Saving for retirement can be a very daunting and confusing chore for anyone with a pulse. But squirreling away cash is especially tough for the growing number of young(ish) Americans who work non-traditional jobs.
Whether you call yourself a freelancer, permalancer, entrepreneur, independent contractor, part-timer or small business owner, chances are good that you’re not saving enough to even come close to living well when you retire.
If you are in your 30s, as I am, it’s time to get serious about saving. I know it’s tough, but unless you (we) face the retirement monster head on while we’re still relatively young, we’ll be in some deep trouble in just a few years.
So let’s get organized — together. Over the next few weeks, Mint.com will begin examining different ways that you, the independent worker, can save and plan for retirement. We will also take a look at ways to help you get organized come tax time.
Since this can be a scary and confusing topic, I will be tackling the issue with you. From filling out strange forms, to finding a broker, to (possibly) forming a trust or a corporation –- I will be with you every step of the way.
Luckily, Mint.com can help us with a lot of these pesky tasks, so if you don’t have an account, now would be a great time to sign up for one.
The IRA – Traditional versus Roth
Alright, let’s jump right into the deep end. Our first course of action will be to set up a retirement savings account. Since we are individuals, let’s first open an IRA (Individual Retirement Arrangement). These accounts are easy to open and maintain. You can use the money deposited in your IRA to invest in virtually anything, from high-risk option plays to very low-risk certificates of deposit (CDs).
There are five types of IRAs, but for now, we will be focusing on the two most popular accounts – the traditional IRA and the Roth IRA. The differences between a Roth and a traditional IRA have mainly to do with taxes and freedom. In a Roth IRA, you are investing after-tax dollars and with a traditional IRA, you are investing pre-tax dollars. But when it comes time to retire, you will be able to withdraw all the money out of your Roth IRA account tax free, whereas you must pay taxes on withdrawals made with a traditional IRA.
So do you want to pay your taxes now (Roth) or later (traditional)? Paying now (Roth) seems to be the most favored course of action. That’s because you will probably be in a higher tax bracket when you are older (assuming you will be making more money –- fingers crossed). If that’s the case, you can save money on taxes by paying your tax bill earlier when you are in a lower bracket, rather than later when you will be taxed at a higher rate.
Furthermore, tax rates are currently at an all-time low, so even if you don’t think you will be in a higher tax bracket when you retire, there is a chance you will still pay higher taxes in the future.
Another major difference between Roth and traditional IRAs revolves around the freedom to deposit and withdraw your money. With a traditional IRA, you will only be able to start pulling out your money once you turn 59-and-a-half (yes, six months after you turn 59). If you pull your money out before then, you will have to pay a 10% penalty and deal with a hefty tax bill on your principal and your gain.
At the same time, you are only allowed to make contributions to your traditional IRA up to the age of 70 and a half. That’s because you are required to start withdrawing your funds after that age.
With a Roth IRA, you can set up an account and make contributions at any age. You also have the freedom to pull out your contributions (not your gains) whenever you want without penalty or paying taxes — provided that your account has been active for at least five years.
This is key for independent workers, as we never know when we will be in need of some cash. Most of us don’t qualify for unemployment insurance, so a Roth can function as a sort of secondary emergency fund — more about this later.
Opening an account
Ok, enough about traditional versus Roth — let’s dive in and open an account. Mint.com’s IRA Center helps us decide which type of IRA is best for us and how to find a broker or a bank that can act as a custodian for our account.
There are probably many custodian choices available to you, but which one is right? Well, only you can answer that question. All brokers have their positives and negatives. But, in general, if you don’t need much handholding, go with one of the many online discount brokers, as they usually have lower fees and no to little investment minimums. If you require a higher level of personal attention and other goodies, choose one of the many traditional money managers or banks.
I chose to open my Roth IRA with an online discount broker that I already had a regular brokerage account with. The broker already had all my personal information, so I figured it would be an easy set up.
As hoped, the sign up with my broker was ridiculously easy. I just logged into my brokerage account, selected the tab that said “Guidance and Retirement” and then chose “open an account.” It then gave me a choice of IRAs and I selected Roth IRA.
Funding your new IRA
A couple of clicks later my account was open and ready to be funded. There was no minimum required to fund the account and there weren’t any monthly or annual maintenance fees. I was able to put money in the account several different ways, from transferring cash from my brokerage account to mailing in a check.
The next day, I received an email saying I would be getting some papers detailing my account, along with a username and password. The whole process took about five minutes.
Then, I tried setting up a Roth IRA with a few more brokers and some large banks. Apart from having to fill out all my personal data multiple times, the sign up was relatively painless and took about 10 minutes. Some of the brokers required a minimum investment to open the account, while others wanted me to agree to pay an annual fee of some sort.
There are pros and cons to every broker, so take some time to find the one that fits you the best. This may actually be the most time-consuming activity in setting up this IRA.
So how much money should we put in our new retirement accounts? Well, the government limits the amount we can contribute to any IRA money to just $5,000 per calendar year. If you are above the age of 49-and-a half, then you could put in an extra $1,000 for a maximum annual contribution of $6,000 a year.
If you late starting the IRA game, as I am, then it would be a good idea to try and fund the account to the max. With six months left in the year, I can put in around $833 a month. That’s a lot of money.
The Roth and the traditional IRA aren’t the only ways we can save for our retirement. We will explore more in the following weeks, so stay tuned.
Cyrus Sanati is a frelance financial journalist whose work has appeared in dozens of leading publications, including The New York Times, BreakingViews.com, and WSJ.com. Follow Cyrus on Twitter @csanati