Roth IRA May be Your Best Bet

Roth IRA is one of the best tax benefits available to military families

The Roth IRA is one of the greatest tax loopholes ever created by the U.S. Congress. It was created in 1998, and provides one of the very few ways for Americans to generate totally tax-free income. Frankly, it's amazing Congress hasn't repealed it yet, and it could happen at any time.

So you want to make sure you get your Roth IRA set up before Congress wakes up and the Roth IRA disappears! So long as you have it set up and SOME money in it, you'll be set to take advantage of its benefits.

Unfortunately, the Roth IRA represents an oxymoron. By the time taxpayers are in a position to learn about the significant advantages of the Roth IRA, they also may have too much income to be eligible to contribute to a Roth IRA. One of the few advantages to the military pay scale is that most service members, especially those at lower pay grades, will qualify to contribute to a Roth IRA.

In our opinion, setting up a Roth IRA is one of the most beneficial financial moves a military family could make.

Relying on military retired pay as your only retirement income would be a mistake

You may be thinking, "Well, I don't need my own IRA, because I'm going to make the military a career, and then I'll have my military retired pay to live on." It would be a huge mistake to believe that your military retired pay will provide all the income you need for retirement.

Let's say you remain on active duty for 20 years, just long enough to qualify for miiltary retired pay. It used to be that if you retired after 20 years, you could expect to receive roughly 50% of your monthly basic pay as retired pay. In recent years, however, Congress has made some changes to the way retired pay is calculated, and there's no guarantee they won't make more, so you can't be absolutely sure that 15 or 20 years from now, you can still expect to receive 50% (and remember, that's 50% of basic pay ONLY).

Take a look at your most recent LES (leave and earnings statement, or "pay stub"). Find the box that shows your base pay. Divide that amount by 2. Could you live comfortably on that amount? Probably not. Chances are good, if you're like most people, that you couldn't even live on 100% of your base pay alone.

A good rule of thumb in calculating the amount you will need for retirement is that you can expect to need 70% to 90% of your pre-retirement income to continue to live in the manner to which you've become accustomed. That's 70 - 90% of ALL your pre-retirement income, not just your base pay. And if your spouse is working, remember to include his or her income in your calculations.

I don't know anyone who relishes the idea of reducing their standard of living when they finally retire, so it is definitely something you should consider. By doing your homework, and learning all you can about it, you will be able to put your family in the most secure financial situation you can afford. And our example below will show you that it doesn't take a lot of money to create a sizeable nest egg, if you just start sooner rather than later.

It's Never Too Early to Start Saving for Retirement!

Or you may be thinking "Retirement? I'm WAY too young to start worrying about retirement!" That's the point. By starting to save for retirement when you're young, you won't have to worry about it!

And by starting sooner rather than later, you will create another significant advantage -- the magic of compound interest. The longer your money has to grow, the faster it will grow. HOW fast will amaze you! Here's why -- you're earning interest not only on the principal you've contributed, you're also earning interest on the previously-earned interest. So the longer you can earn interest, the more it grows. Here's an example that should drive home the point:

Cost of Waiting to Start Saving for Retirement
Beginning ageAcct Bal at age 65Yrs Lost by WaitingLost Earnings

This calculation assumes that you make a consistent monthly contribution of $200, and that your account earns an annual average of 8%. (You will find numerous financial advisers who will tell you that long-term investing in the stock market, in funds such as the S&P 500, have traditionally averaged around 10%, so this is a conservative estimate. And successful real estate investors have the ability to earn far more than 10%.) Obviously, as any of the inputs change, all of the calculations change. These are hypothetical returns, for illustrations purposes only, and do not reflect past or future performance of any particular investment. This illustration does not reflect payment of income taxes on earnings.

As you can see, waiting just five years to start contributing to your retirement account, using these factors, could cost you almost a quarter million dollars over the long haul. That puts the who in it! So what are you waiting for?!

