Your Money_ The Missing Manual Part 21

- Say you make $50,000 a year but spend $60,000. In that case, your income understates your lifestyle by $10,000 a year. If you based your retirement needs on your income, you wouldn't come close to supporting your lifestyle.

- On the other hand, if you make $50,000 a year but only spend $25,000, basing your retirement needs on your income would lead you to save much more than you need.

As you can see, estimating how much you'll need in retirement by looking at your current income doesn't make much sense. It's one of those rules of thumb-like "buy as much house as you can afford"-that can actually do more harm than good. There's a real danger that by following this advice, you won't have enough saved for retirement. But just as bad, there's a chance you'll have saved too much, meaning you missed out on using money to enjoy life when you were younger.

Instead of estimating your retirement needs based on your income, it makes more sense to base them on spending. Your spending reflects your lifestyle; your income doesn't. The next section explains how to do that.

TipYou can get a rough estimate of the Social Security benefits you'll receive using this Quick Calculator: http://tinyurl.com/socsec-calc. For a much more accurate estimate of your future benefits, check the Social Security statement you receive in the mail every year.

A Better Way If you're going to base your savings goals on how much you'll spend in retirement, you've got to have a way to gauge your future spending. Will your expenses increase or decrease? That depends in large part on your health and your plans. If you get sick or travel a lot in retirement, for example, your expenses may go up. In general, though, your expenses will likely stay about the same. According to the Employee Benefit Research Inst.i.tute's 2009 Retirement Confidence Survey (RCS): - 49% of retirees spend less in retirement than before (26% spend much less) - 35% spend about the same as before retirement - 14% spend more in retirement (though 7% say their expenses are only "a little higher") Overall, 65% of Americans spend about the same or only slightly more or less in retirement. That means their pre-retirement expenses are a good predictor of their post-retirement expenses.

NoteYou can download the full EBRI report for free from http://tinyurl.com/EBRI-rcs. It's filled with tons of data about Americans' att.i.tudes toward retirement-and the realities of being retired.

Expenses often drop in retirement because your kids are out of the house; your mortgage is gone-or nearly so (one of the surest steps toward retirement security is to pay off your mortgage); you have no commuting costs or other work-related expenses; and, ironically enough, you no longer have to save for retirement. Sure, you'll have other expenses-especially health care-but if you've been smart and planned ahead, you should be in good shape.

Make no mistake: You will need a sizable nest egg for retirement-especially if you have ambitions to travel or want to golf every day. In fact, you should save as much as you can. But don't be snookered by the constant refrain that you need 70% of your pre-retirement income. That's nonsense-base your savings goals on your projected expenses instead.

The moral here? Don't panic-you can save enough for retirement. In Retire Well on Less Than You Think Retire Well on Less Than You Think (Times Books, 2004), Fred Brock writes: (Times Books, 2004), Fred Brock writes: Most people can retire from wage slavery sooner than they think if they are willing to pay a relatively painless price for their freedom: a simpler, downsized life and, perhaps, a move to a less expensive part of the country-and it doesn't have to be remote or far away.

The key is to live within your means now, which lets you boost your cash flow so you can acc.u.mulate savings for later in life.

Retirement Calculators Enough theory! You're probably ready for some hard numbers. In that case, you can get a quick estimate of how much you'll need to save by heading online. There are hundreds of retirement calculators scattered across the Web, and each one is a little different. Because this is all a guessing game, no one calculator is necessarily better than any other, but here are a few I've found especially insightful: - T. Rowe Price has an excellent calculator that bases its results on your spending needs: http://tinyurl.com/TRO-rcalc.

- The Motley Fool has two useful calculators, one that estimates your retirement expenses (http://tinyurl.com/fool-rexp) and one that lets you see if you're saving enough (http://tinyurl.com/fool-enough).

- Bankrate's retirement calculator (http://tinyurl.com/BR-rcalc) bases its results solely on your savings. (MoneyChimp.com has a similar-but simpler-calculator at http://tinyurl.com/MC-rcalc.) - Choose to Save has a ballpark estimate tool (http://tinyurl.com/ballparke) that you can use online or off. It's the best of the calculators that use income instead of expenses.

