Good question. It depends. (Don’t you hate that answer? I do.) Let’s say you have $500 per month available after all your household expenses are paid and you’re ready to throw it somewhere to let it build. What’s the best way to make it grow but yet minimize the tax bite?
Some of you have told me you are looking to find ways to take excess cash off the table to put into investments that can grow for you in a “set it and forget it” strategy.
[Side note: I’m assuming you already have a sufficient emergency cash fund set aside for rainy days or unexpected emergencies (by the way, you might consider an internet bank money market account for this…see http://www.nerdwallet.com/rates/Money-Market-Rates for the best rates). Note that these accounts are almost always FDIC-insured, so you can sleep well at night knowing the cash is protected, and earning a tiny bit of interest.]
I’m a big proponent of starting small and growing big. And, I also believe strongly in diversification. So if you have discretionary cash each month, why not think about splitting that up into three or four slices, each with its own purpose? One slice could go into a money market account to continue growing your cash holdings. Another slice could go towards a self-managed investment account (or managed). And yet another could go into a cash value life insurance policy.
If you have the time and risk tolerance to manage your own investment account, you might consider a Roth IRA. I recommend Scottrade (it’s what we set up), and remember it’s AFTER tax dollars contributed into the account. The growth that happens in the account is free of capital gains and federal income tax, and when you retire, you will be able to take distributions tax-free. Remember that the annual contribution limit is $5,500 for 2014, unless you’re over 50, in which case your limit is $6,500 (see http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-IRA-Contribution-Limits).
You’ll want to look at the types of investments in the IRA that you intend to use. If it’s primarily stocks and options, Scottrade is competitive because the per trade fee is $7. (Interactive Brokers is the best per trade fee at $1, but the platform is far more advanced and not the best for beginner traders).
But remember, a Roth IRA may not be best best choice for everyone. There are drawbacks to using a retirement account for building wealth, one of which is accessibility to the cash. You can’t touch it until age 59 1/2, (except for some limited cases), and this may be a deal breaker for you, particularly if you are interested in leveraging your growth into other investments. Once the funds are in a Roth, you CANNOT roll the funds into another vehicle.
OK, now on to the next slice. Have you thought about a cash value life insurance policy? This is something we’re doing, and it’s not only an investment vehicle, but it’s also a hedge against your other investments tied to the stock market, such as your 401(k) that may be heavily invested in mutual funds. There are life insurance policies out there that will guarantee a minimum return each year, regardless of how the markets are doing. On the other hand, when the markets are roaring, you get to benefit from the upside as well.
By the time the cash value begins to grow, you can borrow against it tax free and invest into other opportunities. Again, this is a VERY long term strategy. It is NOT for the quick fix investors. Talk to me if you’re interested in this. I can connect you with an EXCELLENT attorney and life insurance agent (who we work with) that will customize a policy for you, based on your income, risk tolerance, and objectives.
Another idea for discretionary cash is to convert it into equity into your home or rental property. There are a number of home improvement projects that qualify for tax-deductions, and by investing into your home, you increase the value of the property, AND could receive a tax break in the process!
For the win,