Give Yourself The Gift of Wealth


Do you hear that Christmas jingle in the air?  Maybe it’s all that spare change falling out of your pockets!

The end of the year is a flush time for many in the Western world — Companies tend to pay out bonuses and profit sharing rewards to employees at the end of the year.  It’s the most cash-rich time of the year for many … at exactly the same time when society turns on the most pressure to spend. 

Any other time of year, and the bonus money might get put into a savings account, pay down some debt, or possibly even get invested.  But the holidays are built around spending.  It’s hard to resist.  No one wants to be a Scrooge afterall.

Scrooged

 

Give The Gift Of Wealth

Last year, (in one of my earliest posts) I talked about my favorite ways to avoid Capitalist Christmas.  All those ideas still hold true.

If you have a family obsessed with gifts and holiday cheer, I suggest you go read that post first.  Spending money is not required to have yourself a holly-jolly happy holiday!  (Say that 3 times fast!)

But this year I’m going to recommend a different kind of gift:  Giving yourself the gift of wealth!  

It’s a gift that will change your life!  

What could be better than buying yourself (and your spouse) the gift of an ever growing income stream?  It’s a gift that doesn’t just “give once”, but it gives every single year you own it!

Obviously saving wealth for financial independence takes time, but you can get there by following a few key principals.  That, and having the right financial tools at your disposal.

So what is the magic “gift” you’ll give to yourself (and your spouse) — The best two financial tools in the world, a Taxable Brokerage Account, and a Roth IRA.

Instead of spending your holiday bonus, invest that money into the two accounts and realize a lifetime of wealth.

Let me explain…

 

Taxable Brokerage Accounts

Taxable accounts may not get a lot of respect in the Personal Finance Blogging world, but they are a HUGE part of “The Gift of Wealth”.  If you (or your significant other) don’t already have one…go get one!

Don’t get me wrong, I LOVE tax advantaged accounts.  When I had jobs with employer sponsored 401k’s, I used ’em!

But tax advantaged accounts have limits.  In the case of a U.S 401(k), contributions are limited to $18,000 (this year).  That’s not nearly enough for financial independence at a young age!  What’s worse, you can’t withdraw funds from a 401(k) without penalties until age 59.5! 

So instead, we utilize both tax advantaged and taxable accounts to our advantage!

In my case, I maximized the use of my tax advantaged accounts. and then everything else was saved into a taxable account!

Taxable accounts often get a bad reputation.  You may have heard horror stories about people with brokerage accounts before:

  • Day-traders who buy and sell investments continuously and rack up tons of losses and trading fees.
  • Gamblers who think they’ll strike it rich by betting on the next big technology stock!  Then they lose it all!
  • Speculators who buy a stock with leverage only to have a margin call when the stock price drops.  They lose tons!
  • People with more money than brains that follow the advice of a broker … and end up losing it all.

Each of these horror stories has some truth to them, but they also miss a key point — Taxable accounts can hold exactly the same assets as any 401k or retirement account!  

That’s right!  There’s absolutely no need to day-trade, use leverage, or gamble on tech stocks.  You can invest in the same slow and steady index funds that you’re used to with pre-tax accounts!

That said, taxable brokerage accounts are the single most flexible accounts at your disposal.  It’s entirely possible to do incredibly stupid things.  Don’t.

A taxable brokerage account is a tool just like a car.  They can be sensible efficient grocery-getters, or they can be a flaming death machines for your portfolio!  

Drive carefully.

Monster truck
Efficient grocery-getter or monster truck? A taxable account could be both! You decide how it gets used!

 

The Roth IRA

For individuals looking to retire early, the Roth IRA is an invaluable tool.  Hell, you even don’t have to be interested in early retirement and it’s still a incredible tool!

Instead of pre-tax contributions, Roth IRA contributions are “post-tax” contributions.  This is money contributed from your taxable accounts.  But the beauty is that after initial taxes have been paid, distributions made later in life are tax free!

