401(k) vs. Roth 401(k): Which One Is Better?

401(k) vs. Roth 401(k): Which One Is Better?

Chris Hogan explaining the difference between traditional 401(k) vs Roth 401(k).

11 MINUTE READ

If you’ve heard of a Roth 401(k), you may be wondering how different it really is from a traditional 401(k). I get it, 401(k)s can be confusing! While these two types of 401(k) accounts have some similarities, they also have some pretty huge differences.

Trust me, if you want to make the most of your retirement savings, you need to understand those differences and how they affect you. So I’m going to break it down for you, question by question. This is your future we’re talking about, so that’s why understanding the difference between a traditional 401(k) and Roth 401(k) is important.

Access to a Roth 401(k) is becoming more and more common, so you’re in the majority if you have this option at work. Over half of companies who offer some type of retirement savings plan offer a Roth 401(k). The bigger the company, the more likely it is you can contribute to a Roth 401(k).

And guess what? Savers (no surprises here!) are taking advantage of this new option. Among workers who know about the Roth 401(k) and are offered it by their workplace, around six in 10 choose to contribute to it.

If you can contribute to a Roth 401(k) and a traditional 401(k) at work, which one should you choose? I know which one I would pick, but let’s dig into some of the differences between these options so you can make the best decision.

 

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What is a Roth 401(k)?

The Roth 401(k) is a type of retirement savings plan that allows you to make contributions after taxes have been taken out. Then, you receive tax-free withdrawals when you retire.

The Roth 401(k) was introduced in 2006 and was designed to combine features from the traditional 401(k) and the Roth IRA. With a Roth 401(k) you can take advantage of the company match on your contributions, if your employer offers one, just like a traditional 401(k). And the Roth component of a Roth 401(k) gives you the benefit of tax-free withdrawals.

What Are the Similarities Between a Traditional 401(k) and a Roth 401(k)?

Let’s start with what a traditional 401(k) and a Roth 401(k) have in common.

First, these are both workplace retirement savings options. With either type of 401(k) plan, you can enjoy the convenience of having the contribution drafted out of your paycheck.

Second, both a traditional 401(k) and a Roth 401(k) have the ability to include a company match. Nearly 80% of companies who offer a 401(k) or similar product offer a match on employee contributions.3 If you work at a place that offers a match, take it. Your employer is giving you free money!

Third, both types have the same contribution limit. In 2018, the contribution limit is $18,500 per year or $24,500 if you’re over 50. The opportunity to invest that much every year is a huge perk of traditional and Roth 401(k)s, especially when compared to the Roth IRA’s contribution limit of $5,500 per year.

The Roth 401(k) includes some of the best features of a 401(k)—convenient contribution methods and the possibility of a company match if your employer offers one. But that’s where their similarities end. Let’s dig into the distinct differences between these two retirement savings options.

401(k) vs. Roth 401(k): How are They Different?

The biggest difference between a traditional 401(k) and a Roth 401(k) is how the money you contribute is taxed. I know taxes can be confusing (not to mention a pain to pay!), so let’s start with a simple definition and then we’ll dive into the details.

A Roth 401(k) is a post-tax retirement savings account. That means your contributions have already been taxed before they enter your Roth 401(k) account.

On the other hand, a traditional 401(k) is a pretax savings account. When you invest in a traditional 401(k), your contributions go in before they’re taxed, which makes your taxable income lower.

Traditional 401(k) vs. Roth 401(k) Contributions Traditional 401(k) vs. Roth 401(k) Withdrawals Traditional 401(k) vs. Roth 401(k) Access

Contributions

How do those definitions play out when it comes to your retirement savings? Let’s start with your contributions.

With a Roth 401(k), your money goes in after-tax. That means you’re paying taxes now and taking home a little less in your paycheck.

When you contribute to a traditional 401(k), your contributions are pretax. They’re taken off the top of your gross earnings before your paycheck is taxed.

You may be wondering why anyone would contribute to a Roth 401(k) if it means paying taxes now. If you only look at the contributions, that’s a fair question. But hang with me. The huge benefit of a Roth 401(k) is what happens when you start withdrawing money in retirement.

Withdrawals in Retirement

The biggest benefit of the Roth 401(k) is this: Because you already paid taxes on your contributions, the withdrawals you make in retirement are tax-free. Any employer match in your Roth 401(k) will still be taxable in retirement, but the money you put in—and its growth!—is all yours. No taxes will be taken out when you use that money in retirement.

How is Your 401(k) Taxed in Retirement?

By contrast, if you have a traditional 401(k), you’ll have to pay taxes on the amount you withdraw based on your current tax rate at retirement.

Here’s what that means: Let’s say you have $1 million in your nest egg when you retire. That’s a pretty nice stash! If you’ve got it in invested in a Roth 401(k), that $1 million is yours.

If $1 million is in a traditional 401(k), you’ll pay taxes on your withdrawals in retirement. If you’re in the 22% tax bracket, that would mean $220,000 of that $1 million is going to taxes. That’s a hard pill to swallow, especially after you’ve worked so hard to build your nest egg!

It goes without saying that your nest egg will last longer if you’re not paying taxes on your withdrawals. That’s a great feature of the Roth 401(k)—and a Roth IRA too for that matter.

Access

Another slight difference between a Roth 401(k) and a traditional 401(k) is your access to the money. In a traditional 401(k), you can start receiving distributions at age 59 1/2. With a Roth 401(k), you can start withdrawing money without penalty at the same age, but you also must have held the account for five years.

If you’re still decades away from retirement, you don’t have anything to worry about! But if you’re approaching the 59 1/2 year mark and thinking about starting a Roth 401(k), it’s important to be aware that you won’t have access to the money for five years.

Why I Recommend the Roth 401(k)

If you’re investing consistently every month—whether it’s in a Roth 401(k), a traditional 401(k) or even a Roth IRA—you’re already on the right track! The most important part of wealth building is consistent saving every month, no matter what the market is doing.

But if I’m choosing between a traditional 401(k) and a Roth 401(k), I’d go with the Roth 401(k) every time! We’ve already talked through the differences between these two types of accounts, so you’re probably already seeing the benefits. But just to be clear, here are the biggest reasons the Roth 401(k) comes out on top.

