Traditional vs. Roth IRAs

IRAs are one of the most convenient vehicles when it comes to saving for retirement (Click here for more on what IRAs are all about). There are two types of IRAs, traditional and Roth IRAs. When you have to decide between traditional IRA and Roth IRA for your investments for retirement, a lot depends on how far away you are from retirement and what will be the possible economic climate in the future. Both types are great options for savings, each with its advantages and limitations. Knowing both plans will help you in choosing the right plan to meet your needs ensuring a good retired life no matter what the economic scenario is in the years to come.

Tax

One of the most confusing parameters is the tax deferred vs. tax-free. In traditional IRA, the tax is deferred. This means that the contribution you make towards the traditional IRA account is not counted as your income and is exempted from taxes. However, contributions to Roth IRA are very much part of your income and you need to pay tax on the contributions as well. The net money you get when you retire depends a lot on the taxation policies. If you expect the taxes to be higher when you retire, it is best to invest in Roth IRA since withdrawals are not taxed. Even the earnings on Roth IRA account are not taxed and this is a great benefit. However, earnings, capital gains and principal amount is taxed when you start withdrawing from a traditional IRA account.

Withdrawal

In a traditional IRA account, you can start withdrawing the savings when you reach an age of 59 years and six months. You need not make withdrawals until you reach an age of 70 years and 6 months, when withdrawals become mandatory. However, in Roth IRA account, there is not mandatory age for distributions. This option is beneficial for those who have enough money for their retirement through other sources and want to leave some money to their heirs.

Investment

The savings in both traditional and Roth IRA can be used to invest in other modes such as certificates of deposit, bonds or stocks, though there are some restrictions that apply to both he accounts. Record keeping is much easier for a Roth IRA account since there are no minimum withdrawals or tax on the withdrawals. The single biggest advantage of traditional IRA account is that it is open to any income level. Roth IRA has filters on and is open to only those who earn more than $95,000 or married couples earning more than $150,000 combined annually.

Which one?

Roth IRA may seem a better option than traditional but it is not open for all. Instead of procrastinating opening an account, even if a traditional IRA account might seem inferior, it is best to start saving now for your retirement. Fulfilling your dreams after retirement largely depends on how you invest your money today.

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Online savings vs. traditional savings account

An online savings account is different from the savings account offered by traditional banks. Unlike traditional savings account that you may be familiar with, an online savings account gives you a higher interest rate and often requires no fees for processing and transacting.  Also, these accounts have no minimum balance requirements, which gives you enough liquidity. Contrary to the traditional form of banking, an online savings account allows you to conduct all activities electronically.

If you are apprehensive about the online bank’s reputation, then there is a reason to smile.  Most online banks operating today offer excellent security for your hard earned money and offer FDIC insurance protection up to $250,000. With such high level of assurance, it will be a waste to stash away your cash in a traditional savings account that gives you a fraction of the interest rate offered by online banks.

There are many online banks operational today. Before you settle in for one of them, it is best to do some research and compare the offers from different banks. There are mainly three criteria that need to be evaluated to compare the offers.

1. Interest rates – Obviously, the interest rate has to be the most important factor for comparison. Though the interest rates fluctuate with the economic policies of the government, some banks are able to offer consistently higher rate of interest than others. Check for banks, which have been able to give the highest rate of interest despite market conditions. Some people try to open accounts in multiple banks and try to take advantage of the higher interest rates. This may not be feasible unless you have plenty of time to check the interest rates and keep transferring money from one bank to the other.
2. Minimum Balance requirement – Most of the online banks do not require you to maintain a minimum balance, but it is better to check for any hidden terms and conditions. You will not want to be taken in for surprise at a later date since banks charge a fee for not maintaining a minimum balance. Some banks also offer a higher rate of interest if you maintain a minimum balance.
3. Simplicity of operations – You will do all transactions online. This means that the website of the bank should be easy to navigate and user friendly. You may also want to check the uptime of the site.

