How should I invest for retirement without a 401k or tax deductible IRA?

Question

I switched jobs at the beginning of the year and my new job doesn't have a 401k plan for the first year of employment. Unfortunately I put a small amount of money this year into a 401k from my previous employer so investments into a traditional IRA won't be tax deductible this year (I make $85,000 so I believe my MAGI will be too high).

After all's said and done I can invest $1300 to $1400 every month. I have $20,000 in student loans, $13,500 at 6.5% and $6,500 at 3.15%, so I want to put most of my money into that to pay them off within a couple years. After that I'm not sure where to put my money, I have a healthy rainy day fund so I don't need to worry about that.

Since I'm not putting any money into a 401k this year I want to save some money for retirement another way. I also want to get a house in 5 to 10 years so it might be a good idea to make some shorter term investments I can use for that.

Is it still worth it to put money into a traditional IRA if I don't get tax deductions or should I invest it elsewhere? Should I make any investments for a down payment on a house?

Answer 1

The hard decisions are down the road. For the time being, put all your extra cash toward your 6.5% student loan. That's a no-brainer. By the time you pay that off you will be close to being able to contribute to your 401(k).

If you pay it off before you start contributing to your 401(k), either pay down the subsidized loan or put your money in a Roth.

• Paying down the loan is equivalent to putting money in a savings account that pays 3.15% APR. That's not a ton, but it is way better than savings accounts pay and is more than the inflation rate.

• Putting it in a Roth is appealing too: Remember that you can take out your contributions (not gains) from a Roth any time you want without a penalty, so this is a fine place to save for a down payment. You can also take out the gains without a penalty if you use it to buy your first home. Putting money in a Roth pretty much dominates saving for a down payment through a taxable brokerage account. It also is strictly better than a non-deductible traditional IRA contribution, both in the tax implications and in the ease of getting to the cash.

Also, work up your expected taxes and see if there is any way you can get under the limit (under $72K a single person can deduct something). Did you move? You may have moving expenses you can deduct. Health savings account? Any other pre-tax payments on your paycheck that won't end up as "wages" on your W2? Maybe (just maybe) your employer will defer your last paycheck into the next year?

Answer 2

When I couldn't fund a traditional IRA (Individual Retirement Account) because I had contributed to a 401k, I contributed to a Roth IRA. That allows you to contribute to retirement and keep up those contributions. It is more limited than a 401k, so you may have more than you need for that ($5500). I'd prefer a Roth to excess contributions to a traditional IRA. Through April 15th (or whatever the tax deadline is this year), you can contribute to a Roth (or a traditional IRA) for last year. And still contribute to a Roth for this year.

Paying off loans always makes sense to me. It sounds like you could reduce the $20,000 to around $10,000.

Saving for a house can be good. Consider whether you might be better off interest wise paying off the loans. Often times the loan charges more interest than a savings account pays. A higher return option is a REIT (Real Estate Investment Trust). Those tend to be variable, but they swing with the property market. So when they lose value, houses tend to be cheap.

Personally, I'd go with maxing a Roth followed by paying off the highest interest student loans.