Insight Personal Finance
Founder / Principal Planner
Christina Empedocles is an Artist, Design, Illustrator, and CERTIFIED FINANCIAL PLANNER™. Her mission is to understand the most pressing financial issues of hardworking, creative people. Over the last 10 years, she's talked to hundreds of artists and creative entrepreneurs about their money and learned the nuances of what can be a counter-intuitive business. With this insider perspective, she's developed specific tools to build financial stability while supporting wild aspirations.years she's talked to hundreds of artists and creative entrepreneurs about their money and learned the nuances of what can be a counter-intuitive business. With this insider perspective, she's developed specific tools to build financial stability while supporting wild aspirations.
Christina has a BA from Oberlin College, an MFA from California College of the Arts, and an Executive Certificate In Financial Planning from San Francisco State University. She loves learning and has found that her varied background and interests have given her a rich understanding of people, business, and real life. Her unending curiosity has become one of her sharpest tools as a financial planner.
For years Christina has focused on the specific needs of working artists and creative entrepreneurs, helping them to deal with the thorny issue of a fluctuating income. People think artists are bad with money — it's not true. After having hundreds of conversations with artists about their money, she thinks the exact opposite is true. Artists are masters at doing so much with so little. But not knowing how much money you're going to make from month to month, year to year would be challenging for anyone. And if you don't know how much money you're going to make — it's really hard to save. Christina has made it her mission to come up with strategies to cut through that mystery and help creative people build assets despite the uncertainty inherent in their work.
BA, Geology, Art, Oberlin College
MFA, California College of the Arts
As the beneficiary of the account you are free to take withdrawals in any amount right away, and could distribute the entire amount if you wanted to. The IRS would be glad to tax all the remaining tax-deferred growth, and since the account has already done it's job of seeing your aunt through her lifetime, the age constraints for withdrawal are no longer an issue. What's more important is that you're aware that there could be an opportunity for you to leave funds in the account to continue to grow tax free.
If your aunt set her account up as a Stretch IRA, naming your mother as primary beneficiary and you as the contingent beneficiary, or if you were designated as your mom's successor beneficiary, it's possible you could limit your withdrawals to the Required Minimum Distributions (RMD) based on your mother's life expectancy. If she predeceased the IRS's RMD schedule set for her, you could still have time to defer the account's gains and withdraw funds gradually — allowing you to pay the tax gradually as well.
Because a Traditional IRA is a pre-tax account, the IRS is eager to finally have tax paid on the original deposits and gains. As the second beneficiary of the account, the clock is ticking faster on those funds to be distributed and ultimately taxed. Once you do make withdrawals they will be subject to regular income tax. If any non-deductibe contributions were made to the account by your aunt, then each distribution would be partially taxed and partially tax-free, mirroring the overall corresponding proportionality of the account.
There are a few things to consider as your son approaches making changes to his IRA in order to maximize it's efficiency and effectiveness. Here are my suggestions:
Investments in the stock and bond markets are naturally volatile, so it isn't uncommon for new accounts to dip below their initial value in their early days. Because an IRA is generally considered a long-term investment, and I assume your son has many years (or even decades) before retirement, this kind of short-term decline will, in hindsight, be considered an insignificant blip in the accounts long-term growth. With that in mind, I would caution him from lowering the account's risk exposure because of jitters felt from a momentary slump. Risk is inextricably linked to return, and if his objective is growth, he'll need to find a way to stick it out for the long haul.
A strategy I suggest for maintaining long-term investments with less day-to-day worry, is to build a healthy emergency cash reserve of 3 to 6 months of living expenses. This would give your son a buffer around his IRA by accommodate unanticipated cash short-falls, while allowing him to weather through periodic market declines with his IRA intact and posed for continued growth when the tides eventually turn.
That said, there's no harm in reviewing your son's asset allocation to make sure it's highly-diversified (an important tool for eliminating unsystematic risk) and properly matches his risk tolerance. Making sure his investments are in alignment on these two fronts will go a long way in allowing him to feel confident sustaining, and regularly adding to his IRA between now and retirement, no matter what the markets are doing.