You can also check for other features like online payment of bills and free unlimited online transactions. Open your online savings account today to stash away cash for a rainy day and also enjoy the power of e-banking!

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Since our creation (est. 2009), we have made purposeful use of the collective intelligence of engineers who use our site.  By gathering articles and surveys on their career, lifestyle and educational experiences, we have been able to compile a series of articles which address these important aspects of our engineering lives.

Our day-to-day guide is a product of this collective intelligence. The sole goal is to provide engineers with insightful and relevant articles aimed at guiding them through the day-to-day challenges of an engineer’s life and career.

If you are an expert on any of the following areas topics please share your thoughts, and opinions by submitting your articles to us.

Do you have anything you would like to share on this topic?

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The first mistake is not going after the low hanging fruit. No/low cost ways of saving energy include temperature setbacks on thermostats when buildings are not being occupied, keeping equipment properly maintained, eliminating building infiltration, reducing the use of lighting and appliances to only when needed, making sure plumbing systems do not leak, keeping fuel burning appliances properly tuned….on and on. When implemented, the energy savings can be single digit percentages of the overall utility costs.

The second mistake is having unrealistic expectations about making larger reductions in energy use. The best place to start is to account for the total energy costs (gas, water, electric, sewer, other) on a monthly and yearly basis. Then these costs should be analyzed to see which ones vary with weather, with occupancy/use, etc. After the low hanging fruit is addressed, additional savings means investing money. Having a payback period in mind and commitment by management helps too. An audit can then be performed identifying any areas for improvement, potential savings, and investments required.

For example, if your yearly energy bills are $10,000 and you’d like to reduce that by 10% or $1,000. How much money are you willing to spend to get those savings? Let’s say its $3,000. So, you are expecting that your investment will payback in 3 years ($3000 divided by $1000). When the audit is performed, you need to focus on proven technologies that can provide you $1,000 savings with a $3,000 investment. No need to look at spending more money or investing in alternatives with longer paybacks since they would be outside your expectations. It would make sense to start with the utility that makes up for most of the $ 10,000 or the one that is known to be least efficient. Let’s say it’s electric at $ 5,000. So, now you need to make a $1,000 impact on $ 5,000 or a change in efficiency of 20% ($1000 divided by $5000). Now you can ask yourself, what technologies are available at $ 3,000 to save your electric by 20%.

You can scale this example up or down but the process is the same. Go for the low hanging fruit. Then start with the big picture of what you can spend to obtain greater savings. It will save you time, money, and effort in the end.

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Budget

It is worth mentioning that you should live on what you earn. Most people end up in debt because they have chosen a lifestyle which they can not sustain based on how much money they earn. The first step to prevent yourself from falling into this all-too-common trap is to come up with a budget, clearly noting all inflow and outflow cash amounts.

While creating the budget, please note the following:

1. Make sure you conservatively estimate for all essentials, rent, insurance, food etc.
2. Always save a portion of your income, say 10% and stick to it
3. Allocate a standard amount which you are comfortable with to debt repayment. Several factors should be in play here, how much you have in debt, how long you need to pay off your debt, interest rates etc. (more under “paying off your debts” below).
4. If you are planning a major purchase in the future, a simple excel worksheet should help you determine how much you should save every week.

No matter how deep in debt you might be, stay away from Debt Management Companies

The way these companies work is that they take a monthly lump sum payment from you and distribute the money to your different creditors. In some cases they might negotiate with your lenders for lower payments, or reduced interest rate. For these “services” they will charge you a standard or monthly amount. DO NOT sign up for their services.

Most credit card companies are willing to make exemptions if a customer calls them directly. You do not need a paid emissary to negotiate a better rate for you with your creditors. A simple call to your creditors explaining your financial difficulties might be all you need.

