Sell taxable investments to fund Roth IRA?

[Guest ctfudge07]

My husband and I only started contributing to IRAs this year; we each invested $4,000 into a Roth IRA (one for each of us, obviously.) These have done well and so have our taxable investments.

Now that a new year is coming, I understand that we are each eligible to contribute $5,000 (we are both under 50 and meet all other eligibility requirements) and can do so as soon as Jan. 1, 2008 or as late as approx. April 15 of 2009. (or any and all dates in between in increments, if we wanted to do that.)

Instinctively it seems that it would be better to just plop that money in there ASAP; to do so, we'd have to sell investments in our taxable accounts. We have far more in our taxable accounts so the resources are there. Of course I'd wait till after the new year starts to sell one of those investments, since we'd then be liable for the taxes on the sale. But of course we wouldn't have to think about paying those particular taxes till April 15, 2009.)

I'm assuming it's advantageous to sell and incur the tax and move the money into the IRA, and since it seems to be the only way to fund the IRA, I guess this is a moot point and I have no real question except: Does this sound OK to you more experienced financial wizards out there? The only other way I can think of to fund the IRA is to put the money in throughout the year in dribs and drabs - and I guess a lot of people do that and it's fine - but we don't have a budget that allows for that (for better or worse, no lectures please, we have no slush fund, every spare penny we have is invested, and our returns have been great, rocky at times, but pretty darned good so its working for us - credit is tapped at times when we need it for emergencies and our investment returns are far greater than what we pay in credit interest, so please don't get sidetracked on that point - no "e-fund" diatribes, please - that's not what I'm asking about), and it seems that it would be better for the money to start appreciating (hopefully!) within the Roth IRA as soon as possible. If there is some other way to fund the IRA or some reason to fund it later rather than sooner, let me know. I'm just looking to pick some brains here. Thanks! (also, a regular investment can't be "changed" to an IRA, can it? For example, outside of my regular brokerage I have one particular USAA mutual fund all by itself directly through USAA and it's just a regular, taxable account, but if I could convert it to a Roth IRA, it would make a good IRA investment).

Let me say pre-emptively, I already know that someone is going to suggest (or at least this is the way it "should" be done) that we fund the IRA with "fresh" money, meaning money we just earned or obtained in some way other than selling investments, but this is not possible since we have a low income stream and high asset base, comparatively. In other words, we are income poor/ asset rich and that's what puts us in this position, and there's no way we're going to be keeping that much money sitting around in savings accounts, not with the returns we've been getting investing; I'd rather pay taxes than celebrate the little bits "earned" in savings/money market/CD-type accounts so that's not an attractive option, either.

Ooops, last question (as you can see, I'm not the retirement account expert.) Is there any problem, other than recordkeeping, with having as many separate Roth accounts as desired? Example: My one and only Roth contribution was a $4,000 contribution to a Metzler-Payden mutual fund serviced directly through Metzler-Payden. Suppose I wanted to open a new account at a new fund house every year with a new $5,000 contribution (or whatever the limit may be in the future) - not that I'm planning to do this - but having multiple accounts does not matter as long as not more than the 4 or 5 grand per year is not exceeded as an investment, right? For example, if I wanted to "convert" the USAA mutual fund or let's say, if that's not possible, open a Roth IRA account there, too... (I use those two as examples because those two and Vanguard are the houses where I happen to have only one fund apiece - the remainder of my investments are in Firstrade) that's fine, right? Of course I realize I could just make an additional contribution to the Metzler-Payden fund in the account I already have with them. Or invest in another fund with them. Obviously I'm having a little trouble differentiating between an IRA account and a mutual fund investment made as an IRA contribution. THANKS for showing me the ropes a little bit here.

[Bird]

I wouldn't sell assets and incur a tax just for the sake of funding a Roth IRA. Use new money and if you don't have it, so be it. Maybe your dividends and capital gains are being reinvested and you can change that so they're paid in cash; then you'd have some "new" money to fund the IRA.

[Guest ctfudge07]

I wouldn't sell assets and incur a tax just for the sake of funding a Roth IRA. Use new money and if you don't have it, so be it. Maybe your dividends and capital gains are being reinvested and you can change that so they're paid in cash; then you'd have some "new" money to fund the IRA.

