Investing Should Be Simple: Tax-Advantaged Accounts and Retirement

Piggy Banks for Saving

Too many choices? Don’t worry, they all help you save.

Investing can be complicated if you let it be. There are a million different concepts, strategies, and funds to think about.

And that’s okay for some, but not for most. Most people are turned off by investing and never really get into it because of the multitude of choices.

With that in mind, here is some simple information to help you frame your approach to investing.

The way I see it, there are two types of investing you can do:

  1. Tax-Advantaged – This is where you should focus your attention. There are more than enough options in this area to have you set for retirement and have your kid’s college paid for, all while reducing your taxes. Keep things simple and focus on investing here.
  2. Taxable – This is the area of investing that should take a back seat for most people. Only go here if you’ve exhausted all options above. If you do invest in this area, please don’t use money that could be securing your retirement or your children’s college.

To help you understand this concept a little more, here’s a calculator that outputs the financial difference between taxable and tax-advantaged investing.

Financial Calculator...

Again, that’s just my take on things. I’m sure there are people who could argue against it. To me it’s just the simple way to approach things. Here’s more…

Tax-Advantaged Investing Specifics

Whether they know it or not, most people are already doing tax-advantaged investing through their 401k, which is great. However, even more tax-advantaged investing can be done through a Roth IRA (which uses after-tax dollars, plus earnings are tax free if withdrawn after you’re 59 and 1/2).

This is the investing sequence most should use:

  1. 401k to Get the Employer Match
  2. Roth IRA to the Max
  3. Back to the 401k to the Max

See the IRA contribution limits to find out how to get to the max with your Roth IRA.

This approach will help you avoid taxes now and in the future. The government, via the IRS, is trying to encourage you to save for your retirement so you won’t simply rely on Social Security. That’s why we have these types of accounts. And that’s why most of these accounts come with stipulations about leaving the money where it is, for its intended purpose.

A Roth IRA can be opened at a bank or at an investment firm. I recommend Vanguard. They don’t have minimums on their accounts and their funds are some of the cheapest in terms of fees. If you don’t have one of these, please go open one today. Just do it and get started. It’s really simple.

There’s even more tax-advantaged investing you can do. I won’t get into it here, but I’ll just refer you to this article on 529 Plans and other tax-advantaged education savings accounts.

Taxable Investing Specifics

Taxable investing is taking your after-tax dollars and investing it without a tax-advantaged account. Simple, right? The key thing to remember here is to only invest money here after you’ve exhausted your options in the tax-advantaged areas. These investments will be taxed before you put the money in and the earnings on the investments will be taxed.

Taxable accounts can be opened up at the same places as tax-advantaged accounts, at banks and investment firms. But the best places are the ones who’ll let you trade cheaply, since you’ll theoretically be doing that more often (because of no limitations by the IRS). These are places like eTrade, Scott Trade, Zecco, Sharebuilder, etc. See my complete list of the best online stock brokers for cheap stock trading.

More Information

There’s obviously more to investing: what to invest in, proper asset allocation, etc. But the above should hopefully give you an initial framework when trying to decide which direction to go with your investing.

So what’s your take? Is there ever a reason to go with a taxable account first?

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Last Edited: April 2, 2014 @ 9:56 am
About Philip Taylor

Philip Taylor, aka "PT", is a husband and father of two. He created PT Money back in 2007 to share his thoughts on money and to meet others passionate about managing their finances. All the content on this blog is original, and created or edited by PT. Read more about Philip Taylor, and be sure to connect with him on Twitter, Facebook, or view the Philip Taylor+ Google profile.

7 comments
FrugalRules
FrugalRules

Good post! As Jason said, I would see the two times as being when you're retiring early and/or do not qualify for a Roth. That said, I think investing in a tax advantaged account is the way to go. This is especially true if you're trading on any regular basis so you can shield any gains in the Roth. You'd be surprised how many people open taxable accounts, trade regularly and completely forget that the IRS wants their cut.

Lonnie
Lonnie

Can my wife and I have our own Roth IRA accounts, that we both max out?  My wife freelances so last year our combined household income was just under $100k and it looks like this year, our household income will come in a little less.

Right now, I am the only one with a Roth IRA so if my wife doesn't have one, I don't see how we can contribute enough to tax deferred accounts and have enough to retire.

HullFinancial
HullFinancial

Two times: 1. When you're looking to retire significantly early and need a bridge to age 55. 2. When you don't qualify for a Roth and are investing in an asset that is solely for capital gains and your post-retirement income will be in a higher marginal tax bracket than long-term capital gains taxes.

Pat at FeelingFinancial
Pat at FeelingFinancial

I think that's great advice for the majority of people out there. There are certainly people who want to retire early (you can always take contributions back from Roth at any time), or those who are concerned about paying taxes at ordinary income rates instead of LTCG, but most people just need to save money. If you want flexibility, there's nothing wrong with using taxable accounts a bit more as long as you actually put the money in and leave it alone until there's a good reason to use it.

Momat3isplenty
Momat3isplenty

We're investing in taxable accounts before maxing out our tax-deferred options because we want to retire early, and we'll need access to that money without jumping through hoops (SEPP).  That being said, our goal is to put enough money into our 401(k)s to bring our MAGI down to where we *can* invest in a Roth, then invest in taxable accounts.

PT Money
PT Money

@Petunia - Good catch. Yeah, I don't know what I was thinking there. The Roth IRA account has a $3K minimum. Maybe I was thinking brokerage.

Good points about accessibility.

Petunia
Petunia

I'm not sure what you mean by your statement that Vanguard has no minimums. Most funds have a minimum of 3k, though you can start with the STAR fund with a minimum of 1k. Are you referring to the brokerage account?

I think for some people it may make sense to have some of their retirement money in taxable accounts, so that it can be accessed early without locking into substantially equal periodic payments. You would want to stick with very tax efficient things though, such as an index fund.