A commenter on my recent post Meg’s Millionaire To Do List recently took issue with my “to do” item of maxing out my retirement accounts:

I don’t know if I would max out my roth and roth 401k. That’s a lot of money tied up to your retirement. It also depends on what your retirement funds are invested in. With all those funds tied up, you can’t really touch them until you’re 59 1/2.

Another commenter responded in support of maxing out retirement accounts:

What I honestly don’t get is why the young dread the idea of having large amounts of money “tied up” in a retirement fund. Compound interest (especially tax deferred and/or tax free interest) is the easiest and safest way of generating wealth there is.

What do you people have against it?

What an interesting question! There are many reasons to hold substantial assets outside of retirement accounts. From a purely financial perspective, some people argue that holding money in taxable accounts is another important component of making your portfolio “tax diverse.”

Withdrawals from tax deferred accounts like 401ks are taxed at your personal income tax rate which can exceed 30% (and may be much higher than that in the not so distant future!). Income from taxable accounts (dividends and long term capital gains) are currently taxed only at 15%. Of course no one knows how those rates could change over the years (dividends and capital gains tax rates are already scheduled to increase somewhat in 2011) – but that’s why it can be good to have some money in all tax-baskets.

It’s true that the younger you are, the more likely it is that the tax deferred aspect of retirement accounts will outweigh the risk that you might be taxed on income withdrawals at a higher rate. However there are other reasons to hold funds outside retirement accounts: you might need that money before you reach retirement age!

Here are just a few things you might need a chunk of non-retirement change for before you retire:

• Home downpayments
• cars
• starting a business
• sending the kids to college (or private school)
• getting sued
• getting divorced.

Also as a banker I can tell you that we disregard retirement accounts when analyzing a person’s financial statement, because those are protected from creditors and are considered inaccessible if you’re not retirement age. Calculating a person’s “liquidity” is a key component of whether they will get approved for a loan; if a borrower doesn’t have any, we’ll deny them – even if they have millions in retirement accounts. Just a thought.

My personal goal is to have a third of my net worth in cash/investments outside of retirement accounts, a third invested within retirement accounts, and a third in real estate equity.