The important part is to get started! Don't wait until you feel you can "afford" $200 per month. If you can't "afford" to invest $200 per month in your future, at least get started contributing whatever you can. Then bump up the amount as soon as you can. Many financial advisers suggest that you should be saving a minimum of 10% of your current income towards retirement (and naturally, that number will increase each time you receive a pay increase).

Don't Count on Social Security

As a general rule, you can collect both Social Security benefits and military retired pay. There is generally no reduction of Social Security benefits because of your military retirement benefits. You should receive your full Social Security benefits based on your lifetime earnings.

But you've heard all the gnashing of teeth and seen all the wringing of hands over the precarious condition of the Social Security program. Traditionally, Social Security payments have accounted for about a third of retirees' income. But will it be available when YOU retire? Actually, no one knows.

While no one can accurately predict the demise of the Social Security Program, or when it will run into a deficit, it is fairly certain that your retirement won't be your parents' retirement. Remember that Social Security is a government program. Congress can enact changes to it at any time, if it becomes politically expedient to do so. That is why it is so important for you to create your own retirement income security and not rely exclusively on Social Security and your military retired pay.

Consider these statistics from concerning what the current state of the Social Security program means for the future:

  • In 1950, for every retiree receiving benefits, there were 16.5 workers paying into the program.
  • When Social Security was established in 1935, the average lifespan among Americans was 63. Today, the average lifespan is more than 77 years, according to the National Center for Health Statistics.
  • By the year 2030, when Baby Boomers will be leaving the workforce in large numbers, the ratio may be approaching one retiree for every two workers paying into the program. By then, the burden of taxes on each worker may well be unmanageable.
  • This aging of the population has led some experts to predict that the Social Security system may run out of funds by the year 2041 [other estimates say Social Security could be bankrupt by 2037], a possibility that makes building your own funds for retirement more important than ever.

Though no one has a crystal ball to predict exactly what will happen with Social Security, present trends clearly indicate that your own efforts to build financial security for your retirement years are more crucial than ever. The time to begin planning for retirement -- no matter what your current age -- is now.

One thing that is important for you to understand is that the Social Security system was never intended to provide the total of your financial security during retirement. So the more you can do for yourself to save and invest for retirement, the better off you will be.

According to the Social Security Administration, the income of current retirees looks something like this:

Social Security Benefits39%
Savings & Investments 16%
Employment/Other 26%

The good news is that hopefully your military retired pay will provide more than 19% of your total retirement income, which would reduce the amount necessary to make up that 26% they call "Employment/Other." What they're saying is that today's average "retiree" still has to work or find some other way to make up 26% of his or her income needs. So even though they're "retired," they're not really. Many people in today's economy are having to delay retirement because they realize they just don't have enough savings to live on (or to generate enough income to live on).

If you're fortunate enough to invest wisely and find yourself with a comfortable retirement so that you don't need Social Security benefits, and it is still a viable program, consider paying it forward by donating a sizeable portion of your Social Security income to charities like Fisher House Foundation, Center for the Intrepid, National Military Family Association, or other similar charities that take care of the service men and women who come after you. (See ratings for military charities.)

So, now that we've hopefully convinced you that you need to be saving towards retirement, even if you're only 21, let's return to the discussion of Roth IRA's, in our opinion, the best retirement vehicle available to you other than your military retirement. The beauty of it is that your earnings in a Roth IRA are tax-free. If they meet the program requirements and are taken as qualified distributions, you pay NO tax on the earnings -- that's 0%! THAT's the tax rate you want!

Some of the special features of Roth IRA's include:

  • Qualified distributions from a Roth IRA are not includible in income and, therefore, are tax-free.
  • Contributions can be made to your Roth IRA regardless of your age.
  • There are no required minimum distributions that must be made from a Roth IRA, unlike a traditional IRA.
  • There are limits, however, on eligibility to contribute to a Roth IRA, generally dependent on your income and filing status.
  • And, like a traditional IRA, there are limits on the amount you can contribute each year to a Roth IRA.

