This is the fifth article in Frugal Dad’s week-long series, The 7-Day Turnaround: One Week to Change Your Family’s Financial Destiny. Each day brings a new step to implement and help you get control of your finances.
Now that you have moved beyond the half-way point in your 7-day turnaround, it’s probably a good time to look back and see what all you have accomplished. After taking an inventory of your finances you established a three-month emergency fund to break the cycle of relying on credit cards. In step three we cut up those credit cards, saving one no-fee, low-interest card for emergencies only. Slashing your monthly, non-utility expenses was a major emphasis in step four, requiring you to think long and hard about trading your hard-earned income for things like gym memberships and cable service (make sure to find savings from retailers like Verizon and gym alternatives include items from Amazon). By now you are debt free with a solid emergency fund – it’s time to start saving for your [tag]retirement[/tag].
The first step in planning for your retirement is coming up with your Number. Everbody has a Number, but few of use know what it is. Your Number is the amount of money that will grant you the level of financial independence that allows you to quit working for money. The Number, by Lee Eisenberg, offers many strategies for calculating your Number. It isn’t good enough to say, “I’ll retire when I have a million dollars in the bank.” Determining your Number takes actual planning, determining how much working capital you will need to live off of your [tag]investments[/tag], and estimating your expenses in your golden years.
Take advantage of matching funds from employer retirement plans. Most employers offer full time, professional employees the opportunity to invest in an employer-sponsored [tag]401k plan[/tag] (or 403b, if you work for a non-profit or educational institution). Many companies even offer to match employee contributions up to a certain percentage of the employee’s income. This is like free money. Get your retirement savings started by enrolling in the plan and contributing up to the percentage of income the company matches. Don’t worry if it is only 3% of your income, we’ll use your remaining earnings to save in a different savings vehicle.
A Roth IRA is the best retirement savings vehicle around. Some experts argue over whether or not to fully fund a 401k or a [tag]Roth IRA[/tag]. For me, the argument for Roth IRAs is explained beautiful in the following analogy.
Would you rather pay taxes on the seed or the crop?
In other words, would you rather pay taxes on your income now, when it is smaller, or later when you are a millionaire (and you will be if you stick to this plan!). Easy choice. I would rather pay [tag]taxes[/tag] on money now, and invest in a Roth IRA with after-tax dollars. When you withdraw that money in retirement Uncle Sam will let you keep 100% of the contributions and earnings, tax free! Conversely, 401k balances grow tax-deferred, which means you will save a little now diverting pre-tax income to your 401k plan, but you will have to pay more when making large withdrawals in retirement. Remember, the key to any good financial plan is to keep a long-term view. Sacrifice the reduced tax liability now offered by the 401k for a tax free payoff from the Roth IRA years down the road.