||Ask the Dollar Diva
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?
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.
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.
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
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."
-- Posted: Jan. 11, 2001