For a great combination of simplicity and complexity, check out FireCalc.com. This site may seem overwhelming at first (there's a lot of text to read), but it's actually fairly elegant. What it does is give you an idea of just how safe or risky your retirement plan is based on how it would have withstood every market condition we've ever faced since 1871. All you do is enter how much you've saved, how much you think you'll spend every year, and how many years you expect to live in retirement. Then FireCalc spits out a percentage telling you how likely your retirement plan is to succeed: 0% means that it never would have worked in the past, and 100% means it always would have succeeded.

NoteIn How to Retire Early and Live Well How to Retire Early and Live Well (Adams Media, 2000), Gillette Edmunds shares his formula for calculating retirement needs based on current expenses. His formula takes taxes, inflation, and investment returns into account. It's too math-y for this book, but if you'd like to calculate things by hand, track down a copy at your local library or used book store. (Adams Media, 2000), Gillette Edmunds shares his formula for calculating retirement needs based on current expenses. His formula takes taxes, inflation, and investment returns into account. It's too math-y for this book, but if you'd like to calculate things by hand, track down a copy at your local library or used book store.

Looking at the results from just one retirement calculator isn't very useful. But if you compare the numbers and recommendations from several, you can get a pretty good idea of how much you'll need to save for the retirement you want. If your results are anything like mine, you may feel a little overwhelmed. In that case, make a commitment to start saving for retirement today.

Tipa.n.a.lyzenow.com has lots of great info about sensible retirement planning. The site doesn't include a calculator, but it offers plenty of free downloadable spreadsheet templates so you can run your own numbers, as well as tons of articles about retirement planning.

Why You Should Start Saving Today If you're young, you may not think you need a retirement account-you can worry about that later, right? Besides, you have better things to do with that money, like taking a trip to Vegas with your friends. But the hard truth is that, no matter what your age, you should start saving now.

According to the 2009 National Retirement Risk Index from the Center for Retirement Research, 51% of Americans are "at risk of being unable to maintain their pre-retirement standard of living in retirement" (http://tinyurl.com/CRR-nrri). Part of the reason is that these folks didn't plan ahead and set aside enough when they were young.

"The amount of capital you start with is not nearly as important as getting started early," writes Burton Malkiel in The Random Walk Guide to Investing The Random Walk Guide to Investing. "Procrastination is the natural a.s.sa.s.sin of opportunity. Every year you put off investing makes your ultimate retirement goals more difficult to achieve."

An article about retirement in the February 2010 issue of Consumer Reports featured a survey of more than 24,000 of the magazine's readers. The findings won't surprise you: "Satisfied retirees planned early and lived within their means," the article noted. Those who started saving in their 30s had an average of almost $400,000 more than those who started in their 50s and 60s. Even readers who started in their 40s typically had $200,000 more than those who waited till later in life.

The bottom line: Save early and often. People come up short of cash in retirement because they put off saving. As you'll see in a moment, the secret to getting rich slowly is the power of compounding. When you're young, time is your greatest ally. Even modest returns can generate real wealth if you start early and stick with your plan.

Frequently Asked Question: Finding Cash to SaveI know saving for retirement is important, but I can hardly find the money to pay my bills, let alone to sock away for my golden years. How can I possibly set money aside for retirement?Saving for retirement is crucial, but if your current financial situation is precarious, it's more important to find a way to make that more stable first-to improve your cash flow (see The Power of Positive Cash Flow The Power of Positive Cash Flow)-and then then worry about the future. This isn't license to ignore retirement savings; it's just a reminder to take care of today before tomorrow. Be sure to: worry about the future. This isn't license to ignore retirement savings; it's just a reminder to take care of today before tomorrow. Be sure to: - Stash some cash for emergencies. Before you save for retirement, save for the present. Without a rainy-day fund, even small disasters can sidetrack your savings for months (or years). See Chapter7 Chapter7 for tips on where to put the money. for tips on where to put the money.

- Pay off your credit card debt (see Chapter4 Chapter4). At the very least, make significant headway on your debt and have a plan for getting rid of it all.

