Rollover and Conversion to Roth IRA Completed; New Milestone Reached

A few weeks ago I posted an update about rolling over the money from two retirement plans held with my former employer into an IRA, then converting that into my existing Roth IRA. I am pleased to report that the entire process has now been completed. As a result, I added a little over $25,000 to my Roth IRA, more than tripling its size. Note that I already set aside sufficient external money for the estimated taxes on the conversion, which I will be paying soon.

In the meantime, I now find myself in the unusual position of having over 20% of my overall portfolio in cash. Even though I am eager to put the rollover money to work, I do not see much in the way of attractively valued dividend growth stocks at the moment. The value investor inside of me cringes at the thought of buying overvalued stocks simply because I have money to invest. For that reason, I will not be investing the money all at once. However, I will not attempt to time the market, either.

I have decided that a reasonable course of action is to invest the money at regular intervals in whichever stocks happen to be fairly valued or undervalued at the time. With over $25,000 at my disposal, my tentative approach will be to make two purchases per month over the next five or six months, with each purchase being in the range of $2,000 to $2,500. The only constraint is that a stock has to be either fairly valued or undervalued by my judgment in order to be purchased. If the market happens to take a sudden downturn and more than two opportunities become available in a month, then I would accelerate the purchasing schedule.

Note that these purchases will all occur in my Roth IRA. Let's not forget that I will also be contributing new capital to my taxable account on a monthly basis (I have not made my November contribution yet). The amount will vary a bit from month to month, but it will likely average over $2,000. Thus, I will have sufficient cash to make a third (and possibly a fourth) purchase every month.

That's the plan as it currently stands. Incidentally, thanks to the rollover money, my portfolio reached a new milestone today, closing above $125,000 for the very first time ($125,862.52). Continuing with $25,000 increments, the next milestone will be $150,000.

Milestone history for portfolio value:

• $125,000: November 2013
• $100,000: October 2013
• $90,000: August 2013
• $80,000: March 2013
• $70,000: January 2013
• $60,000: September 2012
• $50,000: March 2012

Update on Rollover IRA

Some readers might remember this post from early February where I talked about opening a Roth IRA. At that time I knew I was going to be moving and changing jobs mid-year, so I mentioned that later in the year I was going to rollover the two retirement plans associated with my previous employer into my Roth IRA. Now that I've settled down financially after my move, I've set the wheels in motion for the rollover.

I've opened a Rollover IRA with Scottrade (the brokerage I use for my other accounts) and I've initiated direct rollovers of the 403(b) plan held by TIAA-CREF and the 401(k) plan held by Vanguard. Once those institutions have verified some information, they will send checks to Scottrade that will be deposited in my Rollover IRA. I was told it would take about 1-2 weeks for that to happen. After the funds are deposited, I will then convert (or merge) my Rollover IRA into my existing Roth IRA. My hope is that the rollover and conversion will be completed by mid-November, at which point I will have a sizable chunk of money in my Roth IRA to reinvest.

The move of pre-tax money into my post-tax Roth IRA will result in the money being treated as taxable income for 2013. Even though I do not like taking a big tax hit, it is a one-time expense that makes financial sense. Using various online calculators, I determined that the taxes I pay now will be much smaller than the taxes I would likely pay on withdrawals from a traditional IRA in 30+ years. By converting to a Roth IRA, I can look forward to making tax-free withdrawals in the future from an account that will benefit from 30+ years of tax-free compounding. Besides, I have already set aside enough money to pay the estimated taxes on the rollover money, so it will not affect my current rate of new capital investment.

I will post another update once the rollover and conversion have been completed.

Roth IRA

This week I started a Roth IRA as a supplement to the taxable account in which I currently hold all my stocks. For readers who don't know, a Roth IRA is a retirement account in which contributions are made with after-tax money (currently up to $5,500 per year), all dividends and capital gains within the account are tax free, and withdrawals are tax free (after age 59 and a half). The tax-free status of the Roth IRA is its main advantage over a taxable account, where dividends and capital gains are currently subject to a 15% tax rate. In a Seeking Alpha article that explored different factors that affect the long-term compounding of dividend income, I showed that dividend growth is slowed by taxes, so it is beneficial to hold stocks in tax-advantaged accounts.

I had been thinking about starting a Roth IRA for a while, but I held off because of uncertainty about my future employment -- there was a nontrivial possibility that I would be either unemployed later this year or working in a different country. Fortunately, that uncertainty disappeared a few weeks ago when I managed to get a new job (starting in the summer), as discussed in a recent post. With greater clarity about my employment and income, I decided it was time for the Roth IRA.

My plan is to fully fund my Roth IRA each year and use the money to buy dividend growth stocks, making the account a tax-advantaged extension of my current portfolio. The only difference between investment decisions for my Roth IRA and taxable accounts will be with respect to dividend yield. I currently require a 2% minimum yield for stocks in my taxable account, whereas I will require a 3% minimum yield in my Roth IRA. The rationale is to keep higher-yielding stocks in the latter account to take greater advantage of its tax benefits.

I have already made a contribution to my Roth IRA, putting in the full $5,000 allowed for 2012 (which can be done prior to April 15). It was easiest to do it in one shot, but that meant supplementing my January savings with about $3,000 from my emergency cash reserve. I will replace that money with my February and March savings. Later this year I will contribute the $5,500 allowed for 2013.

Once I start my new job I plan to rollover the two retirement plans I have with my current employer into my Roth IRA. The first is a 403(b) with TIAA-CREF that has about $14,000 and the second is a 401(k) with Vanguard that has about $6,000. These amounts solely reflect employer contributions over the past five years and the money is currently invested in target date funds. I will have to pay some taxes because the rollover money comes from pre-tax contributions; my calculations show that I will stay in my current marginal income tax bracket if I do it this year, whereas I would be in a higher tax bracket next year because of the higher salary at my new job. Even though the tax hit will hurt, it is a one-time expense that I will save for in advance. The upshot of the rollover is that it will add nearly $20,000 to my Roth IRA, which will allow me to buy a lot of dividend growth stocks. Thus, by the end of this year, I could potentially have around $30,000 in my Roth IRA ($5,000 from my 2012 contribution, $5,500 from my 2013 contribution, and about $20,000 from rollovers).

In case you are wondering, the taxable account with all my current dividend growth stocks will continue to grow over time. My next few purchases will be in my Roth IRA, but once my 2013 contribution is made and I have covered all my moving expenses during the summer, I will resume adding new capital to the taxable account from my monthly savings. Some readers may recall that last year I saved over $17,000 for investment. If I manage to maintain or increase that amount going forward, then I would be able to add over $10,000 to my taxable account each year, after my Roth IRA contribution. Given its higher starting balance and larger contributions, my taxable account will produce the majority of my dividend income over time.

The last point leads to an important question regarding investing and retirement: What if I want to retire early? If I retire before I'm 60, then I would only be able to withdraw direct contributions from my Roth IRA, which would entail selling some stocks. I would not be able to withdraw any earnings, such as dividends, without incurring penalties. This sounds like a disadvantage, but only if you ignore the fact that I will also have a much larger taxable account. If my taxable account produces enough dividend income to retire early, then I wouldn't need to worry about age restrictions on my Roth IRA. When I do turn 60 (actually, 59.5), I would gain access to a second, tax-free dividend income stream. Thus, I don't think having a Roth IRA will adversely affect me in the event of early retirement.

I will start reporting information about my Roth IRA on this blog once I make my first purchase. Given that it is separate from my taxable account, I will distinguish between them when reporting transactions, dividends, etc.