Am I saving too much in tax-advantaged accounts?

Am I saving too much in tax-advantaged accounts?

Kind of feel weird even suggesting such a thought, because as a personal finance nut it is my job to fully take advantage of every possible edge I can use to stretch my dollars. Whether it is signing up for the rewards card with the biggest cash back, putting money in the highest yeild savings account, or stashing as much money away as possible where Uncle Sam can’t get his grimey mits on it. However I am continually wondering if I may be going overboard on my retirement savings, in fact I’m honestly worried that by putting so much money away in my retirement accounts that I may actually be delaying my retirement. Eeek!

Ok I will admit that I just finished painting my son’s room so the paint fumes may be affecting my judgement here, but the thing that worries me is that I may in fact become a multi-millionaire by the time I am 50 years old and not be able to touch any of my money. Because all of my current investments are in IRAs and 401Ks I will not be able to take any money out of those accounts without paying taxes and an additional 10% before I reach the age of 59.5, which in turn means I either have to work until age 59.5 or find some other source of income to get me from whatever age I decide to retire at until age 59.5.

Tax-advantaged accounts are very powerful tools, partly because your money grows tax free and depending upon whether its a Traditional or Roth vehicle any money you add to it is either: tax-free when you contribute it (Traditional) or you are able to be withdraw tax-free (Roth). So in most cases and for most people you would just be throwing money away if you did not take full advantage of Tax-Advantaged accounts like 401ks and IRAs before putting any money in a taxable account.

When I look at my situation though I am on a “ok” pace when it comes to building my net worth and if things go as planned I will potentially have enough money in my nest egg to retire earlier than age 59.5, if I so chose. Probelm as I stated earlier is that I just won’t have access to this money. So maybe it makes sense for me in this case if my goal truly is to be able to become financially independent before age 59.5 is to actually start putting a percentage of my “retirement savings” in a normal taxable account.

If I do put money in a taxable account I will have to pay taxes every time I sell a security and also I won’t get any tax breaks when I deposit money into the account or when I withdraw it, so Uncle Sam will definitely be supporting the situation. When I look at the actual taxes I will ahave to pay though, it actually may be fairly insignifigant when it comes to having to pay taxes, at least under the current tax structure. My wife and I are firmly planted in the 15% tax bracket so even if I sell a security that I have held for less than 1 year I only have to pay 15% federal tax (ignoring state right now). When compared to the tax-advantaged accounts still looks like a horrible deal.

However I am a long-term investor and almost all of my investment are held for much longer than 1 year, which then means I pay a long-term capital gains tax on the profit instead of paying taxes at my income tax rate. Long term capital gain tax for my tax bracket is only 5%, which is much better than 15%. Also if I happen to sell one of my securities at a loss, I actually get to use that loss to offset taxes I have to pay on any gains (not something that you want to happen very often, but admit it we all make mistakes….a lot).

So in my situation where I am already in the poor-house I really am not getting an incredibly signifigant advantage of putting my money in tax-advantaged accounts, which means that at least in theory it may be advisable that I at least keep a portion of my retirement nest egg in taxable accounts just for the flexibility stand point. Also seeing as how this money will be used much earlier than the 401k and Roth IRA money, maybe its advisable for me to be more concerned about funding these taxable accounts more so than my tax-advantaged accounts as my tax-advantaged accounts will have roughly an extra 10-15 years to grow before they will be touched.
I guess this article is probably less of a definitive statement and more of a what the heck should I do article. I’m really just posting this blog entry because this question has been bouncing around him head quite a bit lately and honestly I am not sure which is the best path to take. I know there is not cut and dry answer, but I just want to know if I am completley missing something here by actually considering putting some of my money in accounts where it will in the long run create a smaller nest egg for myself. So in short I am looking for advice.

Please help!

[tags]401k, IRA, Early Retirement[/tags]

  • When you contribute to a Roth IRA you are allowed to withdraw your original contribution without penalties. So if this is one of your current retirment accounts this will provide you with one source for early retirement. Plus once you have a sizable nest egg some of the penalties you are looking at will seem small in comparison.

  • My Financial Journey

    Thanks for the comment- this is exactly why I posted this. I knew that I was overlooking something simple/major like this. Being able to withdraw contributions tax free should tide me over for a quite a few years as in the end I will probably be 95%+ Roth IRA/Roth 401k.

    Do you know how they treat rollovers as far as contributions are concerned. For example rolling over a Roth 401k into a Roth IRA after leaving a job? Is there something in that process that lets you know how much of your previous 401k was contributions and which part was capital gains?

  • Pingback: Quinn's Brain, aka QBrain()

  • I was going to mention the contributions to Roth accounts, but I was beaten to the punch. You can put your money in Treasury I-Bonds. The rate is ~6.73%, or something, right now. You only pay taxes when you withdrawal funds. You have to have your funds in there for a year, or you have penalties. Also, if you remove money within the first five years, you lose the last three months of interest. But, this is one option you have. They mature at 30 years, and you must take distributions at that point. That will probably be a decent place for some funds, especially if you add in the contributions to your Roth accounts, and individual securities.

  • Anonymous

    If you expect to be in a higher tax bracket in the future, now would be the time to take advantage of Roth IRAs. There is an interesting backdoor that is worth noting. You can roll traditional IRAs and 401(k)s from previous employers into Roth IRAs and pay the taxes now. The net effect is to transfer the money you pay now in taxes into retirement savings and here’s why. Your balance in the traditional IRA or 401(k) appreciates at whatever rate your investments there are appreciating. That’s just a simple definition of the account. You will owe taxes on the balance, so in effect, the tax burden is increasing at the same rate. You don’t know what your tax rate will be when you withdraw the money, but you do know that you will have to pay it. When you do the conversion, you pay the taxes today, and lower the balance on which you will pay taxes in the future to $0.

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