It?s only January, but I?m dreading tax day already. Our taxes will be quite complicated this year because I sold a bunch of stock options and the rentals will muck things up as well. Anyway, I already purchased a copy of H&R Block and I?ll fill it in as the required W-2 documents arrive. I really hope we won?t have to send the IRS a big check this year.
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Taxes take a huge bite out of your income and nobody likes to pay them. That?s why I advise people to invest in the 401(k) and Roth IRA. An investor can use the amount contributed to the 401(k) to reduce their AGI and pay fewer taxes now. When you withdraw from the 401(k) in retirement, you?ll have to pay taxes then. ?I make the assumption that most people will be in a lower tax bracket in their retirement so they should come out ahead overall. For the Roth IRA, you invest after tax money, but you don?t have to pay taxes when you withdraw in retirement (assuming you meet the qualifications.) However, you will have to pay a 10% penalty on both these accounts if you withdraw before you?re 59 ?. For those of us who plan to retire early ? does it make sense to invest in the tax advantaged accounts?
Personally, I think it is still a good idea to invest in the 401(k) and Roth IRA. We have maxed out our contributions for many years now and built a respectable retirement portfolio for our age. Mrs. RB40 will continue to max out her 401(k) contribution as long as she can. We?ll maximize our Roth IRA contribution for the foreseeable future as well. We have 20 years left until we?ll both be 60 and then we can withdraw from the retirement portfolio without having to pay penalty. Some readers with an early retirement goal question why we would limit access to a big chunk of our net worth for 20 more years. If I retire early, shouldn?t I just focus on the after tax account?
Here are my reasons for investing so heavily in the tax advantaged retirement accounts.
Avoid withdrawal
For me, having to pay the 10% penalty withdrawal is a big deal. This psychological barrier will prevent us from touching our retirement fund until we really need it. If the funds are in a regular taxable brokerage account, it will be too easy to withdraw and spend it.
Let it ride
After 16 years of work, I accumulated a nice sum in my retirement accounts. The sum isn?t enough to retire on at this time, but it should keep increasing if I let it ride in the stock market for 20 more years. My strategy is to make the finances work without touching this retirement fund until I?m 60. In 20 years, my retirement portfolio should be able to support a comfortable retirement.
Phased retirement
Most people work very hard until they are near retirement age and then jump straight into it. My retirement strategy is a bit different. I worked hard at a corporate job until I turned 39, then I retired from that career. The 40-60 phase of my life is wide open. I am a stay at home dad now and I?m building my online business. After my kid starts school and I have more time, I would like to explore more self employment options. At this age, we are still active and can bring in some income. I don?t see the point of a full retirement this young. Also, I advocate being frugal because even a small income will go a long way toward covering your expenses.
The retirement portfolio is still accessible
There are some ways to access the fund without having to pay the penalty. First of all, the contribution portion of the Roth IRA can be withdrawn at anytime without a penalty. As for the 401k, I can use the 72(t) rule to access that fund if needed. The 72(t) rule is a bit complicated, but basically you?ll have to withdraw a portion from your fund every year. We might resort to this if Mrs. RB40 retires early (say at 55 years old) and we need the money. Anyway, we don?t plan to withdraw until 60, but it?s nice to know that there are ways to access the retirement portfolio while avoiding the 10% penalty.
Those are the reasons why I like investing in the 401(k) and Roth IRA. The money is (somewhat) off limits until I?m 60, but that?s fine. These retirement funds are for the 60+ phase of my life. Fortunately, we also have investments in our taxable accounts.
Each of these investments generates a small income. Along with my online income and Mrs. RB40?s paycheck, we can live a comfortable lifestyle right now.
Do you plan to retire early? If so, do you think investing in the 401(k) and Roth IRA is a good idea?
Source: http://retireby40.org/2013/01/early-retiremen-invest-401k-roth-ira/
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