Photo by micsalac.

In my last post, Save Early and Become a Millionaire, I commented on how a 16 year old can go from a pauper to a millionaire by saving up some cash and investing it in a Roth IRA over 40 years. I wanted to do a little more research and find out exactly what an IRA is. So this is what I found out…

IRA stands for Individual Retirement Account. It’s a retirement plan that lets you contribute up to a certain amount per year and provides tax advantages too. After you establish the account you can invest in bonds, stocks, mutual finds and CDs just like a regular cash account. There are a few different IRAs but the two most common types are Traditional and Roth. Roth IRAs were created to encourage people to save for retirement by offering significant tax breaks.

So what’s the difference between Traditional and Roth? Good question. Now listen up, this part is important. With a Roth IRA you pay income tax, and then make your contribution with after tax dollars. There are no taxes when you make a withdrawal. With a Traditional IRA you get a tax deduction, which lets you deposit before tax dollars then when you make contributions but you also pay income tax on the entire amount of your withdrawals. Roth has the extra advantage since taxes will probably rise in the future; paying taxes now rather than later will save you money in the end. Read more…

Photo by theritters.

It’s easier than ever to become a millionaire. So what’s the secret? Don’t laugh, but it’s plain old saving. Getting an early start on your savings coupled with the right investing strategy will bring you up to millionaire status. The catch? You’ll have to wait a few decades.

According to the MSN Money article Start on your first $1 million at age 16, the simple recipe to become a millionaire has five simple steps:

• Work 4 summers, from age 16 to 20
• Save the income in a Roth IRA account
• Invest in a simple, low-cost equity portfolio
• Wait 47 years
• Collect at age 67, untaxed and ready to spend (maybe on a new hip by this point)

The article takes into account that, starting from age 16, a person earns $2000 each summer for four straight summers. Then if invested in a Roth IRA, it will grow, tax-free, for as long as the account exists. All withdrawals from the account after age 59 1/2 will be tax-free. The money grows to $25,917 by age 30, $197,943 by 50, $547,037 by 60 and finally gets over one million by age 67 or $1,114,423 to be exact.

Two problems I see right away. First, getting an average return of 10.7% isn’t as easy as the article says it is. But, then again, some people say the opposite. The article also states that if you invest in small company stocks, whose long-term annual return clocks in at 12.5 percent annually, you will have even more money. Nice to know. Read more…