A Maxed Out Roth IRA = $11 a Day

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$10 here, $25 there. What’s the point of doing all these little things? For the most part, I look at grabbing freebies and bonuses as a hobby. Sure, there are a million different ways to make more money, and on a pure hourly-return basis it may look like crap, but I can do it in my free time, sitting on the couch, while watching HGTV at 1 am in the morning. But here’s another way to look at it:

You may have heard this before, but here it is again… If you’re young and aren’t in a high tax bracket yet, one of the best things you can do is max out your Roth IRA. You put in some of your take-home pay, and you’ll never be taxed again on it. It’s like supercharging your stock returns by removing the drag of taxes. If you’re 25 and invest $4,000/year and it returns 8% a year, at age 65 you will have over a million dollars. (No, not inflation-adjusted, but still a million dollars.)

$4,000 a year is just $11 a day. It doesn’t take that much to really make a difference. (Or put differently, a free $10-$25 can be seen as a significant amount of money.)

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Comments

  1. Joseph Sangl says

    I’m cool with a million dollars – inflation-adjusted or not! Plus, the fact that the earnings are pulled out tax-free in a Roth IRA makes it even better!

  2. The Roth IRA is a great investment vehicle.

  3. …and by HGTV you really mean SpikeTV, or your Conan the Barbarian DVD, or some Thundercats reruns, right?

    …erm, go Roth IRA!

  4. Preach on brother!
    I agree, small steps towards the big one.

  5. Amen!

    Let’s just hope Congress keeps their grimy hands off it in 2040 when Social Security is out of cash.

  6. How about Roth 401(K)? I have both of them, not sure whether I should max out Roth IRA, or try to put as much as possible into the 401(K) by increasing my paycheck contribution…

  7. This is exactly what I’m doing… the IRA thing and the HGTV part too..

    House Hunters is on at 1AM here, 😉

  8. If you are in a high tax bracket traditional ira is the way to go?

  9. For people who eat out a lot, take you lunch to work and save 11 bucks a day easily – the put it towards an IRA.

  10. I’m 24 and have been saving up an emergency fund and paying down credit card debt in anticipation of opening a Roth IRA. I’ve looked at a few companies offers – but to you & your readers what company would you suggest I start my account with. I don’t need research help, I just want a low cost/fee account that I can mainly control over the internet.

    Thanks.

  11. Inflation is not something to gloss over. Over 25 years your 1 mil will be worth about 360K only assuming inflation runs at benign 4%.

  12. Sure, $1,000,000 sounds great, but as you recognized, due to inflation it’s cheating to think of it as such. In 2047, at around a conservative 3% inflation, a million dollars will be worth a little over $300,000 of today’s dollars.

    Of course, the situation’s not quite as grim as it might seem, because it’s ridiculous to assume you’d keep contributing $4,000/year despite ongoing inflation. Sometime I’d like to calculate/see a calculation of what you’d end up with in real inflation-adjusted dollars at a given rate of return, if you contribute the equivalent of, say, $4,000 in inflation-adjusted dollars each year.

  13. Hey Modern Worker, I recognize and applaud the enthusiasm, but please don’t fall into the inverse Latte Factor(tm) trap.

    The Latte Factor is a great concept, but usually completely fails the equality test: “Don’t buy coffee and donut in the morning” does not save you $2, it saves you $2 minus the cost of making coffee and replacing the donut with something else. Unless you’re throwing out lots of food, neither of these are zero.

    Saving $11/day on lunch seems pretty tough. Especially if you’re planning on replacing that meal (rather than just saving money and downgrading the meal).

    I’m running the lunch program at work. We’re each spending ~$2/day and that gets us fresh bread (from Safeway), fresh lunch meats (Turkey Breast and Ham mostly), mustard, pickles and cheese slices all bought in bulk (thank you Cost-co). Calorically and nutritionally, we are replacing $5-7 worth of sandwich from the local deli or convenience store.

    To save $11/day on lunch you’d likely have to be spending $15+ on your daily lunch.

    Not that this is a bad idea, but around here $15/day gets me a wrap (with real chicken breast), fresh garden salad and a juice (and someone else to prepare the meal and do dishes), and that’ll include tax and tip. I could likely drop this to $4/day, but I would have to spend a few hours/week on preparation, but only if you could prep it all at once on Sunday afternoon (i.e.: Grill 5 chicken breasts, Prep a big garden salad and divide into 5, etc.) Of course, the quality suffers, b/c your Friday salad has been in the fridge for 5 days, so not all things are equal.

    I hear your point, but I must tell you that I don’t know anybody in any of my immediate circles that spends $15+/day on lunch, not even the president of my company. So it’s good advice, but it sounds pretty hard to apply.

  14. Him – Thunder-thunder-thunder cats!!! Did you hear they are doing a Voltron movie now? It makes me feel happy and old at the same time.

