Section III-B - Lesson 1
Your IRA - As A 401k Alternative
Let’s talk first about setting up a self directed IRA as your retirement account when you have no 401k available to you. This involves pretty much the same procedure that we'll use in Section IV to set up your regular money account. You select the mutual fund company that you want to deal with, which will probably be the same company that is handling your regular money account, and request another application, but this time an IRA account application. This account will be handled separately, of course, from your other account, even though they’re at the same company.
You now determine your maximum allowable annual contribution, which at the moment, in 2002, is $3000 if you’re under the age of 50. If you make $50,000 a year, this will be 6% of gross income, and you should probably contribute the maximum. If you earn more than $50,000 and want to contribute 6%, you are out of luck because $3000 is all that Uncle Sam will allow you to deduct. You’ll probably do well to direct the balance of your 6%, over and above $3000, to your regular money account, to go along with your other regular contribution.
When you’ve determined your contribution, say $3000, you want to arrange for 12 monthly debits from your bank account, for $250 each, to be sent to your mutual fund company for purchase of an S&P 500 Index fund. Be careful when you first set this up that your total first year allowable contribution gets in before the IRS cutoff date, which is usually April 15 if the following year.
Do whatever tweaking you need to do to make the first year come out right, and then you should have it easy for future years. A wonderful thing about IRA’s, as opposed to 401k’s, is that at least you get to pick exactly what security you want to invest in, just as you do in your regular money account. Most likely, your IRA will be at the same company as your regular account, and invested in the same security.
You’ll instruct your mutual fund company to reinvest all dividends and capital gains distributions, and the fund company will hold all monies and securities and act as custodian for your IRA. They will send you periodic reports for this account just as they do for your regular account.
You’re bound by pretty much the same tax rules as a 401k as far as leaving this money alone until you’re 59 ½ years old, and as far as money being taxed in full when you take it out. Unlike a 401k there are no loans available against your IRA, but also unlike a 401k, there is nothing to stop you from making withdrawals any time you want, providing you are willing to pay the taxes and all the applicable penalties.
You may find that you contribute to an IRA for several years, and then leave it alone for several years when you change jobs to a company with a 401k, only to resume contributions later under different circumstances. This is not a problem. Your IRA will continue to grow whether you’re actively contributing or not.
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