Tips for investments and better managing taxes in my situation?

[softwareguy1985]

Hello!

Long time reader but I'm finally at the point where I'm not quite sure what to do next, I recently have been lucky enough to get a job which boosts my income quite a bit and will be very stable, but have questions especially in regards to my current investments and better managing taxes which I don't know much about.  My long term goal is to be FI at 40 and be semi-retired in Hawaii, I'm currently 27.

Here is my current situation:
- No debt besides a mortgage
- 150k/year salary + another 100k-200k in stock (RSU) once a year depending on which way the wind blows
- 700k (small) house with 415k left on the mortgage, its a 5yr ARM at 2.75%, I live in a high cost/tax area
- 110k in 401k (75% in FCNTX, 20% in VIIIX and 5% in VEMPX)
- 25k in Roth IRA (all in VFINX)
- 10K in a HSA (half in cash incase I actually do get sick, and half in some mutual funds)
- 170k in various stocks
- 40k in savings/cash
- I married with no kids (don't have plans to), my wife makes 50k, and currently has 25k in a rollover ira, its all also currently in VFINX

In terms of monthly expenses, we don't spend money on anything crazy, we don't have cable, we go out to a resturant or fast food once or twice a week, otherwise we eat at home.  On average our electricity and water average out to about $100 a month over the year, mainly in summer to water the lawn, and winter to heat the house. Car insurance and phone are both $100 a month. Property tax+home insurance ends up at about 9k a year. Spend 2-3k a year on a vacation/travel/misc.  If someone wants more detail I can provide it, but besides the travel/misc I don't think there is much to cut back on, but maybe I'm being naive...

My wife and I monthly take home income, after taxes, insurance, 401k & HSA (maxing both of those out), employee stock plan (not including the RSUs), about 8k.  Since we end up in the highest tax bracket when the RSUs are included, does anyone have a good plan or tried to raise your federal tax exemption (I currently have 2), to be paid more upfront and hopefully make a bit off some interest and then pay the larger tax bill?  Or any other tax saving tips besides what turbotax already tells me?

Since we can't contribute to a Roth IRA, I'm contributing to a traditional IRA and converting it over to a Roth IRA and taking the tax hit, I was never really sure if this is the best thing to do, but since I'm still young, I figure whatever growth I gain will offset the current tax amount.  Does anyone think converting my wife's IRA to a roth will be worth it?  She hasn't added any additional cash to her IRA this year, does it even make sense to do that at this point or does just a general brokerage account make more sense?

I have thought about moving to a cheaper area, but I like my job and it happens to pay well, downside obviously is the cost of living is crazy.  But I don't want to have to do a really long commute and at this point since our mortgage payment is low, I think it makes sense to stay put.  I'm not to worried about my house losing value, prices have stayed pretty consistent where I am.  Ideally I'd just either refinance in a few years and then sell the house when I want to move.

So I guess my overall questions does anyone have any better suggestions for investments? Should I just do a lazy portfolio?  And with my situation does anyone have any tips to lower taxes?

Finally figured I throw this out there, does anyone think it makes sense to just purchase a house in Hawaii now, while I do have an income and can probably afford it on our income, and then possibly just rent it out while I'm not there? The goal would be to just pay it off by my mid-late thirties. I wouldn't be going for anything on the beach or anything, so that should keep living costs down quite a bit.  Or is this just a really antimustachian idea...

Thank you!!!!

[chucklesmcgee]

First, I'd say you're in pretty good financial shape overall.

As far as the Roth vs. Traditional goes, I'm one to say that it's best for young people to go with Roth. Getting even the market average 7-8% returns, your investments now will be many times greater down the line, and keeping that out of Uncle Sam's hands by paying taxes on it now will likely work out in your favor. Plus I have no idea what tax brackets will be in 40 years, but it's pretty fair to speculate that it very well could be higher, much higher- just back in 1981 the highest bracket paid 70%! Getting your Roth together will help you avoid that uncertainty. I'm all for getting as much into Roths as possible if people are young and if you have the cash on hand to pay the taxes (which you seem to do), converting your wife's IRA to a Roth will probably be worth it in the long run.

As far as your investments go, I don't quite understand why you have so much cash on hand. Any and every savings account and CD these days is giving well below inflation and is eroding the value of your money. No emergency is going to require cash immediately. I assume you have a healthy credit line and can put expenses on a credit card. You can then sell whatever stock you need and pay off your card before any interest is due. Your assets are substantial enough that it's not as though market fluctuations will make you unable to pay for whatever emergency. I'd really suggest just keeping enough in cash on hand to cover your expenses for 1-2 months.

What should you invest in? I'm a supporter of the efficient market hypothesis. I believe that without incredible knowledge of an industry, privileged information or an actual role in a company and an incredible vigilance of the market, it's really impossible for investors as a whole to do better than average investing. I have yet to see any market guru continually outperform the market for an extended period of time to suggest he really has a "winning" strategy. And anyways if you had a million monkeys invest in the stock market randomly, some of them, by chance, would substantially outperform everyone else, and a few of them will do so continuously- but that doesn't mean they're any better at investing that the average chump. In the end, I think the low-cost mutual funds are generally a good bet.