    James – You make good points. $1M won’t be a mil, but if you continue to max out your Roth as the limits increase, you’ll also be putting in more and getting more than that $1M (using these assumptions.) The limit for 2008 is already set to increase to $5,000.

    If you do assume contributing $4,000 every year for 40 years and a 5% real (after-inflation) return, you’ll still end up with over $500,000.

    RE: Latte Factor – I’ve always liked a combo of both spending less and making more. Shaving off a couple dollars a day also adds up.

  15. Hunter:

    I would say that your best bet is Vanguard. When you sign up for the e-delivery of statements/confirmations/etc, they waive the various quarterly fees that tend to add up over time. While you will still have to deal with some of the $3000 fund minimum stuff, you can still get diversification immediately by just jumping into a target retirement fund for a few years until you have enough money to buy multiple funds with your own asset allocation choices.

    I made the mistake of jumping in on a TD Ameritrade Roth promotion (45 days of free trades & a copy of MS Money 2007) and thinking I would do ETF’s (as Vanguard hadn’t rolled out their e-delivery + no fees deal yet), but then realized the following:

    -I could never be fully invested as partial share purchases were not possible (and would therefore have some dollar amount of money sitting idle making a piddly .1 % apy or something).

    -Even though I had free trades initially, the account was not a long term savings solution because I would be paying commissions for every future re-balancing or contribution.

    -I wanted to primarily buy Vanguard funds in the Roth, but their was a hefty transaction fee for each purchase.

    With such issues in mind it became an obvious choice to go directly to Vanguard where I could have no commissions, be fully invested, and move things around whenever I wanted.

    Hope that helps – Good luck!

  16. I max out my roth every year, but am not confident that the policies will never change. I would not be surprised to see Roth’s taxed in 10-20 years. Who or what could stop that from happening?

  17. Gates VP……….I whole heartedly agree!!

    Here’s my routine in case anyone’s interested……..

    Breakfast = some kind of breakfast bar (Circa $1)

    Lunch = Footlong subway sub…..1st half eaten on day 1, 2nd half eaten on day 2. (typical cost $3.50/day)

    Dinner = Some kind of frozen meal (circa $3)

    All that said it looks like I spend $7.50 on lunch. But what about the occasional soda?? What about the occasional Starbucks?? Tea?? etc. etc. etc.

    Plus, I don’t like to get too caught up in cost-conscious eating habits. It starts to sour the zest of life.

    It’s definitely a delicate balance, but once I try to manage w/o allowing the stress/worry outbalance the pleasure/variety.

    😉

  18. They say $1 million 30 years from now is not what it is today….but wasnt $1 million 30 years ago and $1 million today still big?

    I know u could have bought more 30 years ago but lets not complain too much…..$1 million is still lots of mullah!

  19. Hunter & Andrew, re Roth IRAs:

    Yes, Vanguard is easily the best choice for most situations. Best fees, modern website, great money market rates. My wife’s Roth IRA is at Vanguard.

    I went with Scottrade because of their good $7 commissions and the fact that they have lots of local offices (more reassuring than other web brokers). Scottrade lets you buy a wide range of mutual funds and ETFs easier than Vanguard, and this is important if you’ve got your eye on specific funds (e.g. Loomis-Sayles Bond).

    Negatives: Scottrade has a terrible interest rate on cash (~2.5%) and no money market options. Scottrade has a fair enough selection of no-fee, no-load mutual funds but the expenses aren’t as good as Vanguard. (You really should use mutual funds to control transaction costs during the first few years of a Roth IRA, then shift to funds/ETFs with the lowest expense ratios later on.)

    My plan is to leave my wife’s money (conservative) in Vanguard and for now buy generic no-fee mutual funds at Scottrade (e.g. SSgA S&P500, Dreyfus) for dollar cost averaging. When the balance gets high enough I’ll move large blocks of money from the mutual funds into Vanguard ETFs to lower the expenses. No harm doing it through Scottrade, their fees are good overall, but I’m not exactly loyal to them either.

  20. IAmSoOverMe says

    Hopefully the dollar doesn’t crash any time in the future. If it does, all of our IRA’s will become worthless. But investing in an IRA or 401K, especially if you get company matching is the way to go. The way the stock market is these days, I wonder if mine will ever turn into $1 million. Compounding interest takes it’s best effect the longer you leave it in. Also, it might be a good idea to put 20% into a gold bulion fund in your IRA, just in case the dollar is no longer a dollar. Then you can convert to any currency you want when you pull it out. I think. That’s something that I’d have to check into to make sure.

  21. “Jonathan Says: If you do assume contributing $4,000 every year for 40 years and a 5% real (after-inflation) return, you?ll still end up with over $500,000.”

    I do not think that this is realistic. I can not imaging being able to contribute to a ROTH IRA for 40 years given the Gross Income limits on those that can contribute. From a credit union site I found the following:
    *Single individuals with a Modified Adjusted Gross Income (MAGI) of less than $95,000 can contribute a maximum of $3,000 to a Roth IRA.
    *Married couples with a joint MAGI of less than $150,000 can contribute a maximum of $3,000 per spouse to a Roth IRA. Must file joint federal tax return.

