18 year old making $60k a year; how should I invest? Traditional or Roth IRA?

Question

I've had a lot of questions regarding personal finance, and I figured this would be the best place to get some good answers. To start, I made over $60,000 in 2013 and just over $44,000 in 2012. I make videos on YouTube, and currently run 4 YouTube channels; my revenue is accrued through advertisements that are displayed on my videos, which have been averaging over 4 million views a month.

In the past, I've filed my taxes as an individual (paying self-employment tax), but I recently set up an LLC, so I will now be using a TIN for my taxes. I've been contributing the maximum amount of $5,500 each year to a traditional IRA, but I'm interested in switching to a Roth IRA. My traditional IRA is a T. Rowe Price and Vanguard target date retirement fund (set for 2060).

I generally see between $5000 and $10000 a year in business expenses, which I list as deductions when filing taxes. I understand that I should probably consult with a financial adviser, but I just want some sound advice from others before consulting a professional.

A few last things to consider: I expect my YouTube income to grow steadily, but not reach above 100k a year. I am also attending college for free on a Air Force ROTC scholarship, so I will commission as an officer in the Air Force after college. So, I expect to be making a median of 160k a year in about 8 years from now (from my YouTube and Air Force income combined).

Here are my questions:

1. Would it be wise for me to transition to a Roth IRA instead of a traditional IRA? So far, all of my research indicates that it would be wise, but I would like an outsider opinion.

2. Instead of investing solely in a Roth IRA or Traditional IRA, should I do a mix between the two? For example, $3,000 a year in Roth IRA and $2,500 a year in Traditional IRA?

3. If you were in my position, how would you balance your Roth IRA portfolio? For example, would you recommend just setting up a target date fund that is managed by someone else, or would you suggest actively managing the account?

Thanks in advance.

Answer 1

1) Usually, the choice between Traditional vs. Roth is whether you believe that your tax rate will be higher or lower in the future than it is now. Your income is probably in the 25% bracket now. It's hard to say whether that should be considered "high" or "low". Some people advocate Roth only for 15% bracket; but your income would probably go into higher brackets in the future, so Roth may be preferable from this point of view.

Roth IRA also has another advantage that the principal of contributions can be taken out at any time without tax or penalty, so it can serve as an emergency fund just as well as money in taxable accounts. Given that you may not have a lot of money saved up right now, this is useful.

2) In a sense, it's nice to have a mix of Traditional and Roth when you withdraw to hedge against uncertainty in future tax rates and have the option of choosing whichever one is advantageous to withdraw when you need to withdraw. That said, you will likely have many years of access to a 401k and high income in your future working years, in which you can contribute to a Traditional 401k (or if no access to 401k, then Traditional IRA), so a mix will almost certainly happen even if you go all Roth IRA now.

3) I think that depends on you, whether you are a hands-on or hands-off kind of investor.

Answer 2

With this level of income, you might consider a Solo 401(k). It would allow you a much higher level of contributions and is more appropriate for your savings than the limited IRA deposits.

It also offers a considerable number of options not available for IRAs. A loan for example.

Answer 3

In asnwer to your questions:

1. As @joetaxpayer said, you really should look into a Solo 401(k). In 2017, this allows you to contribute up to $18k/year and your employer (the LLC) to contribute more, up to $54k/year total (subject to IRS rules). 401(k) usually have ROTH and traditional sides, just like IRA. I believe the employer-contributed funds also see less tax burden for both you and your LLC that if that same money had become salary (payroll taxes, etc.). You might start at irs.gov/retirement-plans/one-participant-401k-plans and go from there.

2. ROTH vs. pre-tax: You can mix and match within years and between years. Figure out what income you want to have when you retire. Any year you expect to pay lower taxes (low income, kids, deductions, etc.), make ROTH contributions. Any year you expect high taxes (bonus, high wage, taxable capital gains, etc.), make pre-tax payments.

3. I have had a uniformly bad experience with target date funds across multiple 401(k) plans from multiple plan adminstrators. They just don't perform well (a common problem with almost any actively managed fund). You probably don't want to deal with individual stocks in your retirement accounts, so rather pick passively managed index funds that track various markets segments you care about and just sit on them. For example, your high-risk money might be in fast-growing but volatile industries (e.g. tech, aerospace, medical), your medium-risk money might go in "total market" or S&P 500 index funds, and your low-risk money might go in treasury notes and bonds. The breakdown is up to you, but as an 18 year old you have a ~50 year horizon and so can afford to wait out anything short of another Great Depression (and maybe even that). So you'd want generally you want more or your money in the high-risk high-return category, rebalancing to lower risk investments as you age. Diversifying into real estate, foreign investments, etc. might also make sense but I'm no expert on those.