I have a friend who’s gearing up to retire early, and he has a problem. He’s 52 years old and has saved enough money where he’s comfortable wrapping up his career for good. (As a point of clarity, he expects to do gig work on an ongoing basis, but he’s looking to leave his stressful corporate job behind.) Only he can’t really access the money he’s worked hard to save for retirement.
The reason? My friend has about $1.5 million in an IRA. He got to that point by saving a portion of his paycheck since he started working about 20 years ago, and also by investing his money over the past three decades.
My friend chose to save in an IRA because these accounts give you a tax break on your contributions. But IRAs also impose penalties for taking withdrawals before reaching age 59 1/2 (there are some exceptions, like taking some money out for a first-time home purchase, but none that my friend qualifies for).
So now, my friend is sort of stuck. He wants to retire and has the money, but can’t access it without facing a big penalty. And he’s kicking himself for not partially saving for retirement in a taxable brokerage account.
If you want to avoid a situation like the one my friend is in, you may be thinking of skipping the IRA and sticking to a taxable brokerage account only. That way, you’ll have complete flexibility with your money. You can contribute as much as you want in any given year (with an IRA, there are annual limits), and you can remove funds without penalty at any time.
But even if you choose to keep most of your money in a regular brokerage account, you may want to save at least some money in an IRA. Here’s why.
You’re likely to use that money at some point
In reality, when my friend began to burn out at work in his mid-40s and started planning for an early retirement, he should’ve started funding a regular brokerage account after coming to that conclusion. Prior to that, early retirement wasn’t necessarily on his radar, though. So it’s understandable that he chose the account for his long-term savings that offered up a nice tax break.
Now you may be planning on an early retirement from the start. And if so, you may be inclined to stick to investing via a taxable brokerage account.
But one thing to remember is that barring tragedy, you’re going to be 59 1/2 years old eventually. From there, you’ll have penalty-free access to your IRA funds. So you might as well contribute some money to an IRA during your career and snag a tax break in the process.
Don’t give up a tax break
Let’s say you’re in a position where you’re able to save $10,000 a year for retirement. Incidentally, you can’t even contribute that much to an IRA, since these accounts currently max out at $7,000 for savers under age 50 and $8,000 for those 50 and older.
You may want the most flexibility with that money. But rather than put $10,000 into a taxable brokerage account each year, consider putting, say, $2,000 of that into an IRA. That way, you’re shielding $2,000 of earnings from taxes. And while you’ll have the bulk of your long-term savings in an account that’s flexible and accessible at all times, once you turn 59 1/2, you can start tapping your IRA accordingly.
Remember, exempting $2,000 of income from taxes could result in a lot of savings. If you’re in the 24% tax bracket, that’s $480 less that you’re paying the IRS.
For the most part, it rarely pays to keep all of your long-term savings in a taxable brokerage account. At this point, though, my friend wishes he had some savings in one of these accounts.
Thankfully, he’s still in a good position either way. But he’s sort of stuck working longer than he wants to due to choosing to house his entire nest egg in an IRA. So the lesson here is that it’s smart to spread your money across different accounts so you can enjoy tax savings while also having options.
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