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How Do I Invest Outside a 401k?


"I have fully funded my 401k at work, but need to invest an additional $20,000 to meet my goal of saving 20% of yearly income.  My work offers a 457 plan, but the choices are fairly limited. I don't qualify for Roth IRA.  Can you offer some guidance about other investment vehicles, taking into consideration tax implications?"  

Kudos to you for aggressively funding your retirement and setting aside 20% of your income.  This is quite admirable.

I know you mentioned the choices in your 457 plan are quite limited, but you didn’t mention that all of those were bad investment options.  If there is at least one good investment option within the 457 plan then it would make sense to use the tax advantages of your 457 plan.  Simply direct all of your deferrals into that fund.  Of course, the asset class of the fund matters and how that asset class fits into your overall asset allocation.  You may need to change some of your investments in your 401k to accommodate this strategy, but it would be worth it for the tax advantages of the 457 account.

Your next option is to make a traditional IRA contribution ($5500 for 2013 or $6500 if you are over 50).  Since you do not qualify for the Roth IRA, you would be well over the limit to be able to deduct this contribution.  Even though this is not a deductible contribution, the growth in this account would still grow tax-deferred.  This is important because it sounds as though you are right on the cusp of being exposed to the new 3.8% Medicare surtax on unearned income.  Just make sure that if you choose to make a non-deductible contribution that you file form 8606 to account for the basis within your IRA.

Another option would be to convert the traditional IRA contribution to a Roth IRA.  There are some limitations to doing this correctly.  Without knowing your entire situation, I cannot say to do this with absolute certainty, though it is a very good option.

The next best option would be to invest the rest in a taxable brokerage account.  This is where your choice of investments will dictate the tax efficiency of this portion of your portfolio.  Since you are looking to use these investments as a part of a retirement strategy, I am going to assume you are going to buy and hold these investments.  This will save you on some capital gains, but you may still have capital gains passed through to you or you may earn dividends on these investments.  This is where your choice of investments is important.

You do have another option which I generally do not recommend, but I want you to know that it is out there.  That is to purchase a variable annuity.  These generally charge a lot in fees and commissions which can really eat away at your return.  The benefit is that all the growth is tax deferred.  By choosing the right investments in your taxable account, you should be able to minimize taxes and save you from paying all the fees and commissions associated with a variable annuity.

I hope this was helpful!