I decided several months ago that I wanted to start investing, so I signed up with Schwab and started contributing automatically each month. It made sense, and I wanted to do SOMETHING, even if it wasn’t perfect.

Well, now I realize that it wasn’t perfect and I want to tweak my plan. I currently contribute to a Roth 401(k) through work but until Sunday, I hadn’t created a Roth IRA.

So my brilliant idea is to use the Roth IRA as an investing account! I can withdraw my contributions at any time (but not the earnings!) and if I want to withdraw the earnings, I’ll be able to take money from other places (reduce my 401(k) contributions for a few paychecks, dip into one of my sub-savings accounts) to make up for the interest I won’t withdraw from the Roth IRA. Essentially, I would keep my investing in a Roth IRA, earn tax free interest there, and withdraw that interest by making smaller 401(k) contributions equivalent to the amount of interest I earned but didn’t withdraw.

I think this is definitely the way to go. Why invest and pay taxes when I can invest and not pay taxes?? It seems like a no-brainer now, why didn’t I consider this as an option earlier?

So I set out to open my Roth IRA. Opening with Vanguard was so easy. It took less than 5 minutes. I had to start with $1,000 in a STAR fund, and I’m going to contribute as much as possible (after making my regular contributions to the emergency fund) until April 15, which is the cutoff date for 2009 contributions. Also, I’m stopping my Roth 401(k) contributions for the time being and using all that money to go toward the Roth IRA. That way I’ll be able to take full advantage of all my Roth options for the 2009 year. After my 2009 contribution window closes, I’ll contribute my regular 401(k) amounts to my 2010 Roth IRA plus the amount of any additional investing I want to do. Once I reach $5,000 of Roth IRA contributions in 2010, I’ll go back to contributing to my Roth 401(k) through work.

So why not just change my investments from Schwab brokerage to Roth IRA and leave the 401(k) alone? For flexibility. No matter what, I’ll always have my Roth IRA contributions to withdraw, penalty-free at any time. With a 401(k), there are rules for when I can withdraw, even the contributions, without penalty, and I wouldn’t qualify. So I’ll max out my Roth IRA contributions first because I see no reason not to.

My goal this year was to contribute $5,000 to my retirement funds, and that is a goal I will keep in mind. Anything above $5,000 will be my investing money, and at the end of the year, will just be my total contributions minus $5,000. Although it will seem like I am putting a lot of money away in retirement accounts this year, I will still have to remember that some of that money, while in a retirement account, will not be used for retirement purposes. But if I’m lucky, I won’t be tempted to withdraw it at all and will continue to take advantage of the tax-free interest I’ll be earning.

I found a few sites that I really like to answer financial questions that I wanted to share with everyone. Cash Commons and Basically Money both allow you to ask and answer any financial question you like, vote for answers you life, and earn points and awards which mean nothing but gives you a better reputation on the site. I’ve asked several questions and answered a few others and I’ve gotten a lot out of the site so far.

The question I’ve been most interested in lately is what to do with the money I’m saving. I’m able to save over 50% of my paycheck, but I’m not entirely sure how to spend that money. I narrowed it down to several choices:

• Aggressively pay off my student loans, which stand at around $23,000.
• Invest the money knowing that I can probably beat the low rates of my student loans (~2.8%).
• Save it in an online savings account earning only 1.40% APY but allows me to have some flexibility later.

I’ve gotten a lot of excellent feedback, some that I agree with and some that I know may be helpful in someways but ultimately don’t feel comfortable with.

Here are a few of the various responses I’ve gotten and afterward I details what I ultimately decide to do.

Dr. Dean: Pay off the student loans aggressively after building up a 6 month emergency fund.

Mighty Bargain Hunter: Pay only the minimums on the student loans and throw the rest of the money into an emergency fund so that I’ll have added flexibility later.

MrChrister: Pay off the bills, invest a little for fun, save up for a big purchase, and enjoy the extra money.

ScottW: Save and travel. Create memories

Thanks for your advice guys, and I’ve taken a combination of your answers and decided to do this:

Save an additional $500 a month and building up a nice savings account. I will be sure to treat myself well and enjoy experiences and create memories rather than buying toys and gadgets I will likely forget about. I am increasing my “fun” budget by $100 a month for this, and I will not hold back if that needs to increase for special occasions. I’ll also be investing $200 a month, and I will save the other $200 in a savings account targeted for student loans (but I’ll take Mighty Bargain Hunter’s advice and retain some flexibility, even if it means losing 1%.)

What do you think, am I being smart or should I be more risky or conservative?

We hear a lot about retirement accounts, but I wanted to spend today’s post explaining the different types of accounts.

Traditional IRA – Individual Retirement Account

Individuals can set up these accounts and invest for their retirement. Individuals put away pre-tax income in these accounts so that when they retire, they’ll have income saved up.