Tax Benefit

It may be tempting to delay paying taxes so you can get slightly more in your paycheck now. I get that. But think about it this way: You’re already doing the hard work of saving for retirement. If you can get that money to go even further, wouldn’t you want to take advantage of that opportunity? I don’t know about you, but I want to make that money go as far as I can.

Here’s another thing to consider: No one can know how the tax brackets or tax percentages will change in the future, especially if you’re still decades away from retirement. Do you want to take that risk? I don’t.

Emotional Toll

Like it or not, it’s hard to separate emotions from investing. Imagine getting to your retirement years and watching your $1 million-dollar nest egg reduced to less than $800,000 because of taxes! I don’t know about you, but I’d much rather pay taxes now than see all that money fly out of my hands later. I’m going to miss $100,000 a lot more than I miss a $100 on a paycheck now.

I promise, if you can get into the habit of contributing 15% of every paycheck to your Roth 401(k) early on, you won’t even miss the money you’re paying in taxes. And when you get the retirement, you’ll be glad you don’t owe the government part of your hard-earned nest egg.

Who Is Eligible for a Roth 401(k)?

If your employer offers it, you’re eligible. Unlike a Roth IRA, a Roth 401(k) has no income limits. That’s a fantastic feature of the Roth 401(k). No matter how much money you earn, you can contribute to a Roth 401(k).

If you don’t have access to a Roth 401(k) at work, you can still take advantage of the Roth benefits by working with your investing pro to open a Roth IRA. Just keep in mind that income limits do apply when you contribute to a Roth IRA.

What Are Roth 401(k) Contribution Limits?

For 2018, the 401(k) contribution limit is $18,500. This contribution limit applies to any 401(k) contributions, whether they are in a Roth 401(k) or a traditional 401(k). That means if you’re contributing to both, the combined total of your contributions can’t exceed $18,500.4

If you’re 50 or above, the contribution limit increases to $24,500.

How Much Should I Invest in a Roth 401(k)?

I recommend investing 15% of your income into retirement savings. If you have a Roth 401(k) at work with good mutual fund options, you can invest your entire 15% there. Let’s say you make $60,000 a year. That means you would invest $750 a month in your Roth 401(k). See? Investing for the future is easier than you thought!

What Kinds of Mutual Funds Should I Choose for My Roth 401(k)?

Diversifying your portfolio is key to maintaining a healthy amount of risk in your retirement savings. That’s why I recommend balancing your investment among four types of mutual funds: growth and income, growth, aggressive growth, and international funds.

If one type of fund isn’t performing as well, the other ones can help your portfolio stay balanced. Not sure which funds to select based on your Roth 401(k) options? Sit down with an investing pro. They’ll be able to help you understand the different types of funds, so you can choose the right mix.

Should I Roll Over My Traditional 401(k) to a Roth 401(k)?

There isn’t a one size fits all answer when it comes to rolling over your retirement savings to a Roth account. If it makes sense for your situation, it’s a great way to take advantage of tax-free growth on your accounts. But keep in mind that rolling over a traditional 401(k) means paying taxes on it now. If you’re rolling over $100,000 and you’re in the 22% tax bracket, that means you have to come up with $22,000 cash to cover the taxes. I don’t want you to pull that money out of the investment itself!

If you can pay cash for the taxes without taking money out of your nest egg and you’re still several years away from retirement, it may make sense to roll it over. But before you roll over accounts, make sure to sit down with an experienced investing professional. They’ll help you understand the tax impact of rolling over your 401(k) and how you can be prepared for it.

Who Can Help Me Make Decisions About a Roth 401(k)?

If you want to learn more about your Roth 401(k) or other investing options, find an investing pro in your area. A financial advisor can help you understand your investments and make confident decisions.

A do-it-yourself approach to investing is never a good idea. I know all about investing, and even I work with a financial advisor! Your family’s future is too important to wing it.

Looking for a qualified investing pro? Try the SmartVestor program! It’s a free way to find top-rated financial advisors near you. Start building a relationship with an investing pro who understands the financial journey you’re on.

What is a Solo 401(k)?

What is a Solo 401(k)?

Solo 401(k) written over a desk workspace.

9 MINUTE READ

You’re living the dream of working for yourself—hats off to you! There are so many benefits of having your own business. You get to set your own schedule, you get to set the rules . . . after all, you’re the boss!

On the other hand, there are some downsides—like not having access to an employer-backed retirement plan such as a 401(k). And since the most popular investing vehicle to becoming an everyday millionaire is—you guessed it—the 401(k), that probably has you wondering what is available to you, because—as a business owner—you know the importance of planning ahead.

That just means it’s up to you to make sure you’re taking steps to secure your retirement future, because no one else is going to do it for you! So, where does that leave you? Hang tight—the good news is that you do have options when it comes to planning for your retirement as a self-employed go-getter. Let me introduce you to one of those options: the solo 401(k).

What Is a Solo 401(k)?

Don’t worry, this isn’t a trick question. A solo 401(k) is an individual—hence the word solo— 401(k) created for business owners that do not have employees. And that’s a key distinction.

 

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You’ve got a couple options when it comes to choosing the solo 401(k) that’s right for you.

Traditional 401(k): Contributions are made pre-tax—this reduces your taxable income for the current tax year. But you’ll have to pay taxes on any money you take out of the account in retirement.

Roth 401(k): Contributions are made with after-tax dollars—this doesn’t reduce your taxable income for the current tax year, but you’re able to enjoy tax-free growth and tax-free withdrawals in retirement. Now that’s a win-win! If you have a chance to go with a Roth option, take it.

You probably know that a lot of companies that do have employees offer 401(k) plans like this that allow them to build their retirement nest eggs directly from their paychecks. Some companies will also match their employees’ contributions.

Now, with a solo 401(k), you—as the business owner—can make contributions both as an employee and as an employer. This allows you to maximize your contributions to your retirement account and also make deductions on your tax return.

Who Is Eligible for a Solo 401(k)?

While there are no age or income restrictions to participate in a solo 401(k), the main qualifier is that you must be a business owner with no employees. Uncle Sam is pretty strict on this. You can’t have any employees if you want to be eligible for the solo 401(k).

There is one exception: If you’re married and your spouse also works in the business, there’s a provision that allows your spouse to also receive contributions from the business at the same percentage. We’ll dive more into that in a minute.

More on that later!

What Are the Tax Benefits of a Solo 401(k)?

