Author Topic: Case Study - 401K, IRA, Roth, and Taxes  (Read 1283 times)

TDWagner

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Case Study - 401K, IRA, Roth, and Taxes
« on: June 21, 2017, 07:55:03 AM »
I tried to stay as close to the template as possible.  I use YNAB and have a pretty good handle on my expenses, so didn't include a detailed break-down.  I'm mostly looking for retirement savings advice (see Specific Questions at the end)...but let me know if you notice anything else important.

Thanks,
Tim
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Life Situation:
Married - filing jointly
2 dependents: 1 & 3 years old
Indiana, USA

Gross Salary/Wages:
$73,000 per year

Expenses:

$40,000 last year ($3300-3400 per month)

401k contributions:
$500 per month (my contributions ($275) + company match($225))

Health Insurance:
$800 per month

HSA:
$300 per month

Mortgage Payments:
P&I: $618.26
T&I: $209.74
Total Payment Amount:$828.00
Currently paying: $1,000 (excess to principal)
Interest Rate: 3.75%

Assets:
House: ~$145,000
2 old cars: paid off
401k: $35,000 (roughly 50/50 Roth/Pre-tax)
IRA:  $37,000 (Pre-tax)

Liabilities:
Mortgage (30 yr): ~$125,000 balance @ 3.75 APR

Specific Questions:
  • If I increase my savings rate by $100 a month, should I put that toward: mortgage, 401k (no...expensive ~1% mutual funds are only options), pre-tax IRA, or Roth IRA?
  • Should I use a Roth IRA as a savings account?  For example, we need to save to buy another car when one of our current, old, paid-off cars die.  Since contributions can be pulled back out penalty-free, does it make sense to put the car savings in a Roth IRA and pull it out when I'm ready to purchase in a few years?
  • After deductions and exemptions, my taxable income is well below the $75,000 cutoff for the 15% bracket.  Should I be converting pre-tax IRA to Roth and paying the 15% now?  My wife likes to use our tax refund for home improvement projects (back yard fence, shed, etc) so I'll have to figure out how to explain to her why we're not getting a refund if we decide to go this route.
  • Should my current 401k contributions be Roth or pre-tax?...I've gone back and forth with this.
  • I'm 37 years old and not optimistic about early retirement based on my current savings rate.  That said...if, by some miracle, I'm able to STASH enough to retire in my 50s...what money would I have to live on if I can't pull from 401k or IRA yet cause I'm not 60?  This is why I'm thinking about Roth conversions and/or Roth contributions...to have money to draw from in case I AM able to retire a few years early.
« Last Edit: June 21, 2017, 01:28:19 PM by TDWagner »

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #1 on: June 21, 2017, 10:50:06 AM »
You are in the 15% tax bracket so traditional/roth is essentially a wash.

Quote
If I increase my savings rate by $100 a month, should I put that toward: mortgage, 401k (no...expensive ~1% mutual funds are only options), pre-tax IRA, or Roth IRA?

None of the above. Put it in your HSA. It saves you an additional 7% on your FICA taxes over a pretax IRA/401k. Always max the HSA first.

Quote
Should I use a Roth IRA as a savings account?  For example, we need to save to buy another car when one of our current, old, paid-off cars die.  Since contributions can be pulled back out penalty-free, does it make sense to put the car savings in a Roth IRA and pull it out when I'm ready to purchase in a few years?

If you don't have the capacity to max out your IRA's then yes this is a better option than using a savings account. Make sure you are not investing this money in equities if you need it soon though.

Quote
After deductions and exemptions, my taxable income is well below the $75,000 cutoff for the 15% bracket.  Should I be converting pre-tax IRA to Roth and paying the 15% now?  My wife likes to use our tax refund for home improvement projects (back yard fence, shed, etc) so I'll have to figure out how to explain to her why we're not getting a refund if we decide to go this route.

There is no advantage unless you anticipate making over $130k as a couple in the future. Adjust your withholding. You should not be getting a tax refund!