Hmm... I'm not exactly sure what you mean - I understand what you mean about dividends being reinvested, but I'm not sure what you mean about capital gains.

Example: a particular mutual fund I bought $4,000 worth of in May has increased in value to approx. $4,800, and the only dividend I'm aware of was a few weeks ago and it was only about $13 (which was, in fact, reinvested.) Isn't the appreciation of the value of the shares in the fund (I assume that's what's meant by capital gain) just part of the... appreciation of the value and not something that can be reinvested or not? I can think of another one with a similar, small dividend - we're not talking about tons of money here or large dividends.

(they don't have the little confused icon here with a question mark over his head)

Can you (or anyone) explain to me what would be disadvantageous about selling exactly $5,000 worth of an investment (the commission would be low) and taking the tax bite (we use Gainskeeper so I can get an estimate of the tax impact - we're in a low tax bracket, I forgot to say) and then putting the proceeds into an account, possibly with the same exact investment that was just sold, if desired, where it can grow and be harvested, so to speak, someday, tax-free? (I understand the withdrawal rules.) Thanks in advance.

** wait, I think I understand - were you talking about capital gains distribution, typically made toward the end of the year? So... we could elect to have capital gains and dividends paid in cash - but that still would not be enough to fully fund the Roth IRAs, and if I understand correctly, we'd pay tax on that cash anyway, the same as if we sold a certain amount of the investments, so I'm still not understanding why that would be the better way to do it.

[John G]

1. You can not fund a Roth with mutual fund or stock shares. Contributions are made in cash.

2. You left out key information that would help folks give you advice. This includes your current marginal tax rate, your current ages, if you have significant other retirement assets, would the asset sales be at the lower long term capital gains rate, and if you expect to be in a much higher tax bracket in future/retirement years. Some folks can make a strong case that their taxes are not likely to go down in during their withdrawal period, which could make the Roth and pay taxes, or continue with taxable accounts more likely a wash. What is missing in your comments is where does the Roth component fit into your long term plan.

3. It sounds like you may be in a low tax bracket right now. It may also be true that you were thinking of selling some assets that might get the lower long term capital gains treatment. This makes the tax hurtle of selling an asset more manageable. You might also be able to sell assets with minimal gains, or perhaps sell some assets that have a loss to offset some with gains. Again, this would reduce the tax burden. For example, if you sell 10K in assets that have a 30% gain, then you would owe taxes on just $3,000 and might be able to fully fund your two Roths (if you paid for the taxes with other funds).

4. While there are facts that you have not presented, I did not see anything in what you wrote that suggests you should take extraordinary measures to move money around the fund your Roths. Yes, it is nice to fund Roths at the beginning of the year, but that generally applies to folks who have cash sitting around and it just makes more sense to move it in January.

5. You should have a cash reserve. I see that you prefer to keep money in investments. Well, the good news is that although you should not want to tap your Roths, they can in a sense serve as a cash reserve. That is because you can always take out contributions without penalty.

6. Remember, you don't have to write one big check. You could decide to fund say 1500 each early in the year and more later on.

I understand the tight cash in/out situation. Perhaps one of you can find a second job or other source of income that can be dedicated to fund your long term Roths. Or perhaps you can adjust your expenses (like deferring a car purchase for a year, or taking 1/2 of your holiday presents budget) to allow you to contribute to these Roths.

[Guest ctfudge07]

All right; I tried my best to be complete without writing a book. I think I said our tax bracket is low; it's never been higher than the 15% bracket and I expect it to stay the same at least for the next year. I see that because I mentioned "converting," it may have sounded as if I didn't understand that an IRA must be funded with cash - I do understand that; that's why I'm turning over in my head the only way I see possible to raise the cash to do so. I suppose that was addressing my question about recharacterizing or converting an account; I guess there's no way around liquidating an asset so that cash can be obtained if I want to fund an IRA.

Ages: 42 and 46. No other retirement assets except a 401K which is only worth about a thousand dollars right now.

Thanks for the input; I've just read through it. We have no purchases on the horizon like car purchases, and Christmas is already cut to the bone (there's no way we'd spend close to over a thousand dollars) so maybe I haven't made it clear how much of a shoestring we operate on compared to plenty of others.