The rules for eligibility and contribution limits change periodically, so be sure to check for current restrictions on income limits and contribution limits.

In 2008, you can contribute to a Roth IRA if you have taxable compensation and your modified AGI (adjusted gross income) is less than:

  • $166,000 for married filing jointly or qualifying widow(er),
  • $114,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year, and
  • $10,000 for married filing separately and you lived with your spouse at any time during the year.

For 2008, if you meet the eligibility requirements, you can contribute up to $5,000 to a Roth IRA (plus an additional $1,000 "catch-up" contribution if you're over 50), and an equivalent amount to a Roth IRA for your spouse.

One reason some people prefer a traditional IRA over a Roth IRA is that you can take a tax deduction for the contribution to a regular IRA, and you don't get a deduction for contributions to a Roth IRA -- it's funded with after-tax dollars. But that's not all bad, either. You'll be much better off to pay the taxes on the $5,000 you contribute this year, and be able to take out the thousands in interest that $5,000 earns for the next however-many years. As the chart above shows, that could be a sizable amount, especially if it earns interest for a number of years.

Let's say you make that maximum $5,000 contribution to a Roth IRA when you're 25, and then your spouse gets a fabulous job that pays so much that you don't qualify to contribute to a Roth IRA in any other year (wouldn't that be nice!). If you use the same 8% rate of return we used above, and never add another penny, at age 65, that $5,000 will have grown to $108,623 that you don't have to pay any taxes on, because you paid the tax on your contribution in the year you made the contribution.

Now, if your tax rate is 25% (and assuming it stays constant at 25%), you'll pay $1,250 in taxes on that $5,000 in the year that you earn it and contribute it to your Roth IRA. That makes many people decide not to fund a Roth IRA, because they don't want to pay the taxes now. But look what that decision will cost you:

If you make that $5,000 contribution to an investment account (that's taxable) instead, earning the same 8% rate of return, never adding another penny, but paying income tax at a 25% tax rate, when you're 65, you'll have just $51,429! So, in the long run, that decision would cost you $57,194!

And if you choose to make that contribution to a traditional IRA instead, remember the earnings in a traditional IRA are not tax-free, they're just tax-deferred. You'll pay the income taxes as you receive the distributions. So at 25%, the taxes on $108,623 would be $27,155.75. Of course, the justification that people use is that surely they'll be at a lower tax rate when they retire, because they'll have less income. I don't know about you, but I'm hoping that my investments are successful enough that my retirement tax bracket isn't any lower than the one I'm in now, because I'll be making at least as much! (And with the totally legitimate tax-saving strategies that we've learned and plan to pass along in the program we're creating, that effective tax rate is much lower than you would expect! If you're interested in learning more about that, subscribe to our blog, or send us a note and ask to be put on our mailing list for announcements.)

One of best ways you can maximize the rate at which your Roth IRA grows is to create a true self-directed IRA and invest it in real estate, which will generally return much more than 10%, if you take the time to learn how to choose profitable real estate investments. Then you can earn an unlimited amount of tax-free money with your Roth IRA. But you must be very careful to learn all the rules on how to do this, and have it set up for you by an expert, because it can be very tricky to do it correctly. And if it isn't done correctly, you'll lose the tax-savings benefit and may be subjected to heavy fines and penalties.

In fact, if you ask your average CPA about this strategy, he or she will tell you it can't be done. Well, for them, it can't, because they don't know how to do it.

But there are a handful of specialists who have studied carefully and learned how to maximize the legal loopholes Congress has created. Generally, only the very wealthy ever find these specialists, or even hear of these types of strategies. But one of the reasons we wanted to create this program was to share just such rich-get-richer strategies with you! We think you deserve to know the strategies that will help you maximize your financial security. We'll introduce you to a tax attorney (a former Army JAG, in fact) who is an expert in this particular tax-saving strategy. Again, if you want to know more about this, send us a note to be added to our mailing list.

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