Confused?  Think about it this way:

IRA / 401(s) — Don’t pay taxes now, pay later!

Roth IRA — Pay taxes now, but don’t pay taxes later!

If you’re relatively young, the advantage of a Roth IRA is decades of tax-free growth!  That’s right, any money you contribute now can grow substantially and you’ll won’t need to pay taxes on that growth at age 59.5!

But what if you want to retire earlier than 59.5?  Can you withdraw Roth IRA contributions without penalty?

Yes, you can!  But only the standard contributions, not the dividends, interest, or capital appreciation, AND your rollover contributions must be seasoned for 5 years before withdrawal.

(After age 59.5, all money is fair game of course)

Normally Roth IRA’s have contribution limits of $5,500 or $6,500 (depending on your age), and that’s not a lot.  But there is a MASSIVE HACK in the tax system that allows for larger contributions called rollovers.  

The following chart from the IRS details all the possibilities, but most pre-tax retirement accounts allow rollovers into Roth IRAs.  Here’s the kicker:  There are no limits on rollover contributions

For early retirees, this is fantastic news!  We can have our cake, and eat it tax-free 5 years later!!

The IRS rule on rollover contributions means you can roll-over pre-tax 401(k) dollars into a post-tax Roth IRA after paying the low income taxes of a early retiree!

Do this every year and you’ll build a steady stream of tax-free income called a Roth IRA Conversion Ladder.  Justin over at Root Of Good has the best writeup on the internet about how to build one of these conversion ladders.

Even if you’re not early retired, I suggest setting up a Roth IRA this holiday season.  Contribute the maximum $5,500 from your Christmas bonus into that IRA as soon as possible.  Your spouse should do the same.  

Then, when you finally say goodbye to 50 hour work weeks, you’ll have years of contributions already seasoned!  At that point you can begin rollover contributions, and live off the already seasoned contributions along with money invested in taxable brokerage accounts.

Can the Roth IRA story get even better?  Yes it can!  A traditional IRA has a terrible rule called the required minimum distribution when you reach age 70.5.  It means you have to start withdrawing money…even if you don’t want to pay those taxes.

 The Roth IRA does not require minimum distributions!  You can continue to grow wealth tax-free even after you turn 70!

 

Where To Open Accounts

OK, if you’re still reading this there might just be hope for you!  Are you ready to give yourself this fantastic holiday gift?

 You can create these awesome wealth building accounts right away, but first you need to decide where.  

There are literally hundreds of different fund companies and banks vying for your investing dollar that offer both traditional brokerage accounts and Roth IRA’s.  A quick google search will provide hundreds of comparison sites … no need to redo that here.

That said, I have my favorites: Vanguard and Fidelity.

Most brokerages will charge fees for investing in stocks, ETF’s and Mutual funds.  Typically this is less than $8 for stock/ETF transactions, and Mutual fund fees will vary based on what you’re buying.  

For example: At large mutual fund houses like Vanguard or Fidelity, investing in home-grown funds is typically free.  But if you invest in a Vanguard mutual fund from a Fidelity account, they normally charge a $49.95 fee.

In that case, there are several options:

  • It could make sense to pay the $7.95 fee to buy the Vanguard ETF version of that same index fund rather than pay the $49.95 fee Fidelity charges…depending on how frequently you’ll be buying.
  • Or, better yet, just open a Vanguard account and skip all the fees.  
  • If we’re talking index funds, another option is to find a Fidelity version of the same index fund.  Usually they’re quite comparable.

As you can see, there’s numerous possibilities to avoid or reduce fees.  Do your homework!

Here’s the fee breakdown for these two popular fund companies:

BrokerStock/ETF fee“House” Mutual Fund FeeOutside Mutual Fund Fee
Vanguard$7$0$35
Fidelity$7.95$0$49.95

Both Vanguard and Fidelity have taxable accounts and Roth IRA’s available to customers.  They share many similar features.  Both are great companies with a stable financial situation.

Mrs. Tako and I have historically kept our funds at Fidelity, but that’s mainly because our employer sponsored 401(k)’s were located there.