Listen to me, just because you’re not at a big company with a fancy retirement plan doesn’t mean you can’t save for retirement. In fact, there are several perks to going the solo 401(k) route! One great thing is that there’s flexibility with when you choose to pay taxes on your contributions. With a solo 401(k) all of the contributions you make as the employer are tax deductible for your business.

And for contributions you make as an employee in your business, it can go one of two ways. If you go with the traditional solo 401(k), these contributions reduce your personal taxable income for the current tax year and grow tax-free until you start taking distributions at retirement age—then the distributions will be taxed as regular income.

The other option is the Roth solo 401(k). While there’s no upfront tax break, it does allow you to enjoy your distributions tax-free. Again, if you’ve got the option, a Roth solo 401(k) is the way to go!

Just remember that if you decide to tap into your account before retirement age—regardless of whether it’s Roth or traditional—you’ll have to pay any penalties and taxes for doing so before age 59 1/2. Don’t do it!

How Much Can I Contribute to a Solo 401(k)?

Think of it this way—when it comes to your business, you’re essentially two people: the employer and the employee. That means you’re able to contribute to your retirement plan in two different ways.

There’s a total $57,000 contribution cap for 2020, with limits also applying to each role you play.

You—the employee—can contribute up to $19,500 in 2020. On top of that, if you’re 50 or older you can take advantage of an additional $6,500 catch-up contribution. Yeah, baby!

You—the employer—have the option to contribute an additional profit-sharing contribution up to 25% of what you’re compensated (or your net self-employment income) up to that $57,000 cap for 2020.1 And just to keep it interesting, the IRS added one more rule: When you calculate your contribution percentage, the max amount of compensation you can use is $285,000 for the 2020 tax year.

For example, let’s say you’re a 52-year-old business owner and earned $65,000 in 2020. You contribute the $19,500 “employee” maximum for the year plus the $6,500 in catch-up contributions to your solo 401(k) plan. As the employer, you also contribute 25% of your compensation, which comes out to be $16,250 ($65,000 x 25%). The total contributions you made to the plan for 2020 were $42,250 ($16,250 + $19,500 + $6,500). This is the most you can contribute to your plan for 2020.

Now, if your business is a side hustle and you still work for a company, keep in mind that your employee 401(k) limit applies to you as a person, not to each plan. That means if you’re also participating in a 401(k) at your regular job, the limit applies to contributions across all retirement plans that you’re contributing to—so $57,000 is still your cap.

Can a Solo 401(k) Cover a Spouse?

Yes! The IRS allows one exception to the no-employees rule on the solo 401(k). Your spouse is eligible to contribute to the same plan if he or she earns income from your business.

This is great news because you have the potential to double what you’re saving. Your spouse can contribute to the plan up to the $19,500 employee contribution limit, and—if they’re in the 50 and older category—they can add in the catch-up amount.

As the employer, you can then add the additional profit-sharing contribution for your spouse—up to 25% of compensation.

Are There Any Alternatives to the Solo 401(k)?

The solo 401(k) is not your only option. There are a few other retirement plans out there that may work better for you. You also have some options in addition to your solo 401(k) to help you save even more for retirement. The bottom line? You’ve got choices, people!

The other retirement plan options for business owners include:

Simplified Employee Pension Plan (SEP)

A SEP plan allows you—the employer—to contribute to traditional IRAs (SEP-IRAs) that are set up for your employees. It doesn’t matter how many employees you have (or don’t have) to be eligible to set up a SEP.2

Traditional Individual Retirement Accounts (IRA)

With a traditional IRA, you’re able to save for retirement with some pretty sweet tax advantages. The contributions you make to a traditional IRA have the potential to be fully or partially tax deductible. Plus, these contributions aren’t typically taxed until you start taking out distributions at retirement age.3

Roth IRA

I’m just going to go ahead and say that I love the Roth IRA! It’s an IRA that has a few different rules than the traditional IRA.

  • Contributions to a Roth IRA are not tax deductible
  • If you meet certain requirements, some distributions are tax-free
  • You’re able to contribute to your Roth IRA after you hit 70 1/2
  • As long as you’re alive, you can leave your money in the Roth IRA4

Also, keep in mind—for the 2020 tax year—your total contributions to all of your traditional and Roth IRAs can’t exceed either of the following:

  • Either $6,000 ($7,000 if you’re 50+)
  • Your taxable income for the year (if it was less than the limit)

Of course, this list doesn’t cover everything. There may be other types of retirement plans that work better for you. Either way, I would strongly encourage you to connect with an investment professional to help walk you through your options.

How Do I Open a Solo 401(k)?

Got an employer identification number? Good, because that’s all you need in order to open a solo 401(k). Typically, these are set up with an investment broker. They’ll provide you with a plan adoption agreement and an account application to complete. After that you can set up your contributions.

If you plan to make contributions this year, make sure your plan is set up and ready to go by December 31 and make your employee contribution by the end of the calendar year. If you want to make your employer contributions, you can typically do so until the tax-filing deadline for the tax year.

Find a SmartVestor Pro!

As a business owner, you’re no stranger to getting scrappy and figuring things out on your own. But when it comes to something as important as investing, don’t go it alone. I’d encourage you to reach out to an investment professional who can help you with your financial goals. I don’t make any big financial decisions without talking to an advisor, and neither should you.

Find a SmartVestor Pro in your area!

About Chris Hogan

Chris Hogan is a #1 national bestselling author, dynamic speaker, and financial expert. For more than a decade, Hogan has served at Ramsey Solutions, spreading a message of hope to audiences across the country as a financial coach and Ramsey Personality. Hogan challenges and equips people to take control of their money and reach their financial goals through national TV appearances, The Chris Hogan Show, and live events across the nation. His second book, Everyday Millionaires: How Ordinary People Built Extraordinary Wealth—and How You Can Too, is based on the largest study of net-worth millionaires ever conducted. You can follow Hogan on Twitter and Instagram at @ChrisHogan360, and online at chrishogan360.com or facebook.com/chrishogan360.

Your Age, Your Money: How to Spend, Save and Invest Right Now

Your Age, Your Money: How to Spend, Save and Invest Right Now

4 MINUTE READ

I say it all the time: Anyone can retire a millionaire.

It just takes discipline and attention to a few commonsense concepts like living on a budget, paying down debt, and saving like crazy.

But what does that actually look like in your 20s, 40s or even 60s? Here’s my list of the best money moves to make at every age. And if you feel a little behind in the game, use it as fuel to work harder and smarter to get to where you want to be. It’s never too late.