I've also gotten heavily involved in Prosper.com as a microlender and have seen very good results, average returns of around 12% after about 3 years. I like the concept for a number of reasons. One is that you're directly helping out people, albeit at usurious interest rates.  The second is that I feel Prosper notes are intrinsically more easy to value. What's one share of Apple worth? Well, whatever another person is willing to pay for it, which is based on what they think other people in the future will be willing to pay for it, based on all sorts of uncertain factors like earnings, new products, new leadership, scandals etc. A prosper loan is just a bet as to whether or not you think the borrower will be able to stay current on a loan, or that he'll at least be able to make enough payments that you'll break even on average. The third is that I feel the Prosper market itself allows you to diversify and remain insulated from market forces at large. The whole stocks/bonds/currency/housing/gold market of traditional assets moves so closely with one another that it's difficult to truly "diversify". Many of these traditional assets can fluctuate enormously. The Dow might rise and fall 4-5% in a day just based on some news of fiscal woes, war, new taxes, etc. But whether Jimbob can keep current on his motorcycle loan is really only minimally impacted by the global events and fluxes. Returns on Prosper might actually get better if the hiring situation improves (or at least doesn't get worse). But I admit it's extremely risky and I wouldn't get too wild with it. That said, I have structured my Roth 401k (self-administered from by business) and Roth IRA to be totally invested in Prosper.

Taxes are a real pain. I'm no expert but I do think the penalties and interest for having estimated tax payments as being too low is pretty minimal compared to returns you can get. You could look at municipal bonds as an investment opportunity and tax-work around, but I think returns are pretty low right now. Also many state governments are in pretty poor financial shape and could start defaulting on munis pretty soon. It might be worth consulting with a tax attorney or financial adviser and looking at your options. Capital gains can be very tricky, but they may give you some better options for your stock options. I've heard that donating stock can have some very beneficial tax implications vs. simply selling it and donating the proceeds to charity, that would be something to check on.

I think your getting a house-as-an-investment in Hawaii has bad idea written all over it. When you consider property taxes and the interest you're sacrificing on the downpayment, it just doesn't make sense even on the surface. Then you consider maintenance costs and just how difficult it would be to remotely manage the property (could you imagine the cost and hassle of remotely trying to find a contractor to check out a tenant's complaint about the drywall or some other issue?) and I just don't see it working. Housing prices have hardly ever given returns much beyond inflation, especially after costs are taken into account, though Hawaii may be an exception. If you aren't really benefiting from the house now, you'd be way better off investing your money to maximize your returns and then renting a house for a week or two with the interest when you go to vacation.

I think you're in great shape. Your expenses are so low relative to your income that it's probably better to spend your time, as you have been, at ways to increase your investment returns and reduce your tax burden.

[capital]

I'm guessing you're in tech in the Bay Area?

There's a bit of diversification risk in working in tech and owning a house in the Bay Area. A big driver of high house values there is high tech salaries combined with restrictive zoning laws, so if there's a long-term downtrend in tech for whatever reason, there will be a decline in your house values at the same time you lose employability. Compensating for that depends on how paranoid you are. There's always moving to a smaller house or condo, especially if don't plan on having kids. Owning a full-sized house is clearly a luxury you can certainly afford, but having to maintain and clean extra rooms, a yard, and so on is a lot of work, and there's the opportunity cost on the extra money in the house and the extra taxes on a more valuable house. It does look like there are some super-cute tiny '20s cottages near the CalTrain line in Redwood City you could buy at something like half the price of your house if you wanted to cut expenses, or even live in a trailer near CalTrain if you really wanted to cut expenses.

You can cut down on phone plans by moving to pre-paid plans on unlocked smartphones if you want, though it's harder to get LTE service that way, which is a luxury you can afford should you choose to.

If you wanted to be semi-retired in Hawaii, you likely could do that right now. If you're working at tech at your salary, I bet you could find a job working remotely 20 hours a week, and buy a house in Hawaii in cash after selling your house. But maybe you want to make your mark first?

[softwareguy1985]

For the two comments, thanks for the tips! Definitely looking in to everything.

For the first comment, lots of good info, I'll be converting my stuff to a roth.  It does indeed sound like I should talk to a financial advisor or tax attorney.  I have been trying to avoid doing that, but I should probably bite the bullet and give it a shot. 

Yea I'm in the bay area, I'm not too worried about losing my job if there was a big tech-bust, maybe my future stock would go down the toliet, but I'm fairly confident with my situation that I'd still have a job with a salary.

The problem with Redwood city is depending on where you are can get a bit seedy, I'd be ok with it but my wife probably less so :).  We are currently in a pretty small house thats in a pretty good area so the prices were a bit higher, not a big lawn, etc... I didn't get a condo so I could avoid HOA's, I try to do all the repairs myself ,so I think I can save there.  We bought it recently, well past the bust, so our house value has had a big chunk of value already taken out of it, and recent sales in the area have been about the same, but yea where that will be in 10 years, only time will tell.  Our mortgage is relatively cheap, at least per month.  Renting something similar would be more than our mortgage+property tax for the short term, and I save a bit of money with the mortgage interest, so moving at this point I don't think will save us all that much except being able to avoid some risk.  But if I were to do it again I'd probably still rent.

