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401K or IRA?

Making a decision to join your companies 401K is a no brainer; especially if they match your contributions.  We are going to make an example of Joe in this case.  Joe works for a major telecommunications company and started at the company in 1990 making $50,000 a year as a line technician he was 20 years old at the time.  Joe being young and stupid like you and I decided retirement was a long way away so he chose to go out buy a nice new sports car, and lived in a nicer apartment around town so all the girls would think he had it going on.  Joe making $50,000 a year at 20 in 1990 actually had it going on!  Then there is Mary, she worked at same company making $30,000 a year as a telephine operator at same company she joined in 1990 when she turned 20 but lived with 2 roommates to save on rent.  Mary dreamed of owning a home and retiring early.  Mary felt it important to contribute to 401K because the company matched dollar for dollar everything she contributed up to first 5% of her income so she invest the 5% as soon as she was able on her 90th day of employment.

I told you the purpose of this blog is to make you rich, one thing a rich man will tell you is no matter what 10% the first 10% of your income is for you; save this even if you have bills, rent, mortgage, insurance, car payment.  Loan shark blackmailing brother, or a huge drinking problem; the first 10% goes to savings or retirement.  So lets break down Joe and Mary to understand better:

Annual Income = $50,000
20years old = worked since 1990 = Retirement age 2037
Savings = $0

Annual Income = $30,000
20years old = worked since 1990 = Retirement age 2037
Savings = $5,000 ($1,000 401K + $1,000 company match + $3000 saving / 10% a year)

Ok, so we are going to keep things simple, using flat formulas and not compounding interest in the 401K savings accounts understand Mary's totals would be much higher.  It is now the year 2037  and both Mary and Joe have retired, Mary bought a house in 2000 at $100,000 and used $10,000 of her savings as a down payment. Your 401K will allow a loan you can pay back for that deductible if you have no savings. We are also going to assume that Joe and Mary have similar Social Security payouts based on incomes that stayed the same till they retired.

Annual Income = $50,000
Age 67
Savings = $0
Social Security income = $3,000

Age= 67
Savings= $131,000  401K
401K =$360,000
Social Security income=  $1,875
401 payout = $1,500

Joe has monthly income of $3,000 while Mary has monthly income of $3,375 and owns her home outright, Joe still pays $2,000 a month rent  do you want to live on $1,000 a month in 2037?  Time to invest in 401K or IRA or both.

The difference?  401K is sponsored by company and is named after IRS rules regarding the account.  IRA (Individual Retirement Account) is something you would open at bank or brokerage firm.  There are two types a "Regular" IRA and a "Roth" IRA (named after Senator who created legislation)  with a regular IRA you take a tax deduction every year which lowers your IRS total taxable income; but you are taxed on the funds when they are withdrawn.  With a Roth IRA you do not take the tax deduction yearly but when you retire the funds are tax free.  Both IRA's have advantages, so you will need to speak to your bank or brokerage firm to determine which one will be the most beneficial to you.

Remember if none of this makes sense to you just keep saving 10% until it does, max out your companies 401k as a way of giving yourself a raise and not leaving money on the table. 


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