20s — Build a Solid Foundation

  • Newly married or about to be? Go ahead and get on the same page about money. Good communication now will pay off in spades later.
  • Avoid debt. That means no credit cards, car payments or financed furniture.
  • If you have student loans, pay them off ASAP! Sallie Mae is not your bestie.
  • Buy good medical insurance. A single hospital stay can bankrupt you in a heartbeat.

Related: 2 Words That Will Change the Way You Shop

30s — Shift to a Family Focus

  • If you’re having kids soon, rework your budget for diapers, daycare, cribs and car seats. You’ll have a little less money, but you’ll have a whole lot more love.
  • Buy enough term life insurance to cover your family should anything happen to you or your spouse. We recommend getting 10 times your income. Learn why and get a free instant quote.
  • Build up your emergency fund to three to six months of expenses. Sooner or later, you’re going to need it.
  • With children in the picture, you may be thinking about home ownership. Just make sure you can put 10–20% down at a 15-year fixed interest rate. (And keep your house payment to less than 25% of your take-home pay.)

Related: 3 Ways Managing Money Changes in Your 30s

40s — Shovel the Savings

  • You’re at the top of your career, and your kids are finally out of daycare (or at least out of diapers). That means a little more money in the bank to invest. Go with a good growth stock mutual fund, and be sure you’re contributing 15% of your household income toward retirement.
  • Ramp up the kids’ college funds only after you’ve secured your own future. Your kids can get scholarships, but nobody gives scholarships for the retirement years.
  • Keep your home well maintained to avoid paying huge repair bills down the road.

Related: Retirement isn’t an age . . . it’s a financial number. Find out what your number is by using Chris Hogan’s free R:IQ assessment tool.

 

Be confident about your retirement. Find an investing pro in your area today.

50s — Look Forward but Stay Focused

  • You’re starting to look forward to a life without that daily commute. It’s okay to be excited. But don’t cash in your retirement savings just yet—keep investing a full 15%.
  • Now’s the time to pay off your mortgage. With the kids out of the house, maybe you can even downsize and pay cash for your next place.
  • If you have some spare change, you may want to invest in rental real estate for some extra income.

Related: Need help? Talk with a financial advisor in your area.

60+ — Enjoy the Fruits of Your Labor

  • It’s time to retire. But that doesn’t mean sitting on your couch all day watching documentaries. Be proactive and tweak your budget. And find ways to stay active!
  • The day you turn 60, buy long-term care insurance. A few years of long-term care can deplete your entire life savings. So prepare for this possibility now.
  • Enjoy yourself! Without a house payment or a growing family to support, you can focus on fun: Travel abroad, visit the grandkids, and give generously to your community.

Winning with money is a marathon, not a sprint. It takes hard work over the long haul. So set your goals, stay focused, and keep moving forward. Your million-dollar payday awaits!

 

About Chris Hogan

 

 

Chris Hogan is the #1 national best-selling author of Retire Inspired: It’s Not an Age. It’s a Financial Number and host of the Retire Inspired Podcast. A popular and dynamic speaker on the topics of personal finance, retirement and leadership, Hogan helps people across the country develop successful strategies to manage their money in both their personal lives and businesses. You can follow Hogan on Twitter and Instagram at @ChrisHogan360 and online at chrishogan360.com or facebook.com/chrishogan360.

 

Start Saving for Retirement Today, Not Tomorrow!

Retirement is a financial number. It’s all about saving enough to live the retirement you want. The earlier you start, the quicker you’ll get there. Start saving now!

  1. 1) Start with a firm financial foundation.

    Dave recommends that you begin investing for retirement after you’ve done two things: paid off all debt but the house and saved up three to six months of expenses.

  2. 2) Determine how much you need to save for retirement.

    Retirement isn’t an age. It’s a financial number. It’s the amount of money you’ll need to enjoy the kind of retirement you want. Plan how much you need to save for retirement by determining your Retire Inspired Quotient (R:IQ).

  3. 3) Follow a simple investing plan.

    Invest 15% of your gross income into pretax retirement accounts and Roth IRA. Put your retirement money in mutual funds with a great track record. Read more about specific funds here.

  4. 4) Treat retirement investments as a marathon, not a sprint.

    The longer you keep your retirement money invested, the more it can grow with the magic of compound interest. When you’re choosing retirement funds, it’s a great idea to work with an investing expert endorsed by Dave. Find a SmartVestor Pro in your area!

    For further information contact an advisor in your local area.

     

Do You Have the Right IRA for Your Retirement?

Do You Have the Right IRA for Your Retirement?

4 MINUTE READ

Dave has always been a fan of Roth IRAs for retirement investing (combined with a workplace retirement plan when it’s available). The tax-free benefits are just too good to turn down for most people. But it’s a good idea to know the differences between a Roth IRA and a traditional IRA and the few occasions when a traditional IRA can be a better choice.

Traditional vs. Roth: What Do They Have in Common?

First, let’s talk about how the two are alike.

traditional and roth IRA similarties

So far, IRAs probably don’t look like anything special. But we haven’t gotten to the good stuff yet.

Traditional vs. Roth: What Makes Them Different?

traditional vs. roth IRA differencces

Roth IRA Tax Benefits for (Nearly) Everyone

Make sure you catch that last difference, because it’s a big one. When you retire, the money you withdraw from a traditional IRA is taxable while the money you withdraw from a Roth IRA is tax-free.

A study by T. Rowe Price showed that the benefits of that tax-free retirement income make a Roth IRA a better choice for nearly everyone investing for retirement. “Even though the Roth IRA contribution doesn’t qualify for an income tax deduction, decades of compounding tax-free money can generate more spendable income in retirement,” the study concluded.(1)

 

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For example, a 30-year-old investor whose income tax rate drops by 5% in retirement will still have 9% more spendable retirement income by using a Roth IRA rather than a traditional IRA. If his rate remains the same, as is the case with most retirees, he’ll have 17% more non-taxable income. Investors age 50 or older who experience a 6–10% drop in their tax rate could, however, be better off with a traditional IRA. “For investors nearing retirement, there isn’t enough time for the money to compound at a rate to counter the significant reduction in their tax bracket during retirement,” the study explained.

Talk through the pros and cons of each type of IRA with your investing professional so you can make the right choice for your situation.

