by AFrazz » Wed May 23, 2012 12:01 am
Hello everyone, my name is Alex and I'm 17 years old. My parents told me that saving money for retirement is very important, and I should start at a young age especially with how the economy is right now, and that social security is not guaranteed by the time I hit retirement. Is life insurance and retirement saving similar? What are the different options for retirement savings? Bare with me here, I'm young but I'm very eager to learn my options! Thank you for your time.
Posted: Thu May 24, 2012 11:42 pm Post Subject:
Is life insurance and retirement saving similar?
Absolutely not!
What are the different options for retirement savings?
A) any and all employer-sponsored retirement plans, such as 401(k), 403(b), SIMPLE, SMART, Keogh, SEP
B) individual retirement arrangements such as Roth IRA, Traditional IRA, nondeductible IRA
C) after fully funding all plans available to you under A and B above, if you still had money you wanted to commit to retirement savings, you could consider an annuity.
My recommendation: fully fund your Roth IRA ($5000 in 2012) first -- requires that you have "earned" income, then contribute to any employer-sponsored plan in which you are eligible to participate.
Life insurance provides money for those whom you leave behind at your death and were dependent upon your income for some or all of their living needs. Until you are married, you probably will have little or no need for life insurance, but you could consider a small policy ($25,000 - $50,000) now and name mom or dad as your beneficiary. It would pay for funeral expenses if, God forbid, you died anytime soon.
But don't let anyone talk you into using cash value life insurance as a way to save money for retirement. You'll could easily waste your money doing that by putting it into any kind of policy other than "whole life" -- and ending up with no money and no insurance.
Posted: Fri May 25, 2012 09:39 am Post Subject:
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[Links were to a company based in India]
Posted: Sat May 26, 2012 02:46 pm Post Subject:
Max,
Why are you recommending a Roth IRA before an employer sponsored plan without any conversation about whether there is an employer match?
Why are you writing in such a way to make it sound like a "traditional" IRA is a different IRA than a "non-deductible" IRA?
Posted: Sun May 27, 2012 02:42 am Post Subject:
Why are you recommending a Roth IRA before an employer sponsored plan
That's a fair question. The answer is one of simple economics.
Many advisers have been making this solid recommendation for the better part of the last 15 years. The Roth IRA will provide tax free income in retirement (unless Congress changes its collective mind at some point in the future, as it could), but the 401(k) -- including the employer match -- will be taxable 100%.
In case you haven't been paying attention, we have $16,000,000,000,000 of current debt and another $189,000,000,000,000 in unfunded Social Security, Medicare, and Part D (prescription drug) liabilities, so the prospects for reaching retirement and finding oneself in a lower tax bracket -- which is the economic picture we've been sold for about 40 years -- is no longer realistic.
Even though the Roth contribution limit is significantly lower than that of the 401(k), very few people, especially younger ones such as the OP who posed the question, maximize their contributions to the plan. Older executives, and higher wage earners, yes, but the majority of participants, no. So if a person is going to contribute more than $5,000 to their 401(k) in a year, it makes a lot of sense to put as much or all of the $5000 into a Roth IRA along with contributions to the 401(k). One gives up the tax deduction of a traditional IRA and the pretax contribution to the 401(k)/403(b), but gets the bigger carrot at retirement time.
When it comes to an employer's matching dollars, a second school of thought says contribute just enough to the 401(k) to capture all of the employer contribution and put the rest available for retirement savings into the Roth IRA (until it is maxed out for the year). This may or may not be the best advice. One needs to do a complete comparison of the accounts side-by-side during accumulation and at retirement to see the difference. We don't even know if the OP, as young as he is, is working for a company that allows him to participate in a 401(k) plan. Legally, he could be excluded until he turns age 21, even if he works full time, if the employer sets up the plan that way.
[Don't forget that the employer-sponsored plan may have really lousy investment choices (or none, as a few do, because the employer makes everyone put their money into very conservative GICs). The Roth IRA is self-directed, and could invest in ultra-low cost index ETFs or any other permissible asset, and obtain greater returns than the employer-sponsored plan]
I'm definitely not saying one should necessarily forgo the employer match in favor of the Roth IRA. There are several contribution "analyzers" across the Internet that can show the differences in both scenarios. But I am looking at the long term prospect of taxation and making an educated guess about the future, and I think, as many advisers do, that it makes more sense to maximize the Roth first. (If we end up with another four years of Obama, you can be sure the fix is in for higher taxes in the future.)
It also makes great sense to convert IRA and 401(k)/403(b) assets to Roth assets today for the same reason. Pay the lower tax on the conversion at today's rate (but only as one has the ability to do so, of course -- giving up that venerable "refund" is one way to pay for it) and have complete tax-free use of the money when the time comes, while others are struggling to take their RMDs (none of those in a Roth IRA) and pay the higher taxes on that money.