Since our taxable-account assets are far greater than our retirement-account assets, I just thought it would make sense to move as much as possible into a Roth, meaning as much as is allowed per contribution limits, even if that meant selling taxable account investments to do so. I guess we'll have to run it through Gainskeeper and see what kind of tax impact there is; I believe it is minimal.

I'm a little confused because I thought the standard advice was to contribute to an investment account like a Roth as fully as possible, and invest in taxable accounts only after filling up retirement-investing accounts first. So I'm having trouble understanding when/where the disadvantage would occur in selling taxable accounts and effectively "moving" that cash into a non-taxable account.

We got started investing only this year and barely have any retirement accounts started, as you can see, and have the bulk of our money invested outside retirement accounts.

[Guest mjb]

Interesting idea. For 2008-2010 tax years taxpayers in 15% bracket will pay 0% on capital gains which would allow a tax free transfer (need to check state tax law) of capital assets to Roth account. Purchase of same fund in Roth will eliminate taxation on dividends and income provided that you dont withdraw taxable amounts until 59 1/2. All that is needed is compensation from wages or self employment income. If you are eligible you can also contribute to a 401k plan.

[Guest ctfudge07]

Thanks, mjb - this was very useful. And I just learned that capital gains apply to investments held for more than 365 days, so I'll be doing this later in the year, rather than earlier, watching the timing. Thanks again.

[Bird]

I'm a little confused because I thought the standard advice was to contribute to an investment account like a Roth as fully as possible, and invest in taxable accounts only after filling up retirement-investing accounts first. So I'm having trouble understanding when/where the disadvantage would occur in selling taxable accounts and effectively "moving" that cash into a non-taxable account.

There's a difference between investing new cash in a Roth and selling something else, paying a tax, and then investing in a Roth. I was just saying I wouldn't bother incurring a tax in order to make a tax-advantaged investment. It's not the end of the world to have some money in regular taxable accounts - remember that capital gains aren't taxed until the sale of the asset (and yes you figured out what I was saying about capital gains distributions from a mutual fund) - and at the extreme, aren't taxed at all if you hold the asset til death.

Having said that, if you can sell something and pay no tax, go for it.

[John G]

I concur if you can sell something and pay no tax, then go ahead and fund you Roth.

Part of the bigger picture is what you think your future tax rate in retirement might be. It sounds like you might expect modest income/taxes in retirement. But, I don't think to addressed that long range issue.

We get a wide range of folks posting questions here. Scenarios can vary a lot. A engineer, doctor, entrepeneur or sales person might expect to have high incomes for most of their lives. They might amass a significant fortune and would perhaps be up in 6 figures in retirement. Another person might have a modest pension and because much of their other assets were in a Roth, they might not expect to have a high tax rate.

Unfortunately, circumstances vary so much, its very hard to generalize.

You mentioned the common advice to max out a retirement account. Lets parse that generalized statement into a few specific examples. If you work and get a nice matching amount from your employer, it is almost always wise to contribute up the the match. Some folks get a 100% match, which is huge! It takes some investors seven years to double their money (at 10% annual compounding). Example 2: a household has very high tax rates now but expects to have much lower tax rates in retirement (perhaps they plan to move to a state with no income tax, perhaps they have only modest SS and pensions). This household might be better off using tax deductible IRAs rather than a Roth. Example 3: a young couple with low tax rates now but expect there incomes to rapidly increase (MD resident married to someone still in law school). They might want to push their Roths now because they may not qualify in the future and expect to have high tax rates later.

Good luck with your investing.

[Guest ctfudge07]

Thanks, John. I always appreciate your input. You remember my story from early in the year. I think I told you, we decided it would be foolish to pay off the car and therefore reduce the amount of money we'd have to invest. The good news is that very soon, we'll refinance the car loan to a reasonable rate. We've solidified our relationship with USAA which is about the best I can find for good rates on various products like loans; we already have checking accounts there and relatively small investment accounts there.

