Tax savings are great, but… don’t make tax deferred accounts the only place you put your money.
I made that mistake so you don’t have to.
Contributing to 401k and IRAs is a good thing. Getting a tax deduction for 401ks is a mostly great benefit. Getting a tax deduction for IRA contribution if you qualify is mostly great, too. But these should not be the only places to save.
Regular IRA and 401k
In this post, I am referring to regular IRAs and 401ks, not Roth accounts.
Why Not?
Why shouldn’t a 401k and IRAs be the only place to put money?
Answer
Many reasons.
Firstly, while relatively easy to get money into, they are not easy to get money out of. As you know, there is a penalty to take money out before age 59.5. And once you turn 70.5, you must start withdrawing from you regular IRA and 401k.
Secondly, you need to have savings for other purposes. Want to every buy something that you need more than one paycheck for? Yes, you can buy it on credit, but what then? You later need to pay off the credit card. But if you money is tied up in tax-deferred account, you will soon start paying interest when you buy on credit. Not good. Paying off credit card balances every month is the prudent and financially responsible thing to do.
Thirdly, for some things you need real cash in the bank. Some things you cannot use a credit card to buy. A major purchase such as a down payment for a house usually cannot be put on a credit card.
Fourthly, when you must start taking out money at 70.5, you will owe taxes on the money withdrawn. This might come as a surprise. You saved money on taxes when contributing, but those taxes did not disappear. They were postponed. Once you start withdrawing the money, the taxes have returned. So how will you pay those taxes?
Fifthly, the the minimum amount you must start withdrawing at 70.5 is determined by the IRS. The amount may be more than you would prefer. But you have no choice, it must be at least the amount the IRS has determined. The amount starts at about 3.65% for the first year, and increases every year from there.
Therefore
For all these reasons, I heartily recommend not putting all savings into tax deferred accounts. I guarantee you will need cash for other things.
How do you mix savings in deferred accounts and regular savings? Send a comment here: Contact
The painting “Viewing the Sunset over Ryōgoku Bridge from the Onmaya Embankment (Onmayagashi yori Ryōgokubashi sekiyō o miru), from the series Thirty-six Views of Mount Fuji (Fugaku sanjūrokkei)” was by Katsushika Hokusai. Japan, 1830-32.
The Apothecary Jar is from late 15th century Italy.
The painting of “Boats with Mourners and Provisions, Tomb of Neferhotep” is from Upper Egypt, ca. 1327–1323 B.C.
Illustrations courtesy Metropolitan Museum of Art.
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