Flexible Capacity

The pressure's on the screen
To sell you things that you don't need
It's too much information for me
--Duran Duran

Recent cover stories in BW, Fortune, et al remind us of how poorly positioned the median US citizen is for retirement.

A common prescription is that people need to divert more of their incomes toward various tax favored vehicles such as 401(k)'s and IRAs. If at all possible, the Rx continues, one should 'max out' contributions to the tax exempt limit. In 2009 this maximum is $16,500, with another $5,500 of 'catch up' contributions possible for those 50 yrs or older.

I wonder, however, whether many folks are not diverting more income than they should toward retirement accounts. While their retirement accounts build, they are living 'cash poor' in the present. They live paycheck by paycheck with little cash cushion to absorb situations like unplanned car repairs or hospital bills.

My sense is that many folks would be better off contributing less to their retirement accounts and build liquidity to cope with living their lives in the present period. While income and capital gains realied would be subject to tax, so ultimately will retirements funds once they are tapped (retirement funds are treated as ordinary income).

And just precisely what those future tax rates will be are anyone's guess--although there is a reasonable case to be made that taxes in the future will be much higher than the present. (As a sidenote, it may be worth pondering how government might plunder 'tax advantaged' Roth IRAs in the future!)

A couple years back, I cut back on my 401(k) contributions to the minimum necessary to receive the employer match. For me, it was one of the better personal finance decisions I have made. I was able to pay down debt and build cash. The resources that I'm building in taxable accounts can still apply toward retirement. Indeed, I can use them whenever I want without reservation. And they are outside the retirement system and its vagaries.

My flexibility (freedom) has increased.