After you finish paying off your debt, saving for retirement is easy: Take the amount you were putting toward debt reduction each month and-instead of spending it on Stuff-stick it in a retirement account. You've already developed the habit of using the money to improve your financial life; this is just another way to do it!

The Power of Compounding On its surface, compounding is innocuous-even boring. How much does it matter if you start saving now? Will it truly make that much of a difference?

In the short term, compounding doesn't make a huge difference. But remember what you learned in the last chapter: Investing is all about taking the long view. Short-term results aren't as important as what will happen over 20 or 30 years.

Imagine you make a one-time, $5,000 investment when you're 20 years old. a.s.suming the return on that investment is 8% per year (in real life, you're never going to find an investment that guarantees this much, but bear with me), even if you never touch the investment again-never add or withdraw any money-you'll have nearly $160,000 by the time you retire at age 65. But if you wait until you're 40 to make your single investment, that $5,000 would grow to only $34,000. As you can see from this example, time is the main ingredient in compounding.

You can get even more out of compounding through systematic investing (see All-in-one funds All-in-one funds). It's great that a single $5,000 investment can grow to $160,000 in 45 years, but it's even more exciting to see what happens when you make saving a habit. If you invest $5,000 each year for 45 years (for a total of $225,000 invested) and the money earns an 8% return every year, your savings will grow to over $2.24 million-nearly 10 times what you invested!

NoteIn real life, there's no way to earn a guaranteed 8% per year. As you learned on How Much Do Stocks Actually Earn? How Much Do Stocks Actually Earn?, the stock market returns an average of 10% per year-but this average is not normal. Because stock market returns fluctuate wildly, if you invested $5,000 into a stock-market index fund every year for 45 years, you could have anywhere from less than $1 million to well over $4 million when you retired, even if your average return was exactly 8%. Confused? Just remember that, even with the power of compounding, you need to watch your progress and make course corrections along the path to retirement.

To make compounding work for you: - Start early. The sooner you start, the more time compounding has to work in your favor, and the wealthier you can become. (The next best thing to starting early is starting now.) - Stay disciplined. Make regular contributions to your savings and retirement accounts, and do what you can to increase your deposits as time goes on. (This is part of paying yourself first-see Get in the game Get in the game.) Don't sabotage yourself by cashing out your retirement account when you move from one job to the next. And don't be tempted to sacrifice your future well-being for a few more bucks today.

- Be patient. Don't touch the money; compounding only works if you let your investments grow. You can think of it like a s...o...b..ll of money: At first your returns may seem small, but eventually they become enormous.

TipTo learn more about compounding, check out the compound-interest calculator at Money Chimp http://tinyurl.com/MC-compound).

A Brief Guide to Retirement Accounts A lot of people believe that wealth is something that happens all at once, through inheritance or winning the lottery or magically picking the right stock. But in reality, you get rich slowly. The road to wealth is like a marathon: It's a long race, and the best approach is measured, even paces. To help yourself win this "race," it's important to make the most of your retirement accounts.

When you put money in a regular investment account like the ones discussed in Chapter12 Chapter12, you're using after-tax money: You earned the money through your job, paid tax on it, and then used it to buy stocks and bonds. And when you sell your investment, you'll have to pay taxes on the returns the account earned. (Depending on how you invest, you may also have to pay taxes on dividends and capital gains along the way.) One of the great things about retirement accounts-investment accounts specifically for retirement savings-is that they let you put off income taxes until a later date (that's why they're called tax-deferred), meaning you get to hold onto and profit from your money longer. And a Roth IRA (which you'll learn about shortly) lets your money grow tax-free!

There are lots of places to put your retirement savings, so it can be difficult to know where to start. Each person's situation is different, but most folks can follow these simple guidelines: 1. If you have a 401(k) or similar program at work, contribute to get the employer match (Disadvantages of 401(k)s). If your employer doesn't match contributions, go to the next step.

2. If you qualify, open a Roth IRA (Learning to Love Roth IRAs) and contribute as much as you can (up to the maximum allowed).

3. If you have money left, put as much as you can into your 401(k) (see Funding Your Future with a 401(k) Funding Your Future with a 401(k)).