Advantages

The big advantage of putting money away in an IRA is that all money deposited into the IRA is tax deductible, so instead of paying taxes and then investing, as you do with regular investments, the money goes straight into the account without being taxed first.

Distributions

That doesn’t mean that tax is never paid on that money. When it is time to take distributions in retirement, all the investments and all interest earned is taxed as ordinary income at your normal tax rate.

Limits

For 2009 and 2010, the contribution limit on IRAs is $5,000 each year, although depending on your filing status and job status, the limits are phased out beginning at an income of $55,000 for individuals and $89,000 for couples. In addition, those who are 50 or older can make an additional catch-up contribution of $1,000.

401(k)

These accounts are similar to IRAs in that contributions are pre-tax. These plans are usually employer sponsored plans where employees have a portion of his or her wages paid directly to the 401(k) account.

Advantages

401(k)s have similar tax advantages to IRA in that all contributions are pre-tax. Additionally, some employers choose to “match” part or all of the employee’s contribution. (This ranges, but employers often give a 50% match on employee contributions, of up to 6% of his or her salary.)

Distributions

Distributions work in similar ways to IRAs, and all distributions of contributions and interest income are taxed. There are heavy penalties for withdrawing funds before the permitted age of 59 1/2.

Limits

Another advantage of 401(k) accounts is that the contribution limits for 2009 and 2010 are $16,500, over 3 times that of traditional IRAs. In addition, employees who are 50 years old or over are allowed to make additional pre-tax catch-up contributions of up to $5,500 in 2009.

Roth IRA

This retirement savings plan consists of after-tax contributions.

Advantages

Contributions are made after taxes, so all earnings made over the life of the IRA are tax free upon disbursement. In addition, contributions may be withdrawn at any time without any penalties, something that can’t be done with traditional IRAs.

Distributions

Direct contributions can be withdrawn at any time. However, there are restrictions on when earnings can be withdrawn without tax or penalty. First, 5 years must have elapsed since the opening of the Roth IRA. In addition, the individual must be 59 1/2 years old.

Limits

The contribution limits are similar to that for traditional IRAs, $5,000 for 2009 and 2010. Single filers earning up to $105,000 qualify for a full contribution, while joint filers earning up to $166,000 qualify for a full contribution. After that, the contribution limits are phased out.

Roth 401(k)

This employee-sponsored option combines the features of the Roth IRA and tradition 401(k) plans. This is typically the best options for those who are eligible.

Advantages

Contributions are made after-tax, and all contributions and earnings can be withdrawn at any time tax and penalty-free. These plans are best for younger workers who are currently taxed in a lower tax bracket but expect ot be taxe din a higher bracket upon reaching retirement age.

Distributions

Required distributions begin at age 70. All contributions and earnings can be withdrawn at any time tax and penalty-free after they meet the two restrictions: they must be open for 5 years and the individual must be 59 1/2.

Limits

Contribution limits are the same as for traditional 401(k) plans.

Next week, I’ll go over which plans are best for individuals in different situations. Plus, we’ll talk about options for those who have 401(k) accounts when they leave their employers. Send in your questions, I’ll try my best to answer yours!

First, let me clarify. I’m not rooting for it to drop like it did last year, I’m just hoping it doesn’t increase like it did in the first half of this year. At least not yet.

Entering the workforce, you may think that this would be the best time for me. I didn’t lose anything last year and as the market improves, my investments will do well. Over time, we may look back and decide that 2009 was one of the best points in history to start investing.

So why am I rooting against the stock market?

Because I haven’t really been investing yet! I’ve contributed a small amount to my retirement savings since August, but don’t have significant amount of money in that account. I am trying to save up money so that I can invest outside of my retirement, and while I am in that process, big percentage gains on small amounts of money won’t make that much of a difference. Why make $100 on my $1000 investment now (10% return) when next year, that 10% increase could mean $500 a year and increase after that? So until I have a little bit more money in investments, I’m not quite ready for the stock market to take off.

Also, interest rates are extremely low right now. That includes my student loans. Right now, my debt is only accruing interest at a rate of around 3%, which is extremely low, and as the market improves, the rate will increase. My plan is to pay the minimum on my student loans while investing my extra income, thinking that if my returns exceed the interest rate of my student loans, I’ll come out ahead. So when I have a little more money invested, I’ll be able to make more significant gains and have results to show for my effort. Also, the market will likely improve before the student loan rates increase, so I’ll have a little bit of a head-start before the student loan interest rate increases.

This is a very short-term view, but that’s the situation I’m in right now. I can think of other situations where I would like the market to stay low. When I buy a house and get a mortgage, a weak economy would bring low mortgage rates. By locking in a low rate, I would be able to save a considerable amount of money over the life of the mortgage.

What are you rooting for this year?