(Every now and again, I receive an email that is a great guest post. This one about Roth IRAs for younger folks is one of those…enjoy!)
All you in your 20’s and 30’s out there listen up!
If you’re just starting out in your career and making over $60K you’re probably smart with a good head on your shoulders. Even if you are earning less, try and work these rules into your budget plans as soon as you can, and yes you are still smart for listening to ole Josh. Let’s start you off right.
Just Starting Out
Rule Number One: After you get your first paycheck open a Roth IRA account and start contributing to it monthly! I would suggest a larger reputable established brokerage firm like Vanguard, Fidelity, T Rowe Price, etc.
Rule number two: Hopefully the company you work for offers a 401K plan with company matching contributions, most do. Sign up to contribute as much as you can to the company 401K but at the beginning make sure you contribute enough to get the “full” company match. If you don’t you’re just leaving money on the table. I would suggest that your contributions go into a Roth 401K if it’s offered. The company match will have to go into the tax-deferred 401K plan but that’s ok, we’ll deal with that later.
Rule number three: When, not if, but when you quit your job to go to work at a better job for more money, transfer your Roth 401K funds into your Brokerage Roth account (See rule one). Then transfer the tax deferred 401K funds to your new jobs 401K plan. There’s a reason for transferring these tax deferred funds to the next companies tax deferred 401K plan and not to a Standard IRA account and we’ll cover that later on. Then setup your 401K options with the new company like you did with your last job (see rule two). Rinse – Wash – Repeat…
What to Do When You’re Making Good Money
“But Josh! Now both the wife and I are making BANK (over $193,000 income a year for 2019). We are making too much money to contribute to our Roth IRA and we both are maxing out our 401K plans so we can’t contribute any more there either. Yet we still want to save more for retirement so that we can retire early! Is there anything else we can do before we open another Brokerage account and have to start paying taxes on those dividend earnings and capital gains.”
Why yes, yes there is! Since you and your wife can no longer contribute to your Roth brokerage accounts, you both can use the Roth Backdoor Conversion method to add more funds to your Roth IRA account at your brokerage firm. How you ask? This is how. You open a Standard IRA account with the same Roth brokerage firm using after tax money to fund the account. Do not invest this money!
For 2019, under the age of 50, the maximum you can contribute to a Standard IRA is $6,000. This number will probably rise in the future. As soon the money clears and is available in the account you would do a Roth conversion and transfer the money into your Roth brokerage account. Because you already paid taxes on the money you will not have to pay any taxes to do the conversion. Thus the legal Roth Backdoor conversion method…
The IRS has special rules when dealing with tax-deferred Standard IRA accounts that mingle both tax-deferred funds and after tax funds so it’s better just not to deal with that at all. But there are other reasons for transferring your tax-deferred 401K funds to your next job and not to your tax-deferred Standard IRA and we’ll cover that later.
Fully Funded ALL Retirement Accounts
“Ok Josh!” That sounds great and right now everything is maxed out and working smoothly. We still have a few dollars left to save.” Well you can always contribute more to an HSA account or open a regular brokerage account then invest in Bonds or CDs.
Looking at Retirement
“Sup Josh? We are getting closer to age 55 and want quit our crappy jobs soon! Got any suggestions on how to avoid any sort of early retirement penalty” Now it’s time to explain why you were told to move all of your tax-deferred 401K fund from your old company plan to your new company plan each time you switched jobs.
When you turn 55 you can quit your job (provided you’ve run the numbers and have enough money saved) and start taking distributions from that last companies 401K plan without incurring a 10% penalty from the IRS for early withdrawals. The withdrawals have to come from that last company plan that you worked for. You cannot leave money in other company 401K plans that you have worked for in the past and withdrawal without penalty. That is why you were told to transfer those tax-deferred 401K funds to your new company each time you switched jobs. The amount just keeps getting bigger over time and is in one location.
The best rule of thumb is to withdrawal from your Tax-Deferred accounts first for as long as you can. Retiring at 55 I would personally would make sure that I had enough money in my tax-deferred 401K account and cash on hand to make it until 59.5 years of age. If there’s plenty to cover that and then some, you would still withdrawal from your tax-deferred 401K account first. If your 401K plan is plentiful but lacking in investment options, you can always transfer “PART” of your 401K funds to your tax-deferred Standard IRA account at your brokerage firm in order to get better investment options. Once your tax-deferred 401K funds have run out (after you are over 59.5), you can then start distributing for your tax-deferred Standard IRA. Depending on how much money you have left in your tax-deferred accounts will determine when you want to start doing Roth conversions before you turn 70.5 and RMD’s kick in.