4. Once you've done all of the above, then put your money in regular investment accounts (see Chapter12 Chapter12). You might also consider paying down your mortgage.

Following these steps is one the best ways to take control of your financial future. The following pages cover each step in more detail.

Funding Your Future with a 401(k) According to the Congressional Research Service, nearly half of American workers partic.i.p.ate in retirement plans offered by their employers (http://tinyurl.com/CRS2007pdf). About one-third of these folks have defined-benefit plans, while two-thirds have defined-contribution plans.

With a defined-benefit plan-which most people simply call a pension-when you retire, you receive a fixed monthly payment for the rest of your life. (The amount you get paid is based on how long you worked for the company and how much you earned.) With a defined-contribution plan, on the other hand, your benefits aren't fixed; they're based on how much you (and your employer) put into the plan and what kind of returns your investments earned.

The 401(k) is a specific type of defined-contribution plan that, over the past couple of decades, has become much more common than traditional pension plans. (The name 401(k) comes from the section of the tax code that defines these plans.) Let's look at the pros and cons of 401(k)s.

NoteThere are a variety of defined-contribution retirement plans out there. For-profit companies offer 401(k) plans, while nonprofit organizations and governments offer 403(b) plans. And if you work for the federal government, you may have access to the Thrift Savings Plan. Though these plans aren't identical, they're similar, so you can generally apply the advice in this chapter about 401(k)s to other defined-contribution plans, too.

Advantages of 401(k)s 401(k)s have a lot going for them. For one, they make contributing to your retirement automatic: Once you sign up for your company's 401(k) plan, your retirement saving comes directly out of your paycheck. You can "set it and forget it," only making changes when you want to increase (or decrease) your contributions. This takes the human element out of the equation, preventing you from gumming things up (and that's a good thing-see Being on Your Best Behavior Being on Your Best Behavior).

Even better, your contributions and earnings are tax-deferred. In plain English, that means you don't have to pay taxes on the money you put into a 401(k) until you withdraw it. You're not taxed on the profits (the returns the account earns) until then, either. This is a big advantage over a regular investment account. For example, if you earn $50,000 per year and you put $5,000 into your 401(k), your taxable income drops to $45,000; if you're in the 25% tax bracket (see Know what you owe Know what you owe), say, that would save you $1,250 in taxes. And you won't be taxed on that $5,000 contribution (or any returns it earns) until you take the money out at retirement, so your investment has a chance to grow even faster than in a regular investment account.

But the biggest advantage of 401(k)s is the employer match: Many companies match at least a part of what their workers set aside for retirement. IBM, for example, currently matches employee contributions dollar for dollar up to 6% of their income! Most company matches aren't so generous, but they're still worth taking full advantage of. In effect, you can give yourself a raise by taking advantage of the employer match-though you won't see the effects of the "raise" until you retire.

Disadvantages of 401(k)s Alas, 401(k)s aren't perfect. For one thing, once you put money into a 401(k), you can't easily access the cash if you end up needing it for something else. Except in cases of hardship (see http://tinyurl.com/401k-hsw), if you pull the cash out before age 59 and a half, you'll be socked not only with taxes, but also a 10% early withdrawal penalty. (On the other hand, you have to begin pulling money out by the time you're 70 and a half, unless you're still working for the company that sponsored the plan.) Also, find out the details of your company's vesting policy. Vesting is the process by which you gain "ownership" of any contributions your company makes to your 401(k) (as with an employer match). You always own the money you've put into the plan yourself, but you only gradually gain ownership of your company's contributions. You might own none of them during the first year you partic.i.p.ate, for example, 20% the second year, and so on. If you leave the company before you're fully vested, you won't get 100% of the money they contributed. Check with your company's HR department to learn more.

But the biggest problem with 401(k)s is that they often offer only limited investment options. The firm that manages your company's retirement accounts probably gives you a small menu of mutual funds from which to choose. Your challenge is to find the one best suited to your needs (which, as you learned in the last chapter, is likely to be the lowest-cost fund; favor index funds, if possible).