Conversion Considerations

Anyone with a traditional IRA can convert it to a Roth IRA regardless of income or marital status. Converting isn’t complicated, but there’s one big factor to consider: taxes. When you convert your account, you’ll owe taxes on the entire balance.

To make conversion worthwhile, you’ll need to cover that tax bill out-of-pocket. Do not use funds from the IRA itself to pay the taxes! You’ll reduce the amount that goes into your Roth IRA, and, if you’re younger than age 59 and a half, you’ll have to pay the 10% early withdrawal penalty as well. At the least, you’ll lose more than a third of your available retirement dollars.

retirement funds available after 30 years of growth

An investor in the 25% tax bracket converting a $30,000 traditional IRA to a Roth IRA will have a $7,500 tax bill. If he chooses to pay the taxes from the IRA itself, it will cost him $10,500. After 30 years of growth, that decision could end up costing him more than $180,000! Talk about missing some spendable income!

You can also roll any old 401(k)s into a Roth IRA as well, but the same deal applies. You’ll have to pay taxes on the amount of pre-tax money you roll over.

Talk With an Investing Pro

Consult an experienced investing professional who can help you decide if now is the right time to convert or roll over your retirement accounts to a Roth IRA. Your investing professional can also help you choose the best mutual funds so you can take advantage of all that tax-free growth!

With our SmartVestor program, you can find investing professionals who will partner with you as you make important decisions about your retirement plan. Interview as many as you want to find the right pro for you! Find an investing pro today!

Roth IRA 101

Roth IRA 101

A Roth IRA notebook in a backpack.

10 MINUTE READ

In the world of retirement investing options, there’s one savings plan that stands out head and shoulders above the rest. It’s easy to set up, simple to maintain, and comes with tax advantages that enable you to build wealth and increase your retirement savings for the long haul.

That’s right—I’m talking about a Roth IRA.

Maybe you’ve heard about these retirement savings accounts, but you haven’t had time to discover if they’re a good option for you. I’m going to answer the most common questions about Roth IRAs and show you how this investing account can turbocharge your wealth building over time.

1. What Is a Roth IRA?

A Roth IRA (Individual Retirement Account) is a retirement savings account that allows you to pay taxes on the money you put into it up front. The growth in your Roth IRA and any withdrawals you make after age 59 1/2 are tax-free, as long as you’ve had the account more than five years.

Because you pay taxes on the front end with a Roth IRA, you don’t owe them in retirement.

If you want to contribute to a Roth IRA, you must open and maintain it outside of your employer-sponsored retirement savings plan.

 

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2. What Are the Benefits of a Roth IRA?

The Roth IRA has some serious benefits.

Let’s start with the tax impact. When you make contributions post-tax, that means you’ve already paid taxes on the money you set aside for retirement. That helps your retirement savings go a lot further! Here’s why:

  1. The money you invest in your Roth IRA grows tax-free.
  2. You won’t owe taxes when you withdraw your money in retirement.

So, if your account grows by hundreds of thousands of dollars over time, you won’t owe taxes when you withdraw that money in retirement! That’s a huge perk, especially for folks who expect to be in a higher tax bracket when they retire. Talk about a win!

Here are a few more benefits of a Roth IRA:

  • You’re not required to take distributions at a certain age, unlike the traditional IRA (which requires withdrawals beginning at age 70 1/2).
  • You can keep contributing to your Roth IRA if you choose to work past retirement age, as long as your income still falls within the income limits.
  • You can choose beneficiaries to inherit your account, and they will be able to withdraw funds tax-free as well.

3. Roth IRA vs. Traditional IRA: How Do They Compare?

That’s a great question. The main difference between a Roth IRA and a traditional IRA is how they are taxed. Take a look at a side-by-side comparison:

Traditional IRA Roth IRA
In most cases, contributions are tax deductible. Contributions are not tax deductible.
There are no annual income limits on contributions. In 2019, you can contribute up to the limit if your gross income is less than $122,000 for single filers and $193,000 for married couples filing jointly.
You must make annual withdrawals from your IRA after you turn 70 1/2. No withdrawals are required if you are the original owner.
You must pay taxes on withdrawals in retirement. You are not taxed on withdrawals in retirement.

4. Am I Eligible for a Roth IRA?

Do you earn income? Then, yes. You’re eligible. However, you can’t contribute more than you make. So, if your 19-year-old son or daughter earned an income of $3,000 waiting tables over the summer, they can only contribute up to $3,000 to a Roth IRA. It’s also okay for you to contribute the $3,000 on their behalf.1

Another perk: There are no age restrictions with Roth IRAs. As long as you’re earning income, you can contribute—even after age 70 1/2, unlike a traditional IRA.

5. What are the 2019 Contribution Limits?

For 2019, the total amount you can contribute to either a Roth IRA or a traditional IRA is $6,000—or $7,000 if you’re age 50 or older.2

6. Are there Income Restrictions?

You knew there had to be a catch! A Roth IRA offers some great tax benefits, but it’s not available for people with high incomes.

Income Restrictions If Single

According to the Internal Revenue Service, single tax filers must have a modified adjusted gross income (AGI) of less than $122,000 to contribute the maximum amount of $6,000 ($7,000 if age 50 or older) to a Roth IRA.3

What if you make more than $122,000? If your AGI is between $122,000 and $137,000, you can still contribute, but it must be a reduced amount. Once you’re making more than $137,000 as a single filer, you aren’t eligible to contribute to a Roth IRA.4

Income Restrictions If Married Filing Jointly

Married couples filing jointly must have a modified AGI of less than $193,000 to be able to contribute up to the limit for a Roth IRA. After that, you may qualify to make reduced contributions if your AGI is between $193,000 and $203,000.

If you have an AGI of $203,000 or higher, you’re not eligible to make Roth IRA contributions.5

If your filing status is… And your modified AGI is… Then you can contribute…
Married filing jointly or qualifying widow(er) Less than $193,000 Up to the limit
Between $193,000 and $203,000 A reduced amount
Greater than $203,000 Zero
Married filing separately and you lived with your spouse at any time during the year Less than $10,000 A reduced amount
Greater than $10,000 Zero
Single, head of household, or married filing separately and you did not live with your spouse at any time during the year Less than $122,000 Up to the limit
Between $122,000 and $137,000 A reduced amount
Greater than $137,000 Zero

If your income exceeds the eligibility limits, good for you—but bad for your ability to open a Roth IRA. You won’t be able to stash your cash in a Roth IRA, but a traditional IRA might be an option. Tax benefits for traditional IRAs have different eligibility requirements, so check with your investing pro to see if it’s a good choice for you.