Fees can change over time, so watch them closely.  Today, Vanguard seems to be the most fee efficient option of two.  In the future Mrs. Tako and I may end-up moving some of our funds there if this pricing situation continues.

 

Final Thoughts

The holiday’s are here and that means year-end tax planning!  

Mrs. Tako and I will be making our maximum Roth IRA contributions in the next few days before the end of the year.  The rest of our excess income and dividends are contributed into our taxable accounts.

For now, we’re not performing 401(k) rollovers while Mrs. Tako is still working.  We’ll avoid large rollovers because of our ‘high’ income tax bracket.  Once Mrs. Tako quits working though, we’ll start that process.  Ideally this will be done at a lower tax rate.

If you’re interested in building wealth, I suggest considering a similar strategy for your own accounts.  

Rather than spending your holiday bonus on material gifts that only bring temporary happiness, I hope you’ll consider a different kind of gift this year (and every year hereafter).

While it may take a number of years to get the ball rolling, these accounts are an incredible advantage for building wealth.

Talk about it with your spouse.  Read the IRS rules.  Take that holiday bonus and open a taxable brokerage account and Roth IRA at your favorite brokerage.

There’s still time too — 3 weeks left in 2016 for you to make your Roth IRA contributions.  It’ll only take a few minutes, but you’ll continue to reap the rewards year after year after year…and maybe pass on that income to your heirs tax free.

You’ll thank me for it later.

Update:  A reader corrected me that rollovers from pre-tax retirement accounts are not taxed at capital gains rates (like I originally stated), but at income rates.  The post was corrected to reflect this.

 

[Image Credit: Flickr1, Flickr2]

32 thoughts on “Give Yourself The Gift of Wealth

  • December 10, 2016 at 5:40 AM
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    This is a great idea! I also like applying this principle to other celebrations, like birthdays. Most of us don’t need more crap anyways–why not put that money towards something that will really be valuable? I prefer Christmases without presents, but Mr. Picky Pincher loves his celebrations. 😉 We decided to do DIY presents this year as a compromise, so it’s more personal while saving some money, too. It’s not ideal, but it works.

    Our real present to ourselves is starting our student loan payoff this month! We’re hoping to tackle $65,000 of debt in 18 months. Finishing that will be a real gift to ourselves. 🙂

    Reply
  • December 10, 2016 at 6:21 AM
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    I believe you can make Roth IRA contributions for 2016 until April 17, 2017.

    Reply
    • December 10, 2016 at 10:58 AM
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      Interesting, can you sight the IRS documentation for this?

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        • January 1, 2017 at 8:38 PM
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          I was coming in to say the same thing.

          I love my Roth and my brokerage. I know that I want to invest more than $5500 a year and don’t have access to a 401K. The brokerage will be available at any age for any purpose, which is also great.

          Reply
  • December 10, 2016 at 7:00 AM
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    I wanted to rollover some tIRA to Roth this year but I have tax loss harvested to a point I get the full Obamacare subsidy. That’s a better deal than rolling 20k this year versus next year. I should be out of tax losses to harvest next year so the rollovers will begin.

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  • December 10, 2016 at 7:14 AM
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    A co-worker of mine casually mentioned Christmas and gifts for their 2 sons (both in their early 20’s). He started talking about all kinds of crap (in my opinion). I then threw out the idea of opening Roth IRAs for them… he loved the idea.

    Although he doesn’t have the money to open a Roth IRA for each of them with Vanguard (which I believe is at least $1k minimum), he’s going to open them with TD Ameritrade and then buy them a share or two each of the VTI ETF. They’ll still get the Vanguard fund with the low expense ratio and Ameritrade makes some ETFs (including that one) as no-commission.

