Do I need to open a Roth IRA or can I just use a taxable account?
I am 28 years old and currently making well into the high six figures. I am maxing out my 401(k) and investing any additional funds I have into a taxable account. Is there any benefit to opening a Roth IRA? I like the fact that the earnings are tax-free, but I am planning to use the funds before age 59 1/2.
If you are earning a high six figures income, the odds are you can not fund a Roth IRA, outright.
The limits the IRS allows, which are all based on your Modified Adjusted Gross Income (MODI), is your Adjusted Gross Income with a few additional adjustments as outlined in IRS brochure 590-A. A single person limits are $118,000 and phases out by $133,000. For a married person, the income limits are $186,000 and phases out at $196,000.
Some alternatives are, if your employer adopts/ puts into place a Roth 401(k). Roth 401(k)s are becoming a more popular benefit with employers and allow you to contribute without the income restrictions and can be in addition to having a regular 401(k). There are some subtle differences between a traditional Roth IRA and the Roth 401(k), but that is for another time. You could also do a back door Roth, but I would look at the breakeven process of paying current taxes and the time it would take to get your money back and eventually be tax-free. You could fund a tax deferred account or some high level tax alternatives with insurance or real estate, but check with your tax advisor before implementing any strategies and make sure you understand the risk involved.
As a point of clarification, earnings are not tax-free, but grow tax deferred. Withdrawals of principle (money you contributed) and earnings are tax-free after age 59 1/2. Principle can be withdrawn after 5 years of account opening, tax free, but earnings, unless you meet certain exceptions listed in IRS brochure 590-A, will most likely be subject to the early withdrawal penalty of 10% and may be taxable. Speak to your tax advisor if you are seriously considering this strategy.
OK. Here's how I understand your situation:
You earn a high income, so you have money to invest. You have maxed out your qualified plan contribution. You are putting additional money into a non-qualified fund that is taxable, and would prefer to not pay taxes. You want to access the money before age 59 1/2.
Give some consideration to using life insurance. It happens to meet your specifications: You will have very broad contribution limits, and with the right product, those payments can vary year-to-year. Earnings can grow tax-deferred. Distributions can be made tax-free. With the right plan structure, you could access the funds as early as the first few years of the policy.
You are young, so the overhead of the policy, in terms of the cost of insuring you and related expenses, could be very low. Even if you pose a higher risk, due to some medical or lifestyle factor, the cost could still be low enough to give you an extremely competitive return.
Of course, the feather in your cap will be locking into a life insurance product at the lowest rate possible. Later on in life, when you need it for family or business purposes, you will already have a policy in place.
Here's my suggestion; get prequalified for coverage and see what different life insurance products could do for you. Then compare those options to non-insurance products, and do a cost-benefit analysis. See which gives you the biggest bang for your buck, and also meets your other criteria. There is nothing like a little market research, using real numbers, to make a purchasing decision.
I work with a lot of high-earners and the following are additional ways to invest:
- Taxable account (not bad if used in tax-efficient manner, I use DFA tax-managed accounts)
- Normal Roth contribution (income limit starts at $118K if filing single)
- Back-door Roth IRA (no income limit but need to be careful of ProRata Rules. See my guide: http://sonafinancial.us13.list-manage.com/subscribe?u=26e44f1c8b78433d53dbe25c3&id=54f798e999)
- Back-door Roth 401(k) (a lot depends on your plan)
- Health Savings Account (HSA, can reduce taxable income and invest for the long-term)
- I-Bonds (can be tax deferred, responds well to inflation, after one year can access principal, low-cost and held with US gov)
Because Roth contributions are available anytime, tax and penalty free, they are perfect for accessing before age 59 1/2, but just be careful of what you invest in. My wife created this fun video:
Here is an article on the advantages of the Roth:
Mark Struthers CFA, CFP®
Congratulations on your awesome savings habits! If you are making more than $118,000 in 2017, you will not be eligible to make a full ($5,500) Roth IRA contribution. There is a sliding scale, but at $133,000 modified adjusted gross income, you can't make any contribution to a Roth IRA.
For funds that you want to use before retirement, it's best to invest them in a taxable account like you are doing. That way, you can get the money out any time you like without any hassles from the IRS.
Hope that helps!
At your age, a Roth IRA can be a very nice compliment to your retirement savings plan. Besides providing for tax-free distributions in retirement, one of the other advantages of a Roth IRA is that you can access the funds you have contributed prior to age 59-1/2. However, based on your income, you may not be eligible for a straight contribution to a Roth. There is a solution that might work for you. You can do a "backdoor" contribution if your income disqualifies you from a direct contribution. You make a non-deductible contribution to a traditional IRA and then convert it to a Roth IRA. I would recommend getting guidance because the rules are a bit tricky and you don't want to trigger any surprise tax consequences.