Monday, September 25, 2006

Second Thoughts on Retirement Accounts?

As I begin to realize that maybe I can realize my dream of financial independence much faster than I ever thought possible, I am beginning to rethink the role of retirement accounts in my financial plans. Up till recently I have always contributed the minimum to retirement plans with my employers. The other side of the coin is that my main employers have had extreme levels of retirement contributions. In my first academic job in the UK contributing to the retirement plan was voluntary. It was defined benefit and I was only planning on staying a year or two. I thought reducing my debt was more important. The cost-benefit analysis I did at the time showed that the right choice was to opt out. In my next job (in the US) I didn't stay long enough to become eligible for the retirement plan. Then when I moved to Australia, participation was mandatory. Between employer and compulsory employee contributions, 24% of my nominal salary was going into my retirement account. I thought this was enough especially as it is almost impossible to get the money out in the Australian system before age 60. Then after a gap where I claimed to be "self-employed" :) I was back in the US and here we have to contribute a minimum of 1% and the employer 8%. My goal was to rebuild my savings from the 2002 drawdown and then head for the goal of financial independence. Then this year I opened a Roth IRA account when I learned that you can always withdraw the contributions without penalty and use up to $10,000 in earnings towards the first time purchase of a house. My plan was to save towards a potential downpayment using a Roth IRA. This summer, as I began to understand the tremendous profit potential of my trading model I began to rethink my Roth plan. I think I will hardly miss the $4000 annual contributions and the earnings on them. Therefore, I now plan to continue contributing as long as I can and not withdraw my contributions as soon as I hit $10,000 in profit (I am halfway there at the moment).

Now a new idea has struck me. If I maximized my 403(b) contributions to the $15,000 annual limit I could rollover my account into my Roth when I eventually leave my current employer (subject to paying the appropriate taxes). This would be a way of getting much more money into the tax-free Roth environment. I think I may do this as soon as my trading program has reached its full size and if I continue to be profitable money will then be flowing out of the trading program into long term investments (in order to minimize the potential of a catastrophic loss there is a maximum sensible leverage that should be used in a trading program relative to total net worth - in the long term probably 70% of net worth will be directed to long-term investment and 30% to margin for trading). At that stage I will no longer need my salary to expand the size of the trading program and can direct it to a more tax advantaged environment.

The bottom line is that if you are following a Kiyosakian path at first you want to maximize the assets you have to achieve immediate financial independence. But once that goal is achieved, it makes sense to take full advantage of tax sheltered retirement accounts.


StealthBucks said...

mOOm, you are a smart guy... Max the 403B and kick it to a Roth someday. Although you are showing excellent returns, tax deffered growth is a powerful tool and if you cna quit your job in the beginning of a year.... show minimal U.S. income for that year and blaze the money in to a Roth and follow your gal to Sweden.... How great is that? Good luck.

Finally, how about the 2010 unlimited Roth conversion rule? I am thinking half my IRA's get converted or about $300K.

mOOm said...

Yes, there are a lot of issues to consider - earned income limits on Roths aren't an issue for me (at least not now while I'm single). But for you that 2010 thing could be great - but do a spreadsheet simulation of the alternatives. If things go to plan my total income will be rising rapidly and so even if I quit my job on 30 June one of these years it hopefully will make little difference to my tax bracket which affects the tax bill on the Roth conversion. I think I need to do a formal spreadsheet analysis but at the moment am thinking that I will continue to do the minimal contribution this year (we can only change these things once a year). If I am still in this position next academic year that is when I would step up the contributions.

This all highlights that the one size fits all advice in some personal finance books and websites really doesn't. The best thing to do depends on individual income, savings rates, job security, net worth accumulated, potential inheritances (very rarely mentioned), and many other factors including personal preferences.

Am hoping my GF comes up with a job in the US, but at least I can live in Sweden with no hassles, but do not want to pay Swedish taxes :) To keep the green card when I finally get it I shouldn't spend too much time outside the US either.