Why Do I Need a Retirement Account?
Here, recently, I was speaking at a conference for entrepreneurs. After I got off stage, I ended up having a conversation with one of the speakers. He listened to my presentation where I was talking about 401Ks and IRAs for entrepreneurs, and he asked me, "Why should I get a 401K, or an IRA, set up?I've got money in my bank account. What's the difference between having money in my bank account versus having money in these retirement accounts that you talk about?"
Well, that's a legitimate question, because a lot of entrepreneurs, like this gentleman I'm talking about, are super successful in their own right. But when it comes to retirement accounts, and saving money on taxes, and maximizing their finances, it's an area that is not talked about. We don't learn this kind of stuff in school, right? So, Quest Education comes into play, and this is our space.
This is what we do. We teach business owners about their money. So I got to answering his question, and I helped him understand that we need to set money aside in retirement accounts for two reasons. Number one, we need to maximize our tax benefits. Right? You've got inflation, you've got the cost of living that's eating away at our money.
So to combat inflation and the cost of living, we've got to maximize the tax game, and we've got to maximize compound interest. If you can really understand the tax code, and get the tax game working for you and get compound interest playing in your favor, you're going to be able to save a lot of money over the years.
You're going to be able to retire when you want to retire and feel really, really good about your financial situation. So, back to the question that I answered for this gentleman. I helped him understand that there's three buckets when it comes to your money. So, the first bucket, let's call it your bank account money, your bank account bucket. That's money in checking and savings. That's money that gets zero tax benefit. Second bucket of money is going to be an IRA or a 401K on a pre-tax basis, a tax deferral basis.
Best example is, you probably had a 401K with one of your jobs. You put money in that 401K and they gave you a tax benefit upfront. Let's just say you put in $10,000 in a 401K one year, that $10,000 is a tax write-off that year. It's tax deductible, 100%. So that's going to bring down your tax bill and save you immediate money upfront. What it's also going to do, it's going to kick the can down the road.
So down the road, when you retire and take money out of the account, you're going to have to pay taxes on those dollars. But in the meantime, your account has more money to work with. There's more dollars in the account because you haven't paid taxes, and if there's more money in the account, then compound interest comes into play. Compound interest is huge.
Albert Einstein calls compound interest the eighth wonder of the world, because the more money you can have in the account, it's like a snowball. If you're making 8-10% a year on $100,000 versus $8-10,000 a year on $500,000, right, it's that snowball effect. It grows, it compounds. That's huge.
You want to have compound interest work for you, and if you can eliminate the need to pay the taxes upfront, that's just going to have more money in the account working in your favor. The third bucket of money is going to be the Roth account. You can have a Roth 401K, just like you can have a Roth IRA. Roth just means post-tax, and it works opposite in the pre-tax basis.
So the third bucket of money is the Roth. It works in an opposite manner as the second bucket of money, meaning money you put in the Roth bucket, you don't get that immediate tax write-off. Right. So that same $10,000 you put into your Roth account, you don't get that write-off that year. It's not a tax deduction, so it doesn't help you upfront. Where it helps you is down the road.
That $10,000, let's just say it grows to $100,000 over 5 or 10 years, it becomes tax free. You never have to pay taxes on those gains. You think about, you saved tons of money on the taxes, plus you've got compound interest that comes into play, so bucket two and bucket three, they have their advantages.
It gives you huge tax benefits. You don't get those tax benefits on the first bucket of money, your bank account. If you had $100,000 in your bank account, and it was invested in a CD, or invested in a mutual fund, and it was making you five percent a year, you get zero tax benefits, but if you had that same investment in your pre-tax IRA, or your Roth IRA, you'd get tons of tax benefits.
So personally, I think it's a good idea to have six months worth of your bills in your bank account, just for an emergency basis. Have enough money for a rainy day, but after that, start having money go into your 401K, or IRA. Take advantage of the Roth accounts.
If you have a 401K or IRA already, keep putting money into that account. Keep having those tax benefits come your way. Keep having that compound interest come into play. If you don't have a retirement account, start thinking about setting one up. It's never too late to start putting money away so you can have a solid future. I'm Daniel Blue, owner of Quest Education.
I've got a whole team that's here to assist you. If you have any questions, reach out to us. We're here to help you.