IRA or Taxable Portfolio?

[l2jperry]

Hello all,

Most likely going to start the PP next month... 22 making approximately 45,000 a year... In 6 months I will be able to start a 401K with my employer where they match the first 3%, and then 50% of the next 2% of contributions. I do not know any other information on that as far as what is available. I will start that when it is offered. My main concern is whether to start my PP now in an IRA or a taxable account?

I have about 20,000 sitting in a low interest savings account (and I mean very, very low, not your typical .8% that is offered on average right now. So I know I need a better plan for it.) The arguments for a deflationary period, inflationary period, prosperous period all make sense to me, so I have never been quite certain what to do with my money, until I started reading about the PP. However, I remain undecided whether it is best to start the PP in an IRA or in a taxable account. I am somewhat skeptical that IRA's and 401K's rules will not change out of individuals favor in the next 40 or so years...

What are some of the advantages/disadvantages of using an IRA or just using a taxable account via an online brokerage like sharebuilder?

Try to keep the responses for a mostly ignorant beginner investor . Thanks so much! I enjoy learning from you all on here.

[Pointedstick]

I'd put as much of that money into a Roth IRA as you possibly can. You're in a low-ish tax bracket, and any money you put in the Roth is tax-free for life. The Roth becomes a worse deal the higher your current taxes are; a traditional IRA is the opposite--it becomes a better deal the higher your current taxes are (since you can avoid them now and possibly have lower taxes in the future once you retire). So that's why I'd prefer a Roth IRA to a traditional IRA at your income level.

Now, if you're in the 10 or 15% tax bracket, a taxable account is actually a pretty good deal, since you're exempt from federal capital gains and dividend taxes. The advantages of having a taxable account compared to a Roth IRA are the lack of contribution limits and other annoying rules. Once you fall into the 25% bracket or higher, a tax-sheltered account can shield you from those taxes better.

You can also do clever things like contribute enough to a traditional IRA to lower your taxable income far enough to be in the 15% tax bracket, and then put the rest of your available savings for that year into a taxable account.

[moda0306]

Definitely load up on the Roth first... more than anything because it's important to build up liquidity when it's as dry as it is when you're 22 years old.

A couple other things, though:

1) Learn what forms of insurance you should get, and get them.  I refer to it as the "Unlucky 7."

- Auto Liability
- Renters/homeowners
- Umbrella
- Health
- Disability
- Life
- Long-term Care (last one is debatable and probably not necessary yet for a 22 year old)


2) Get good at budgeting, and using a financial calculator for "life decisions."  Every financial decision you make is going to have an affect on your liquidity, cash-flow, "Rate of Return," and maybe taxes.  Best to know where to allocate scarce resources in a balanced way.  Keep your nut low if you can.  Don't commit yourself to payments unless it offers some unique benefit.

Long-story-short... most of your great rate-of-return opportunities come in very unexpected and sometimes hidden forms... sometimes it's merely handling an emergency strategically... sometimes it's taking advantage of a huge opportunity (or small opportunities with great rates of return).  Keep this in mind when designing your financial decisions around investing in the PP and VP.  If you think of your investments as the main tool to grow your wealth during your working years, you'll wast hundreds of hours trying to squeeze some more RoR out of some meager savings, rather than improving your savings habits, making strategic decisions in budgeting, or increasing gross income.  You'll also miss opportunities you otherwise would have seen to grow your wealth.

3) Have a healthy respect for getting your legal documents done correctly, especially if you enter the world of business.

Just some things I wish I had thought more about when I was 22.

[ns2]

... 22 making approximately 45,000 a year...I have about 20,000 sitting in a low interest savings account

I can't give you any qualified advice because I was making approximately $0k when I was 22 with approximately $0k in savings.

I will, however, predict that you'll do fine, financially speaking.

The only thing I can say about whether to go with taxable or IRA at your age is that there is absolutely no idea how it will all play out for you in the future. I'm a few years from retirement and right now I'm wishing I had more in taxable than I did in my IRA and am working towards that goal. I think the reason I think that way is pointless for you to even consider because you have no idea if you'll be in the same situation 42 years from now.