    Now, these may be old numbers and there are other details, but the fact remains, once you get to a certain income level you can no longer contribute. And I don’t know about you, but well within 40 years I plan on earning over $95k. Even worse, once i get married that number drops to $150k.

    My future wife and I are professionals with eaqual salary. Assuming healthy raises we will reach $150k in less than 4 years.

    Am i misunderstanding something about contribution limits or is it completely impracticle to think you can contribute to one of these for 40 years?

  22. I think this is encouragement for alternatice streams of income to come in. If you can find some type of work you can do for $11/day.

  23. Ian – The income limits will also be adjusted for inflation in the future. The great majority of households in the US will never reach these limits.

    If you do go over the limits, I would look elsewhere for tax shelter like a Roth 401(k) or 403(b), or even a non-tax-deductible IRA.

    In addition, if you are a higher income earner, it may be a better idea to take the tax break now in a traditional 401(k), if you think your tax bracket will be lower in retirement vs. now.

  24. Where do I go to find a Roth IRA with 8% return?

  25. Denis Moreira says

    I’m 22 and at the rate I’m investing in my IRA, I don’t think I’ll max out this year but I hope to increase my input now that I’ve got my 1st full-time job out of college.
    Anyone here start in their low 20’s?

  26. I’m 23 and started saving when I was 22 right out of college with a good full time job. I know you wanted more experience than that.

    I spent last year funding my 401k at 6% to get a half match from my employer (9% income investment).

    I also saved 10% for 6 months for my wedding which, by the way, we had an awesome time on only 6k (thanks to my wife’s amazing efforts). Her father gave us half of that. I saved $2000 in those months for the honeymoon which we still have in the bank.

    I continue to save 10% a month for savings but I’m trying to decide if I should open and fund Roth IRAs for us instead of a high-interest savings account.

    We’re both paying off our college debt still and I can’t decide if I should get rid of that instead of saving. At our current rates it will take 5 years to get out of that debt. I pay my parents $300 a month too since they liquidated their retirement to send me to college. But we have no other debt.

  27. Hey Keith, you’re obviously doing a good job handling the money, so I wouldn’t worry too much. The debt is probably annoying, but the question of stopping your savings vs paying off debt is always a tough one.

    Typically it depends on both psychological weight and actual hardship. You have this great savings habit started and you’re building money, is it better to break the habit to pay down the debt or live with both? Sometimes you can’t and then you must focus on the debt, if your “hardship” level is too high, then you just throw everything at the debt and “damn the rest”.

    The same goes for you “psychological weight” level. Some people can’t live with any visible debt, even good debt like student loans, it simply consumes them. These people need to pay down their debt ASAP (and maybe learn to “let go” a little).

    You seem to be right in the middle and you seem like you can handle both saving and debt paying. Barring any stupid-high interest rates you’re probably only paying a few percent on your loans, so you may be “bleeding” money, but very little. If you can both stand to simply pay off the debt every month and ignore that it’s there, then hey just keep trucking. Accumulating cash is very empowering and cancels out some of the bleeding, it also means that you can keep the good habit (saving), which is very important.

  28. I’m 22 and my current goal this year is saving $2.5k to start a Roth IRA at Fidelity. I recently bought a house, and only have the mortgage and student loan debt, as I paid off my revolving debt. Yesterday, I paid $3k off one of my student loans in my father’s name, mainly to remove the liability of the loan in his name. He made the mistake of signing for the loan, thinking he was cosigning, and I have paid for it the past 4 years while in school.

    My goal is to open the Roth IRA and fully fund it by April 15th, 2011, while paying down the student loans. I have already been contributing to my 401k since January 2009, at 4% of my salary, maxing the 100% company match. I also have various savings accounts for emergencies, medical expenses, and for when one of my vehicles die.

    I feel as though I built myself a solid foundation for my future, even though I haven’t even finished school yet (almost done). I’m hoping things get a lot easier once I finish.

    My motto: “work extremely hard now, play sooner than later”

  29. Richard Kaulfers says

    Shane. You paid off debt that was your but not in your name first. That is great also starting a Roth even better. I know you see how many people our age miss the opportunity to build some real wealth just by starting right now. Glad to see your taking that step. If you do not know who the Montly Fools are, look them up. Fool dot com. Also check out the book Millionaire Next Door. A great way to keep motivated.

  30. Dennis:
    I’m 21 years old and have been actively contributing to my roth since I was 18. My father is a local CPA, and ever since I started making my own money, he has preached the importance of saving for the future. Compound interest is an amazing tool if used correctly and can make you a lot of money over time. The key is to put as much money as you can afford in your IRA while you’re young. I have contributed $13,000 thus far to my IRA while still leaving myself $1200 in a savings account for emergencies. I just finished maxing out my 2009 contribution and now working on 2010. Remember it’s not about how much you make, but how much you save.

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