

Now that I have opened your eyes to the intoxicating world of credit rewards, I want to leave you with a few words of caution. Credit card rewards can legitimately be addicting. It is not uncommon for people to get so wrapped up in the introductory deals that they begin to haphazardly open new accounts, reap the benefits of the introductory points, and then close them before moving on to the next rewards program venture. This can and will have a negative effect on your credit score. Do yourself a favor and pick two or three rewards cards that work the best with your lifestyle and shopping habits, and then stick with them. 

Good luck and happy card hunting!!

"Loans, Loans, Loans #womp," by Guest Blogger Ashley Sciora

If you’re reading this blog because you have some student loans weighing you down, welcome to the same boat that Anthony and I are in. Grab an oar, start paddling, and let’s talk about some ways to shed the debt!

Before you leave the safe space of your college or university, if you took out loans to pay for your education, you’ll have to sit through an exit interview to make sure you know the terms of loan repayment. If you’re me, this consists of frantically looking up your odds of winning the lottery and calculating how long a person can survive on pasta.  Had I paid a little more attention, I probably could have breathed a little easier knowing that there are options available.

Identify your loan holder

While the Department of Education may have a corner on the market, there are plenty of other entities who are willing to lend you money for school.  You can’t find out what options are available to you without figuring out who you have to pay back. Other common sources of loans: private banks and state departments of education.  Your school’s financial aid office should be able to help you with this.

When the grace period’s over…

Most, if not all, loans come with some sort of grace period; breathing room to figure out what your strategy is when the first payment request comes.  The federal government gives you six months, while other loan servicers may give you a shorter stretch of time.  The grace period is usually determined by the amount of time needed for the servicer to determine that you have graduated, won’t be re-enrolling in school and should be making payments.  A quick call to your loan servicer or a visit to their website’s FAQ section should help you make a timeline before repayment.

To Consolidate or Not Consolidate?

Most of us have multiple loans to our names when we graduate – whether your servicer granted a loan for a semester or a year or if you’re juggling multiple servicers, you’ll have multiple balances owed.  Consolidation will be the first option most of us consider.  The process of consolidation, if you’re eligible and the specifics of your arrangement will vary, but who cares about all that if you don’t know what consolidation means?  Consolidating your loans means that you’re essentially taking out another loan, equivalent to the balances on all of your eligible loans (you can only consolidate loans with the same servicer).  Consolidation is a much-talked about option, but may not be best for everyone.

Things to Consider:

• Decrease in monthly payment. It may be a marginal decrease, but in this economy, any little bit helps!
• Convenience. If you’re like me, you may get some piece of mind from only having to look at one balance and one statement per month (assuming you only have one servicer.)
• Change in interest rate. If I were to consolidate my student loans from my home state, the interest rate on the consolidated loan would be an average of my existing loans.  (Some of my loans had lower rates than others, that all gets factored into a new rate for the new loan.)
• Length of repayment. You’ll have longer to payback the consolidated loan, but that means more that you’ll end up paying in interest.
• Effect on deferment/forbearance options. Depending on your servicer, consolidating existing loans can have make you eligible for or disqualify you from some deferment or forbearance options.

Well, that's enough of that for now. The bottom line is not to panic! Educate yourself about your options and work out an appropriate repayment plan. Also, look out for a follow up post about loan discharge, forgiveness programs, and deferment/forbearance. Let us know about your thoughts and experiences with student loans in the comments!

Tools for Success in Financial Planning

For many people, managing their finances does not come so naturally; creating a spreadsheet on excel and trying to work through each of the separate mobile banking sites for their individual accounts may not always cut it! Luckily for all of you broke college students, there is another way! 

For this post, I wanted to talk a little bit about a neat tool that can help you to manage your finances effectively through a number of awesome features. The site is called Mint.com and it will:

• Compile all of your accounts in one place (checking, savings, credit, loan, etc.)
• Help you to create and stick to a budget that can be as basic or meticulous as you would like
• Send you email/mobile alerts for things like upcoming payments, nearing a credit limit, suspicious activity, and more
• Categorize your expenses in a pie chart to show you how much money you spend on things like gas, food, clothes, transportation, bills, etc.
• Make some personal recommendations based off of your spending history and financial position to help you save money
• Help you set legitimate goals, and track your progress from start to finish. Examples: paying off your credit card debt or saving money for a new car 

The bottom line is that Mint.com will help you to organize your finances in a way that you can understand, and then provide you with the tools to get on the right track, make smarter financial decisions, and plan for your future. The site is very user-friendly, clean, and customizable. Mint also offers a super convenient mobile app available on apple and android devices! For more information about how the website works, check out this link: https://www.mint.com/how-it-works/

If you happen to be one of those people that just can't seem to get on top of your spending, or you are chronically late on your credit card or student loan payments, this is a really simple way to take control of your life and avoid damaging your credit score. Also....did I mention that the service is COMPLETELY FREE?

Here is a quick video to explain some of the basic functions of the site -- if you like what you hear, I definitely encourage you all to sign up on the main site, and connect all of your accounts (have no fear! Mint uses bank-grade security on it's website).

As always, let me know your thoughts!