If your company's 401(k) plan is lousy (it has high fees and poor selection, say), move the money into an IRA (Learning to Love Roth IRAs) when you leave the company. But no matter how bad the plan, it's probably not bad enough to pa.s.s on the employer match. For more info on how to deal with a bad 401(k) plan, read this article from Money magazine: http://tinyurl.com/bad401k.

Every company's 401(k) plan is different. Your best bet is to read up on how yours works and do what you can to make the most of it. And whether or not your company offers a 401(k), you should definitely take a look at the investor's best friend: Roth IRAs.

TipAt some point, you may want to shift money from one retirement account to another, like moving the money in a 401(k) from your old job to a Roth IRA. (The technical way to say this is that you want to roll over your 401(k).) Be warned: These moves can be tricky. The IRS has a handy chart that shows which accounts can roll over into other accounts: http://tinyurl.com/IRS-ropdf. For more info, read the Get Rich Slowly article at http://tinyurl.com/GRS-401kmove and contact a financial planner (see and contact a financial planner (see How to open a Roth IRA account How to open a Roth IRA account).

Learning to Love Roth IRAs Even if your company doesn't offer a retirement plan, you can still save for the future. One of the best ways to do so is with a Roth IRA.

An IRA is an individual retirement arrangement, a retirement plan that gives you tax advantages when saving for retirement. There are two types of IRAs: - With a traditional IRA (first introduced in 1975), the money you put in is typically tax deductible, but the money you pull out at retirement will be taxed at the then-current rate.

- With a Roth IRA (first introduced in 1997), you contribute after-tax dollars, but when you retire, you don't have to pay taxes on the returns the money earned. (These IRAs get their name from Delaware senator William Roth, who helped pa.s.s the law that created them.) In other words, money in a traditional IRA is taxed when you withdraw it, but the money in a Roth IRA is taxed before you contribute it. (For more on the difference between Roth IRAs and traditional IRAs, see the box on Extreme Retirement Saving Extreme Retirement Saving.) You make investments in an IRA through an individual retirement account. Many folks use the term "IRA" interchangeably to refer to both individual retirement arrangements and individual retirement accounts, but there are some important differences. You have just one Roth IRA, for example, but you can have many Roth IRA accounts. That is, you can have a Roth IRA account at your credit union and one with your mutual fund company, but they're both part of the same IRA. (It's kind of like how this page and the last one are both part of the same book.) One important thing to realize is that an IRA isn't itself an investment-it's a place to put investments. When you open an IRA account, it's like an empty bucket just waiting to be filled. The things you put into your IRA bucket are investments. You might, for example, buy stocks to put into your bucket, or maybe bonds. Some people use their IRA accounts to buy investment real estate, and some simply let their cash sit there, earning interest in CDs, just as it would if it were deposited in the bank down the street (which may actually be where they keep their IRA account!).

As you might expect after reading the last chapter, smart people mix up the contents of their IRA accounts over time. Their buckets might contain a combination of stocks, mutual funds, bonds, and real estate. (When you start out, your bucket will probably hold just a single investment, and that's fine.) For many people, Roth IRAs are the perfect place to put retirement savings. They're an easy way to contribute to your financial future, and they're such a good deal that it's worth taking an extended look at them.

NoteSome companies offer Roth 401(k)s, which are like a cross between a Roth IRA and a regular 401(k): You put in after-tax dollars so that you can withdraw them tax-free. You can learn more about Roth 401(k)s at http://tinyurl.com/yh-401k.

Roth IRA rules and requirements There are some restrictions on who can contribute to Roth IRAs. These arrangements are designed to help ordinary working folks to save for retirement by giving them a significant tax break. They're not meant for people with really high incomes.

If your tax filing status is single and you earn more than $105,000 but less than $120,000 in 2010, the amount you can contribute is limited. And if you earn more than $120,000, you can't contribute to a Roth IRA at all. If you're married and filing jointly, your contributions are limited if your household income is more than $167,000 but less than $177,000 in 2010. And if you and your spouse earn more than $177,000, you can't contribute to a Roth IRA at all.

