Nick H recently emailed me a question about how much money he should invest in tax-advantaged accounts before adding to non-qualified accounts. Due to the large number of emails I receive I am unable to provide individualized tax advice unless you are a client. Nick’s question had a familiar ring. Several times per week I get a variation of the same question. Rather than ignore the request, I decided to put it into a post so all readers can benefit from my suggestions.
Here is Nick’s complete email:
Dear Wealth Accountant,
I have been a reader of yours for a few months now, and enjoy it very much. I was introduced to your site via a MMM post.
I have a question for you regarding investing in tax-advantaged accounts vs. normal accounts. Standard advice is that I should max out tax advantaged accounts before saving in normal accounts. However, with financial independence/early retirement in mind, if I do not make enough to max out tax advantaged accounts and save enough in a normal account for early retirement, I think that it makes more sense to put just enough into a 401k to get my match, then save everything else I can in a normal investment account.
I reach this conclusion because the goal of early retirement is to build up an income stream, unlike standard retirement in which you just achieve the largest possible pile of cash. Since there are significant limitations on access to the funds in taxed advantaged accounts, this seems like an inefficient method of saving. Again, assuming that I have to choose between the two.
PS. I also posed this question to MMM. I am very curious to get both of your perspectives on it. Thanks & hope to hear from you!
Nick makes a narrow assumption of either/or. He indicates he either has to max out his retirement accounts before funding non-qualified accounts or he will not have an income stream to fund his early retirement.
Nick also turns the tables on the standard advice by saying standard advice says to max out retirement accounts. I guess it depends on whose standard advice we are looking at. Most standard advice is geared toward generating larger fees for the investment house. Standard advice says you should save 10% of your income. It makes me nauseous thinking about it.Continue reading