Part 1 here was all about investing my Taxable bucket. This is part 2 of my buckets of money and how I plan on investing the funds in them. My Tax Deferred Bucket, although the funds are already invested, it’s become clear that I need to re-think how I’m investing funds in this account.
Tax Deferred Bucket
My second bucket is the “tax deferred” bucket. This is a bucket that holds my retirement funds that I’ve contributed to in my 401k and then, over the years, converted and consolidated onto an IRA. I currently have one 401k and 2 tax deferred IRAs and my wife has a 401k since she’s been at the same employer for a long time.
Taxes on 401k
The tax rate on money inside a 401k is zero as investments grow. The money in this bucket can grow larger and larger and there is no immediate tax consequence. Because there is no tax on the funds that grow in here it really doesn’t matter if it’s dividends, interest, or capital gains. The goal should be to invest the money in here that will be preserved and grow. More importantly, funds in a 401k can be withdrawn with no penalty at age 55 if you happen to lose your job but that’s not the case if you roll it over to an IRA so be careful rolling over 401k’s if you are in your 50’s and plan on withdrawing that money.
Taxes on IRAs
Like 401k’s, the tax on money inside IRAs is zero as long as you leave the funds in the account and just let them grow. Because there is no tax on the funds that grow in here it really doesn’t matter if it’s dividends, interest, or capital gains. The goal should be to invest the money in here that will be preserved and grow.
Taxes on Withdrawals
So how do withdrawals from IRA and 401ks work after you retire (at age 59 1/2 or after)? Well the beauty of tax deferred accounts is that you don’t need to touch the money at least until the Required Minimum Distribution (RMD) kicks in at age 73 (depends on year born). After you take money out of your IRAs it will be taxed as ordinary income and the standard tax brackets apply.
Filling The Bucket
I’m filling my tax deferred bucket with value and dividend stocks as well as some US Treasuries to make sure that this bucket of money grows in a stable and reliable way. The key is to be diversified in a good mix of stable investments. I favor dividend stocks in this bucket or dividend ETF like Schwab’s SCHD.
Read about my taxable bucket or tax free bucket.