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When A Taxable Account Is Better Than A Retirement Account
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Right to the point in today’s Juice, which you might call short and sweet, but oh so complete. As much as we love financial calculators, sometimes financial calculators suck! Because, quite often, they fail to take into account real life, on the ground. For example, one of the most popular financial calculators you’ll see asks you to put in an initial investment, how much you’ll invest periodically, at what rate you expect to get and for how long. From there, it says you’ll have X amount of money in X years. The people who think you shouldn’t spend $5 a day on coffee run those numbers to shame you for spending $5 a day on coffee. As if, a simple daily pleasure is what’s keeping us from becoming millionaires. For some of us, that small investment helps create the conditions for us to make money or, at least, be less stressed. Worthy endeavors that the time spent relaxing and maybe interacting socially, even if informally, can help facilitate. The specifics of that aside, it can be dangerous to run numbers without much, if any context. Another popular calculator shows how much you’d have at the end of a time period if you keep your money in a tax-advantageous account (typically a retirement account) versus a taxable account. Many of these calculators break it down by tax-free, tax-deferred and taxable. So, for example, let’s assume you start with $10,000 and invest $500 a month for 20 years at a 7% rate of return. The amount of money you can end up with in the different types of accounts looks like this:
In the coming weeks, we’ll go over the differences between different types of tax-advantageous accounts. Because we think they are fantastic for large numbers of investors. So we’re not saying you shouldn’t use one. We’re just saying the idea of “maxing out” can be dangerous if it makes everyday and emergency money tight. As we noted late last week in There’s A Big Problem With The 401(k) Plan: Show us a money article about how to invest that doesn’t start with “max out” your 401(k) and/or IRA contributions. Great advice. Until it isn’t. One of The Juice’s general concerns is that if you have to stretch to do something financially, it probably isn’t a great idea. Whether that’s buying a house or saving for retirement, what’s the point of crunching your budget to the point where you have to backtrack? If you have to turn to credit cards to make ends meet? If, as we outlined in that aforementioned Juice, you have to take a hardship or otherwise early withdrawal from a retirement plan to cover expenses. Some people are simply better off in taxable accounts where they get their hands on their money with no or relatively fewer tax consequences. We don’t talk about these people enough. Which is why we talk about this type of stuff. To consider context and the sometimes hard realities of life on the ground. There isn’t a financial calculator to capture the situation we describe. And, if there is, it will come with a negative spin. If you break the momentum of regular investing and tax-deferral (for example), you’re hurting yourself. You’re losing money. Fine. But how do you quantify falling into credit card debt or incurring a 10% penalty and paying taxes (or accumulating IRS tax debt) because you absolutely needed the money you probably should not have been putting into a place where you can’t access it quickly and without restrictions in the first place? If your budget is tight or you don’t have money accessible to cover a significant unplanned expense, this is a consideration you should make, even if it goes against conventional advice. Similar logic applies to using a CD (certificate of deposit) to save versus a high-yield savings account. Access to your money sometimes matters. Do your own personal math before you max out anything.
The Bottom Line: The Juice will continue to cover some basics in future installments from several perspectives. For example, when we look at the different tax-advantageous accounts we’ll make some points about who they might or might not be good for. When we distinguish between CDs and savings accounts, we’ll compare interest rates and features that can help you make the decision of where to put your money. Because there is no one size fits all, only you can make the final call. However, The Juice is determined to lay out the facts and have conversations that consider all types of situations, not only the cookie cutter strategies that have been repeated so many times we often uncritically accept them as the only way. |
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