The following is adapted from Down Home Money.
“Do you want to be a millionaire when you retire?”
A little over twenty years ago, a successful man named Bob asked me that question and my life has never been the same since following his advice.
There are many paths to financial freedom, but all of them should include a retirement account. That was the advice Bob gave me while I was cutting his hair at my salon. He told me I’d be a millionaire faster than I thought if I followed his advice and he was right!
Eleven years after I opened an SEP index fund account with Vanguard, my balance reached $165,991.23. By the end of 2019, the balance was over $1.1 million!
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In ten years, it had increased more than $970,000, and all I did was consistently make a monthly deposit. Compound interest did the rest! If you’re interested in opening your own retirement account, there are various types to choose from.
I’m not a financial advisor and you should work with one before opening an account but I do want to offer a brief primer on the different types of accounts to show you what’s out there.
Types of Retirement Accounts
When it comes to investment firms, Vanguard is my favorite because the fees are low, and the website has great tutorials and a list of questions to walk you through your decisions. The type of account you choose will depend on your financial situation and income.
A Roth offers tax-free growth and tax-free withdrawal in retirement—tax-free because the money contributed has already been taxed. It can be set up independent of your employer, but there are contribution and income limits to consider.
As long as you own your Roth for five years and wait until you’re 59.5 before you start making withdrawals, you will not owe federal taxes on the money you draw during retirement. With a Roth IRA, there is no required minimum distribution (RMD) for as long as you live.
If you open a traditional IRA, your contributions will come from pretax money. This means two things: (1) you can write off your contributions on your taxes each year, and (2) you will be taxed when you start making withdrawals.
Unlike a Roth, there is no income limit with a traditional IRA. Like a Roth, the traditional IRA has an annual contribution limit: $6,000 for individuals under fifty and $7,000 for individuals fifty and older. You must take your first RMD from your traditional IRA by April 1 of the year following the year you reach age seventy-two (age seventy and a half before 2020).
A SEP (simplified employee pension) is for anyone who is self-employed, owns a business, employs other people, or earns freelance income. Like a traditional IRA, the money contributed to a SEP has not been taxed, which means you can write off your contributions each year. It also means you will be taxed when you start making withdrawals.
In 2020, the cap on the annual contribution to a SEP is 25 percent of the employee’s total compensation, up to $57,000, whichever is less. If you’re self-employed, your contributions are limited to 20 percent of your net income (figured from the net profit determined on IRS schedule C minus the deductible self-employment tax).
With a brokerage account, you deposit money like you would in a bank, but then you use that money to buy and sell stocks and invest in index funds, exchange traded funds, and more. When your investments increase in value, you earn dividends, which you can reinvest or receive as income. Each firm has a different minimum deposit for opening a brokerage account.
It’s completely up to you how that money is invested, so you’ll need to do some research if you pursue this option. It can take a lot of money to earn a sufficient income stream from a dividend investment portfolio income stream—possibly hundreds of thousands of dollars.
My suggestion is to start building your passive income stream and at the same time, start saving. When you have more money to invest, open a brokerage account to start working on your dividends passive income.
Pick a Plan and Get Started
The advice Bob gave me changed my life. He told me to get started, keep investing, and I’d reap the benefits. He was right! Now that you know the different types of retirement accounts available, you can work with an advisor you trust to pick the one that’s best for you.
Along with passive income streams like real estate or a small business, a retirement account is a powerful tool in achieving your financial freedom. It works through the power of compound interest, a force so powerful that Einstein called it “mankind’s greatest invention.”
To tap into that power, all you have to do is get started!
For more advice on how to fund your retirement, you can find Down Home Money on Amazon.