An IRA is an account that is designed to help you in planning for retirement to supplement your 401k. A 401k account may or may not be able to support your lifestyle upon retirement. There are two major types of IRAs, a traditional and a Roth IRA which each have their own specific tax advantages.
• Traditional IRA
A Traditional IRA is a tax deductible way to contribute to a savings account in addition to your 401k. There are no income limits to a traditional IRA and you may contribute until you are age 70 ½ . The maximum annual contribution limit is $5,000. The growth on your Traditional IRA is fully taxable when you begin to withdraw from it upon retirement. The true tax benefit from a Traditional IRA comes from the tax deduction you get when the investment is made.
• Roth IRA
The most important benefit of the Roth IRA is that any growth in your account grows tax-free. There are income limitations when contributing to a Roth IRA. Essentially, you get no tax advantage for the savings that you put in to your account. However, if you let it grow for 20 or 30 years, you are able to take out all of the profit without any tax consequences. This can be extremely valuable if you are able to make a nice return on your investment.
We recommend consulting with a financial professional in order to determine which retirement options are best for you. The one thing that is consistent across the board is that saving for retirement is critical. Since, you may not have a military retirement to look forward to, it is important to start planning for your future now. A good Roth IRA calculator can be found at Bloomberg.com.
Investing
• Financial Planners
There are many pros and cons to having a financial planner. For most of the folks leaving the military, investing and understanding the risks and rewards of the markets is not a core competency. Financial planners typically get paid off of a percentage of “assets under management”. This simply means that they will get paid a fee based on the actual dollar amount of whatever you invest through them. They will get paid whether the investment goes up or goes down (not on their performance). If you can find a trustworthy and competent financial planner, they can be a valuable asset. However, they are not 100% necessary for everyone.
• Mutual Funds and Exchange Traded Funds
Mutual funds are professionally managed investment funds that pool together capital from many different investors and invest it for them. The Mutual Funds take all of the money and invest it across multiple categories (Stocks, Bonds, Money Markets, etc.) as well as multiple sectors (industrials, technology, energy, etc.). Mutual funds are a good way to begin investing in the market because you are giving your money to a professional money manager who will diversify your investment through the fund. Mutual funds typically have management fees associated with them and you have little control over where the investments actually go. Therefore, before you invest in a mutual fund, do your homework and determine whether or not you agree with their past investments and/or their track record. You can research mutual funds at Fidelity, Bloomberg, or Morningstar.
Exchange traded funds (ETFs) are another type of investment vehicle that trades assets of a specific index or category. This is a way to invest in a particular industry or category that you feel strongly about while diversifying your risk.
• Equities (Stocks)
The equities market is the most risky of all investing, however it has the opportunity to provide the highest payoffs. A unit of stock, or a share, represents a piece of ownership in a particular company. If the value of the company goes up, you will make money on your stock, and vice versa should the value of the company go down. There is typically no fixed return associated with stock. However you are entitled to a dividend should the company declare one.
• Fixed Income (Bonds)
A bond is a type of debt security which is typically a more secure investment than a stock and which will provide a fixed annual or semi-annual interest payment to you. Typically, a bond has much less risk associated with it than stock. However the upside is limited as well. The best way to think about a bond is that it is a loan. You will receive an interest payment, and ultimately receive your money back should the underlying asset perform reasonably well.
Saving
• 10% rule
There are many philosophies when it comes to saving cash for a rainy day. There are also many reasons to save: children’s education, a down payment on a house, etc. We typically recommend saving 10%-20% of your Gross Income per month if you can manage it (this is over and above any retirement savings plan that you are involved in). If you plan on these types of savings, you should reflect the reduction in available monthly cash in your budget. We shall discuss this matter in detail below.
• Contingencies
Another important thing to think about when creating a budget and trying to determine how much money to save is a contingency budget. All of us have unexpected expenses that catch us by surprise such as a major car or house repair or an uninsured medical procedure. Keeping a sound savings account can prevent having to resort to credit card debt or worse should an unexpected cost catch you by surprise.
Budgeting
One of the most difficult things for servicemen and women to do is adjust to their new budget. A budget consists of both the income you bring in and the costs associated with your life. When you get out of the service, both your income and your living costs will change dramatically. It is up to you to understand exactly how much they have changed.
• Know your new Income
When you leave the service, your take home pay will likely change significantly. Your new income will not have as many variables such as rank, time in service, or as many sources of revenue. For example, BAH, BAS, etc. often provided certain tax benefits. Your new income will likely have one or two sources of revenue, and it will not be shielded from federal or state taxes. In certain instances, servicemen and women will think that their new job is going to pay the exact same as the military, but when they receive their paychecks and see all of the taxes and deductions, the take home pay can be substantially lower than expected. It is up to you to prepare accordingly and know exactly how much cash you are going to have in your account after each paycheck.
• Know how much you spend
There are many new costs to servicemen and women upon leaving the military. You no longer have access to free medical care, free dental care, housing, and free gym memberships, etc. Even some of the smaller items that we take for granted in the military can add up (low cost car washes, the commissary and of course, the exchange). It is important to understand what your new living expenses are going to be in detail to avoid a shortage of cash at the end of each month.
• Budgeting Software
There are several different types of budgeting software available, however we recommend Mint. Mint.com is free budgeting software that allows its users to see what their expenses are, help pay off debt, and understand their budget. It is a free service, but they do make money by taking your personal financial information, and using it to sell you appropriate financial products that fit their needs. The other budgeting software that has been around the longest is Quicken. Quicken is a great tool and is similar to Mint. However you have to pay for it.