Paying off your debts

Use your budget to help you plan your debt-reduction strategy. The first step is to list all your debts, from the highest interest rate to the lowest. Aggressively pay down the highest-rate balances while making on-time minimum payments on all the others. The amount you allocated for debt repayment should dictate how much you can devote to paying down your balances each month.

In addition, consider these tips:

• Use any extra cash — bonuses, extra paychecks, lottery winnings — to pay down debts.
• Based on your budget you should be able to figure out how long you will take to pay off the debt. If paying that debt within that time-frame is not possible, you might need to consider alternate ways of generating income such as, volunteering to work overtime, getting a second job or selling merchandise on eBay.
• If you can’t earn more money, you’ll need to spend less. Try these tips.

NO NEW DEBT

A successful debt-reduction strategy is only so if you do not accumulate any new debt. Be mindful of traps which might lure you into debt such as an unnecessary credit line increases. Spend wisely on the essentials and avoid getting ripped off.

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What is 401(k)?

401(k) plans are named after the section of the Internal Revenue Code in which they appear. Basically, a 401(k) retirement plan is a participant-directed retirement account funded through direct withdrawals from a participant’s paycheck.

Unless your company provides its employees with some kind of a pension, the 401(k) plan might be the only retirement vehicle available to you. Most engineering companies sponsor 401(k) retirement plans which are managed by a third party (Scottrade, for example).

Why contribute to a 401(k)?

Just 50 years ago, any decent job offered a pension that guaranteed you payment of a percentage of your salary after you retired. However that changed in 1986 when congress replaced the defined benefit plan for federal civilian workers with a less generous defined benefit plan and a generous 401(k)-type plan. This was very appealing to both employers and employees because the retirement responsibility and obligation was shifted entirely to the employee.

Benefits of 401k plans

One of the most interesting features of the 401k plans is that you control how much money you want to contribute to your 401(k) and your employer automatically takes that money out of your paycheck to deposit in your plan. Some companies might match a portion of your contribution. It is therefore important that you take sign up as soon as you are eligible to take advantage of this match.

Some additional benefits include the following,

1. Some employers match a percent of your contribution – Basically, think of the matched amount as free money, you lose it if you don’t take it.
2. Tax deferred savings – Your 401(k) account is not subject to federal taxes until you make a withdrawal. That means that your investments grow tax-free for decades. However, if you decide to withdraw from your account before retirement, the IRS taxes you accordingly.
3. Large deferral limits – As of 2009 the IRS allows employees to defer up to $16,500. If you are over 50 years of age, the limit amount is $22,000.
4. 401(k) rollovers – Thanks to the 401(k) rollover; a 401(k) retirement plan is highly portable. As it is unlikely you will work for one employer throughout your career, so you have the option of rolling over your 401(k) into a new company’s plan or an Individual Retirement Account (IRA) without incurring any tax penalties.

If you haven’t already, sign up and start contributing today

There is no reason not to take advantage of a 401(k) retirement plan if your company offers one. Remember, just like any other investment, the earlier you contribute the higher your potential future returns. Sign up today and start working towards a comfortable retirement.

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The “New Engineer’s Guide” articles are an ongoing series of articles for engineers new to the profession. These articles offer helpful tips, recommendations on issues that most engineers have had to deal with in their careers. These articles range from transitioning from college to the work environment to studying and passing the PE exam.

New Engineer Guides

1. New Engineer Guide | Studying and passing the FE exam
2. New Engineer Guide | Landing your first job as an engineer
3. New Engineer Guide | Search for your first engineering job
4. New Engineer Guide | An introduction to the 401k retirement plan
5. New Engineer Guide | Transition from college to work
6. New Engineer Guide | Debt Management and Smart Budgeting
7. New Engineer Guide | Finding the right mentor
8. New Engineer Guide | Owning or Renting?
9. New Engineer Guide | Buying your first home
10. New Engineer Guide | All about the PE exam and how to apply for your license
11. New Engineer Guide | Studying for the PE exam
12. Suggest a topic | -
13. Lost your job, now what? | A step by step job loss guide for engineers
14. Thinking about going back to school | Back to college guide for engineers
15. Get ahead at work | Timeless public speaking tips for engineers

