Once I have completed the down payment on my condo and finished furnishing it, I will direct my savings towards maximizing my roth IRA and a solo 401k. I decided to open a roth IRA instead of a traditional IRA because I wanted to diversify the tax-sheltered retirement accounts. My solo 401k will be funded with pre-tax money, while a roth IRA is funded with post-tax money. Fortunately my AGI is below the contribution limit level for 2008, which is $101,000 so I am eligible to invest $5,000 into my roth IRA. For those of you less fortunate to be making such a large salary, there is a way to invest in a roth IRA for the future.
Contribute to a Roth IRA Even Though You Don’t Qualify
First, you have to open a nondeductible traditional IRA. Everybody qualifies for a nondeductible traditional IRA. In 2010, income limits for converting a traditional IRA into a roth IRA no longer apply. Once the income limits no longer apply you transfer your traditional IRA to a roth IRA. Since you funded your traditional IRA with post-tax money the conversion costs are minimal. The only cost is the taxes on income earned from your investments between now and 2010.
Let’s take this scenario one step further. Most CDs that I have invested in paid out interest monthly. Suppose you invest in a CD that only pays out interest when the CD matures. If the maturation date is after January of 2010 when you convert to a roth IRA, there is no cost associated with converting since there has been no income. Obviously, a CD such as this will provide a lower return as the interest will not be compounding. Before deciding to follow this route, you must investigate how much you save in taxes on the interest versus how much interest you are losing by not compounding.
Maximizing Investments on IRA Contributions
All funds have some sort of annual fee associated with them. At the very least there is an annual expense ratio. When you fund your IRA or 401k, most everybody allows the broker to take the annual fees out of the contribution. When this happens you’re not maximizing your contributions or your deductions. If you send in a separate check that covers your annual fees, the full $5,000 of contributions is invested in your retirement account. In addition, the check you sent for annual fees can be deducted as an investment expense.
If your goal is to maximize your retirement contributions make sure you are truly maximizing your retirement contributions. The tax laws can be confusing, but if understood you can retire much earlier, which is my long-term goal.