Dispelling Myths about Building Wealth Through Retirement Accounts

Many people should prioritize using retirement accounts to build wealth even if they don’t plan to stop working any time soon. The benefits of these accounts are too good to pass up. If you’re still skeptical of using retirement accounts, let me clarify some common critiques:

Critique #1: With retirement accounts you are limited to what you can invest in

Truth #1: Anyone can open an individual retirement account (IRA) and invest in almost anything they’d like. With a self-directed IRA, you can even invest in cryptocurrency and real estate. The few limitations that do exist are in work-sponsored retirement accounts because in those types of retirement accounts people can only invest in the funds that are offered through their employer. This means it is highly unlikely you’ll be able to buy shares of bitcoin through your work 401K or 403b. However, most jobs offer a variety of index funds and mutual funds that you can invest in.

Many jobs also offer target-date retirement funds (or lifecycle funds) which put your investing on autopilot. Index funds in these target date retirement funds offer a return of about 8-10% each year on your money which is more than you’d get from most actively managed mutual funds on wall street. My point? Most people have very good investment options inside of retirement accounts.

Critique #2: There’s a limit to how much you can invest

Truth #2: This is actually true. Contributing to retirement accounts offers various tax and asset protection benefits. It makes sense that the government would try to limit how much of those benefits each person can take advantage of each year. That being said, you can still invest thousands of dollars per year in these accounts before you hit the annual limit.

With your work-sponsored retirement accounts, you can contribute up to $19,000 per year. With a traditional IRA or Roth IRA, you can contribute another $6,000 per year. If you are self-employed or work as an independent contractor, you can open your own retirement account and put up to 20% of your income (up to a max of $58,000) per year. Some people even have access to another pre-tax retirement account called a 457b that allows them to contribute even more money. My point? Although there is a limit to how much you can invest in retirement accounts, that yearly limit is quite high and most people have access to more than one type of retirement account.

Critique #3: You can’t take the money out when you want to

Truth #3: The purpose of retirement accounts is to invest money for retirement. The government gives you tax and asset protection benefits to do so. If you take the money out of the account before you retire there is a penalty. So no, you can’t investment money in retirement accounts, make a profit, then withdraw the money to take a fancy international vacation or buy a new car. The money must be used for retirement. That being said, the government understands that there are many reasons you may need the money you invested before retirement. In fact, there are a list of qualified expenses for which you can withdraw money from retirement accounts.

For example, if you are over the age of 59.5, have unreimbursed health care expenses over a certain amount, want to buy your first home, need the money for education expenses, or get disabled, you can withdraw a certain amount from your retirement account. If you want to use the money for another reason you can also “borrow” from your 401K. When you borrow from your 401K you can withdraw money from the account (up to $100,000 or 50% of the amount you have invested, whichever is less) but you have to pay it back within 5 years with interest. My point? Retirement accounts must be used for retirement but there are a list of reasons for which you can withdraw money from these accounts sooner without any penalty. If you want to use the money for something else, you can borrow money from this account as long as you pay the money back within the repayment period.

Critique #4: You can’t use the money if you retire early

Truth #4: This is not true. Many people have the desire to invest as much as they can as early as they can. They want to build wealth faster and retire at an early age. However, if they retire before age 59.5, they wonder how they will get access to their retirement money without having to pay a penalty. As mentioned above, there are lots of exceptions to the retirement account withdrawal rule like buying your first home or paying back high health care expenses.

If you can’t find an early withdrawal exception that applies to you, you can use the substantially equal periodic payment (S.E.P.P.) exemption. With this exemption, you can use IRS formulas to take out an equal amount of money from your retirement account each year based on the number of years they estimate you have left to live. You must take out the same amount for at least 5 years or until you turn age 59.5, whichever is longer. My point? The government realizes you may want to retire early (before age 59.5) so it created an exemption to allow you take out money from your retirement account for this purpose.

What do you think? Will you use retirement accounts to build wealth?

