We're celebrating Financial Literacy Month in numeric style. Follow our crash course on maximizing your portfolio and finances with The 10 Essential Money Lessons.
Planning what to do next Saturday night is hard enough. Earmarking money today to be used decades from now? Please.
Actually, please do: Please start making plans for the way-off future ASAP. The sooner you get your retirement savings squared away, the better off you'll be.
How to bottle time
You've heard how time heals all wounds in matters of the heart and that it's all about timing in comedic circles. Time is also one of the most critical factors in financial planning -- specifically, how much time you have to let your money grow before you need to spend it. Time is the salve that smoothes those stomach-wrenching stock market ups and downs -- helping you ride it out and recover. Even better, the more time you have to let your money compound, the richer you'll be.
So let's stop wasting it and get your money to work. In today's brief lesson in financial literacy, we'll show you where to park your long-term savings so that your future self is handsomely rewarded.
The right place for your long-term savings
Elsewhere on Fool.com we talk about the different accounts that are best for your short- and medium-term savings -- places where you have ready access to your funds and where your money won't be subject to the volatility of stock market swings.
Your long-term cash stash (mostly earmarked for your retirement) belongs someplace else entirely -- we're talking IRAs, 401(k)s (or other employer-sponsored retirement accounts, such as a 403(b)). These are types of accounts (just like you have a checking account), with a few key differences:
- Uncle Sam rewards you with tax savings for putting money into such accounts.
- The money is truly earmarked for your retirement years, and you will potentially pay penalties and taxes on any withdrawal you make before age 59 ½.
Retirement account basics
Although there are a handful of retirement account types, picking the best place for your savings needn't be complicated.
401(k), 403(b), 457s: These fall under the category of employer-sponsored accounts. If you work for a company and it offers such a plan, we typically recommend that you earmark your first investment dollars into this. Why? The best reason is if your employer offers to match a portion of the money you squirrel away. That amounts to free money -- and who would leave free money on the table?
Another great advantage to these types of plans is that they allow you to put pre-tax money directly from your paycheck into the plan. (The limit this year is $16,500 ($22,000 if you are age 50 or older.) That way your money grows tax-free, and (added bonus!) your contributions lower your taxable income for the year (which means a lower tax tab come April). Taxes come into play only after you retire and begin to withdraw the money.
Here's more on how to pick the best investments in your workplace retirement account.
IRAs: Individual Retirement Arrangements (sometimes referred to as Individual Retirement Accounts). These offer more flexibility than work retirement plans because your investment choices are not limited to what's in the plan. The contribution limits for both Roth and Traditional IRAs this year is $5,000 (or $6,000 if you are age 50 or older).
There are two types of IRAs:
Traditional IRA: Tax-wise, this works just like a 401(k) -- the money you put into this account is not taxed until you make withdrawals in retirement. Also, like a 401(k), you can deduct the money you contribute from your income, thus lowering this year's tax bill. Because of the tax deferral, you can save a lot by putting investments that pay high dividends, including AstraZeneca
(NYSE:AZN), AT&T (NYSE:T), and Consolidated Edison (NYSE:ED), in a traditional IRA. All three companies have dividend yields over 6%.
Roth IRA: This type of IRA gives your future self a tax break. The money you sock away in this type of account is never deductible. You pay regular income taxes on the dough you save. However, come retirement you are off scot-free -- you pay no taxes on the gains or the principal when you withdraw the money. That chance at gains without taxes makes stocks with big growth potential, such as Dolby Labs
(NYSE:DLB), Hansen Natural (NASDAQ:HANS), and Marvel Entertainment (NYSE:MVL), look even more attractive. Analysts estimate that Dolby Labs, Hansen Natural, and Marvel Entertainment will have double-digit growth each year for the next five years. A Roth IRA has the added flexibility of allowing you to withdraw your contributions tax-free at any time for certain things, such as a first-time home purchase or education expenses.
Opening an account is a snap, as illustrated in our three-step article on how to get yourself set up.
More reading for the motivated: