AP ImagesPlease see my earlier post on The Humble IRA.
Does the humble and homely Individual Retirement Arrangement (IRA) matter to well-paid people?
I remember being shocked in the late 1990s when my mentor Jim on the bond trading floor at Goldman declared “I don’t bother with IRAs because nobody’s getting rich investing through an IRA.”
I eagerly sought out wisdom on personal finance at the time, so I was struck that such a clear tax-advantaged vehicle could be overlooked by a financially savvy professional like Jim.
He was a Vice President at the time and made a good salary and bonus, with bright prospects. He then became a partner about 6 years later, wholly and thoroughly justifying his scorn for the lowly IRA as a wealth-building vehicle.
His example stuck in my head over the years because – more than the stark irrelevance of an IRA for his own personal situation – I’ve realised that he’s basically right – upper income and wealthy people as a whole really have no use for the IRA. It’s a waste of time for them. This is true for a number of reasons.
1. The maximum tax deductibility limit of $5,000 doesn’t get you very far if you have many multiples of that amount to invest. In the 1990s, when my mentor made his scornful statement about not getting rich from an IRA, contribution limits were stuck at $2,000 – making his scorn even more justifiable. But even with the upward adjustment to $5,000 in 2012 and $5,500 in 2013, that still doesn’t provide much tax advantage.
2. Most highly compensated people have access to a 401K or a similar saving plan which offers many times the tax-advantaged contributions of an IRA. If you own your own business, or if you work for a high-paying salary, you could put away at least $17,000 pre-tax in 2012, in addition to larger amounts through employer profit-sharing, leaving the homely and humble IRA in the dust.
3. If you have access to a much better, bigger employer retirement plan like a 401K, as most highly compensated people do, suddenly you’ve lost the $5,000 IRA tax deductibility if you make more than $68K individually, (or $112K if you file with your spouse.)
The end result: my mentor Jim was right. Upper income people really can’t be bothered with the IRA, and I can’t fault their logic.
All of the above is particularly ironic to me because I’ve spent the past month arguing, pleading, berating, and otherwise pestering the undergraduates to whom I teach personal finance into opening and funding their first personal IRA.
I’ve argued that opening and funding their first IRA – which I assigned as mandatory homework to them this week – is a key culmination of everything I’ve taught them.
And I do believe in the value of the IRA for them in particular, as I assume they will not be highly paid in their first years out of college, nor will many of them have access to a 401K right away. So an IRA makes a ton of sense for them. At least for now.
What I haven’t told them is that as soon as they’re well-paid and wealthy they can forget all about the IRA, with my financial blessing. But please don’t let them know this yet.
First they have to open the IRA, before they can forget all about it.
Please see the earlier post:
The humble IRA
and related posts on the personal IRA:
The magic trick of the Roth IRA – inter- generational wealth transfer
The DIY movement comes to the IRA