These income limits are based on your modified adjusted gross income. (If you don't know what that is, don't worry about it unless you think you're close to the limit.) Also note that the Roth IRA income limits usually increase every year. A few other important facts: - If you're younger than 50, you can only contribute $5,000 to your Roth IRA in 2010 (if you're 50 or older, you can contribute up to $6,000).TipThese contribution limits increase from time to time to keep up with inflation, so you should check every year to see whether they've gone up.

- To invest in a Roth IRA in any given year, you (or your spouse) need to have earned income; in other words, you can't fund a Roth IRA if all of the money you received that year came from an inheritance.

- You can use a Roth IRA even if you have a 401(k) or other retirement plan.

- You have to make your contributions by the tax deadline each year. For example, you have until April 15, 2011 to make your Roth IRA contributions for 2010. (But it's a good idea to fund your account as early as possible.) - You can convert traditional IRAs to Roth IRAs. There used to be income limits on these conversions, but those limits are gone as of 2010. If you think you might like to convert a traditional IRA to a Roth, contact a financial planner. (The topic is beyond the scope of this book.) - You can withdraw your contributions at any time without penalty. But if you try to withdraw your earnings (the returns on your contributions) before you're 59 and a half, you'll have to pay taxes and a 10% early-withdrawal penalty (except in special circ.u.mstances).

- Lastly-and this is important for many people-you can withdraw up to $10,000 in earnings without penalty to buy your first home, as long as your IRA spans at least 5 tax years. Check out http://tinyurl.com/mf-irahome for more info. for more info.

There are other arcane guidelines and provisions, but these are the basics. If you want more info, check out Publication 590 at the IRS website (http://tinyurl.com/IRS-iras) or contact your friendly neighborhood financial planner (see the box on the next page).

On The Money: How to Hire a Financial PlannerIf you don't have the time or knowledge to create a roadmap for your financial future, consider calling in a pro. A financial planner can help you put the pieces of your investment puzzle together in a way that makes sense for your personal goals and values. Even if you do most of the work yourself, you may want to have a planner check things over to make sure your investment plan will work as you intend. Planners can also make recommendations and give advice on how to implement your plan.Before hiring a planner, decide how much help you want or need. Different planners charge different rates, typically based on one of these methods: by the hour (best if you need minimal help), by the project (best if you need help in a specific area), on retainer (best if you want ongoing help), or based on a percentage of the a.s.sets they're managing for you. (Watch out: This last method has a built-in conflict of interest.)The more research you do on your own (like reading this book!) and the more you're willing to do yourself, the less you'll end up paying. Most planners will give a free initial consultation, which will let the two of you get a feel for each other. (Be sure to ask these 10 questions: http://tinyurl.com/CFP-questions.)As you look for a planner, watch out for potential conflicts of interest. Ask yourself if the recommendations she gives you could somehow benefit her. Those paid by commission tend to be salespeople rather than actual planners. So ask questions, read the fine print, and a.s.sume nothing.It's important to know that the term "financial planner" isn't regulated-anyone can call themselves that. But Certified Financial Planners (often simply called CFPs) are regulated and have to agree to uphold a set of standards and follow a code of ethics.You can find a CFP using the Financial Planning a.s.sociation's PlannerSearch website (http://tinyurl.com/FPA-search). The Garrett Planning Network (www.garrettplanningnetwork.com) has a searchable directory of financial planners who charge by the hour. The National a.s.sociation of Personal Financial Advisors (www.napfa.org) also has a searchable directory.For a financial planner to give investment advice, she has to be a registered investment adviser (RIA). RIAs are required to place your interests above their own; stockbrokers-even if they're CFPs-don't have to do that.

How to open a Roth IRA account Opening a Roth IRA account is easy. If you've ever filled out a job application, applied for a credit card, or opened a bank account, you've got what it takes to open a Roth IRA account.