And, guess what, at retirement time, a person could roll all their Roth IRA assets into a qualified annuity and potentially provide perpetual tax-free income to several generations (there are somewhat different distribution rules for subsequent beneficiaries, but with enough money in the account, it is absolutely possible). It would NEVER have to be annuitized and it would NEVER result in a taxable event.
Now, about your second question:
Why are you writing in such a way to make it sound like a "traditional" IRA is a different IRA than a "non-deductible" IRA?
I write about them as different, and teach about them as different, because they ARE different. A "Traditional" IRA is also known as a "deductible" IRA. One funds it, technically, with after-tax dollars and obtains a full or partial deduction for their contribution. A person who is an active participant in an employer-sponsored retirement plan is subject to a sliding scale that limits the deduction to the IRA.
If a person cannot obtain the full deduction, they are not limited in their ability to contribute to an IRA. Everyone can still put the $5,000 (+$1,000 for those over age 50) into one of the three IRAs. Some folks are such high wage earners that they cannot contribute to a Roth IRA, so their only other choice is a "Nondeductible" IRA.
A nondeductible IRA is funded with after-tax dollars, exactly like a Roth IRA, but all the gain is taxable at distribution, unlike the Roth. The contribution dollars are not taxed again.
But, perhaps you didn't think about this, commingling pretax and after-tax dollars in the same account creates an accounting nightmare. That's why folks who borrow money from their 401(k)/403(b) accounts for foolish things like buying an automobile, make a big mistake. They repay those borrowed pretax dollars with after-tax dollars and will be taxed on that money a second time.
While it's certainly possible to keep track of after tax contributions to an IRA, it makes more sense to simply use a second IRA account for that purpose. Keep the two accounts entirely separate from one another.
Even the IRS identifies traditional and nondeductible IRAs as separate creatures. Don't understand why it troubles you. This stuff is tested on the Series 6 and Series 7 FINRA exams -- has been for years.
Posted: Sun May 27, 2012 04:17 am Post Subject:
Hey Max, it's been a while.
To the OP, I'd question the prudence of showing up on any forum and expecting a lot on the way of the serious assistance you need if you plan to truly carry out what you're planning.
Does cash value life insurance work as an asset within which you can save a lot of money? It sure does.
Is this a viable plan for you? There isn't a person here with enough information to make that judgment call, no matter how sensational their tone. However, you'd have a tough time establishing a plan as there a chance you may not yet be legally old enough to enter into a contract, and based on your age you probably are probably yoked to the standard rate used for juvenile cases (maybe not).
As for the discussion about IRA's and 401k's and such. You probably don't have a 401k available to you. Even if employed your employer can exclude you based on your age.
So, if you want to insist, there's a good chance an IRA is your option by default (or you could just go the general brokerage account if you want to pay a bunch of taxes on dividends and capital gains when you buy/sell).
As for the type of IRA. Roth is probably best due to your age (you aren't likely at your earnings peak, so you can afford the tax hit...which is probably minimal from the start. And you can take advantage of FIFO distributions meaning if all hell breaks loose at some point in the future you can withdraw the basis from the IRA if need be with no taxable issues (some people might gasp and finger wag at this, but life happens).
Max, one little issue with something you said that is probably more semantics and you're making a lazy mistake:
The Roth IRA is self-directed, and could invest in ultra-low cost index ETFs or any other permissible asset, and obtain greater returns than the employer-sponsored plan]
At 17, I seriously doubt he's going to establish a self directed IRA. In fact, the amount he's likely looking to put into an IRA isn't enough to cover the fees he'd pay to establish a self-directed IRA.
Oh, this didn't make any sense to me either:
And, guess what, at retirement time, a person could roll all their Roth IRA assets into a qualified annuity
How is he going to roll Roth funds into a "qualified" annuity, and why would he want to?
Posted: Sun May 27, 2012 05:18 am Post Subject:
self directed
Perhaps a poor choice of words. What I meant was he would have complete choice over what assets/ETFs/mutual funds to hold in his IRA.
How is he going to roll Roth funds into a "qualified" annuity, and why would he want to?
I can't believe you don't know this. There are huge amounts of 401(k)/403(b) money currently flowing into annuities, with more to come as the Baby Boomers retire. A Roth IRA is a qualified account. A qualified annuity holds retirement plan assets. A Roth IRA (or a 401(k) or 403(b)) may be rolled over into an annuity for the purpose of providing lifetime income based on assets and life expectancy.
But, since the Roth IRA has no RMD requirement like all other retirement plans, the annuity can simply be used as the conduit to make withdrawals. It could be annuitized or not, but when not annuitized any remaining balance can be rolled over to another beneficiary, who will continue to take tax-free withdrawals.
