Dave Ramsey’s Financial Peace University – Week 7

Investing

Week 7, only two more weeks left in class! Everything that has been taught in the classes so far leads up to this one. Some students may not be ready for it, while others may have been waiting for it a while. This lesson is the Retirement and College Planning lesson.

There can be a lot of fear around investing, but Dave makes it incredibly simple and breaks it all down. He starts off with a simple example of a 30 year old couple who invests $600 a month for 40 years. At 12% interest, they would have over $7 million! If they could manage to invest $833/month they would have $9.8 million.

If that doesn’t motivate you to start saving, I’m not sure what will. Even if you don’t get 12% on your investments, you’d still have a huge pile of money!

After the $1000 emergency fund, paying off all your debts but your mortgage, and building up a 3-6 month emergency fund, baby step 4 is to invest 15% of your income for retirement. Dave recommends the use of mutual funds since it helps take some of the risk out of investing by spreading your money across several different companies. He recommends splitting up your investments equally among growth and income funds (sometimes called large cap), growth funds (sometimes called mid cap), international funds, and aggressive growth (sometimes called small cap).

When you purchase mutual funds, you can purchase them through several tax favored accounts such as 401k’s and Roth IRAs. A 401k or Roth IRA holds mutual funds and other investments, it is not the investment itself. The type of account tells the government how to treat it when it comes to taxes. For example, with a 401k, you put all of the money in pretax, but when you withdrawal from it in retirement, you will pay taxes on everything you withdrawal. With a Roth IRA, money is put in after taxes have been paid, so all of the money grows tax free and you don’t pay any taxes on it when you withdrawal from it in retirement. You can read more about it here.

To maximize your investments, Dave recommends funding your company’s 401k (or Roth 401k if they offer it) to get all of the match that they offer. You don’t want to leave free money on the table. After that, you should put money into your Roth IRAs until you reach 15% of your income. If you still haven’t reached 15% but have maxed out the Roth IRA, then go back and fund your 401k until you reach 15% of your income.

After covering investing for a while, Dave’s daughter Rachel Cruze comes out to talk about saving for college (Baby Step 5). They recommend saving in an Education Savings Account first, and then using a 529 after the ESA is maxed out. Personally, I’m not sure why Dave hasn’t completely adopted the 529 as the primary choice. The only thing I can think of is that there are so many 529s out there and they are different in each state. For example, in Ohio where I live, any money we put in up to $2000 per child is tax deductible from our state income taxes. I wouldn’t get that benefit from an ESA. Look at your 529 options closely. You don’t have to invest in the 529 for your state if you like another state’s options better.

Rachel warns against using insurance, savings bonds, or prepaid tuition to save for college. They don’t get the same returns as using mutual funds. Always look for something that allows you to control what you’re invested in and doesn’t change with age. Finally, they stress the importance of graduating from college debt-free. Some of their money saving tips are to go to an in-state school or community college, look at all your living options (including living at home), get tutoring for the ACT/SAT to improve your scores and get more scholarships, and finally WORK while you’re in school!

I agree with graduating without student loan debt. Personally, my wife and I were able to do it because of the work we put in while in high school and the scholarships we got. When a student graduates with debt, they don’t have the freedom to find the job they really want and instead are sometimes forced into a less than ideal position so they can pay their student loan payments. This makes no sense to me really. Parents and students spend all of this money on college so that they can have the “experience”. If they do it right, a person will be spending a lot more time in the working world than in college and the last thing they need to do is start off in a position that they despise and have student loans hanging off their back.

Next week’s lesson will be covering real estate and mortgages.

Featured Image courtesy of ddpavumba / FreeDigitalPhotos.net

What is a Roth IRA and why do I need one?

Beach

I’ve been pretty focused on finding products and services that will save you money in each post. However, this week, I wanted to take a break from the usual and discuss the Roth IRA. I’m sure everyone has heard of them by now, but perhaps you’ve still got some questions. Well hopefully I’ve come up with just about every question you might have and answered them below. If there is a question that I missed, please post it in the comments and I’ll get the answer for you as quickly as possible.

What is a Roth IRA?

A Roth IRA is a type of retirement account that usually contains one or more mutual funds.

What makes a Roth IRA special?

When you put money into a Roth IRA, you put add to it after tax money, which means the money that you take home in your paycheck. The special part about this is that it grows TAX FREE since you used after tax money to fund it.

Grows tax free? What does that mean?

It means that if you put in $1000 into your Roth IRA and it grows over several years to say $50,000, you can withdrawal money out at retirement and not pay taxes on any of it, including the growth. If you had $50,000 in a 401k and decided to pull it all out at once, it would turn into something like $35,000-40,000 after taxes are paid to the IRS. Plus, who knows what tax rates will be like in the future. If they go up a lot, then you would get even less from your 401k when you make withdrawals.

Can I contribute to a Roth IRA?

As long as you have a job and report your earning on your taxes, you should be able to contribute to a Roth IRA. There are income limits however. If you are married filing jointly and make $178k or more, or you’re single and make $112k or more, you should check with a professional to make sure that you can contribute to a Roth IRA.

When can I take money out of my Roth IRA if I start one?

When you turn 59 1/2 you can usually start withdrawing money from your Roth IRA as long as you’ve been putting money in for at least 5 years. You can take your contributions out at any time before 59 1/2, but if you touch the earnings or growth, you’ll be paying a penalty. It’s best to leave it alone if at all possible. For example, if you put in $5500 each year for five years and then one year you decide that you want $2000. You won’t be able to put in $7500 the next year to try to repay the amount you took out.

But I’m a stay at home mom, can I still open a Roth IRA?

As long as your spouse is working, you can open a spousal Roth IRA and contributions can be made on your behalf up to the limit.

How much can I contribute to a Roth IRA?

The limit is currently $5500 ($6500 if you’re 50 or older) for you and your spouse, for a total of $11000. However, you can’t contribute more than you made so if by some chance you made less than those amounts, that would be your cap. Chances are if you make less than that, you’ve got bigger concerns than contributing to a Roth IRA.

Can I start a Roth IRA for my child?

In most cases, the answer is no, unless they made money and you file a tax return for them. So if you’ve got a child actor on your hands, then you might as well start a Roth IRA early for them to maximize the savings.

What does it mean to put money into a Roth IRA?

When you invest in Roth IRA, what you’re really doing is putting money into an investment, such as a mutual fund under a Roth IRA umbrella. The Roth IRA umbrella is what determines how the IRS treats it.

I hope this has been helpful. Before opening a Roth IRA, I would suggest speaking with an investment professional to make sure that you invest in mutual funds that meet your desired goals.

Featured Image courtesy of Vichaya Kiatying-Angsulee / FreeDigitalPhotos.net