We decided to take advantage of the employer-offered 401K, which my husband was eligible for starting in July. The match offered is 50%, up to 6% of salary, so after much deliberation on whether to "max out" on that (meaning contribute the entire percent of salary allowed, exceeding the match point)(hard to do with income that is not very high - we have to eat, after all) he decided to just take advantage of those exact terms - 6% of salary to get the additional 3% the employer kicks in. Therefore, even though the funds offered aren't as aggressive or impressive as the ones we like otherwise, the match makes it all worthwhile. At first he chose four funds and then recently narrowed it down to the two best performers.

I realize our investing philosophy departs from that of many people, but like you, John, we don't waste time on "target funds" and other such stuff. We're fully aware (not dumb - we spend much time researching and sometimes agonizing) and have taken some stomach punches in our investing, but as of yesterday, our return on investment, which was only started in late May, (by the way, this excludes the 401K so we're talking about just our Roth and taxable accounts) is between 17-20% (I give that range because the lower figure accounts for the IRS version - what I mean is that we have several data crunchers, one of which is Gains Keeper which is the most accurate and accounts for projected tax implications.) Since the market has had its rough patches (to put it mildly) and since we've made mistakes and had "learning experiences" (again, to put it diplomatically), I guess we've been doing OK, huh?

[John G]

Making contributions to get the full match is almost always a great idea, in your example you are booking an instant 50% gain. As long as you can afford the contributions (unlike brokerage or reserve accounts, employee plans can not be used as "household reserves") and as long as the company plan offeres reasonable investment options (company only stock would raise questions), then I would contribute to caputure the company match.

Paying off a car loan? Refinance a car loan? For the general reader...... Car loans are typically different from mortgages or student loans. The interest part of an auto loan is front loaded. This means that the effective interest rate in the later years is much lower than the average interest rate you thought you had. So for most normal car loans (at standard interest rates) it may not make a lot of sense to refinance or pay the loan off early.

Performance stats: Because the market flucuates, performance is best measured over a long multi-year period. In 2007, the stock market has swooned three times - Feb., August, and now in November. You could look great Nov 1 and awful two weeks later. If you can consistently post annual returns of 10% you are doing well and have a great chance of building substantial assets.

Performance chasing caution: Some folks are so hot on performance that they will move their money around

"chasing" performance. Today, the big chase is international investments and particularly China. Its the opposite of investing in banks, mortgage companies and home builders. Yes, it is possible to boost returns if you are very clever about "rotation" by region and industry. But, way too many investors fall into the trap of buying HIGH in euphoria and then SELLING low in panic.

[Guest ctfudge07]

I plead guilty on the "chaser" charge, but yes, we are sufficiently clever and even more watchful (everyone needs a hobby, you know.) You said: "You could look great Nov 1 and awful two weeks later." I sure do know what you're talking about regarding those dates - and I was talking down-to-the-day (date of my post.) If I had been quoting figures from November 1, the figure would have been quite different. I don't know if that translates to great on Nov. 1 and awful on Nov. 16th - I tend to be more of a glass-full and glass-less-full person rather than a glass-almost-full and glass-almost-empty person. (If the glass were getting seriously drained, though, I'd re-assess.)

** take note that I'm conspicuously not saying anything about today.

Thankfully, the 401K options are really decent; not company stock.

Is the November "swoon" going to be over with soon, btw? OK, sorry, I've gotten off-topic now. Going now to see what dire-but-rehashed financial news will shake the market today. (How many times can they rephrase "Credit woes worry investors," "Futures sag on credit crunch," or "Subprime worries keep stocks on edge"?) I think they have a list of several verbs and phrases that just get assembled in a different way each A.M. - or maybe they even reuse the same headlines from a few weeks ago and just hope no one notices.

[Guest jimmy-stock]

i would like to know that is investing in stocks is also taxable

[John G]

"i would like to know that is investing in stocks is also taxable"

Investing where? Here is the short answer:

Roth IRA - - investments in a Roth currently do not incur taxes when the assets are sold or when the funds are distributed at retirement time

IRA - - investments in a standard IRA are not taxed when sold, however IRA distributions are treated as ordinary income (I am over simplifying this answer)

Non-retirement investing - - taxes occur when an asset is sold for a gain, and two different rates apply depending upon if the assets are held for more than 1 year (long term) or less than 1 year (short term - gain is treated as ordinary income)