Many people express concern about their retirement accounts. If I had a dollar for every time someone got excited about contributing to their backdoor Roth IRA, I would probably be a millionaire.
I’m exaggerating, obviously, but people love retirement accounts. While it’s great energy to have, the enthusiasm doesn’t carry over to steps that might be more important to your long-term financial future.
I get questions all the time about “am I screwing something up in my retirement” – but here’s why you don’t need to worry about getting everything right in your retirement accounts.
Backdoor Roth IRAs
Retirement accounts are an important piece of your financial plan. Of course you want to get them right. But here’s my confession: I don’t do backdoor Roth IRAs. It’s not because I shouldn’t, but because I’ve been focusing on other things.
Many people believe backdoor Roth IRAs are the most wonderful thing in all of finance. But I’ve seen people more concerned about their backdoor Roth IRA than putting $50,000 per year into a brokerage account.
Don’t let the allure of not paying taxes on that $6,000 Roth IRA limit take you away from a bigger benefit you could cash in on. Investing 10x that amount in a brokerage account can get you to your financial goals more quickly.
Brokerage accounts vs. retirement plans
The maximum amount you can contribute to a 401(k) in 2020 is $19,500. But think about a high-income earner – a lawyer, doctor, or dentist – where you’d reach that limit with a savings rate of 20% or less.
While saving 20% of your income isn’t necessarily a bad thing, it will take you at least until age 60 to build up enough of a nest egg for retirement.
It’s a much better strategy to have the ability to retire at 50, even if you choose to keep working once you reach that age.
What if you start having back pain at age 50 from decades of leaning over patients to do dental work?
I couldn’t imagine being a dentist in a 50-year-old body experiencing back pain caused by my occupation. Suppose it was debilitating and you needed to work less or consider the possibility of retiring early. In that case, you might not be able to if all you focused on was retirement accounts. That’s because retirement accounts come with age restrictions to withdraw the money without paying penalties.
You could have access to the cash with a brokerage account if you needed it from age 50 to 60 without worrying about penalties.
There’s also no limit on how much you can contribute to a taxable investment account. If you’re making a lot of money, you can contribute a substantial amount without having an annual cap.
How to set yourself up for financial independence
Personal finance experts often say you need 25x your annual spending in an investment account to reach financial independence. But that doesn’t take into account temporary expenses.
Temporary, long-term expenses you don’t need to account for in your plan for financial independence are:
- Daycare expenses
- Commuting costs
- Mortgage payments
- College expenses
They are not “forever expenses.” Instead, add up your annual spending after all fixed temporary and optional expenses are taken out to get your true financial independence number.
For example, let’s say your annual spending is $100,000 but you spend $30,000 on daycare and $10,000 on commuting and transportation costs that you wouldn’t have if you weren’t fully employed. In this scenario, your actual spending is $60,000 – which means you should save $1.5 million to reach financial independence.
It will take you a long time to reach $1.5 million in a retirement account that caps your annual contributions at $19,500.
That’s why brokerage accounts are so important. When you invest in index mutual funds, you can reach your financial goals much faster.
3 things to get right about your finances
If you want to do a backdoor Roth IRA, that’s fine. There’s nothing wrong with it. My friend, the Physician on Fire, has a great guide to backdoor Roth IRAs if that’s something you’re interested in pursuing.
But you don’t have to optimize everything about your finances. The main decisions you need to get right are your student loans, investing, and negotiating your salary.
For help optimizing your student loans, book a consult for in-depth analysis and a personalized student loan repayment plan.