Meet Debt Goals or Invest in Roth IRA?

Lately I've been giving a lot of thought to meeting my financial goals. Its to the point where I'm already planning my financial goals for 2009! Assuming that I am already debt free by 2009, my financial goal will be to fully fund a Roth IRA and make maximum contribution to my 401(k)...

Thats a very, very ambitious goal. Maybe not entirely realistic since I will still have about $40k in student loans to pay off... But thats not the point! My point is I'm starting to think about investing for retirement. The Dough Roller posted The Ultimate Guide to Traditional and Roth 401(k) and IRA Retirement Accounts today. This is a great introduction to retirement investments.

Reading through this got me thinking... am I missing out on an important investment opportunity? The answer is yes. The important difference between Traditional and Roth accounts are the tax advantages.

Traditional 401(k) or IRA

• Money is invested pre-tax
• Money gains interest tax-free
• Tax is paid on qualified withdrawals
• The tax amount depends on your tax bracket at the time of withdrawal

Roth 401(k) or IRA

• Money is invested post-tax
• Money gains interest tax-free
• No tax is paid on qualified withdrawals
• Does not depend on your tax bracket at the time of withdrawal
• Maximum Annual Contribution for 2007: $4,000

Whether or not Traditional or Roth makes the most sense for you depends on what your current and future tax obligations are. Personally, I don't want to count on my ability to predict the future. Either way it can't hurt to practice strong tax advantage diversification! I want to start fully funding those Roth IRAs as soon as I can. Check out this post from No Credit Needed for some bonus motivation: What if you make maximum retirement contributions for 20, 30, 40 years? Seriously. Check this out. I like this because it allows you to consider moderate to best interest rate scenarios. Either way, clearly, starting early makes a huge difference!

If I started fully funding my Roth IRA this year, I would have $820k to $7.6 MILLION waiting for me tax free when I retire in 40 years!!! Notice how quickly those numbers drop down as you look at 39 years... 38 years... There is no guarantee that I will even qualify to contribute in my later years, there are income limits.

An article from Get Rich Slowly almost seals the deal for me. Check out Real-life Choices - Retirement Savings vs Debt Reduction.

Lets look at some numbers. I need a minimum of $1000 to open a Roth IRA. I have until April 15th to contribute for 2007. In debt repayment mode I think, Wait. Every dollar must go to debt. But how much is that really saving me? My highest interest rate card has an APR of 19.99%. Yuck, right? To super simplify things that $1000 will cost me about $200over the course of a year if I set myself back by opening up this IRA rather than paying off debt. However, how much will that $1000 be worth in 40 years?

In 40 years my $1000 Roth IRA contribution will be worth:

• $10,975.34 @ 6%
• $24,326.11 @ 8%
• $53,846.14 @ 10%
• $119,032.56 @ 12%
• $262,789.60 @ 14%
  

Ok, so expecting more than 10% is not wise, but still this $1000 is a big deal. I will be out of debt next year. Whether its January 1 or February 15... I will be out of debt. But this is my last chance to contribute to my 2007 Roth. Should I do it?