I should do a post of the most commonly asked questions I get when talking about personal finance with folks.

How much interest is your IRA paying would probably rank in the top five for sure!

Or you could phrase it this way – what are your IRA rates these days?  Or even, What’s the best IRA you’ve got?!

My guess is that this question originates from folks investing into bank IRA CDs.

Obviously with CDs, the interest rates bear whatever the going rates are in the market.  After so much time investing IRA money into bank CDs, it’s natural to ask what are your IRA rates.

This is a common misconception, and one that I’ll dispel for you today.

IRA’s Don’t Pay Rates, CDs and Savings Accounts Do

If banks are using lingo with their customers like, “Our IRA rates are the best in town!”, they need to stop!

It’s creating confusion.  IRA rates are a misnomer.  IRA’s don’t pay rates, CD’s and savings account do!

I did a quick search for “IRA Rates” and there was even a very well-known bank advertising their Attractive IRA Rates!!

No wonder the financial industry gets a bad rap, it’s confusing.

Personal finance can be confusing enough, let alone something simple like this.

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IRA’s Are Like a Parking Garage

Think of a parking garage a second.  Some garages make you pay on the way in, while others make you pay on the way out.

Think of your IRA like a parking garage.  You either pay your taxes on the way in, like in a Roth IRA; or you pay your taxes on the way out – when you withdraw your money like with a Traditional IRA.

Also, what kind of vehicles can you park in that garage?  Only Chevy’s?  Fords?

No, you can park any kind of car you want in that garage.  Do you want to park stocks in that garage?  Maybe you want to park CD’s in that garage.

The kind of vehicle you park in that garage determines your IRA rate, not the IRA itself.  Stocks, bonds, CDs, cash – that’s what gives you your IRA rates.

IRA’s Determine How Your Money Will Be Taxed

IRA’s don’t pay rates – they simply allow your investments to be parked in a pre-tax or after-tax way, in other words, IRA’s determine how your money will be taxed.

Let’s go back to the parking garage analogy.  If you park your vehicle in the “Pay First” garage, you will have already paid your taxes up front.  So when you exit the garage and pull your vehicle out you do not have to pay again – you’ve already paid them.

That’s what a Roth IRA does for you – it allows you to put in after-tax money, lets it grow tax-deferred and then allows you to pull your money out completely tax free.

On the other hand, a regular IRA says you can come on in to the garage with no payments up front, but you’ll have to pay to get out of the garage.

When you withdraw your IRA in retirement, you’ll have to pony up for the taxes!

It’s good to park in different garages, that’s called tax diversification.  Which IRA account is best for you?  That’s a post you can check out here.

So, next time you hear someone mention IRA rates, gently explain to them that IRA’s don’t pay rates, CD’s and savings accounts do.

Who doesn’t want a little extra cash for retirement?  Of course, we all do.  But since money doesn’t grow on trees we have to find a few ways to create our own money tree.

Let’s take a simple look at how easy it could be to grab some extra cash for retirement, but first let’s start with the basics.

401k Contribution Rules

We need to rview the 401k contribution rules so we’re all on the same page.  In 2010, the contribution limit to a 401k is $16,500 if you are under the age of 50.

If you are over the age of 50 you get the opportunity for a $5,500 catch-up contribution so the total you can throw in your 401k is $22,000!

That is a HUGE opportunity for some additional retirement savings!

Extra Money for Retirement Savings

Let’s assume you are age 50 and you want to retire at age 65, so you’ve got 15 years until that magical age of retirement. 

Let’s also assume that you are currently contributing the max to your 401k or $16,500.  You now have an opportunity to throw in an extra $5,500 to your 401k, but you’re just not sure you want to.

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Do the Math!

Let’s just do a simple Time Value of Money (TVM) calculation to give you sense of what the catch-up contribution could net you when it’s all said and done.

Let’s say you’re contributing $16,500 to your 401k – here’s what an extra $5,500 will do

• PMT (payment or contribution) = $5,500
• PV (present value) = $0 – we’ll assume zero for the sake of argument
• Rate (interest rate earned) = 8% – this is fairly moderate – not too aggressive, not too conservative
• N (number of periods) = 15 years – we’ll compound annually
• Solve For FV (future value) = The answer we come up with is $149,336.63!

You are essentially grabbing an extra $150,000 just by doing the catch-up! 

What If I’m Not Age 50?

Okay, for you younger folks who aren’t able to do the “catch-up”, let’s take a look at what a maxed out IRA will look like if you start now!

The IRA contribution limits are currently $5,000 annually for those under the age of 50.  Let’s do some simple math again:

• PMT (payment or contribution) = $5,000
• PV (present value) = $0 – again, we’ll assume zero for the sake of argument
• Rate (interest rate earned) = 8% – this is fairly moderate – not too aggressive, not too conservative
• N (number of periods) = 30 years – we’ll assume your 30 years old and want to retire at age 60!
• Solve For FV (future value) = The answer we come up with is $566,416.06

Not too shabby – more than a half mildo just by maxing out your IRA! 

It’s Not That Simple

Okay, okay, I know that no one earns 8% every single year for 30 years. The problem with these types of calculations is that they are totally unrealistic!  But here’s the point – don’t hesitate to start saving for retirement or any other goal you have.

It Really Is That Simple

Huh?  Yes, it is simple – because the bottom line is that the sooner you get started and the more you can put away – the greater the impact compound interest will have on your portfolio! 

Maybe it won’t be $500,000 or even $150,000 additional savings – but anything is better than nothing!

So, what are you waiting for!? 

Let me know your thoughts

1. Are you maxing out your 401k or IRA?
2. Do you plan on saving additional money this year for your retirement goal?