Like finding a spot to park your Porsche, some problems are great to have. Add this one to the list: You've maxed out your retirement-plan contributions and need another place to stash your savings.
Steve Kudile, a 33-year-old Verizon employee from Elkton, Md., faces that very problem. He plunks down 16% of his salary in a 401(k) plan and invests $4,000 in a Roth IRA each year.
Kudile would like to shelter even more savings and has considered a deferred variable annuity, in which his earnings could grow tax-deferred until withdrawn later. But the excessively high fees and restrictions on tapping his investment before he's 59#189; give him pause. If you're in the same boat, you have better options that will give you easy access to your money and, in many cases, more favorable tax treatment on your earnings.
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Rainy-day money. Start with a review of your savings. If you don't have at least three months' worth of expenses in an emergency fund, boost your reserves. With short-term interest rates hovering around 5%, now is an excellent time to hunt for a federally insured savings account.
Online accounts generally pay higher interest rates than their brick-and-mortar counterparts, but yields, minimum-deposit requirements and accessibility rules can vary widely. Check out Bankrate.com to find top-yielding accounts.
Tax angles. If you have your emergency fund covered, then open a taxable account with a mutual fund company or discount broker. To get the biggest tax bang, you may have to rethink the way you allocate your assets. In a taxable account, it's preferable to hold investments that benefit from the maximum 15% rate reserved for qualified dividends and long-term capital gains (investments held at least one year). Those same investments held inside a 401(k) plan or a traditional IRA would be subject to ordinary income-tax rates, which can be as high as 35%. Plus, if you have investment losses in a taxable account, you can use them to offset gains and, after that, up to $3,000 of ordinary income.
Although you can't claim losses, retirement accounts do offer an up-front tax break and shelter your investment earnings from tax until withdrawn. They are best suited for investments that tend to be taxed at higher ratesÑsuch as actively managed mutual funds with high turnover, real estate investment trusts and taxable bonds.
However, if most of your assets are locked up inside retirement accounts, it's more important to focus on a mix of investments that match your risk tolerance and time horizon, regardless of the tax consequences.
Roth IRA conversions. If, unlike Kudile, you earn too much to contribute to a Roth IRA, there's a backdoor route to tax-free income in retirement. To contribute to a Roth for 2006, your income can't exceed $110,000 if you're single or $160,000 if you're married. And to convert a traditional IRA to a Roth account, your income can't exceed $100,000.
But you can make nondeductible contributions to a traditional IRA now and switch it to a Roth in 2010, when the $100,000 income limit on conversions disappears. If it is your sole IRA, you will owe tax only on the earnings at the time of the conversion. But if you have more than one IRA, just a portion of your conversion will escape taxes. To avoid that tax tangle, Jack Brod, a principal at Vanguard Asset Management Services, suggests that you roll your existing IRAs into your 401(k) plan (if your employer permits it) and start fresh by contributing to a nondeductible IRA.
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