The 7-Day Turnaround, Day 5: Start Saving for Retirement

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.

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  1. Investing, to me, is the fun part of being frugal. 🙂

    If your company offers a company match, then always start there with your retirement. Otherwise you’re saying no to free money!

    Great post.

  2. Jason,

    Your info in this post was very informative concerning Roth IRAs.

    My questions is this: How much am I allowed to contribute to my own Roth IRA each year? Is there a limit?

    Hope to hear from you soon.


  3. Chris, thanks for your comments. Roth IRA contributions are capped at $4,000 for individuals contributing in the 2007 tax year (which you can still do until April 15, 2008). In the 2008 tax year that amount jumps to $5,000, plus there is an additional $1,000 “catch-up” provision that allows you to invest an additional $1k if you are 50 years old after 12/31/2007.

    Thanks again for visiting!

  4. Jason,

    Thanks for the info!

    Are you allowed to have more than one Roth IRA? Do you have an idea what the average growth or interest rate is for a Roth IRA?

    I know these are probably basic questions, but I really don’t know a lot about these and it’s been several years since I’ve read Ramsey’s Financial Peace.

    I’ll be graduating from nursing school this summer and after getting a house, I really want to start investing for retirement at an aggressive rate.

    Thanks a lot!

  5. Jason,

    Thanks for the response!

    Yeah, I never got Total Money Makeover, but I did read Financial Peace and bought More Than Enough, but never finished reading it. Nursing school, ya know?

    But rest assured that your great blog has been added to me RSS reader and I check it everyday. Lots of great info.

    Thanks again!

  6. Chris, there are no limits to the number of Roth IRA accounts you can have established, as long as your total contributions each year don’t exceed the limits for that tax year.

    A Roth IRA is just a shelter you wrap around investments to shield the growth from taxation. In that sense, the investments themselves could be in anything from index mutual funds to shares of Microsoft. Each investment offers its own historical average, but I would guess a well-diversified retirement portfolio should be averaging 8%-12% growth over the long term.

    I’m happy to help. One thing I would recommend, in addition to subscribing and following my posts here on Frugal Dad, is to start reading through personal finance magazines and books to get a variety of opinions on finance. I like Kiplingers Personal Finance magazine. You mentioned Dave Ramsey, his latest offering “The Total Money Makeover” is an excellent book on starting a personal finance game plan. I would start with that one if you are already a fan of Ramsey’s work.

    Good luck finishing up nursing school. You have chosen a fabulous profession to pursue! I always tell “undecideds” entering school to look at nursing or pharmacy because you can basically write your own ticket with the shortages in both professions, and the aging population.

    Thanks again for visiting Frugal Dad!