IRA advice

Disclaimer:  We are not professional financial advisors.  Talk with a certified fee-only financial planner who has fiduciary responsibility or do your own research before making important financial decisions.

Next week I’ll post a rant about SIL’s truly awful retirement options at her workplace and how mad it makes me that a non-negligible number of school teachers are getting scammed.  This week I’m instead posting the advice we gave them to put money in an IRA outside their work rather than the unmatched and worse-than-edward-jones 403(b) option that she has at work.

If the couple makes less than 99K, they can each contribute up to $5,500 to a traditional IRA (or $11K) each year.  This would mean that they would get a discount on their taxes this year but would have to pay taxes on the earnings in retirement.

If they make less than 186K, they can each contribute up to $5,500 to a ROTH IRA (or $11K).  This would mean that they wouldn’t get a tax break on what they contribute this year, but they wouldn’t have to pay taxes on the earnings in the future.

In terms of which is better– generally if you think you’re going to be in a higher tax bracket in retirement, you should pick the IRA Roth, if you think you’re going to be in a lower tax bracket in retirement, you should pick the Traditional.  It’s hard to say what the tax situation is going to be like in 40 years.  Personally we do about 50% because on the one hand we’ll be making less money in retirement, but on the other hand at some point they’re going to have to raise taxes in the US to pay down the debt and tax rates are historically low right now.  If you want lower taxes now, pick Traditional, if you want lower taxes later, pick Roth.

The best place to invest for an IRA is in Vanguard https://investor.vanguard.com/ira/how-to-open-an-ira?lang=en because they have the lowest fees in the industry.  One potential problem is that they make you start with $1000, and if you don’t have $1000 to invest right away your options are to either save up until you do have $1000 (you have until tax day of the next year) or to go with another provider.  Etrade is a good choice if you don’t have $1000.  Fidelity is another possibility.  Vanguard is definitely the easiest to work with.  I’m pretty sure that you can set-up a monthly auto-deduction from your savings account for these (but you may have to hit the minimum for Vanguard first), but it might make more sense to save up in a separate account and make the purchase all at once each year (so there are lower purchase costs).

The best investment choice is a low fee broad-based index fund or exchange-traded fund.  These are basically mutual funds where instead of paying a manager to pick out funds, just try to match the market for a broad-based set of stocks and sometimes bonds.  These will generally match the market that they’re paid into or mimicking.  If you want to do some active management, you can pick out a Vanguard stock fund and a Vanguard bond fund and get the percentages based on your retirement and then rebalance each year when you add new money.  What matters when choosing funds is not their “Returns since inception” or even the returns at all (since they don’t predict future returns and can be manipulated in ways that make the same funds look higher or lower earning based on when they start counting) but the fees.  You want low fees and broad diversification.

A much easier thing to do is to pick your date of retirement and buy a Vanguard Target-date fund.  A Target-date fund is a mix of broad-based index funds for stocks and bonds that becomes less risky as you get closer to retirement.  (You can do this even if you’re using etrade or fidelity– fidelity has their own target date funds, but they have higher hidden fees than do Vanguard’s.)  These are great because you pick one number– the year you think you’re going to retire– and it takes care of rebalancing and changing your mix of stocks and bonds for you.  Most of our retirement money is invested in Vanguard Target-date funds. It costs a little bit more than just buying the funds it uses, but a small enough amount more (~1/10 of 1%) that we’re willing to pay for the convenience.

tl:dr:

If you make under 186K jointly, you can buy up to two $5,500 Roths (no tax break now, tax break later).  Under 99K you could instead get traditional IRAs (tax break now, taxes later).
If you have at least 1K to invest, then buy a target date fund from Vanguard to put in the IRA with the date of your expected retirement.

14 Responses to “IRA advice”

  1. Becca Says:

    I was think the admiral share ER for VTSMX and was confused by your cost description.
    I’m having a hard time deciding between traditional, Roth and a 529 this year (the 529 only because I’m a Hoosier now, and there may be a tax credit to factor in). I may put it in traditional just to get that up to Admiral shares (I have been doing Roths, but having some of each is nice and I’ve already got the account now, since I did a 401k rollover).

    • nicoleandmaggie Says:

      See the comment to jasonedwards about why a target date fund may be a good deal for someone who doesn’t want to mess with their money.

      The Indiana tax break for the 529 is a really good deal. Ideally you would put money away for retirement first given that you can always get loans for school but not retirement, but a 20% tax discount credit is nothing to sneeze at. It’s probably worth running the numbers to see how much you would qualify for.

  2. jasonedwards57 Says:

    I have enjoyed reading this blog (fellow academic here). It is too bad about SIL’s choices and you are right it is better to put that money into an IRA if the choices are that bad. I like the idea about a target-date fund, but depending on the time frame I would put all of into VTSMX. Of course this is dependent upon your risk tolerance, but if you can handle it getting the broad based VTSMX is a bit better and the cost is a little lower.

    • nicoleandmaggie Says:

      The reason I recommend the target-date fund as “the easier choice” for people who don’t want to spend any time on retirement choices is that it will rebalance and move towards bonds as they get closer to retirement without them doing anything. It truly is set and forget. The Vanguard target-date funds don’t charge much for this service compared to other company’s target-date funds, so it’s a good deal compared to seeing a financial advisor on a regular basis and avoids the trap of going to a local edward jones or other place that’s going to charge a lot for active management. With VTSMX, at some point they have to actually take stock and decide how much to put in a bond fund, and then rebalance again later. That may never happen, which is risky as they get closer to needing to tap it (though as I note in the paragraph previous to the one on target-date funds, that is “the best choice”).

  3. omdg Says:

    It is worth mentioning that if you find out after doing a Roth IRA that you earned too much that year to do a Roth, you must recharacterize it, or else pay massive penalties on it literally every year for the rest of your life. This includes any interest you may have earned on it in the meantime. This is a pain in the butt.

    • nicoleandmaggie Says:

      Good to know. For people who aren’t sure about income, you can still contribute to the previous year’s IRA between Jan 1 and the tax deadline which means you can do your taxes first to figure it out before contributing (it’s a good use for refunds!).

      People who are high income can also look into doing a “backdoor Roth” which is essentially a traditional Roth that you don’t get a tax break on because you earn too much that you then convert to a Roth IRA. (This has some hassle points if you already have a lot invested in traditional roths or if you’ve rolled over a 401K to a traditional roth.)

  4. nicoleandmaggie Says:

    BTW, today is an excellent day to call your members of congress to ask them to not allow congress to destroy the Affordable Care Act: https://5calls.org/issue/recT4p3RFsud6rxuf

    Their hope is that we’re fatigued and not paying attention so they can sneak it in now. Let’s prove them wrong.

  5. Michelle Says:

    What if you make more than 186K jointly and want an option for reducing your taxable income? Can you still invest in an IRA?

  6. Ask the grumpies: How do you approach diversification? | Grumpy Rumblings (of the formerly untenured) Says:

    […] retirement savings it’s all about your employer fees and whether you qualify for an IRA and if you want to do a backdoor […]


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