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When Tax Deferral May Not Be the Best Choice

Maximize your 401(k) contribution, don’t forget to contribute to your IRA, think about funding a Roth. Sound familiar? This advice appears all over the place online, in financial and investing magazines and in advice from your financial adviser or broker. But is it always the right step for you?

Consider the not uncommon situation where working clients seek to fund current education goals or other major expenses in the near-term. If they are saving the maximum to tax advantaged vehicles, they may not be able to set aside enough additional money outside the tax advantaged accounts to fund these current goals.

We are not saying that it is not important to save for retirement. Of course it is. What we are saying is that life is a lot more than simply retirement and things happen – by plan or otherwise – between now and retirement. Those tax advantages attached to your retirement accounts are tied to you waiting until retirement to get at the money, hence the early withdrawal penalties and rules restricting withdrawals.

So if your financial plan contemplates funding goals before retirement and your investments are tied up in tax-advantaged accounts, you have a problem. One solution is to save some after tax money to a taxable account or accounts while still funding your retirement accounts and taking advantage of benefits such as an employer match. Once you have secured that match, put some of those savings where you can access them easily when and if you need them. It will give you more control and may be cheaper than borrowing.

More than one financial plan shows a positive result at the end while overlooking how interim goals are funded and perhaps ignoring completely the early withdrawal penalties that may apply to a client. You can do better than that advice. 

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