    — Jim

    Reply
  • December 10, 2016 at 8:44 AM
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    The one thing I might add is your tax free space might be larger then you realize. HSA allows you to save for health care tax free 3350 per person. 401k 18k per person. Dependent care Fsa if both working, 5000. Roth IRA without conversion, 5500. Muni bonds, sky’s the limit. 529 for kids college under 14k. Most of these except the fsa are possible either through your company or on your own. So right there you have 27k per person with no kids or 43k per person with if both are working. Combined your tax advantaged space is nearly 68k dollars depending on your planned usage.

    Reply
    • December 10, 2016 at 11:02 AM
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      That’s true, and we do use all of those (except for muni’s)…. But I’ll have to save articles about them for another day!

      Reply
  • December 10, 2016 at 9:01 AM
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    A gift of wealth is certainly the one that keeps on giving! And financial freedom is the best present you can get 🙂

    Reply
  • December 10, 2016 at 2:44 PM
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    Good tips. I max out my Roth IRA every January with my Q4 bonus. My wife always wants me to spend it on a vacation or a new car, but I like squirreling the money away before I blow it on something stupid.

    Reply
    • December 10, 2016 at 3:13 PM
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      Just tell her “In a few years that Roth IRA will be buying you a vacation and new cars” 😉

      Reply
  • December 10, 2016 at 7:57 PM
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    “What’s worse, you can’t withdraw funds from a 401(k) without penalties until age 59.5! ”

    I heard that a person can access their pre-tax IRA/401k money before 59.5 using 72t rule? Are you familiar how this works?

    Reply
    • December 10, 2016 at 8:06 PM
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      72t … aka SOSEPP distributions. Yes, it is possible but has problems. It’s a fixed payment distribution. That can work, but it’s not very flexible and must be in place for a minimum of 5 years (I believe).

      There’s penalties too — If you or your brokerage makes any mistakes you’ll have to pay penalties and interest due all the way back to the beginning of the plan.

      Probably more trouble than its worth!

      Reply
  • December 11, 2016 at 11:20 AM
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    What I like about a Roth, is that I know exactly what I have. Whatever the balance is, is what I will have to spend. I don’t have to worry about accounting for tax deductions.

    Reply
  • December 11, 2016 at 5:25 PM
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    Although the article does not bring up the Roth vs Traditional IRA considerations people should consider both and which may be better for them in a given year. And it does not have to be a one or the other choice. For example when my wife and I both worked and had no kids traditional was best for my situation (in my judgement). Now we have 2 kids (= extra deductions) and a single income (less taxable income) . I use the traditional to lower my rate (last dollar principle to 10%) . At that point I am satisfied and fill the remainder in Roth. I have about $100k gross and taxable income of about $23k and pay about $2200 in federal taxes.

    I spent years figuring all the action was on the investment side of things and underapeciated the tax side of it which I regret.

    Reply
    • December 11, 2016 at 5:53 PM
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      Great points Grande. I often put too much focus on the investing too. There’s fantastic savings to be made just optimizing taxes!

      Reply
  • December 12, 2016 at 5:11 AM
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    I just started to really focus on after-tax accounts this year. I’ve always done a good job saving in my company’s 401k. Now that I’m maxing it out, I’m working to increase our after-tax investments as much as possible. It provides a lot of flexibility, especially if you are wanting to retire early. We are now saving just under 40% of our after 401k, after tax income. My goal is to get that up to 50% in the next 2 years.

    Reply
    • December 12, 2016 at 9:01 AM
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      After tax accounts really are the most flexible accounts! Mine ended up growing even faster than the pre-tax accounts!

      Reply
  • December 12, 2016 at 6:19 AM
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    What a great gift for those of us who can never come up with some other ideas… And also a great gift for those of us who can! Nobody is ever satisfied when I ask for money, so I may have to suggest the Roth this year.

    Just wonder though – any suggestions on how to wrap this and put it under the tree? Haha

    Reply
    • December 12, 2016 at 9:00 AM
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      Print-out in a cheap thrift-store picture frame? That’s how I’d do it!

