a little heavy for Saturday morning, but: You Need to do This NOW (re: free money)

Posted on 09.07.2011

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I know that a lot of people are kind of intimidated by the idea of ‘playing the stock market’, and I completely understand, because I am one of those people. On the other hand, I am also a person that got some great advice in ’04 and it is the best thing I have ever followed.

I want to talk about this today, because I learned a while ago that a few of my friends hadn’t even thought about this and that scares me, kind of. It scares me because they are screwing themselves, and because I know how bad things can get when it comes to our personal finances. I’ve been there.

We need to talk about investing your money, and we need to talk about it now before it’s too late. I’m going to talk about saving for the future, or as some people call it, ‘the nest egg’.

Most people think that having a savings account that has money in it is a great idea. And while I’ll agree that it’s smart to do, and give kudos to those who have it, we’re going to talk about two other ways to save money today: the Roth IRA and the 401(k) or 403(b).

The Roth IRA is an Individual Retirement Plan. This is something that you have to open for yourself, you can’t do it through work. You need to find an investment company, walk through their doors, have a talk and sign papers. The Roth IRA is really simple, because it’s all your money, invested.

The way it works: you put in a lump sum of money at the beginning/opening of the account. After that, you can either choose to let that money mature, as they say, or you can set up a system where you make installments once a month or so. They don’t have to be big, they could be $10 a month. What happens from there: your money is invested at a rate of risk that you and your investment banker choose together. It is invested into stocks, funds, CDs. All of it. When you earn interest from these, they can be re-invested into the funds. So eventually you have this nice little circle of earning money and reinvesting it, and you really don’t have to do anything.

It is important, though, to find an investment company and personal investor that you feel comfortable talking to, and can trust. My guy has been a friend of the family since we moved to MD, and we’ve always had our money with his company. It wasn’t until after my mom died that I got to start talking to him, though, as until then it was handled by my parents.

The Roth IRA is a really helpful little account, and here’s why:

It is, ultimately, a retirement account, which means that you really can’t touch the money in it until you’re 59 1/2 years old. However. The Roth IRA does have some cool features that don’t come with other types of investments. Normally, if you want or need to take money from a normal retirement plan (people do this in extreme cases of financial emergency), you get charged by the gov’t for withdrawing early, usually a large tax as well as some penalty charge/s. While that is the case for a LOT of things with the Roth as well, the Roth has some allowances which make it a good choice for everyone.

If you are buying a house and need money for the down payment: you can use the Roth without being taxed. If you messed up your taxes and now you owe the gov’t a lot of money: you can use the Roth without being taxed. You can literally use the money in that account for almost any emergency, and as long as you don’t close the entire account or touch your earned income (from interest), you won’t be taxed or penalized. If you ONLY use the money that you put in yourself, or less than that amount, you can’t be taxed.

What I like most about the Roth IRA is that it’s not like your savings account: you don’t have 24/7 access to it. You have no access to it, you need to talk to your investment company before you can get any of it. I like this, because it means that I can’t be frivolous with it. I need to really need the cash in order to get it, and I need to call the office, file paperwork, and wait a week. So it’s a lot harder to use for stupid things.

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The second type of investing is the 401(k) or the 403(b). I have had both. They are, to civilians, kind of the same thing, which is an Employer-sponsored retirement account of some sort. The 401(k) is often called a retirement plan, while the 403(b) is often called a pension plan. They are accounts that you can set up through your employer. Many employers offer these.

After my mother died, my investment banker told me (as I was opening an IRA with him) that anytime I work for a company that offers one of these plans, to do it. Why? Because they equal FREE MONEY.

The way that both of them work is similar: you select (with your HR office) a specific percentage of your pay from each paycheck to be taken out and put into the retirement account. Most employers will cap you at 10%, which is fine. The good part of this, uh, part, is that this money is taken out of your paycheck PRE-TAX. This means that you are not taxed on the money that goes to the retirement account. This is awesome, because it means that, on paper and at tax time, you make LESS MONEY than you actually do, because your final taxable income (after taking money out for the retirement account) is lower. WINNING! As an added bonus, the amount you put into this account is an amount that you barely even notice after taxes.

After the money has come from your paycheck, your company/employer will generally match a percentage of what you’ve put in. So, they could match 2% (this is common), or if you work for an awesome company, they could match up to 10%. This means, that if you put in $100 per month from your paycheck, your company will put between $20 – $100 in as well. And that’s where the free money comes in. Your company gives you free money to retire.

Even on the low end at 2%, that’s great. It’s great because all of that money is, in turn, invested, just like in the IRA above. So your company is helping you to invest in your future.

From many of these accounts, you can take a ‘loan’ if you need to. This is, effectively, you lending yourself your own money, at a ridiculously low interest rate (much lower than you will get from most banks). When you take the loan, you decide upon a repayment plan of up to five years, and then you have to pay the loan back on a monthly basis. I have done this once before, and it was quite helpful to eliminate some debt that I had. I have just finished paying it back to myself.

The nice thing about lending money to yourself is that, if you have problems and maybe can’t repay for a month or so, it’s much easier to talk to these people than collectors. And if you just can’t pay the money back, it just gets taxed as income on your next tax form. No other penalties.

On top of this, when you leave your company, you generally don’t lose the money they’ve given you unless you haven’t stayed long enough. Some companies require you to stay for a year, others 6 months… either way, try to stay as long as it takes to be fully ‘vested’, so you can take all of the money when you do decide to leave or get a new job.

And when you leave, the account can either sit there accruing (earning) interest, or you can ‘roll it over’ into a new account, with your new company or into an IRA. So it’s good to have an IRA as well:)

Here’s my personal example for you: in 2004 I opened up a 401(k) at Bombay Co. They matched about 3%. Then I went to work for Aquent for a year. I rolled my Bombay 401(k) into the Aquent 401(k), and continued from there, where Aquent matched about 2%. Then I went to MICA for 3 years, and rolled my 401(k) into their 403(b) program. MICA started out matching 7%, but then went to matching 10% (um, amazing!!). So between 2004 and 2009 when I moved to Germany, I was using these plans and getting free money. I haven’t made any deposits or touched my 403(b) since then, and as of now I have over $20,000 in that account.

And no, the financial crisis didn’t hurt my accounts. In fact, I barely saw any change at all in my earnings.

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I feel like this is important for you guys to know, because unless your parents were doing it, or the HR office at your job really sat you down and explained it, chances are you have no idea how any of it works and no idea that you could be getting free money for working at your company. So many of my friends have kids now, this should really be at the front of their minds: saving for the future, whether it’s your future or the future of your kids.

Also, on the political end, there are a lot of issues with Social Security these days, and it’s starting to get used as a bargaining chip. Social Security is what you are paying into now, with the ‘understanding’ that once you are old enough to retire, other people will be paying in and you’ll be able to get social security payments. There have already been forecasts stating that social security won’t be able to support people my age by the time we retire. This makes having a retirement account of any kind an IMPERATIVE. None of us want to be destitute and unable to work, so it’s in all of our best interests to save for our future. We should all be able to enjoy our retirement and do the things we didn’t get to do while in the workforce. If Social Security is still going strong in 40 years, that’ll be great. But if it’s not, at least you’ve planned ahead and will be taken care of.

It’s NEVER too late to start saving for your future/retirement. It only took me 6 years to get $20k. That’s not a lot of time, in the grand scheme of ‘how much time I have left before I retire’.

If any of my MD readers need the name of a good investment banker and company, feel free to message me and I’ll shoot you some contact info.

Posted in: life, money