If you’re self-employed, here’s another option: Establish a Simplified Employee Pension (SEP) plan. Or, if you run a small company, consider a simple IRA that will allow you and your employees to save for retirement.

7. Can I Set Up a Roth IRA for My Spouse Who Doesn’t Work?

Yes. If you file a joint income tax return and have a taxable income, you can both contribute to your own separate Roth IRAs. But the IRS income-eligibility limits still apply.

Let’s say 40-year-old John makes $150,000 and his wife, Kate, stays home with their kids. John and Kate can each contribute the maximum amount of $6,000 for a total of two accounts. However, if John makes $8,000 a year and contributes the max amount of $6,000 to his IRA, his nonworking spouse can only contribute $2,000 because they can’t contribute more than their earned income amount.

8. Is a Roth IRA the Same Thing as a Roth 401(k)?

No. But both accounts are taxed the same way. Adding the word Roth to the name of either savings plan means the money you contribute will be taxed up front, will grow tax-free, and can be withdrawn tax-free after age 59 1/2.

Roth 401(k) plans are sponsored by employers. If you receive an employer match on your Roth 401(k), the match is not tax-favored. That means the growth from your employer’s match will be taxed when you withdraw your funds in retirement.

You can contribute to both a Roth IRA and a Roth 401(k) at the same time. Remember, contribution limits will still apply to the Roth IRA.

9. How Do I Set Up a Roth IRA?

The best way to open a Roth IRA is with the help of an investing professional who will meet with you face-to-face. Before you meet with your investing pro, you’ll need to gather some information and fill out the application. Here’s what you should have on hand in order to open your account:

  • Your driver’s license or other form of photo identification
  • Your Social Security number
  • Your bank’s routing number and your checking or savings account number
  • Your employer’s name and address

As part of the process of opening a Roth IRA, you’ll also choose a beneficiary (or beneficiaries) who could inherit your account. You’ll need their name, Social Security number and date of birth.

Next, you can make your initial deposit and/or set up automatic contributions. You’ll be able to open your Roth IRA with a lump sum up to the annual limit. Or you may choose to deduct a specific amount from your bank account each month. You can actually do both as long as you don’t exceed the contribution limit for that year.

10. What Should My Roth IRA Be Invested In?

You can invest in almost anything through your Roth IRA, but we recommend mutual funds because they have the potential to help you build wealth over time—especially with a Roth IRA’s tax benefits.

Many mutual fund companies will allow you to start a Roth IRA with as little as $50, so there’s no need to put off opening your account until you have enough money to start investing.

11. How Do I Maintain My Roth IRA?

Once you choose the mutual funds for your Roth IRA, it’s important to stick with them for the long haul. Don’t get spooked when the market ebbs and flows. The value of your Roth IRA will rise and fall with the stock market, but over its lifetime, you should see a steady growth trend. Just continue making regular contributions and stick with it despite possible market changes.

Over 30 years, if you invest the annual max of $6,000 into a Roth IRA, it could grow to $1.3 million. The best part is, your contributions would only total $180,000, and the rest—$1.1 million—would be growth.

Those numbers can change depending on how much you invest, how long you have until retirement, and what you expect your annual return to be. You can use our investing calculator to customize those details for your own financial situation.

I’m Ready to Start! Now what?

Opening a Roth IRA is as easy as opening a checking account. The best way to get started is to contact an investing professional who can guide you through the set-up process.

If you don’t have a financial professional, reach out to a SmartVestor Pro in your area who is committed to educating and empowering you to make the best decisions possible for your retirement future.

How Women Can Plan for Their Retirement Future

RETIREMENT

How Women Can Plan for Their Retirement Future

A woman gardening in her gardening gloves.

9 MINUTE READ

I want to give a shout-out to all the women out there for a second—because there’s no doubt that women have been making serious strides in the marketplace lately.

Today, more women are getting college degrees than men, and women now make up half of the U.S. college-educated workforce.1 On top of that, the number of women in executive-level positions has grown from 17% in 2015 to 21% in 2019, while the number of women running Fortune 500 companies is at a record high.23

Those are some great reasons to celebrate! But when it comes to saving for retirement? Well, that’s a different story.

A recent study found that only 12% of women are very confident they’ll be able to retire comfortably. Meanwhile, more than half of women (55%) expect to retire after age 65 or don’t plan on retiring at all.4 That’s not okay!

Listen: This is your money and your financial future. It’s time to take charge and start taking some steps that’ll help you move closer to your retirement dreams. You can do this!

The Challenges Women Face When Planning for Retirement

There are a few unique challenges that women face as they start thinking about saving for retirement. Let’s take a look at the top three:

 

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Challenge #1: Women live longer than men.

The first is that they tend to live longer than men do, usually by an average of six to eight years.5 Sorry, fellas—that’s just a fact! That means women probably need to plan to have more money squared away for retirement to cover health expenses and to make sure their nest eggs don’t run dry.

Challenge #2: More women are caregivers.

More women also find themselves in a position of having to look after aging parents or family members who can no longer take care of themselves. Most caregivers tend to be women (60%), which can add a serious financial and emotional strain on them and their families.6

If you have parents who are getting older, it might be time to sit down and have a conversation about getting long-term care insurance in place. It’s not a fun conversation to have, but it’s so worth it.

Challenge #3: Women feel less comfortable investing.

According to the Federal Reserve, women are less comfortable managing their retirement investments and making investment decisions than men.7  And right now, only a fraction of American women (26%) are investing in the stock market.8

It’s no surprise, then, that 3 out of 4 women are at least somewhat worried about their financial future.9 So it’s safe to say there’s still some work to be done.

These challenges are real, but that doesn’t mean you can’t have the kind of retirement you’ve always dreamed about.

How Women Can Overcome These Retirement Challenges

There are three things I want you to do as you get ready to start thinking about your retirement future—I call it Hogan’s “Triple A” approach: assess, acknowledge and activate. Let’s walk through each step one by one.

First, you have to assess your situation. You’re going to have to be honest with yourself about where you stand when it comes to saving for retirement and how much you know about investments. Once you know where you stand, you can figure out how far you have to go.

