When you're ineligible for tax deferral, seek out tax friendly

Dear Dollar Diva,
I am 29 years old, and my large salary makes me ineligible to contribute to a Roth IRA. I contribute the maximum to my 401(k). Do you have additional retirement suggestions?

Michele

Tax deferral is a key element in accumulating wealth over the long haul: congratulations on the good job you're doing. The Diva offers some additional suggestions to help you as you travel along the road to financial freedom.

Nondeductible traditional IRA

When you have a choice between contributing to a non-deductible Roth IRA and a nondeductible traditional IRA, there's no contest: go for the Roth. But when income limitations make you ineligible for the Roth, contribute to a nondeductible traditional IRA. At least you'll enjoy tax-deferred earnings.

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And with an IRA, you can move from one investment to another without paying capital gains tax. Even with a buy-and-hold strategy, you still may need to sell a mutual fund or stock because its performance has been disappointing or to get your portfolio back in balance.

Contributions and distributions are reported on Form 8606, Nondeductible IRAs when you file your tax return.

Tax-deferred annuities

An annuity is an insurance contract that you pay for before you retire in exchange for guaranteed payments after you retire. Don't start salivating just because this investment is tax deferred. Annuities are complicated, hard to compare, and often have very high fees and commissions. They are also expensive to get out of.

If you do decide to investigate annuities, however, don't forget to check out the financial soundness of the insurance company. Make sure it has the top rating from three or four of the five companies that rate them: A. M. Best, Moody's, Standard & Poors, Duff & Phelps and Weiss Research.

For more on annuities, read the Diva's "The pros and cons of annuities."

Tax-efficient mutual funds

What do you do when you've run out of tax-deferred options? You seek out tax-friendly ones.

Unless a mutual fund is tax efficient, count on being hit with capital gains tax when you file your tax return each year. The taxes can be significant, and hazardous to your wealth building.

Funds that have a buy and hold strategy, like index funds, are tax efficient; so are actively managed funds that keep an eye on offsetting capital gains with capital losses. For more on index funds and tax-efficient actively managed funds, read the Diva's "Tax-friendly mutual funds."

Individual stocks

Another way to defer paying taxes is to buy stocks in good companies, and hold on to them. No tax is due on their appreciation until they're sold.

A dividend reinvestment plan (DRIP) is a good way to buy shares in an individual company. For more on DRIP investing, read the Diva's "Not all DRIPs mean trouble."