I read the Queercents Weekly Roundup by Elizabeth yesterday and couldn’t resist her pointer to check out Kiplingers list of 20 ways to waste your money. One in particular caught my eye:

8. Pay too much in taxes on investments. Are you investing in a tax-sheltered 401(k) or Roth IRA? If you’re not maxing out those accounts before you invest in a taxable account, you’re spending too much.

Now I’ve seen this suggestion a hundred times before and, in fact, as a financial coach, I’ve probably given this suggestion a few dozen times. For many people this is fine advice. But it presupposes a number of important things.

  1. It is actually possible TO max out your 401k AND contribute to a Roth IRA.
  2. There are no options for tax efficient investing in a taxable account.
  3. You are making so much money that item 1 is possible and you are in a high tax bracket.
  4. You won’t be wanting to use that 401k money until you are “retired” at the age of 59 ½ or older.

There was a time when I was working full time with a nice salary, suitable business wardrobe, a new car, a house full of new furniture, 2 weeks vacation, little time to cook and the means to eat out. I did max out my 401k for a few years and I’m glad I did. Of course I was also miserable, exhausted and sick frequently.

My life today is nearly the opposite of this. One of the reasons that is possible is that I started to ignore this advice and contribute to my taxable accounts in earnest when I knew I wanted a way out. As I’ve mentioned before, I am obsessed with financial independence. So much so that I am willing to lead a very frugal lifestyle and continue to find ways to reduce costs. I am, of course, looking for that convergence point where income from investments meets or exceeds personal expenses. Here’s the point. I have quite a few years to go before reaching the age of 59 ½, otherwise known as the age when withdrawals from IRAs (assuming you’ve rolled from your 401k) are penalty free. So if all my money was tied up in IRAs, I would not have easy access to the income generated. And I’m using that income. Right now.

Further, because my expenses are low, my income needs are low so my tax burden is somewhere between non-existent and very small. My wife makes more than I do and we are able to (legally) shift some of her income to me for the management of her portfolio and other administrative services so as to minimize our tax burden as a couple. (An example of an “expense” I don’t try to reduce!) This is one area where we same sex couples actually have some advantages.

There is an exception to this age restriction on IRA withdrawal (IRS rule about 72t) but it is complicated. You can take your principal out of a Roth IRA at any time without consequence (because you’ve already paid taxes) but careful accounting of your basis and more conservative than a typical retirement asset allocation would be important factors if you wanted to access these funds before age 59 ½.  I’m skimming the surface of this topic and there are other issues to consider but the intended take-away is that this conventional advice is geared toward the typical employee who plans to work to near typical retirement age. As with many of these recommendations, it may not be right for you. Ask yourself if you fit the mold.