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It’s time to start saving money and you have no idea where to invest or how to begin building your portfolio. If you follow these tips you will be well on your way to building a foundation for your future. Initially the task seems daunting; do I put money into my 401(k), my checking or setup an IRA and make contributions to that?

These are a few of the questions that will be spinning around in your head as you begin taking your first few steps. I always look at these matters and explain to my clients its all about balance. What is important is finding a way of saving that gives you flexibility, while being relatively simple to get started. Before we can discuss diversification we will need to determine what and how we will be funding. You will first want to take a long hard look at the benefits your employer is providing. This typically will be a great beginning to exploring your options.

Benefits Puzzle–What’s a 401(k)?
When you started your new job, the human resources person gave you a packet of information that contained everything from health insurance, tax withholding, life insurance coverage . . . all of the benefits you can take advantage of through your employer. Somewhere in the packet was information on the Company Retirement Plan called a 401(k), if your employer is offering one (most medium to large size companies will have one). As you begin by thinking . . . ’what the heck is this 401(k) business and why do I care?’ A 401(k) plan is an employer sponsored retirement plan that allows you to save money for retirement and depending on the type of 401(k) the money you save is PRE-TAX (for our purposes I will assume your employer is offering a traditional 401(k)). This means you are not taxed on the money as you are putting it away for the future. Of course in the future when you withdraw those dollars you will have to pay taxes. This then depends on your employer, but you may have to wait for a period of time before you can enroll, others allow you to start saving money right away. Regardless, the money you defer from your checks is always yours for the future.

Now that you have done your budget (see article on Stash Your Cash) and determined you can save 10% of your income (for 2009 the maximum for individuals under age 50 is $16,500 of income deferral into the 401(k)) so what is the best place for doing this? Again, this is where a little bit of balance helps. If your employer is matching your contributions $0.50 on every dollar up to 5% it is an absolute no brainer to contribute a minimum of 5% to the 401(k) plan. So you are getting the equivalent of 7.5% savings by deferring only 5%. Many employers will have a period of time you have to work there before these ‘matching’ dollars are yours; this is referred to as the vesting period and varies. Never . . . ever . . . leave free money on the table.

Roth IRA
So where do I put the other 5% of my earned income? Now, your approach to this becomes a little more subjective, but if you follow my example the next applies nicely. If you are tax savvy, or have a friend who is a CPA and you realize that by adding another 1% into the 401(k) it drops you down a tax bracket, then by all means do so. However, if this either doesn’t matter or is not the case I would typically recommend setting up a Roth IRA. IRA stands for Individual Retirement Account. Look at it from this perspective; 401(k)’s, IRA’s, Roth IRA’s and many of the other types of accounts you can fund are SIMPLY CONTAINERS . . . I view them like martini glasses, if you choose to put a cosmo in them that is fine, if you choose to put Grey Goose in them that is fine as well, so just remember when I refer to the TYPE of account remember it’s the container . . . let’s not get into which type of drink your palate prefers.

Tax-free Savings for Your Future
When we discuss asset allocation we can address that matter in more depth in my next article. Ok, so maybe it’s time to start investing additional monies into your Roth IRA so you have a nice balanced approach. What are the rules and why do I want to do this? Here is how this works; you can ONLY contribute up to $5,000 per year as long as you are under age 50 , and the money grows and compounds tax deferred. At qualified retirement age (currently 59 1/2) and as long as you have held the monies in the account for 5 years your withdrawals are INCOME TAX FREE! So let’s say over 20 years you put $5,000 per year into an account and it’s now worth $200,000 and you are now at an age where you can take withdrawals, you don’t have to PAY ANY TAXES. This is clearly a big deal and should be given great consideration.

There are a few catches that go along with this. The biggest concern is if you are doing well financially. If you earn over $110,000 per year as a single tax filer you are EXEMPT from making contributions to a Roth IRA. However there are other rules that apply here that go beyond the scope of our discussion (I am available via appointment for consultations on these matters). If you are in this arena, there are special considerations that apply and I am more than glad to do an individual consultation to explain some tactics on reducing your income so you can potentially drop to the income range which qualifies for a Roth IRA. By combining these two retirement savings account; The 401(k) Plan and the Roth IRA you can have a great balance in your savings and be well on your way to creating a foundation and planning for your financial future.

In my next series we will take a look at portfolio diversification, which will address the question of what to put in each of these accounts now that you are funding them. We will look to answer your questions on risk tolerance, time frame for certain investments, and asset allocation tactics that will put you in the driver’s seat as you are building your future savings.

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I always recommend my clients seek the advice of a CPA or professional tax advisor in order to understand the ramifications of making contributions. This information is not intended to be a substitute for seeking advice with a CPA and I do not provide accounting or tax services.

The total amount that can be contributed varies depending on income, age, and contributions to other accounts
Special ‘catch-up’ provisions apply to individuals age 50 and older. Amounts could be more or less depending on age and income

This is purely for illustration only and is not indication of any performance, nor a performance guarantee. Investments can and do lose value and previous performance does not guarantee future results.

There are many alternative options and considerations for high income households. This is an area which requires analysis and careful planning to make sure guidelines are followed. Please contact me for a personal consultation.

Kenneth J. Wolfe, CRPS®
Financial Advisor
Raymond James Financial Services, Inc
Member FINRA/SIPC
500 Elm Grove Rd. Suite 108
Elm Grove, WI 53122
262-782-5900 X012