Then you have to acknowledge that better is available. Whether you’re ahead of the curve, falling behind, or right on track, I want you to know that you have the power to improve your situation and secure your dream retirement.

And finally, you need to activate your plan of action that’ll help you get to where you want to go. After all, a dream without a plan is just a wish.

Here are some things you can do right now to start moving toward the retirement future you’ve always dreamed of. Whether you’re a woman or a man, young or old, this is advice that I give to everyone who wants to retire someday. Let’s do this!

1. Have a dream worth working toward.

Take a second to think about what you want your retirement to look like. Are you flying to places like Paris or Rome each year? Are you sitting on a beach somewhere with sand between your toes? Are you spending a bunch of time with your grandkids or volunteering around your community?

Whatever it is, you need to have a high-definition picture of what you want to do in your golden years. But you can’t stop there! That’s why my team and I created the Retire Inspired Quotient (R:IQ) tool. The R:IQ will help you figure out how much money you’ll need by the time you retire—and how much you’ll need to put into retirement savings each month—so you can have the kind of retirement you’ve always dreamed of. It is possible.

2. Get involved in the process.

Your financial future cannot be delegated. I don’t want you handing off investing decisions to your significant other or anyone else—that goes for both wives and husbands. You guys are a team, which means the both of you need to work together and get on the same page about this stuff.

If you’ve been hands-off when it comes to saving for retirement or anything else that involves your money, it’s time to get back in the game. “Whatever you want to do, honey” is no longer part of you or your husband’s vocabulary! The two of you need to be on the same page when it comes to retirement investing.

And for you single or newly single ladies out there, it’s just as important to work with an investment pro and have a trusted friend or family member in your corner. That way, you can stay engaged and focused on your retirement goals.

3. Learn everything you can about investments.

When I sit down with folks who are struggling with the idea of investing or retirement, I can usually trace it back to two things. The first is fear—they’re afraid of investing in the stock market or running out of money in retirement. And the second is a lack of knowledge—they just don’t know where to start. The two often go hand in hand, after all. We usually fear the unknown!

It’s time to face that fear head on. How do you do that? By arming yourself with knowledge. The more you learn about 401(k)s, Roth IRAs and mutual funds, the more confidently you can save for retirement.

You don’t have to be a math professor to get this stuff! Take the time to learn everything you can about investing and saving for retirement. Reach out to an investment professional who will sit down with you and teach you in plain English all about investing.

4. Know your investment options.

When you know what your investing options are and how they work, you’ll feel empowered to make the kind of financial decisions the “future you” will thank you for!

Once you’re debt-free and have an emergency fund in place, I recommend investing 15% of your gross income into tax-advantaged retirement accounts like your 401(k) at work and a Roth IRA. What if you’re a stay-at-home mom? You can open a spousal IRA, which works the same way as a regular IRA and lets working spouses put money into a retirement account for a nonworking spouse.

Is there an element of risk when it comes to investing? Yes, there’s some level of risk. But do you know what’s even more risky? Not saving for retirement at all. Despite all of the ups and downs of investing, the stock market’s historical average annual return is between 10–12%.10

When it comes to building wealth, slow and steady wins the race every single time. If you consistently put money into retirement savings month after month, year after year, you’ll end up with quite a nest egg for yourself. Don’t let fear keep you from investing!

5. Diversify your investments.

Now, what you don’t want to do is put all of your eggs in one basket. You’ve probably heard the word diversification thrown around when folks start talking about investing. Basically, that just means you’re spreading your money across different kinds of investments.

The first way to diversify your investments is to invest in growth stock mutual funds. Mutual funds let you own bits and pieces of many different companies—not just a single stock. On top of that, I recommend adding another level of diversification by including four different types of mutual funds in your investing portfolio: growth and income, growth, aggressive growth, and international. Boom! You’re diversified!

You’ll want to work with an investment professional you trust to help you choose funds with a proven track record—that means they’re consistently outperforming most other funds in their category over a long period of time, preferably 10 years or longer.

Get help from an investment professional

When you get the right information from the right people—folks you can trust—you can make the right decisions. That’s why I always recommend working with an investment professional who can guide you through your financial journey.

And listen to me: Don’t hesitate to ask questions. A good investment professional helps you get all the answers you need, and there’s no such thing as a dumb question. Remember, this is your hard-earned money—you want to make sure you’re working with someone who is on your side.

Our SmartVestor program can connect you with an investment professional who can sit down with you, answer your questions about investing, and help you start saving for retirement.

Find an investment professional today!

About Chris Hogan

Chris Hogan is a #1 national best-selling author, dynamic speaker and financial expert. For more than a decade, Hogan has served at Ramsey Solutions, spreading a message of hope to audiences across the country as a financial coach and Ramsey Personality. Hogan challenges and equips people to take control of their money and reach their financial goals, using The Chris Hogan Show, his national TV appearances, and live events across the nation. His second book, Everyday Millionaires: How Ordinary People Built Extraordinary Wealth—And How You Can Too is based on the largest study of millionaires ever conducted. You can follow Hogan on Twitter and Instagram at @ChrisHogan360 and online at chrishogan360.com or facebook.com/chrishogan360.

How to Roll Over an Old 401(k)

RETIREMENT

How to Roll Over an Old 401(k)

A rolling pin.

9 MINUTE READ

Back in the old days, it was pretty common for someone to work for the same company for 40 years before retiring with a nice pension and a gold watch. Well, those days are long gone.

A recent study found that the youngest baby boomers worked 12 different jobs over the course of their careers.1 Did you hear that? Twelve! And younger generations are even more likely to look for greener employment pastures. In fact, almost half (49%) of millennials say they would quit their jobs as soon as possible if they could.2

But in the process, many American workers are leaving behind a trail of forgotten 401(k)s, sometimes with thousands of dollars in retirement savings left behind!

There’s even a name for those retirement accounts that are left behind: “orphan” 401(k)s. Even the name is sad! It’s time to stop for a minute and think about giving the money in those long-forgotten accounts a new home.

That’s where rollovers come in.

What is a rollover?

A rollover simply allows you to transfer your retirement savings from one retirement account to another without having to pay any taxes on the money you’re rolling over.

The most common type of rollover is the 401(k) rollover, which lets you transfer money from a 401(k) you had at a previous job into an IRA or the 401(k) at a new job. This is the type of rollover we’re going to focus on.

