When maxing out your retirement account(s) isn’t the best move
Conventional wisdom tells us to put as much money as we can toward funding our future retirement. This is something I read all the time, disguised as solid financial advice for people in their 20s, 30s, and 40s. “Put as much money as you can toward your Roth IRA or 401k. When one is maxed out, move onto the other.”
This isn’t bad advice. It encourages investors to avoid short-term thinking, benefit from decades of compounding, and hopefully provides a cushion for the uncertainty ahead. So what’s the problem?
Far too often I see clients come to me with balance sheets that reflect this behavior. If they’ve got their ducks in a row, they have an established stash of cash (Emergency Fund) and anything outside of that is in a retirement account.
Then in our first meeting together, they tell me about their goals. To upgrade their house in five years, take that anniversary trip they’ve always talked about, replace cars in the next couple of years, and make sizeable a charitable donation. All of this spending is set to happen well before they’re age 59 ½. But if they try to tap into their hard-working investments, they’ll be hit with a 10% withdrawal penalty and pay ordinary income taxes. Other funding options include a 401k loan, using a HELOC (Home Equity Line of Credit), slowly saving up cash, creating credit card debt, etc.
Alternatively, I propose identifying how much of their current discretionary dollars need to be saved for the retirement phase of life vs. how much they should be shifting into a non-retirement (taxable) account to fund those very goals. Creating this “mid-term goal” investment vehicle is the solution to potentially overfunding retirement and creating the flexibility to invest for a variety of goals.
Throughout the planning process, I identify the most tax-efficient way to use their hard-earned money to fund their dream future. And that is one of my favorite parts of the job – working with dedicated savers to maximize their dollars. My favorite part of being a financial planner? Reminding clients they have money set aside for a goal they never thought would come to fruition (and encouraging them to act on it).
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