You're contributing as much as you're allowed to a 401 (k) or other employer-sponsored retirement plan. You're also contributing the maximum annual amount to your Roth or traditional IRA. But you want to set aside still more money to make sure your retirement is everything you hope for. What options do you have? Here are some things to consider:
Before moving beyond--are you really maxing out your 401(k) and IRA?
IRAs and employer-sponsored retirement plans like 401(k)s have some real advantages when it comes to saving for your retirement. So, before you go any further, make sure you're really contributing all you can.
In 2007, most individuals can contribute up to $15,500 to a 401(k) plan, and up to $4,000 to a traditional or Roth IRA. If you're age 50 or older, though, you can make up to an additional $5,000 in "catch-up" contributions to your 401(k) for 2007, and you can contribute an additional $1,000 to your traditional or Roth IRA. What's more, if you file a joint tax return with your spouse, your spouse may be able to make a full IRA contribution, even if he or she has little or no taxable compensation (see IRS Publication 590, Individual Retirement Arrangements, for details).
Looking at deferred annuities
If you are looking beyond 401(k)s and IRAs, one option you may be aware of is a deferred annuity. Deferred annuities are generally funded with after-tax dollars, but earnings are tax deferred; you don't pay tax until you take a distribution from the annuity (you pay tax on the portion of each distribution that represents earnings). There's also no annual limit on contributions to an annuity.
The tax deferral offered by a deferred annuity is a nice feature, but it comes with some tradeoffs that you'll need to weigh carefully:
- There are associated fees and costs, including annual fees, investment management fees, and insurance expenses.
- A surrender charge may be imposed if you withdraw funds within a certain period of time
- A 10% federal penalty tax (in addition to any regular income tax) may apply if you withdraw funds from an annuity before age 59½
- Investment gains are taxed at ordinary income tax rates, not at lower capital gains rates
Annuities do have some unique benefits beyond tax deferral. With annuities, you can elect an annual payment amount that is guaranteed for the rest of your life (the guarantee is subject to the payment ability of the issuing institution)--this relative degree of certainty can be psychologically and financially comforting. In addition, annuities may offer some creditor protection under state law.
Taxable investment accounts
Your other basic option is to invest through a taxable investment account. The lower federal income tax rates that apply to long-term capital gains and qualifying dividends go a long way toward taking the bite out of holding investments outside of a tax- advantaged retirement account like a 401(k) or IRA. And, a taxable investment account offers one enormous advantage: You gain a tremendous amount of flexibility. You can choose from a virtually unlimited selection of specific investments, and there's no federal penalty for withdrawing funds before age 59½.
Investment options worth mentioning:
- Mutual funds or separately managed accounts (SMAs) managed for tax efficiency intentionally minimize current taxable distributions
- Index mutual funds and exchange-traded funds (ETFs) trade infrequently and therefore tend to have low annual taxable distributions
- Tax-free municipal bonds and municipal bond funds generate income that is free from federal and/or state income tax
Always keep the big picture in mind
Your investment decisions should be based on your individual goals, time frame, risk tolerance, and investment knowledge. You should evaluate every investment decision with an eye toward how the investment will fit into your overall investment portfolio, and whether it will meet your general asset allocation needs. We at Stage 2 Planning would be glad to help you with your options. Give us a call and we will be glad to spend some time with you.
With warm regards,
Stage 2 Planning Partners
Josh Patrick © 2007
Securities and Investment Advisory Services offered through NFP Securities, Inc., a Broker/Dealer, Member NASD/SIPC and Federally Registered Investment Advisor.
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