 

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You could also transfer money from an IRA into a 401(k)—sometimes called a “reverse rollover”—but in most cases it’s not a good idea. That’s because you usually have less investing options in a workplace retirement plan than with an IRA.

What’s the difference between a direct rollover and an indirect rollover?

OK, once you decide to roll money from one account to another, you have two options on how to do the transfer: a direct rollover or an indirect rollover. Spoiler Alert: You always want to do the direct transfer. Here’s why.

With a direct rollover, the money in one retirement account—an old 401(k) you had in a previous job, for example—is transferred directly to another retirement account, like an IRA or the 401(k) at your new job. That way the owner of the account (that’s you) never touches it and you won’t have to pay any taxes or penalties on the money being transferred. Once it’s done, it’s done!

Indirect rollovers, on the other hand, are a bit more complicated—and needlessly risky. In an indirect rollover, instead of the money going straight into your new account, the cash goes to you first. Here’s the problem with that: You have only 60 days to deposit the funds into a new retirement plan. If not, then you’re going to get hit with withholding taxes and early withdrawal penalties.

Now you should see why the direct rollover is the only way to go. There’s just no reason to take a chance on an indirect rollover that leaves you open to heavy taxes and penalties. That’s just dumb with a capital “D”!  

I have an old 401(k) from a previous job. What are my options?

Great question! Let’s walk through this together. Let’s say you’re starting a new job and you’re wondering what to do with the money in a 401(k) you had at an old job. You have three options:

  • Option 1: Do nothing and leave the money in your old 401(k).

Now, you could just leave the money in your old 401(k) if you’re happy with the investments there and the fees are low. But that’s rarely the case. Most of the time, I recommend folks do a direct transfer rollover to your new 401(k) or an IRA.

  • Option 2: Roll the money into your new employer’s plan.

Rolling your money over to your new 401(k) plan has some benefits. First of all, it simplifies your life because your investments will be in one place. No more checking multiple accounts all the time! You’ll also have higher contribution limits with a 401(k) than you would with an IRA.

  • Option 3: Roll over the funds into an IRA.

Transferring the money into an IRA is probably your best option. That’s because an IRA gives you the most control over your investments. You see, your new 401(k) plan probably only has a handful of investing options to choose from, and if you’re feeling iffy about those options you might not want to put your money in there. An IRA, on the other hand, gives you potentially thousands of mutual funds to choose from!

Traditional or Roth: Which type of IRA should I roll my 401(k) money into?

Now, the type of rollover IRA you transfer your money into depends on what type of 401(k) you’re rolling over.

If you had a traditional 401(k), you can transfer the money into a traditional IRA without having to pay any taxes on it (you’ll pay taxes later when you take the money out in retirement, though). Likewise, if you had a Roth 401(k), you could roll the money into a Roth IRA completely tax-free. Easy, right? Traditional to traditional, tax-free. Roth to Roth, also tax-free.

Now, there is one other option we need to talk about: a Roth conversion. That happens when you roll over money from a traditional 401(k) into a Roth IRA. Here’s how it works: When you put money into your traditional 401(k), you used pre-tax dollars—that means it hasn’t been taxed yet. So when you transfer that pre-tax money into a Roth IRA, which is funded with after-tax dollars, you’ll have to pay taxes on that money now. That’s the bad news.

But the good news is that from now on, that money will grow inside your Roth IRA tax-free and you won’t pay any taxes on that money when you’re ready to withdraw from the account in retirement. A Roth conversion might feel like ripping off a Band-Aid now, but it’ll feel great once you retire.

You might want to seriously consider doing a Roth conversion only if you can afford to pay the tax bill with cash you have saved up. But be careful, because a conversion could add thousands of dollars to your tax bill. If that’s just too much for you to stomach, then stick with a traditional IRA rollover.

This is a big decision, and you don’t have to make it alone! Get in touch with a tax advisor who can help you understand the tax implications of a Roth conversion and help you decide which option might work best for you.

How do I roll over my old 401(k) into an IRA?

OK, now it’s time to get the ball rolling! Once you’re ready to do a 401(k) rollover, you can get the money transferred to your new retirement account in just four easy steps:

1. Decide between a traditional or Roth IRA.

Like we just talked about, the type of account you roll your old 401(k) money into will depend on what kind of 401(k) you’re transferring the money from. In most cases, if you have a traditional 401(k), you’ll probably want to roll the money into a traditional IRA.

2. Open the IRA account.

Opening a rollover IRA can be as simple as visiting a bank or brokerage firm’s website and filling out an application online. But the best way to start an IRA is to talk with your investment professional. If you don’t have one, our SmartVestor program can help you find a pro in your area who can help you open up a rollover IRA .

3. Request a direct transfer rollover from your old 401(k).

Remember, you need to ask for a direct transfer rollover from the plan administrator of your old 401(k)They will give you a form to fill out that will usually ask you to provide your information and account information for the plan you’re transferring money from and the account your transferring the money to.

4. Choose your investments.

When it comes to investing, your IRA or 401(k) is like a grocery bag—and your investments are the groceries that go inside it. Now that you’ve got the ball rolling on your rollover, it’s time to pick and choose what goes inside your bag!

I recommend investing 15% of your gross income for retirement into good growth stock mutual funds with a good track record of success. You’ll also want to evenly spread out your investments between four different types of mutual funds: growth, growth and income, aggressive growth, and international.

There are thousands of mutual funds out there to choose from, so how do you know which funds to invest in? That’s where it helps to work with an investment professional who can help you find the right mutual funds to add to your portfolio and walk you through the 401(k) rollover process. Our SmartVestor program can get you in touch with someone in your area to help you get started.

Find your SmartVestor Pro today!

About Chris Hogan

Chris Hogan is a #1 national bestselling author, dynamic speaker, and financial expert. For more than a decade, Hogan has served at Ramsey Solutions, spreading a message of hope to audiences across the country as a financial coach and Ramsey Personality. Hogan challenges and equips people to take control of their money and reach their financial goals through national TV appearances, The Chris Hogan Show, and live events across the nation. His second book, Everyday Millionaires: How Ordinary People Built Extraordinary Wealth—and How You Can Too, is based on the largest study of net-worth millionaires ever conducted. You can follow Hogan on Twitter and Instagram at @ChrisHogan360, and online at chrishogan360.com or facebook.com/chrishogan360.