Don't think I want to go part-time/semi-retire just yet, I don't mind working right now so might as well save more while I can, or at least until I burn out.

[Another Reader]

In your shoes, I would consider investing in rentals, to build wealth and create sheltered income, especially in the future.  I would also look at maxing out the 401k if you aren't already doing so.  Does your wife have one or some other plan at work?  I would max that out as well. 

You are in the income range targeted for more taxes, so I would actively look for ways to reduce taxable income and avoid the AMT.  A CPA that works with folks in your position would be helpful in accomplishing that.

I would not buy property in Hawaii at this time.  It does not appear to be on sale.  It would be an albatross if you lost your income.  Buy it closer in time to when you will need it. 

[icefr]

I also see RSUs though not quite $100-200k (more like $30-70k) and it makes my income taxes annoying. My employer by default was taking 25% of the RSU vests, which wasn't enough sometimes and too much the first year (though now as they get higher, it's not enough). I was able to adjust that and ask them to take out 28% instead through the RSU brokerage firm's website.

What I do is I run my situation through the IRS Withholding Calculator [1] after each raise and RSU vest since I really have no good estimation of how much taxes I'll pay until the RSUs have already vested. Are you paying enough mortgage interest and property taxes to itemize? You could increase your W-4 allowances based on that as well.

If your income is too high for a Roth IRA, then your income is also too high for a deductible traditional IRA and you shouldn't be paying much in taxes on the conversion. [2] Unless, that is, you have other Traditional accounts and that's a vote for keeping stuff in 401(k)s over Rollover IRAs.

If you move to a cheaper area, your salary would probably drop quite a bit too. Have you refinanced recently? I'm working on refinancing my condo to a 2.5% 5/1 ARM through Schwab Bank, so you might be able to get a better rate on a house than 2.75% - I'm guessing that was based on a jumbo loan?

A lazy portfolio should definitely help with taxes. Are you keeping your RSUs? TFB has a great post on this [3].

[1] http://www.irs.gov/Individuals/IRS-Withholding-Calculator
[2] http://www.bogleheads.org/wiki/Backdoor_Roth_IRA
[3] http://thefinancebuff.com/restricted-stock-units-rsu-tax.html

[softwareguy1985]

In your shoes, I would consider investing in rentals, to build wealth and create sheltered income, especially in the future.  I would also look at maxing out the 401k if you aren't already doing so.  Does your wife have one or some other plan at work?  I would max that out as well. 

Yup, I'm maxing out my 401k, I have an HSA as well which works like a 401k so I'm maxing that out as well.  My wife has a 401k and she maxes that out as well but doesn't get any matching, she just started a new position so there isn't much in there yet so I didn't include it above.

I also see RSUs though not quite $100-200k (more like $30-70k) and it makes my income taxes annoying. My employer by default was taking 25% of the RSU vests, which wasn't enough sometimes and too much the first year (though now as they get higher, it's not enough). I was able to adjust that and ask them to take out 28% instead through the RSU brokerage firm's website.

What I do is I run my situation through the IRS Withholding Calculator [1] after each raise and RSU vest since I really have no good estimation of how much taxes I'll pay until the RSUs have already vested. Are you paying enough mortgage interest and property taxes to itemize? You could increase your W-4 allowances based on that as well.

If your income is too high for a Roth IRA, then your income is also too high for a deductible traditional IRA and you shouldn't be paying much in taxes on the conversion. [2] Unless, that is, you have other Traditional accounts and that's a vote for keeping stuff in 401(k)s over Rollover IRAs.

If you move to a cheaper area, your salary would probably drop quite a bit too. Have you refinanced recently? I'm working on refinancing my condo to a 2.5% 5/1 ARM through Schwab Bank, so you might be able to get a better rate on a house than 2.75% - I'm guessing that was based on a jumbo loan?

A lazy portfolio should definitely help with taxes. Are you keeping your RSUs? TFB has a great post on this [3].

Currently at least the past few years its always been cheaper to take the standard deduction, I don't think this year will be any different since besides our house we don't spend much, no kids, we are healthy, etc... I have always donated a little, but not enough to make a dent in the deduction, I might have to look in to that to see if that helps.  Probably another reason to go see a financial advisor.

For the Roth, yea I only have one traditional IRA, so that should be trivial.  Wasn't aware of the "taxed based all iras" rule for doing that, but good thing it wouldn't of affected me anyway. :)

Yea I'm keeping my RSU's, for the initial income taxes, they are automatically taken out with no choice on my side, so if I get "X" shares, I really end up getting "X-cost of taxes" shares based on my current salary, they somehow have always done a good job estimating how much to take out so thats never really been an issue.  I then usually sell then after a year, but now that the long term capital gain is going up there is probably less of a reason to do so.

And yea I refinanced earlier this year, I'll probably look at it again early next year, I'm going to try to keep that once a year if the situation is right.