My employer does not offer a 401(k) plan, but I am making maximum contributions to my Roth IRA account every year; how else should I be saving for retirement?
I recently started my first full-time job. I make $42,000 a year pre-tax. The company does not offer a 401(k). I have already made the maximum contributions to my Roth IRA account for 2017 and 2018, and I plan on reaching the maximum contribution for 2019 in January. How else can I save for retirement without a Roth 401(k)? I live in California, where there are high state taxes. I plan to spend my entire life here. At my current savings rate, I hope to have around $16,000 saved for retirement by the end of the year. I also have $15,000 saved up for future expenses like buying a house or a car. Should I put all of it into a taxable brokerage account?
Congratulations on starting your first full-time role, the value that you earn is the best way for you to save for your retirement. Unfortunately there are no clever options for you to have more invested and out of the way of the taxman I am afraid.
But just because there isn't an incentive for you doesn't mean that its a bad idea, investments are the best place when you have such a long time line, so the taxable account is your way forward. In terms of the actual holdings and strategy, being aggressive is fine, it will be bumpy, but in a taxable account that gives you the opportunity for tax loss harvesting.
One other option if it is available to you could be a HSA, this would give you 3,450 that you could save pre-tax and have invested tax deferred. But you should not select a HSA insurance policy purely for this tax break though, it needs to make sense for your medical insurance needs also.
Annuities do offer tax deferral from capital gains, but with the tax bracket you are in at the moment I do not think that they add value to you. You can find very basic annuities that have low fees and a wide range of investment options, but until you move into higher tax brackets the taxable brokerage account is the best way to go for now.
Congrats on contributing the maximum amount to your Roth IRA and looking for ways to save more! If you're married, you may also contribute to a spousal IRA even if your spouse has no earned income. If you have any 1099 income from another source, you may consider a establish a SEP IRA and contributing your additional income there which will grow tax deferred like a 401(k) would. If none of those situations apply, a taxable brokerage account or even a direct mutual fund account would be a great option. Focus on investing in individual stocks, ETFs, or tax managed funds that have a low turnover rate to help reduce the tax consequences. Keep in mind, managing your portfolio's allocation for the long term is more important than managing exclusively for taxes. You may also consider and non-qualified annuity. While there are many things to consider when buying an annuity, your investment will grow tax deferred and will only be taxed when you begin taking income which ideally, will be at retirement.
Congrats on your first full-time job and having the discipline to save!
Roth IRAs are excellent tax-advantaged savings vehicles, and your ability to contribute to a Roth IRA phases out as your income climbs (see the IRS table for 2018 limits), so it's best to take full advantage of the Roth now while you can.
If you're enrolled in a high-deductible health care plan, you can also take advantage of a Health Savings Account (HSA). In 2018 an individual can direct as much as $3,450 into an HSA, while a family can contribute up to $6,900. (These contribution limits are $1,000 higher if you are 55 or older). Your contributions are tax deductible, the earnings in your account grow tax free, and you can withdraw funds from your HSA, tax free, as long as they are used for qualified medical expenses like deductibles, co-payments etc.
HSAs are not only a benefit for medical expenses, they are also like IRAs in disquise. Currently, federal tax law allows an HSA owner 65 or older to withdraw funds for any purpose without penalty (non-medical expenses are taxed like Traditional IRA distributions). Prior to age 65, an HSA withdrawal not used for qualified medical expenses is assessed a 20% I.R.S. penalty on top of ordinary income tax. You can grow your contributions through investments, just like any other retirement account, and your HSA is yours forever. The balance carries over from year-to-year, and if you change employers, you can take your HSA with you. If you move out of high-deductible plan, you can continue to use the HSA funds and let the investments grow, but you won't be able to make any future contributions.
HSAs aren't for everyone though - when you enroll in a high-deductible health plan, you agree to pay nearly all of your medical expenses until that high deductible is reached. If you require frequent visits to doctors or specialists, this might not be the best option for you.
Your $15,000 savings is awesome. Before you worry about investing in a taxable brokerage account, I want to make sure you have your emergency fund setup. An emergency fund is a savings account where you set aside money needed in the event of a personal financial dilemma, like losing your job or needing to make a major home repair. The purpose of an emergency fund is to twofold: protect you from having to take on debt when financial mayhem strikes and give you peace of mind. Money in your emergency fund should only be used for unexpected, necessary and urgent financial issues. An emergency fund should not be used for planned purchases, like a car or a house.
Once you have your emergency fund fully funded, you can then can begin to save for your exciting future goals. Saving in a taxable brokerage account is a good idea. The longer you plan to let your investments grow, the more risk you may be able to take, since you'll have more time to recover from periods of poor returns. If you need the money within the next five years, you'll want to avoid individual stocks and stock-based mutual funds. If you need the money within the next three years, you may consider buying individual bonds or certificates of deposit (CDs) with durations of less than three years, putting your money in a money market fund, or using a basic savings account. These safer, short-term, options generate some income while garaunteeing the return of your initial investment.
Besides an IRA, you can also stash money in an HSA, but you must have a high deductible healthcare insurance plan for the year. If you had for 2017 and also have for 2018, you can make both contributions right away. The total amount is $6,850 for a single($3,400 for 2017 and $3,450 for 2018). Not only contributing to an HSA helps you save for retirement healthcare fund, but also it comes with a tax incentive. Yes, you can deduct the entire amount on the 2017 tax return, but you must do so before Apr. 15.
Lastly, if you still have money after making all the contributions, invest in a brokerage account. Just make sure you chose a tax-efficient fund as the income/capital gain/dividends from a taxable account will be taxed every year. Best!
Great question! First and foremost congratulations on starting your first job and beginning to save for retirement at such a young age! In the long-run this will be a tremendous advantage for you since it gives you an extremely long time horizon to compound investment returns.
Also given your current income level it sounds like you have made the smart choice in saving in a Roth IRA. Overtime as your salary grows you will likely reach a point where a traditional IRA (or 401k) might make more sense as you can defer income taxes – but for now a Roth is ideal for you given that you are in a relatively low tax bracket.
Your additional savings ($16k for retirement and $15k for future expenses) could be put into taxable brokerage accounts so you can invest and grow that money. Keep in mind you will probably have two different investment approaches for these two “buckets” of money. Your retirement money has a very long time horizon while your “future expenses” money will likely be needed much sooner and thus will likely be invested differently.
All in all you are doing all the right things. Just continue to: 1) Always spend less than you earn, 2) Invest in stocks for the long run, 3) Do not touch your retirement savings (let it grow), and 4) Let compound interest do all the heavy lifting.
Charlie Munger, the outspoken and incredibly wise vice chairman of Berkshire Hathaway explains it best, “Spend less than you make; always be saving something... Overtime it will amount to something. This is such a no-brainer.”
Best of luck!