Deciding where to open your Roth IRA account is the toughest part of the process. If you already have an investment advisor, ask her for recommendations, but look for other options, too. Many banks and credit unions offer IRA accounts (though you'll usually be able to invest only in deposit accounts, like CDs). If you're willing to make some decisions on your own, you can open an IRA account through a discount broker or mutual fund company. There are a lot of good options out there, but you might start your search with these firms: - Fidelity Investments. http://tinyurl.com/FID-ind, 800-FIDELITY - T. Rowe Price. http://tinyurl.com/TRP-ind, 800-638-5660 - The Vanguard Group. http://tinyurl.com/TVG-ind, 800-319-4254 Set aside an hour or two some Sat.u.r.day morning to explore the options over a cup of coffee. With a little research, you should be able to find a company and program that suits your needs. When you're shopping around for a place to open an IRA account, ask the following questions: - Is there a minimum initial investment?

- What sorts of fees will they charge on your account?

- Can I make automatic contributions?TipMaking regular automatic investments to a Roth IRA account is a fantastic way to build wealth. Most brokers and mutual-fund companies provide some sort of program that'll pull money from your bank account every month. If you make this a habit, you won't even notice the money is missing; it'll be a regular expense in your monthly budget. Do this and you'll put yourself far ahead of your peers.

- What investment options will I have? Can I invest in index funds?

- Will I be able to download statements?

Search for a company that suits your needs. But don't fret about finding the perfect match-find a good match, and then get your IRA account in motion. You can move your money to a new IRA account if the first company you choose isn't a good fit.

Once you pick a place to open your IRA account, it's time to fill out the application. Some firms want you to download forms, and then mail or fax them back, but most companies provide online applications. To complete the application, you'll need your Social Security number, bank account info (so you can transfer funds), info about your current employer, money in a bank account (depending on where you open your IRA account, you might need anywhere from $25 to $3,000), and about half an hour of free time.

When you've gathered all that info, you're ready to fill out the paperwork. You'll probably have to answer some simple questions about your investment plans and goals. Once you complete the application, they'll ask you to transfer money to your new Roth IRA account. (This money will probably earn interest until you choose an investment.) That's all there is to it!

Frequently Asked Question: Roth IRAs Versus. Traditional IRAsHow do I choose between a Roth and a traditional IRA?As great as Roth IRAs are, they're not for everyone. The general rule of thumb is that you should go with a traditional IRA if you need the immediate tax deduction (see Roth IRA rules and requirements Roth IRA rules and requirements) or if you're likely to be in a lower tax bracket when you retire than you're in now. (Both of these are more likely if you make a lot of money, in which case you might not qualify for a Roth IRA anyhow [see Roth IRA rules and requirements Roth IRA rules and requirements]).There are many subtle differences between the two types of arrangements that affect people in or near retirement. You read about some of these details earlier in this chapter, but to save you from having to do a point-by-point comparison, here are the most important considerations for the majority of folks: - Both types of IRAs have the same contribution limits. The current limit is $5,000 a year, or $6,000 a year if you're 50 or older.

- Roth IRAs have income limits; traditional IRAs don't. For the 2010 tax year, single filers have to make less than $105,000 to be allowed to fully fund their Roth IRAs; for joint filers, it's less than $167,000. (Traditional IRAs have income limits on deductibility in certain cases; see http://tinyurl.com/ira-deduct for details.) for details.) - The two types of arrangements have different tax advantages. You typically fund a traditional IRA with pre-tax dollars, so you pay taxes when you withdraw the money. The money you put into a Roth IRA has already been taxed so it grows tax-free and you don't have to pay taxes when you withdraw it.

- You have to take yearly distributions from a traditional IRA (and pay taxes on them) when you're over 70 and a half. As with a 401(k), the IRS says you have to take a certain minimum amount out of your traditional IRA every year once you reach a certain age. There's no required minimum distribution for Roth IRAs.

- You can withdraw your contributions (but not earnings) from a Roth IRA anytime without paying penalties. Traditional IRAs don't give you this option.

If you don't know which option to choose, you're likely best off using a Roth IRA. For more info, check out the Roth IRA vs. traditional IRA calculator at CCH Incorporated (http://tinyurl.com/ira-calc) or talk to a financial adviser (How to open a Roth IRA account).

Extreme Retirement Saving If you've already put enough into your 401(k) to get the full employer match and you've maxed out your Roth IRA, congratulations-you're in great shape! What you do after this depends on your priorities.

