Should I max out my Roth IRA contributions before investing in another vehicle?
I started a Roth IRA about a year ago. I'm really ambitious to save as much as I can over the next 15 years. Besides the Roth IRA, I want to invest another $10K into some other long-term vehicle. What would you recommend? I really want to be smart about this. Should I max out my Roth contributions first before going with a new investment vehicle?
Absolutely. Max your Roth IRA so you can take advantage of the tax-free growth and qualified returns. You can invest the additional $10k in a more conservative taxable account with a low-cost ETF portfolio. If you want it to be long-term, that is great, and it can also be for shorter-term needs with no penalty for early withdrawals. You can setup both account types with advisor oversight at Betterment.
It's difficult to say with 100% certainty because I don't know more of the facts about your situation - but in general, if you are able to contribute to a Roth IRA - it's not a bad idea to do so. You should think of the "investment vehicle" different from the "account type", because you can pretty much buy any vehcile in whichever account type (Roth IRA, non-IRA, pre-tax IRA, etc.) that you choose. I would also encourage you to focus on saving at least 10% of your gross income annually - if not 15 to 20%. In other words, focus on the percentages as a long term goal measure rather than the dollar amount. I would consult with a professional for more specifics!
Max out the Roth IRA first. The tax-free growth and withdrawals are tough to beat. Chances are, over the next 15 years you might end up earning so much you won't be eligible for funding the Roth so, for now, take advantage of it and maximize it. As far as the next step, if your employer offers a 401k, I'd recommend deferring to that. If you are under age 50, you can defer up to $18,000 of earned income each year. For 50 and above, you can defer an additiona $6,000. If it's a pretax deferral this will help reduce taxes each year you fund it.
Beyond that, start a brokerage account, add savings along the way and build a diversified portfolio to help you achieve your long-term goals.
It depends on a variety of factors: your age, your various objectives, your tax situations, debt profile, etc etc.
However, I will say this: if you can max out your Roth contributions for 15 years and also save $10k after tax in a taxable investment account, it should be a great step for your retirement plan. While investing in a taxable account won't shield you from owing tax on capital gains and dividends, these factors are likely to be de minimus by many standards until your account reaches a large size. Additionally, you'll have access to these funds in the event of a short term need for capital (like a home purchase or some unexpected emergency).
Of course, this is for general informational purposes only. If you'd like to talk specifics, feel free to shoot me a call or message.
Adam Harding | Investments & Planning
Great question, and congratulations on being an ambitious saver. I counsel clients on this type of question all the time. I look at retirement savings as a pyramid divided into four horizontal quadrants. The bottom quarter, the biggest section, is where you put your 401k money. If you need pre-tax investments, withhold a percentage of your paycheck that would equal the requirement to get the company's maximum matching contribution. Many companies require you to invest 6% to get their maximum match. Once you've done this and you have more money to allocate to your retirement savings, you can go to the IRA/Roth IRA, the second biggest section of the pyramid, and fill it up. If you can put $5,500 here and you still have more money to invest in your retirement budget, then you can go back and fill up the 401k over and above the 6%. If your budget will allow for you to maximize your 401k ($18,000 + catch up of $6,000 if you are over 50) and your Roth IRA ($5,500 + catch up of $1,000 if you are over 50), then you can move to the next section which is a section that doesn't have limitations on how much you can contribute - low cost annuities, non-IRA brokerage accounts, etc...If you want tax advantages, you may look to tax deferred, low cost annuities or to tax effecient mutual funds in a non-IRA brokerage account. With all of this said, you may want to look at your capacity to pay taxes. If the amount you are placing in your pre-tax 401k creates a tax refund to you of about $2,000 or more, then you have capacity to place money into a Roth IRA to the fullest extent. However, if you owe money to the IRS at the end of each year, you might put more money into the pre-tax 401k before you fill up your Roth IRA to get you to a $0 owed/$0 refund on your tax return. The money you put into a Roth IRA is taxed before you invest so this creates a balancing act with your taxes. It may take a couple of years to get this strategy down, but it will allow you the flexibility to fill either section while keeping the amount you owe or the amount you should be refunded to a minimum, and to maximize the areas you place your retirement dollars. Furthermore, your 401k may have a Roth 401k feature. If you like the funds within the 401k, then you may not have to open up a new Roth IRA, you can just have more of your paycheck withheld into the 401k. Finally, as ambitious as you say and depending on your income, you may not be able to contribute to a Roth IRA (for a Roth contribution outside of the 401k, your income has to be lower than $184,000/married, $117,000/single to fully contribute the maximum amount). If this is the case, and your employer has a Roth 401k option, you can still get money into a Roth through the 401k. Again, you should keep an eye on your tax return to balance the mix of post-tax/pre-tax contibutions. I hope this has been helpful and I wish you all the best in your retirement savings strategies. Ted