To Save or not to Save: A Tale of Why I love the Roth IRA
As an applied mathematician I feel the constant need to prove my worth by working on practical problems for the good of the general public, like a mathematical superhero of sorts. So far I have solved problems/questions such as "How much of the earth needs to be covered in Solar panels to power the world", "What is the probability of getting a meaningful 4 letter acronym from the subtitle of your blog?". I also did "The Mathematics of Credit Cards" in which I ranted against the wretchedness of the credit card industry.
Sustainability and Responsibility
Most people see sustainability as relates to industry and the environment, I see it also in terms of societal and familial preservation. In this article I hope to give a demonstration of how investing in a Roth IRA retirement account can lead to a sustainable retirement in which neither your children, nor your fellow citizens will be taxed by your failure to think about the future when you were younger.
First, how much will it cost to retire? Assuming that you retire at 65 and live to be 85 you will need at least $30,000 dollars per year (assuming you own your house and cars). This totals about $600,000 and leaves little room for error, or inflation. In fact, if we account for inflation, we will need to save $850,000 (3.5% annual inflation). And that's if we retired today! If, like me, you retire in 40 years or so, only spending $30,000 a year means you'll need about $3.3 million due to inflation!
If I made the equivalent of $50,000 a year with a %3.5 annual raise for the rest of my life then I'll have to save about 80% of each pay check in order to reach $3.3 million!
But that's impossible! Who in the world beside Tiger Woods and Bill Gates can save 80% of their pay check?
Off in the distance we see our good friend Roth IRA charging towards us on his white steed. "I'll help you!" he says!
"But how?" we ask.
"By the power of growth funds, stocks, bonds and other compound gains financial instruments....and it's all tax free growth too!"
"But Roth IRA, we heard that the stock market is volatile, and that we could lose all our money if terrorists collapse and the government fails. Shouldn't we invest in Gold?"
"No!" a voice booms. Oh look, it's Dave Ramsey, the guy who keeps telling me to get out of debt. "Gold averages about 2% return on investment since the 1900's. And in time of crisis, it's no where near as liquid as you think! Besides, starting in 1900, even with the Great Depression, the stock market averages a 12% return per year!"
Wow, thank you surprise visitors! So if we want to avoid capital gains taxes (to the tune of 15% of all gains made!) we simply chip in money to our Roth IRA. The only limitation is that you can only put up to $4000 per year into it. Luckily the maximum contribution is adjusted bi-yearly for inflation (every two years I'll get to invest more into it).
So let's see, if I chip in only about 8% of my $50,000 salary, with only 10% growth on average, I will be left with $3.3 million by the time all my hair turns gray! Sweet! That's exactly what I need!
"But wait!" Dave Ramsey exclaims. "Shouldn't you pay off your debts first, and then start to invest in retirement? After all, the credit card companies and students loans are charging you an average interest rate of 15%!"
Well let's do the math. If I have $1000 at the end of every month which I can pay towards debt, my Roth IRA, or a regular (taxable) investment account how much will I have at the end of my 40 year working career?
Let's assume I have $50,000 in assorted debt at 15% interest, and that my IRA earns 10% a year. Furthermore, my regular investment account also earns 10% a year, but I make trades (and thus pay capital gains taxes) on a third of my stock thus limiting my growth to 5%.
Scenario 1
If I pay off all my debt first with my extra money, and then begin to save in the Roth IRA and the regular investment account I will end my career with about $4.5 million.
Scenario 2
However, if I first contribute the maximum amount to my Roth IRA, and then take the leftovers to pay back the debt, and after the debt is paid back continue investing in my regular account I will have about $4.8 million in the bank.
The difference? If you start investing in the Roth IRA at the very beginning it will take you 3 years longer to pay back that $50,000 debt, but during that time you will have been able to contribute about $30,000 to your Roth IRA which will grow to be about $300,000 by the time you retire.
Whether you follow Dave Ramsey's or my suggestion one thing is clear, the sooner you start to save on that Roth IRA the better. Every year earlier that you start saving will be a year that when you retire you will thank your younger, wiser self.
If you would like to start a Roth IRA you can use the same company that I use, Edward Jones. In fact if you give my good friend Ryan Russell a call I'm sure he would appreciate your business!
Note: I have a script saved on my computer for calculating retirement savings, if you would like to see your projected retirement savings email me your financial assumptions and I'd love to help you out!
