I’m starting with a disclaimer here. We could debate for hours the pros and cons of a Roth IRA; Heck, Lanny has written about both sides of the Roth vs. Traditional argument already…first about maximizing your Roth IRA contributions for 10 years and then writing about his plan to use a Traditional IRA going forward during the summer. What am I proving here? There is not a one size fits all approach and using a Roth or a Traditional account may (and should) change as your financial situation changes. This last week I experienced one of the downsides of a Roth IRA and I wanted to share it with all of you.
Today, my beef is with the $5,500 annual contribution limit. As we all know, the IRS restricts the annual contribution for a Roth IRA or Traditional account to $5,500 if your annual income exceeds this amount. Earlier in my investing career, I typically would wait until the beginning of the next year to maximize my Roth contribution for the prior year. Thus, all my investments from January through the deadline were related to prior year contributions. Since my goal is to maximize my Roth IRA annually, I started to dislike this approach because it would force me to buy lower yielding dividend stocks (such as Schlumberger) in my Roth IRA versus regular account just so I could satisfy my desire to maximize my Roth IRA. My goal in maximizing the Roth was to gain the most benefit of tax-free growth and here I was wasting this valuable benefit on lower yielding dividend stocks because I did not plan ahead. Starting in 2015, I made it a goal to maximize my Roth IRA contribution before the end of the year so I could plan on purchasing most of my high yielding investments and REITs in this account.
The last stock I purchased was Realty Income. I added 40 shares to my Roth IRA a few weeks ago and the approximately $2,300 purchase was the exact dollar amount left in my annual $5,500 limit. I was pumped and thrilled that I was able to stick to my goal and maximize my Roth IRA contribution. Then what happened? You guessed it….the stock price dropped 10%. Even Lanny was calling me out in his October dividend income article about the fact I had not added to my position in the beloved REIT. Well, there was a sad, legal reason why I couldn’t just transfer money and purchase more shares. That’s because I hit my maximum limit and was prohibited from transferring funds into the account. UGH! My options were to purchase Realty Income in a regular brokerage account and accept the tax disadvantages or sell a stock and use the proceeds to purchase additional shares. I had a few contenders for stocks I would potentially sell, but I wasn’t ready to make that decision at the time. So you guessed it, my action for the week was no action. I will not be adding to my position most likely until January 1, 2017 at the earliest.
What’s my takeaway from this experience? I’m always trying to find a takeaway when situations like these, especially as I am getting ready to set my 2017 goals. The IRS gives you almost four extra months to contribute to the previous year’s IRA limit, so why I am I trying to contribute the maximum amount within 12 months and potentially change my investment strategy artificially? If I weren’t so adamant about purchasing stock in my Roth and maxing it out before December 31, maybe I would have had between $3,000 and $3,500 to invest in Realty Income, a company that should be held in my Roth, versus only $2,300. Why was I so eager to knock this out-of-the-way? That’s a rhetorical question of course, but going forward, I am going to be more careful about which company’s I buy in my Roth IRA versus regular account so that I have the tools available to me when I want to make a splash.
What are your thoughts on this situation? Has you run into this issue before? How do you manage your Roth IRA investment decisions? Do you only purchase certain stocks in your Roth IRA because of the tax benefits?
-Bert