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Link to this guide:

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Post-Job-Loss Agenda

One of the first items on your post-job-loss-agenda should be determining the state of your finances. First, this is an appropriate time to analyze the money that you have at hand and how much you need to fund your basic needs for the projected time-frame. Secondly, this is also the best time to determine how to handle money in your 401K. If you already have a financial planner you may want to talk to him or her about your 401K and determine which way to go. Depending on the returns and other factors in your existing plan, they might recommend that you leave your 401K in the same plan. On the other hand, complete pullout from your plan might be required by the plan. In that case, it will be necessary to rollover your 401K to an individual IRA.

What is an IRA?

An IRA which stands for an Individual Retirement Account, provides either a tax-deferred or tax-free way of saving for retirement. There are many different types of IRA accounts from which to choose  from, depending on the financial goals and situations of each individual, though traditional and Roth IRAs are the most common choices.

Determine if your 401K carries any restrictions

Call your existing financial institution to determine if they have any restrictions on transferring from your plan after you have been terminated. Some plans have certain guidelines which might restrict you from transferring your money for a set duration of time. It will be nice to find out how much time you have before you embark on a quest for a brokerage firm.

Choosing a bank, brokerage firm or mutual fund company to rollover your 401K into

I am a big fan of recommendations and especially when it comes to matters concerning my finances. Call some of your friends or family members who have had to rollover their 401K in the past and get recommendations on which financial institutions they are currently using. This is by far the best way to get the most sincere  unbiased opinion. Some of the questions you should ask about the financial institution might be,

1. What fees are involved?
2. How is the service? (Especially after you have rolled over)
3. Which other companies did you look at?

If you do not have any friends or family who can give you insightful information on this topic, then I recommend that you visit some reputable websites and read reviews and recommendations. Some of my personal favorites include,

- Fool.com – Personal Finance

- Mint.com- Financial blogs

-Yahoo Finance – News, financials articles, calculators and guides

Others:

Moving your funds

Once you have selected which brokerage firm to go with, you are now ready to transfer funds in your 401K plan to to the new IRA at the selected brokerage firm.  Depending on the companies involved, there might be some paperwork involved before the money can be fully transferred.  Follow along in the process until the money has been transferred into your new account.  Now you can relax before you start looking for a new job.

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2. Open an online savings account

Examples of online savings accounts
The Orange Savings Account. Great rates, no fees, no minimums.

3. Stop buying bottled water

4. Downgrade your cable plan

5. Use the library more often

6. Learn how to cook and cook consistently

7. Switch to a prepaid phone plan

8. Cancel your landline

9. Create shopping lists

10.  Stock up during supermarket sales

and follow these tips,

1. Come to the store with a specific list of items – and don’t stray from it.
2. This means planning your menu for the week and itemizing how much each meal potentially costs.
3. Buy generic. It used to be that generic goods were of poor quality. This just isn’t the case anymore
4. Don’t use coupons. This may sound contradictory, but coupons are often for name-brand products. 50 cents off Lunchables is still too expensive. Of course, this isn’t always the case, and coupons can be useful, but don’t think you’re saving money just because you hand over a coupon.
5. In a similar vein, don’t always buy in bulk if it’s not something you use a lot. Bulk toilet paper makes sense. But a crate of ketchup may never get used in your lifetime.
6. Check prices by size. A large can of a certain brand can be less than a small can of another brand.
7. Stay away from convenience foods: all of them. Frozen dinners, soda, candy, cookies. Yes, it’s less fun, but you can make cookies or buy powdered drink mix and make your dinners for much cheaper.
8. Be sure to always save your leftovers, and never make food that will go to waste.
9. As mentioned, stay away from restaurants.

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