Middle Aged Money Mistakes

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Keep in mind that the beneficiary of your loan is likely sitting on a bean bag chair eating a microwaved burrito right now. Absolutely, help your kids as best you can, but remember, there’s no loan to pay for retirement, so that plan has to be squared away first.

Something else to consider: the current interest rate on Direct PLUS loans is a fixed 6.41%. If parents were to take out a PLUS loan for $25,000, and repay it over the course of 10 years, mom and dad would end up paying nearly $300 a month, making the original $25,000 loan cost nearly $34,000 at the end of ten years.

If, however, they instead put that $300 a month into a Roth IRA for 10 years at 7% interest, they would have over $53,000 saved for retirement. When it comes to interest rates and time, the magic of compounding can work either for you or against you.

And that leads me to my final tip for our more seasoned listeners: The tax man cometh.

Unless you have a Roth IRA or Roth 401(k) retirement plan, there’s someone else with a vested interest in your retirement plan—the I.R.S. With a Traditional IRA or 401(k), your contributions are pre-tax and your earnings are tax deferred. That means you don’t pay any taxes until you take the money out. The I.R.S. is eagerly awaiting your withdrawals from your retirement plan because it’s a payday for them too. Many people assume they’ll be in a lower tax bracket when they retire, but this may or may not be the case. It’s a situation of “Pay the piper now or pay the piper later,” but no matter which way you slice it, Uncle Sam’s gonna blow that horn. Roth IRAs and Roth 401(k) plans are no-brainers for young people because the earnings on their contributions have decades to grow tax-free. It gets a little trickier for the older set, especially if there are numerous financial obligations like a mortgage and kids’ tuition fees. Deferring earnings with a Traditional 401(k) plan keeps this year’s tax bill lower.

Consider this: In the 1970s, the top marginal tax bracket was 70%, and in the early 80s, it dropped to 50%. Today, the top marginal tax bracket for earned income is 39.6%. Who knows what tax rates will be 30 years from now. But if they head back up, we may regret not having invested in the Roth 401(k) versus the Traditional 401(k).

Mellody is President of Ariel Investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts.  Additionally, she is a regular financial contributor and analyst for CBS News.

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