Cashing stock to begin Roth IRA?

[Guest calluke]

I've pretty much decided that I want to begin a Roth IRA with Vanguard (target-date retirement fund) but they require a minimum deposit of $3000. My wife and I have about 10K in our savings, but would like to keep that as our emergency fund. My grandmother had bought me 5 shares of stock in Pfizer as a child and they've grown to over 120 shares now at about $26/share. I was wondering if it would be a bad decision to cash the pfizer stocks in order to begin my Roth IRA. They are worth about $3300. Any suggestions??????

[John G]

If you sell the stock, you will pay a small commission and probably 15% on the long term capital gains. Pfizer represents a blue chip drug company. After many years of great performance, it has been either moving sideways or down for the past 6 years. You are getting a 3.7% dividend.

Sure, you can sell the stock and net about 3,000 in cash to fund a Roth. You can also use your cash reserves to fund the Roth since you would have both the PFE stock and the Roth funds still as a short term reserve. Or, you can use other cash. You may want to consider taping your checking account once a month on a routine basis to start building your Roth. This last approach is less "one shot" and more of an ongoing plan and you may find the mutual fund company holding your Roth will waive their annual fee. You have many choices - no one approach stands out as superior.

I think your grandmother did a wonderful favor on exposing you to investing for the long term.

PS: You did not indicate your ages or incomes, but 10k and the PFE shares is not really much of a "reserve" or retirement nest egg. Think about what you can do to build up you reserve and get going on a systematic investment program. Post again if you have more questions.

[Guest calluke]

Thanks John. That was great advice. I am a teacher with a pension plan but would like to begin the Roth for further funds for the future. I am also planning to put in a $100/month to the roth to keep it growing. I'm only 26, so i'm hoping later down the road i'll be able to put more. At the moment, my wife is only working part-time to be at home with our child. The $10,000 we were hoping to keep in their for emergencies and also for a little cushion until she goes back to work, probably in about 10 years or so. (She is also is a teacher with a pension plan).

I never thought about the fees involved with the stock. And you're right - i can always take out of the Roth if needed, penalty free whatever i had put in.

I guess we will take your advice and take the $3000 from our savings account and try to build that back up in the upcoming months and keep the pfizer stocks.

p.s. i also have whole life insurance for $50,000 that i've had for a few years. i know now i should never have done that, so i've just changed to term for $500,000 which is much cheaper than the whole life! I think the cash value is about $1200 right now, which i plan to cash to put towards Roth.

[Guest mjb]

There 2 are tax consquences to selling the PFE stock to fund a Roth IRA. First Cap gain on the stock sale which will be close to the FMV since the initial purchase was only 5 shares. Assuming $200 basis, cap gain will be 2800 and cap gains tax will be 5% ($140) if you are in the 15% tax bracket. In addition, you will lose a $450 deduction by contributing to the Roth for a total tax of $590. If you invest in the Roth without selling the stock you will only forgo the $450 tax deduction.

[John G]

MJB, your comment is misleading.

When you elect a Roth, you are choosing future tax free status over the chance for a first year deduction (if eligible) of a standard IRA. That is a staight forward tradeoff which taxpayers face. No one can know with complete certainty that they are making the optimal choice because the taxpayer is making assumptions about current and future tax rates, coupled with current and future IRA/Roth regulations.

The $450 (in your example) has nothing to do with the PFE stock sale. This person would have the same math and the same IRA/Roth tradeoff if he funded this Roth with cash. The only direct tax consequence of selling the PFE stock is that this couple would owe tax on the long term capital gains. Currently, the LTCG rate is at a historic low.

This message thread was initiated by a full time school teacher with a part-time working spouse. The income tax brackets are likely to be low, but were not disclosed. When tax brackets are low, the value of the one time deduction of an IRA is small. If my marginal tax bracket was 15%, that IRA deduction might look pretty puny relative to the potential tax bite many decades into the future when supposedly I will have assembled substantial retirement assets. Distributions of from a regular IRA pass out as ordinary income, which can be at fairly high tax rates. It is not inconceivable that this couple could amass more than 2 million before they retire. A 5% distribution would be around 100k. I sure would like a significant part of that income stream to come out of a tax free Roth.

MJB, I have noticed from postings on the related 401K board that you seem to get into a lot of debates about issues were you are not an expert, or on issues that are at best tangental to the original post. If you plan to post here, lets keep the posts as clear as possible and stay focused on the original question.