My first “real” job was exciting and challenging, with a steady paycheck previously unknown to this student. Fringe benefits presented another entirely new, and decidedly welcome, concept. However, mandatory and optional payroll deductions depleted an otherwise impressive gross earnings amount to an underwhelming “take-home” remainder. From there, monthly obligations further challenged those limited resources. Fear of running out of money before running out of month suddenly became a very real concern. The resultant deflated ego stimulated my financial learning experience, which continues several decades later.
Last week we discussed the difficulty of getting started as savers and investors. Despite challenges during early years in the workforce, time is the best friend of the investors we hope to become. Only once a savings regimen is established, can it become a habit. Over time, routine saving, along with investing carefully, will lead to the true goal – financial independence.
Young savers typically favor Roth IRA Accounts, to which current contributions are not tax deductible. Generally subjected to low tax rates in early careers, people are drawn to the promises of future tax-free retirement income Roths provide. Roth IRAs also provide flexibility for young savers, as funds may be withdrawn tax-free for certain qualified expenses, including purchase of a first home.
Traditional IRA contributions are usually tax deductible. As incomes rise over time, workers are subjected to higher marginal tax rates, increasing the appeal of deductible contributions. Young families often find themselves conflicted, and many decide to split the difference. One spouse contributes to a Traditional (deductible) IRA, while the other funds a Roth (after-tax) IRA. This combination provides flexible tax planning in retirement years.
Roth IRAs are darlings of giant media and financial industry insiders. But that does not make them right for everybody. Learning the mechanics of the Tax Code enables planning budgets, taxes, and cash flows. Fortunately, Florida is leading the way for young people by re-introducing requirements for personal financial education prior to graduation. The more you know and understand, the better your decisions will serve you over time.
Trading dollars between retirement savings and taxes (now vs. later), is among the first major financial decisions facing young families. There will be many more to follow. Choosing Roth and/or Traditional IRAs is important.
Next week we will discuss the need to diversify retirement assets, while at the same time keeping expenses as low as possible.
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