A subsequent beneficiary, however, must take withdrawals based on their life expectancy at the time of ownership transfer, so if the money is left to a grandchild, the required distributions will be small and because they are based on life expectancy, regardless of age, are not subject to the 10% penalty tax (additional withdrawals could always be taken, and could be subject to the pre-age 59-1/2 tax on gains only), the account will continue to grow tax-deferred and provide (genuine) tax-free income (not that UL/IUL/VUL loan income) until the account is exhausted. With a great start, it could provide hundreds of millions of tax-free dollars to several generations of beneficiaries.
Google "Roth IRA annuities" and see what you come up with. Most life agents have no clue about this.
Posted: Sun May 27, 2012 08:54 pm Post Subject:
NEVER have I heard an educated advisor other than you recommend the Roth first when there is an employer match.
Here’s an example. Joe makes $50,000. He can afford to put away $3,000 long term. His employer offers a dollar for dollar match on his 401(k) up to 6%.
Choice A (Max’s Recommendation): Put $3,000 into a Roth IRA.
Choice B (My Recommendation): Put $3,000 into a 401(k)
So, Max’s Client will have $3,000 going into a Roth IRA. My Client will have $6,000 going into a 401(k).
Max, you are incapable of coming up with any realistic scenario in which your client’s Roth IRA comes out on top.
In fact, for these two things to even break even, the client's marginal tax bracket would have to go from 0% while working to 50% while retired.
If we make it realistic, we can even assume an increased tax bracket in retirement, and Max's client will have less money. ie. 20% tax bracket now vs. 35% in retirement, it won't even be close.
Max, there are certainly times when a Roth makes sense before a 401(k), but to forgo a company match will almost always be a mistake.
Posted: Sun May 27, 2012 09:07 pm Post Subject:
“It also makes great sense to convert IRA and 401(k)/403(b) assets to Roth assets today for the same reason. Pay the lower tax on the conversion at today's rate”
Max, this sometimes makes sense and sometimes it doesn’t. You are making too much of an assumption on something that you (and the rest of us) just are clueless about. We don’t know if tax rates are going up and we certainly don’t know if the tax rates are going to be going up for any specific anonymous individual.
1) Are future tax rates going up? We don’t know. You want to act like you know that they will. Fine. You might be right.
2) Even if they do go up, is the typical person going to be in a higher tax bracket in retirement than they are while they are working? Most now are in a low bracket. Most people don’t have a ton of qualified retirement money. There is no reason why I see this changing even though for some people they will be in a higher tax bracket.
3) Even if one is going to make as much money in retirement as now, the bump in income from the conversion could mean that this money will be taxed higher now than it otherwise would be.
Ex. Max’s client makes $60,000. He has $250,000 of IRAs. If he converts now, he’ll have a taxable income of $310,000. If his average taxable income in retirement (if he didn’t do this conversion) was going to be $80,000, it would take a humongous tax increase on non high income earners for Max’s client to come out ahead on the conversion.
He’ll be much worse off if tax brackets increase modestly or if he’s like most people and his taxable income is less in retirement than in his working years.
Posted: Sun May 27, 2012 09:11 pm Post Subject:
And, guess what, at retirement time, a person could roll all their Roth IRA assets into a qualified annuity and potentially provide perpetual tax-free income to several generations (there are somewhat different distribution rules for subsequent beneficiaries, but with enough money in the account, it is absolutely possible). It would NEVER have to be annuitized and it would NEVER result in a taxable event.
If this is what a person wants to do, there is absolutely no reason to annuitize it. Annuitizing it would actually be a mistake.
Posted: Sun May 27, 2012 09:21 pm Post Subject:
I write about them as different, and teach about them as different, because they ARE different. A "Traditional" IRA is also known as a "deductible" IRA. One funds it, technically, with after-tax dollars and obtains a full or partial deduction for their contribution….
…A nondeductible IRA is funded with after-tax dollars, exactly like a Roth IRA, but all the gain is taxable at distribution, unlike the Roth. The contribution dollars are not taxed again.
…. Even the IRS identifies traditional and nondeductible IRAs as separate creatures. Don't understand why it troubles you. This stuff is tested on the Series 6 and Series 7 FINRA exams -- has been for years.
Max, you should be ashamed of your lack of knowledge on this. There is no such thing as "deductible" IRA and "nondeductible" IRA. The IRS makes no distinction. An individual DOES NOT have "deductible" IRA and "nondeductible IRA". Instead an individual has a Traditional IRA and a traditional IRA can have both deductible and nondeductible contributions.
CONTRIBUTIONS are "deductible" and "non-deductible". IRAs are not.
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