      Reply
  • December 12, 2016 at 10:20 AM
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    Yes, you can contribute to your Roth IRA and solo 401k by tax day. I love these two accounts and they are the biggest part of our net worth. We just maxed out or Roth IRAs too. This year was strange and we should have done it earlier. The market is very high now, but still probably will go higher next year. Who knows… We’ll just keep investing. The great thing about the 401k is that you can contribute every month and take advantage of DCA. You don’t have to worry about timing the market. Good post!

    Reply
  • December 12, 2016 at 11:27 AM
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    “It’s entirely possible to do incredibly stupid things. Don’t.” Love that.

    For this suggestion of yours:

    “Even if you’re not early retired, I suggest setting up a Roth IRA this holiday season. Contribute the maximum $5,500 from your Christmas bonus into that IRA as soon as possible. Your spouse should do the same. ”

    It might be worth pointing out to your readers that they need to check that they aren’t over the income limits to contribute to a Roth IRA. Not everyone can open a Roth IRA. Some might have to go the backdoor Roth route instead. Lucky others might have the option of the mega backdoor.
    https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2016

    Reply
    • December 12, 2016 at 2:19 PM
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      Solid point that I didn’t touch on Mrs. BITA. There are tons of little irs rules around the Roth IRA, and that includes income minimums and maximums!

      Reply
  • December 12, 2016 at 12:07 PM
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    Good advice overall–one can’t have too many vehicles to facilitate saving for retirement, me thinks!

    Reply
  • December 13, 2016 at 3:34 AM
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    Love the idea of “giving the gift of wealth”. For a lot of people, just getting started is the hardest part. It’s amazing how many people don’t contribute to retirement accounts or don’t have a Roth IRA. It’s easy to believe that you’ll have enough income to do it “next year” or that saving $1K isn’t worth it. Every friend that I’ve convinced to open up a Roth IRA and put in $100 a paycheck has told me how glad they were they did it years later. Dripping water hollows a stone!

    Reply
  • December 13, 2016 at 9:10 AM
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    When I was 16, my dad struck a deal with me and said that he would match a portion of my summer savings in lieu of Christmas gifts if I put that money into a Roth IRA. I’m not sure how he talked me into it because that was the year every kid in school got an iPod for Christmas and that’s what I really wanted too. Still to this day, it’s my favorite lesson/gift because I’ve had this account for 8 years and I’ve seen the compounding returns in action. I learned first-hand why I should continue to contribute the maximum to this account every year, and I make that a priority.

    The experience also forced me to save up enough of my own money to buy an iPod, which broke/became obsolete after 3 years, so I learned that my Roth IRA was the better investment in the long-term. Sure Christmas gifts are nice, but getting the gift of knowledge is much more meaningful.

    Reply
    • December 14, 2016 at 12:59 AM
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      It sounds like your father was a very smart man. Congrats to you both for understanding the gift that just keeps on giving.

      Reply
  • December 13, 2016 at 10:40 AM
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    I totally agree with your thoughts on the Roth IRA and taxable brokerage account. Stinks the Roth IRA has an income limit and contribution limit though, but there are obviously ways around the income limit.

    Brokerage accounts don’t get the blessing they deserve! Sure you get a little dividend tax drag, but most dividends are taxed at the qualified rate. Plus capital gains can get long-term cap gains tax treatment which is great too. Also, you can utilize this account for tax loss harvesting and decrease your taxable income (at the marginal tax bracket) up to $3k per year!

    Reply
    • December 13, 2016 at 9:19 PM
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      Thanks, I hadn’t seen that comparison page before! Usually they have pretty similar funds, but performance does vary a little. Fees also tend to vary over time, so I suggest everyone watch them close!

      Reply
  • December 14, 2016 at 3:33 AM
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    I see a lot of comments about back door conversations for high income savers not eligible for roth contribution. With that, what is the plan for current saving? I’m 38 and still want to work since I like my job for another 10 yeas or so…do i Just max out 401k, post tax traditional IRA and other post tax savings (till it hurts of course) then when ready start a Roth conversation ladder as displayed in detail by Root of Gold?

    Reply

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