4 Steps to Balance Investments in your 403b (or 401K) and your Roth IRA

Last year, I prioritized contributing to my 403b. Nowadays, I use the income from some of my side gigs and other jobs to contribute to a Roth IRA as well. If you are considering doing the same thing (by contributing to your employer-sponsored retirement plan and your own Roth IRA), here are a few steps you can follow:

Step 1: Have a plan for all your retirement investing. My investment portfolio is overwhelmingly filled with stocks. As someone who is [relatively] young with plenty of work years ahead of me, I’m decades away from retirement. Since I won’t retire for a while, I can include a high percentage of stocks and take more risks with my investments. By taking more risk, I increase my chances of making a profit on my money. Even if I “lose” money intermittently by taking so much risk, I have plenty of years to make up the losses, if they occur.

The percentage of stocks you have in your investment portfolio may be different. There are various investment allocations for people of all ages and stages of life with various risk tolerances. Some younger people choose to only invest in stocks, some choose to invest in stocks and bonds, and others like to have some real estate, commodities, or other alternative options. I’ve decided on a retirement investment allocation that fits me best: 75% in stocks, 15% in real estate, and 10% in bonds.

Step 2: Determine the type and percentage of investments to add to the Roth IRA. Now that I know what percentage of my retirement portfolio I want to allocate to each category, my next step is to determine which investments and how much of each investment I need to add to my Roth. Because I already have some of my investments in my main job’s retirement plan, I now need to add the remaining investments to my Roth IRA. When adding the remaining investments to my Roth IRA, I must make sure that the total value of all of my retirement investments remains at my desired allocation of 75% stocks, 15% real estate, and 10% bonds.

In my main job’s retirement account, I am invested in a target retirement index fund that invests my money in 90% stocks and 10% bonds. This means I need to add real estate index funds to my Roth IRA and also invest in some stocks and bonds in my Roth IRA to maintain my desired investment percentage. (Side note, although I plan to invest in actual real estate through the purchase of apartment buildings and multifamily homes, I like my retirement real estate investments to be in REITs aka Real Estate Investment Trusts - which are like giant real estate index funds that invest in many different properties). Also, keep in mind that since Roth IRA investments are made with money you already paid taxes on and never have to pay taxes on again, it’s often wise to make sure that you use this Roth account to make investments in things that pay dividends so you can avoid paying taxes on the money you make from those investments.

Step 3: Have the money automatically withdrawn from your account each month. Once I know how much of each investment I want to have in my Roth IRA, I just need to make sure I actually place the money into my Roth account. Although some people like to contribute the max allotment of $6,000 per year at one time to get their money invested sooner rather than later, I invest it in small pieces each month. Doing it in small pieces instead of all at once has two benefits for me.

First, it gives me more flexibility so that I can decrease the allotment one month and make up for it the next month if I need to. Secondly, contributing periodically each month gives me a greater chance of buying stocks at a “discount.” (The prices of stocks and index funds fluctuates. If I buy all of them at one time with by investing one large sum of money in my Roth IRA at once, then I buy all the stocks (or index funds) at the same price. However, if I invest a little each month then I increase my chances of buying stocks (or index funds) when they may be a lower price. Although there is also a chance I could buy the stocks (or index funds) at a higher price, doing it a little bit at a time has been shown to save people more money overall. This is known as “dollar cost averaging”. Each person is different, but I prefer to have the money automatically withdrawn from my account each month and invested into my Roth IRA. (When my salary increases, I’ll likely have the $6,000 taken out over 3 months instead of over the entire year)

Step 4: Adjust the investment percentages periodically. The prices of stocks, bonds, and REITs can fluctuate. Sometimes the prices change by only a small amount and thus stay at around the same price. Other times the prices of the investments can change by a lot and remain at this new level for a few months or even years. For example, when the coronavirus pandemic hit, the price of many stocks decreased and stayed low for a couple months before they started to come back up. When these fluctuations occur, they can change the balance of my retirement investments.

If stocks (or index funds) decrease then that means the value of the stocks in my portfolio have decreased, which means that instead of having 75% of my money in stocks this percentage may decrease to around 70%. In order to get back to my target of 75% I will need to buy even more stocks in the future (increase the percentage of new money I have going towards stocks) to make up this difference. Although different people have different preferences for how often they plan to adjust their investments, I plan to do it once a year.

Tell me, do you have a Roth IRA? If so, how are you investing it?

