Should I draw from a taxable account in order to fund living expenses to completely maximize some of my retirement accounts?
I am currently 30 years old. I am contributing $11K a year to my Roth 401(k), and am maxing out my ESPP. Would it make sense to withdraw about $12.5K a year from my taxable account (inheritance) in order to cover my expenses as I max out my Roth 401(k) and fully fund a Roth IRA.
All else being equal, yes, I think that is a good plan. The only downside would be if you drain your taxable account to a level where you don't have access to funds needed in an "emergency". I would not want you to pay any 10% penalties or have to do a 401k loan.
Your question actually creates more questions in my mind then a simple yes or no answer. Do you have other assets? Do you own real estate? What is the total amount available to you in your inheritance (taxable account)? What type of assets are in your taxable account? Did they receive a step up in basis upon the death of the original owner? Will you have need for significant funds over the next 5 or 10 years? What is your marital status? Do you have anyone else who is dependent upon your income?
Your answers to these questions may also create more questions... however, generally speaking the younger you are the more it would make sense to fully fund both your Roth 401(k) and Roth IRA. But if you haven't purchased your first home and you don't have the down payment to do so you may be missing out on taking advantage of the current low interest rate enviorment.
Everyone's circumstances are different, but in some cases, it can. Assuming you have an emergency fund, your job is secure, and no major issues or goals, maximizing your retirement contributions can really payoff. You might want to do the math to see if paying the capital gains tax on the taxable investment might be worth a 401k contribution too, or a deductible IRA contribution. The reduced taxes now might be a better option. Also, make sure you are taking advantage of any employer matching contribution.
As always, please be careful of having too much of your net worth in your employer's stock in the ESPP.
With the Roth, it is a little easier since Roth contributions are already taxed and available anytime tax and penalty free. As long as you are invested correctly you can even use them as an emergency fund. So, the main harm might be the taxable investment being a better choice than what you invest in in the Roth. Otherwise, it is hard to beat that tax-free growth of the Roth in retirement.
Depending on your tax bracket, you might even be able to lower your tax bracket via 401k/IRA contributions to make the capital gains rate of zero when selling the taxable account. And having access to pre-and post-tax dollars in retirement can be great. Just make sure you are cordinating tax, account type, and investment choice.
I hope this helps! Keep up the hard work.
Mark Struthers CFA, CFP®
For Sona’s Educational Series KnowThis! KnowThat! go to:
This is for informational purposes only. Your specific situation would need to be taken into account. All information is subject to change. Not to be considered investment, tax, or legal advice.
In theory, your logic is sound, however, there are some missing pieces of information that can clarify your situation a little bit better - your earned income, annual expenses, and the size of inherited investment account.
Let me as you a couple of questions back that might actually help you find the answer. How long can your investment account last before you completely deplete it? Do you have other savings that you can use in the case of emergency? Can you cut down your expenses to cover the shortfall instead of using the inherited money?
Not knowing the entire picture makes it a little difficult to answer - like how much is in the taxable account? What percentage of your monthly expenses is the roughly $1000/month you would withdraw? It might make sense to sit down and take an objective look at your expenses. Maybe you shouldn't fully fund a Roth IRA right now so that you don't have to touch the taxable account. You need to have cash reserves set aside and it's always good to have the flexibility of different types of accounts (tax-deferred, Roth, taxable) - especially for the future.
I would suggest sitting down with a fee-only financial planner and let them look at your situation. Then he/she could provide you with some guidance as to the best way to go.