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?

No doubt most people have heard of a Roth IRA, after all, they’ve been around since 1998.  Although they’ve been available for over 11 years, I’m constantly amazed by how many people are just simply unsure of exactly what they are or what they do. 

The Basics: What is an IRA?

An IRA is simply an Individual Retirement Account (IRA) that provides investors an opportunity to save for retirement in a tax-advantaged way.  Generally, you must wait until 59 1/2 to withdraw the money without IRS penalty. 

A Roth IRA is an Individual Retirement Account named after its legislative sponsor, late senator Bill Roth, that was established in 1998 to provide an alternative method of saving for retirement that offers different tax advantages than the Traditional IRA. 

Features

The main difference between the Traditional and the Roth IRA is how it is taxed.  With a Traditional  IRA, you typically contribute before-tax (with some exceptions) money to the account.  Depending on your eligibility, you can deduct your contributions from your income on your current year taxes.  You receive the tax break now.  The money grows tax-deferred so when you pull your savings out in retirement you have to pay taxes on every single dollar you withdraw at whatever your current tax rate is at the time.

The Roth IRA is just the opposite.  You contribute after-tax dollars to the account and the money still grows tax-deferred.  You cannot deduct your contributions; however, in retirement you can withdraw your money (provided you meet certain qualifications) completely tax free. Not only that, but as long as your Roth IRA has been in existence for five years, your beneficiaries on the account can pull out money income-tax free, so the Roth IRA becomes a nifty estate planning tool as well.

Advantages

1. Obviously the biggest advantage to the Roth IRA is the tax-free withdrawals in retirement.  This can be a huge potential tax savings for you especially if you think tax rates will be going up.

2. The Roth offers more flexibility on withdrawals prior to retirement.  You can withdraw your principal (your contributions)  tax and penalty free at any time during the life of the Roth IRA.  To an undisciplined person might have trouble with this, but someone who runs into a bind an is cash strapped can have a little comfort knowing they have some additional money available.  This is a huge plus compared to the Traditional IRA, where you would pay a 10% penalty on any pre-59 1/2 withdrawals as well as taxes.  

3. Another advantage is that you can contribute to the Roth even if you are covered by an employer-sponsored retirement plan (401k etc).  With the Traditional IRA you are subject to income testing to determine if you could contribute when covered already by a plan  at work. Even if you could contribute, you don’t get to take advantage of the deduction on your taxes.  So the Roth becomes the perfect additional savings plan when you already have a 401k or other employer plan.

 4. For older folks, the fact that you do not have to take withdrawals is a major advantage as well.  With a Traditional IRA, the government forces you to take money out at age 70 1/2 or face a 50% penalty for not withdrawing your savings.  The main reason is of course to generate tax revenue.  Since Roth IRA distributions are tax free, you don’t have to worry about this rule. 

Key Tradeoffs

1. Your contributions are limited.  Currently in 2009, you may only contribute $5,000 and if you are over 50 you can contribute an additional $1,000 for a “catch-up” provision.  Depending on your income, you might be phased out of your contributions.  For example, a couple making between $166,000 and $176,000 will have their contributions limited.  Income over $176,000 disqualifies you for Roth contributions altogether.  Try this online calculator to determine how much you can contribute to a Roth.

2. You still might have to pay taxes on non-qualified distributions.  In order to meet the specifications for a qualified distribution, you must have had the Roth opened for at least five years and meet one of the following:

• Reached age 59 1/2 by the time of the withdrawal
• Withdrawal is due to qualifying disability
• Withdrawal is made for first-time homebuyer expenses (up to $10,000) 

Again, you are still able to withdraw your contributions at any time without penalty or taxes.

3. Tax treatment differs depending on the state.  The tax laws mentioned above correspond to federal law.  Your state may have differing laws for Roth IRAs You should check with your tax advisor to ensure you won’t have to pay state taxes. 

How Do I Get One?

You can open a Roth IRA through any financial institution, bank, life insurance or mutual fund company or even right online through a brokerage website.  Where you establish one primarily depends on your own needs and preferences.  There are many investment options available as well, so consider the types of investments that will suit your needs (i.e. stocks, funds, CDs, ETFs etc).

Contributions must be made by the time you file your tax return. So in essence you have until April 15 of the following year to get your Roth contributions in for the previous tax year. 

The Roth IRA can be a great investment and retirement savings vehicle for many people.  Be sure to do your homework, develop a plan, assess your needs and be comfortable with your decision.