I invest in a 403b AND a Roth IRA, here's why:

As a young professional who is trying to build wealth, I invest money. Although there are a myriad of different investment accounts and strategies, I invest in index mutual funds through my employer-sponsored retirement plan and through my own Roth IRA. Yes, I have both types of accounts. Let me tell you why.

I invest in my employer-sponsored retirement plan (which is a 403b, that is very similar to a 401K) because:

1. I get a match from my employer to invest in their plan. Back in the day, many jobs offered their employees a “pension” when they retired. This pension would guarantee an employee a certain percentage of their salary even after they retired and stopped working. Although these pension plans were great for the employees, they were extremely expensive for many companies. Thus, most jobs today no longer offer pensions. They instead, want to encourage their employees to save for their own retirement and give them an incentive (in the form of a retirement match) to do so. Through this retirement match, your employer will match what you contribute to your retirement plan. My employer, similar to many other employers, offers a retirement match if I contribute to my work-sponsored retirement account (aka a 403b). Since I don’t want to forgo free money, I contribute to my work retirement plan to get their “match.”

2. It saves me money in taxes. As an unmarried physician with no children, I pay quite a bit in taxes. Although I don’t mind contributing money to ensure that our government can run smoothly and fund things like education, infrastructure, and national defense, there are certain incentives in the tax code that can help reduce the amount of taxes I’m expected to pay. One of the incentives is contributing to a retirement plan. By contributing money to my employer-sponsored retirement plan, I am able to defer paying taxes on the money I contribute which decreases my tax rate. I also have the option of contributing to my work retirement plan via a 403b Roth, in which I can choose to pay taxes now and shield the income and profits from taxes when I withdraw the money later. So, whether I choose the pre-tax 403b (to help me save money in taxes now) or the 403b Roth (to help me save money in taxes later), either way I get to save money in taxes. Thus, either option is a win-win.

3. It decreases my student loan payments. Like many college graduates, I have student loans. In fact, the amount of student loans I acquired from medical school is so high that I had to consolidate my loans and enroll into an income-based repayment plan to make the payments more affordable. This plan, called REPAYE (revised-pay-as-you-earn), caps my student loan payments at 10% of my discretionary income which makes my monthly student loan payments much more affordable. As a resident physician who works for a non-profit hospital, I am also considered a “public servant.” Through a program called Public Service Loan Forgiveness (PSLF), after making 10 years of student loan payments, public servants who work for non-profit companies can get the remaining balance of their student loans forgiven, tax-free. Since the student loan payments I need to make are based on my taxable income, the more I lower my taxable income, the less money I have to pay in my student loans. One way I lower my taxable income, and thus lower my monthly student payment, is by contributing to my work-sponsored retirement account.

In addition to my work 403b, I also invest in a Roth IRA because:

1. I can make other types of investments that I can’t make in my employer retirement plan. Unlike my 403b or 401K, a Roth IRA is not set up through my employer. Because it is not connected to my employer, I have more options in the way I want to invest my money. Instead of being limited to certain mutual funds or index funds, I can expand my options. Through my Roth IRA, I invest in REITs (real estate investment trusts). By investing in REITs, I am able to make money via real estate, since these REITs invest in a variety of real estate deals and syndications. Adding real estate to my investments helps diversify my portfolio in a way that can make me even more money overall.

2. It gives me more flexibility whenever I want to withdraw the money One of the things I really like about the Roth IRA, is that because I contribute to it with “after-tax” dollars, there are fewer restrictions on when I can take the money out of the account. Although it is supposed to stay in the account until I retire, I can withdraw my contributions at any time, with no penalty (as long as I keep all the earnings/profits in the account). Thus, if I contributed $5,000 and made $500 in profits, I can take out the $5,000 I contributed at any time as long as the $500 I made in profit stays in the account. This means that if I ever run in to an emergency or decide to use some of the money to pay off student loans or purchase a home, I can withdraw some of the money from this account when I need. A Roth IRA is like a retirement account that I can technically use as a back-up emergency fund if I absolutely needed to.