If you think you need to save more for retirement, then pump up your 401(k) as far as you can. In 2010, you can contribute up to $16,500, including your employer match. If you're 50 or older, you can contribute up to $22,000.

You might also consider accelerating your mortgage payments (see Should you prepay your mortgage? Should you prepay your mortgage?); many retirees find that owning their home free and clear gives them tremendous peace of mind. A final option is to use targeted savings accounts (Targeted Savings Accounts) to pursue other goals. These are all great options, and Super Savers can't go wrong by pursuing any-or all-of them. They'll each put you that much closer to retirement.

Early Retirement and Other Dreams For most of us, a job is a necessary evil. Many folks dream of retiring early-finding a way to leave the workplace in their 40s or 50s instead of sticking it out until age 65 (or older). In fact, the 2009 EBRI Retirement Confidence Survey (A Better Way) found that 18% of retirees left the workforce before age 55 (and another 17% retired before they turned 60).

Early retirement is a fantastic goal, but it's tough to do because of four main obstacles. When you retire early: - You have less time to earn money. If you start working at 20 and retire at 65, you have 45 income-producing years. But if you retire at 45 instead, you only have 25 income-producing years to achieve the same results.

- Your investments have less time to compound. As you learned on The Power of Compounding The Power of Compounding, the longer you go without touching your savings, the more you benefit from the power of compounding.

- You'll be drawing on your savings for longer. The average American will live to be nearly 80. So if you retire at 65, your savings will probably need to last only 1020 years; but if you retire at 45, your savings may have to support you for 3040 years.

- You won't have some of the traditional perks of retirement (at least not right away). If you retire young, you won't be able to draw on Social Security or Medicare for many years. You'll also face penalties if you want to tap your retirement accounts before you reach the minimum age requirements.

In short, if you retire early, you'll have less money saved and it'll have to last longer than if you waited. Even if you stay healthy and the economy cooperates, that's asking a lot.

That's not to say you shouldn't plan to retire early. It's a laudable goal (and one I've set for myself). If you're serious about doing it, you need to be extra diligent about living frugally now so you can save as much as possible for the future.

After Philip Greenspun retired in 2001 at the age of 37, he wrote an article about some of the joys, challenges, and practical aspects of his decision: http://tinyurl.com/PG-retired. And at MSN Money, Liz Pulliam Weston profiled people who retired early. In one article (http://tinyurl.com/rb50-one), Weston looks at what it takes to retire by age 50. In another (http://tinyurl.com/rb50-two), she shares how three couples made this dream a reality.

To learn more about early retirement, check out the Early Retirement Forum (www.early-retirement.org) or track down a copy of How to Retire Early and Live Well How to Retire Early and Live Well by Gillette Edmunds. Edmunds' book pays special attention to the financial challenges faced by early retirees-including the psychological impact of a market crash. by Gillette Edmunds. Edmunds' book pays special attention to the financial challenges faced by early retirees-including the psychological impact of a market crash.

Because early retirement presents so many financial hurdles, some people choose semi-retirement instead. Semi-retirement is like early retirement except that you continue to draw income from some sort of work. In Work Less, Live More Work Less, Live More, Bob Clyatt explains the advantages of this option: With a modest income from part-time work, early semi-retirees may not have to face the dramatic downshifting in spending and lifestyle that so often confronts those who live only on savings or pensions. And semi-retirees learn that a reasonable amount of work, even unpaid work, keeps them energized, contributing, and sharp.

Though semi-retirement is more realistic than early retirement, it's still not for the faint of heart. You have to be dedicated and work hard to make it happen. Semi-retirement typically involves: - Ample savings. Semi-retirees plan far in advance, acc.u.mulating a large nest egg before they make the leap.

- Modest living. Semi-retirees tend to be frugal and use techniques like those in Chapter5 Chapter5.

- Ongoing work. Though semi-retirees aren't employed full time, they do keep working for a number of reasons: The added income means they don't have to draw down their retirement savings as quickly as they would otherwise, and the work lets them spend time with people while doing something worthwhile.NoteAccording to the EBRI Retirement Confidence Survey, one-third of retirees worked for pay in 2009.