And your instincts are correct in wanting to examine the fees he's paying. Ruthlessly minimizing fees will allow your son to leaving more in his account to compound and grow over time. Annual fees of even 1% can cause considerable drag on investment returns, so it's worth taking a hard look at the individual assets to determine his ongoing expenses, and add that to any management costs. Now compare what you calculated to the cost of a few index mutual funds whose annual expense ratios are only a fraction of a percent. Would he benefit from a change? Cutting his annual expenses will be one of his best strategies for boosting long-term results.
The good news is that in an IRA your son won't face any tax implications from reallocating the investments within his account, or even from rolling the account to a different custodian with access to lower fee investment options. Companies like Vanguard and Fidelity offer low-cost, passively-managed funds that would allow him to keep his expenses down and maximize what remains in order to build back to his initial account value and beyond.
Glad to hear you're getting started investing early! I suggest you go with the Roth. Because you're just getting started in your career, you're likely in a lower tax bracket than you will be in the future. So using this opportunity to save post-tax dollars — which will grow tax-free, and can be withdrawn tax-free after age 59.5 — will give you some valuable tax-diversity in your income in retirement.
There is a myriad of ways to save pre-tax over the course of your lifetime — and only 2 ways create Roth savings. And with annual contribution limits and income limits with Roth IRAs, it isn't necessarily straightforward to amass Roth dollars in your retirement portfolio. So while your income and tax burden are relatively low, why not pay the tax upfront and start building your Roth Savings now? And there's an extra bonus with a Roth IRA that isn't an option with any other tax-advantaged retirement account. Because you've paid income tax on your contributions upfront, you can always withdraw those contributions at any time tax and penalty free. So it can act as a double backup to your emergency savings in case you unexpectedly need excess funds before you plan to retire. If you're interested you can read more about why I think the Roth IRA is so special in my article: Like a Unicorn with Nikes and a parachute — here's why I love the Roth IRA.
I applaud you in starting to save and invest at such a young age! Your future self will thank you — not only for these early investments which could have the longest time to grow and compound — but for the life-long habit of savings and investing which will serve you extremely well in accumulating assets.
The first thing to do is be really clear on what the money you have in your Roth IRA is earmarked for. Even though Roth IRAs were established to help people save for retirement, because they're funded with after-tax dollars, you have the option of pulling out your contributions anytime without tax or penalty. So before you choose an asset allocation you'll want to determine what job those dollars will have. Are they going to stay in for the next 40+ years for retirement, or will they be used sooner, say for college tuition?
With a shorter timeline, you'll want to expose your dollars to less risk, so that you won't be subject to an unexpected market downturn that could compromise your goals. But if instead, you plan to use your Roth IRA to fund retirement — and you feel comfortable with the day-to-day stock market volatility — then your instinct to invest in equities a savvy one.
Equities will provide sufficient risk exposure for significant potential return — meaning you'll be giving your money the best chance to grow. Even with the possibility of future setbacks in the market, stocks have historically provided the best overall, long-term growth when compared to cash and bonds.
To reduce the effects of unsystematic risk you'll want to make sure to your investments are broadly diversified. As complicated as that sounds, there's an easy way to achieve this. You can easily purchase a sliver of dozens, if not hundreds of securities with a single mutual fund or exchange-traded fund (ETF) instead of relying on individual stocks. To be as diversified as possible, you can own the entire stock market in one fund (for example Vanguard's Total Stock Market ETF) which would not only give you the stability and income from the largest companies in the US economy but also provide the growth potential of small and mid-cap companies.
Keeping your costs down is another important consideration. Choosing Index funds or Index ETFs will easily do the job of diversification but will also avoid loads, while lower fees and expenses, resulting in more money left in your account to grow and compound over the long term.
If you're interested in reading why I think you're so smart by going Roth, check out my article: Like a unicorn with Nikes and a parachute — here's why I love the Roth IRA.
Great job getting started early! The best book I can suggest, which will set you on the right path, is Allan Roth's, "How a Second Grader Beats Wall Street." You can even listen to the audio book version. It a fun, and easy to understand explanation of low-cost, index fund investing, which will serve you well as a long-term investor. Enjoy it!