[Xan]

I think the reason I think that way is pointless for you to even consider because you have no idea if you'll be in the same situation 42 years from now.

I'm both older than 22 and very curious.  Why would you be wishing for more in taxable nearing retirement?  Aren't you just about able to pull from the IRA without penalty?  Is the issue the taxation of your IRA withdrawals, or are you running low on usable savings leading up to retirement age?

[ns2]

I think the reason I think that way is pointless for you to even consider because you have no idea if you'll be in the same situation 42 years from now.

I'm both older than 22 and very curious.  Why would you be wishing for more in taxable nearing retirement?  Aren't you just about able to pull from the IRA without penalty?  Is the issue the taxation of your IRA withdrawals, or are you running low on usable savings leading up to retirement age?

Tax on the IRA is potentially higher than tax on traditional. The IRA tax is ordinary income tax - period - so it depends on your tax bracket. Taxable has a cap on long term investments at 15% and there is no tax on capital gains under a certain income limit (don't hold me to that but I think it is true).

Depends on your own situation. Like I was advising the original poster if you're a long way from retirement there isn't any reason that I can see to even think about these things.

Modification: And I forgot to mention something called MRD - Minimum Required Distribution. No such thing in a taxable account and it is something you won't have any control over. If all your money is in IRA you will have to liquidate and pay the taxman according to their rules. No other options available.

[l2jperry]

Thank-you all for the responses, I appreciate it. I have done more reading into everything and have a few more questions.

1.) To clarify, not that I would, but with a Roth IRA, you can withdraw on the principal at any time penalty free, correct? It is just the growth that can not be taken penalty free.

2.) From my understanding, under a Roth, I could down the road purchase a house and take out whatever I wanted to in principal, as well as up to 10,000 in growth penalty free?

3.) With a Traditional IRA, since you are deferring tax payments to a later date, and are then taxed at whatever income bracket you are in during retirement , do the withdrawals from your IRA count as income or no?

4.) Pointedstick, depending on how much you make, if you could deduct enough money from your income via a traditional IRA to get into the 15% tax bracket and start your own portfolio in a taxable account is it only long-term capital gains that are not taxed? Would short-term still be taxed? I am under the impression that it is possible you will have to re-balance when meeting the PP bands within a year. And I am curious.

5.) Since you need to be 59.5 to collect penalty free growth on the Roth, do you actually have to be retired, or can you still be working?


6.) As ns2 said, about the rules being changed, and this why I primarily asked the question, for anyone with a ways to go until retirement, are you worried at all about government changing the rules or anything? I am worried, which is why I was considering a taxable account.

2) Get good at budgeting, and using a financial calculator for "life decisions."  Every financial decision you make is going to have an affect on your liquidity, cash-flow, "Rate of Return," and maybe taxes.  Best to know where to allocate scarce resources in a balanced way.  Keep your nut low if you can.  Don't commit yourself to payments unless it offers some unique benefit.

Moda, thanks for the extra advice... I am very budget conscientious, and very careful how I spend my money. I am debt free right now, and plan to keep it that way until I take out a mortgage in a few years! I also am very much more so interested in creating wealth through working and not investments, but when you work hard and refrain from consumption, you really do want your money in a safe place, or as safe as it can be. I just want to maintain purchasing power.

[D1984]

Thank-you all for the responses, I appreciate it. I have done more reading into everything and have a few more questions.

1.) To clarify, not that I would, but with a Roth IRA, you can withdraw on the principal at any time penalty free, correct? It is just the growth that can not be taken penalty free.

2.) From my understanding, under a Roth, I could down the road purchase a house and take out whatever I wanted to in principal, as well as up to 10,000 in growth penalty free?

3.) With a Traditional IRA, since you are deferring tax payments to a later date, and are then taxed at whatever income bracket you are in during retirement , do the withdrawals from your IRA count as income or no?

4.) Pointedstick, depending on how much you make, if you could deduct enough money from your income via a traditional IRA to get into the 15% tax bracket and start your own portfolio in a taxable account is it only long-term capital gains that are not taxed? Would short-term still be taxed? I am under the impression that it is possible you will have to re-balance when meeting the PP bands within a year. And I am curious.