3. I don’t have to pay taxes on the money in retirement when I take it out. Unlike my employer-sponsored retirement plan, I contributed to this Roth account with after-tax dollars. This means, when I withdraw the money in retirement, I don’t have to pay taxes on the earnings I made or the money I contributed. Because of this fact, a Roth IRA helps me keep more money! For example, if I retire with $1,000,000 in a pre-tax 401K and $1,000,000 in a Roth IRA. I will have to pay 20-30% in taxes on the money in the pre-tax 401K. So even though there is $1 million in the account, I will have to pay $200,000-$300,000 in taxes on that money. With a Roth IRA, I will owe no taxes and will get to keep it all.

4. I can leave all the money in my Roth IRA to my children without them having to pay taxes on it. Another thing I love about the Roth IRA is that I can give it away to my [future] kids. Instead of trying to leave them a separate inheritance, I can simply leave my Roth IRA to my kids and their kids. Doing so, will help the money keep building overtime and allow me to set future generations of my family up for financial success.

My point? Both my employer-sponsored retirement plan and my Roth IRA have advantages. Instead of choosing one over the other, I contribute to both accounts to maximize the benefits. Tell me, do you contribute to your work-sponsored retirement plan AND a Roth IRA?

4 Reasons to Open a Roth IRA

I am a huge proponent of saving and investing money for retirement, even as a relatively young professional. One of the best accounts to use is a Roth IRA. Here are 4 reasons why.

1. It allows you to save/invest money for retirement which can help you build your net worth quicker. A Roth IRA is a type of retirement account that you can invest in with income you earn from your job. The benefit of contributing money into this account is that although the account technically is for retirement, it has many other benefits as well. One of the biggest benefits is that it allows you to invest money in a way that builds your net worth quicker (since there are fewer fees and taxes associated with it). The sooner you are able to build your net worth, the more options you will have in life. Not only can you retire early, but you can also choose to work part-time, accomplish many of your financial goals a lot sooner, and rethink how you want to spend your life. If you choose to stay at your current job you may do so, but if you decide you instead want to take a year-long sabbatical to travel or work for a non-profit organization you can do that as well. Building your net worth sooner rather than later allows you to re-define how you want to spend your life. Investing in a Roth IRA makes this easier.

2. It’s tax-efficient, so you don’t have to pay taxes on the profits or the withdrawals. Taxes may not be the top thing on your mind, but when it comes to making and investing money, it is something that I think about often. The taxes you pay each year, from each paycheck, is likely your largest expense. If you are able to find ways to reduce your taxes, then you’ll likely have a lot more money in your pocket each month. One of the reasons I like the Roth IRA is because it’s tax efficient. Instead of having to pay taxes on the profits you make from your investments or paying taxes when you withdraw your money from the account later in life, a Roth IRA works differently. Since you contribute to a Roth IRA with earned income from your job (which is money that you have already paid taxes on), you never have to pay taxes on that money again. This means that any profit you make from your investments is tax free and you don’t have to pay at least 20% in taxes like many other people do with other types of accounts. Plus, when you withdraw the money in retirement, that money is also tax free.

3. There is more flexibility on when you withdraw money, so it can serve as an extra emergency fund. Unlike many employer-sponsored retirement plans like a 401K or a 403b, a Roth IRA is not tied to your place of employment. This means you have a lot more flexibility in the type of investments you can make. Instead of being limited to the funds supported by your job, you can use a Roth IRA to make various other real estate or stock investments. You also have a lot more leeway on when you can take the money out of the account. Although the goal is to leave money in the Roth IRA until you retire, you can take out the money you contributed sooner rather than later if you need. In fact, as long as you leave the investment profits you make inside the account, you can withdraw your contributions at any time tax-free. This means if you desperately need the money to pay off student loans, buy a home, or move to a new city, you can technically just withdraw the money from your Roth IRA account to do so. It can serve as a back-up emergency fund.

4. You can give the money to your children tax-free, which gives you an extra way to leave your family an inheritance. I am a single young professional with no kids, yet. However, at some point, I’ll have children and would ideally like to leave them an inheritance. Unlike other accounts you can set up for your children as an inheritance, any money you give your future kids in a Roth IRA is tax-free. This means they won’t have to pay any taxes on this money when they get it. The less taxes they pay, the more money they keep. Thus, each year you can contribute to your employer sponsored retirement accounts to work on building your own net worth AND contribute to Roth accounts which you can then use as extra money for yourself and eventually gift to your children as an inheritance.