5.) Since you need to be 59.5 to collect penalty free growth on the Roth, do you actually have to be retired, or can you still be working?


6.) As ns2 said, about the rules being changed, and this why I primarily asked the question, for anyone with a ways to go until retirement, are you worried at all about government changing the rules or anything? I am worried, which is why I was considering a taxable account.

2) Get good at budgeting, and using a financial calculator for "life decisions."  Every financial decision you make is going to have an affect on your liquidity, cash-flow, "Rate of Return," and maybe taxes.  Best to know where to allocate scarce resources in a balanced way.  Keep your nut low if you can.  Don't commit yourself to payments unless it offers some unique benefit.

Moda, thanks for the extra advice... I am very budget conscientious, and very careful how I spend my money. I am debt free right now, and plan to keep it that way until I take out a mortgage in a few years! I also am very much more so interested in creating wealth through working and not investments, but when you work hard and refrain from consumption, you really do want your money in a safe place, or as safe as it can be. I just want to maintain purchasing power.

Disclaimer: I am neither an acountant/CPA nor a tax attorney so the following is the advice of a layman.

1. The principal can be withdrawn penalty free in a Roth IRA (Roth 401Ks have a five year waiting period from the time of contribution then those contributions can be withdrawn penalty free too)

2. You can take up to 10K out penalty free and it doesn't matter whether it's earrings or principal (except perhaps for purposes of FIFO principal basis if you want to take out some principal later on at any time before age 59.5)

3. Yes, they count as income (albeit unearned income, not income subject to FICA taxes...it is only subject to Federal and if applicable state income tax)

4. Yes, short term would still be taxed as they are considered ordinary income and not any special kind of capital gains eligble for special cap gains tax treatment.

5. AFAIK you can be working full time, retired, working part time, whatever so long as you are at least 59.5

6. I worry a little about it but please consider how many people they'd piss off if they (for instance) made Roth withdrawals after 59.5 taxable...we're talking trillions of dollars worth of money (which got even bigger with the new Roth conversion rules earlier this year). They would probably grandfather existing accounts in under the old rules and apply the new ones to new accounts only. Perhaps sn overall limit on the total allowed to accumulate (or more likely, on contributions after a certain amount has already accumulated...or in the case of regular non-Roth IRAs on the deductibility of said contributions after said certain amount has accumulated) or changing the inherited IRA "stretch IRA" distribution rules to five years from the current "actuarially estimated lifetime of the heir" are more likely if anything DOES happen.

[l2jperry]

Do any of you have any recommendations as far as where to go to open up a Roth IRA? I am considering Sharebuilder... is there a better place? As far implementing a portfolio, I will be using ETF's, but the gold I will have physically, so I will need to be able trades.

[KevinW]

I think the brokers that are often mentioned here are Schwab, TD Ameritrade, Vanguard, Fidelity, and E*TRADE, because those brokers offer commission-free trades on ETFs that are OK for most or all of the PP assets.

[Pointedstick]

My personal experience:

Schwab is nice because they have commission-free trades of all of the PP assets as ETFs (SCHB, SCHO, SGOL, and TLO). The downsides are that while they have a bond window, you have to call them to sell bonds, and their selection of commission-free ETFs isn't as great as others.

TDAmeritrade is nice because you can both buy and sell bonds at their bond window and they have a nice assortment of commission-free Vanguard and iShares ETFs. The downsides are that they don't have a commission-free gold ETF and commissions are $10 a trade.

Vanguard is nice because all Vanguard's ETFs and mutual funds are commission-free, and they have a complete buy/sell bond window. The downsides are that their interface is clunky, ETF trades take several date to settle for some mysterious reason, and they don't have a commission-free gold ETF.

[Pointedstick]

Do these places let you set up automatic purchases of ETF's or bonds with regularly scheduled deposits?

Vanguard lets you easily set up automatic mutual fund purchases. I don't know of any place that lets you do automatic ETF or bond purchasing.

[l2jperry]

Great! Thanks for all the replies, I am going to look into all of them. Does anyone have anything particular against sharebuilder? Trades are $6.95 each.