Quote
Should my current 401k contributions be Roth or pre-tax?...I've gone back and forth with this.

In the 15% tax bracket it doesn't really matter. I would just stick it in a traditional and work toward maxing this out at 18k per person.

Quote
I'm 37 years old and not optimistic about early retirement based on my current savings rate.  That said...if, by some miracle, I'm able to STASH enough to retire in my 50s...what money would I have to live on if I can't pull from 401k or IRA yet cause I'm not 60?  This is why I'm thinking about Roth conversions and/or Roth contributions...to have money to draw from in case I AM able to retire a few years early.

Research the roth IRA ladder or sepp distributions from your 401k.

 

VoteCthulu

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #2 on: June 21, 2017, 11:15:50 AM »
First, max out your HSA. If your current HSA plan  administrator doesn't allow investment, look at transferring money to one that does when you get $5-10k saved up.

Second, max out your personal ira, since your 401k doesn't have good funds (as long as you're getting all the 401k match you can). This should be pretax until you get down to the 15% bracket, then roth after that, so if you're already in the 15% bracket you should move to more roth.

You can use the Roth as a savings account, but I don't suggest doing that, because short term cash shouldn't be invested in the market. Instead, the year I wanted a new car I would simply budget for it and reduce my 401k contributions for that year by that amount if necessary.

If you don't want to retire early, that's ok! If you do, it's simply a matter of reducing your expenses until the pain balances the  joy of your future freedom.

MDM

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #3 on: June 21, 2017, 11:20:23 AM »

Expenses:

$40,000 last year ($3300-3400 per month)
Does this include any of the listed items (e.g., mortgage, insurance, etc.) or is this in addition to all of those?

Quote
Specific Questions:
  • If I increase my savings rate by $100 a month, should I put that toward: mortgage, 401k (no...expensive ~1% mutual funds are only options), pre-tax IRA, or Roth IRA?
What is your marginal tax saving rate if you make traditional contributions?  See the instructions in the case study spreadsheet and Marginal tax rate.  This will probably be higher than your tax bracket.
...
  • After deductions and exemptions, my taxable income is well below the $75,000 cutoff for the 15% bracket.  Should I be converting pre-tax IRA to Roth and paying the 15% now?  My wife likes to use our tax refund for home improvement projects (back yard fence, shed, etc) so I'll have to figure out how to explain to her why we're not getting a refund if we decide to go this route.
Check your marginal tax rates.
  • Should my current 401k contributions be Roth or pre-tax?...I've gone back and forth with this.
Check your marginal tax rates.
  • I'm 37 years old and not optimistic about early retirement based on my current savings rate.  That said...if, by some miracle, I'm able to STASH enough to retire in my 50s...what money would I have to live on if I can't pull from 401k or IRA yet cause I'm not 60?  This is why I'm thinking about Roth conversions and/or Roth contributions...to have money to draw from in case I AM able to retire a few years early.
Your 50s are ~15 or more years away.  For at least the next 10 years, just save as much as practical and use the marginal rate comparison - notice a trend? ;) - described in Traditional versus Roth - Bogleheads to choose between traditional and Roth.

See also Investment Order.

TDWagner

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #4 on: June 21, 2017, 11:21:13 AM »
None of the above. Put it in your HSA. It saves you an additional 7% on your FICA taxes over a pretax IRA/401k. Always max the HSA first.

Thanks! I'll have to do more research on using the HSA as retirement savings...I'm currently just using it for medical expenses.

Quote
If you don't have the capacity to max out your IRA's then yes this is a better option than using a savings account. Make sure you are not investing this money in equities if you need it soon though.

Why not equities?...because of the time it takes to liquidate?  I was thinking index fund...I wouldn't need the money in a hurry, there'd be plenty of time to sell and transfer money while car shopping...

Quote
Quote
After deductions and exemptions, my taxable income is well below the $75,000 cutoff for the 15% bracket.  Should I be converting pre-tax IRA to Roth and paying the 15% now?  My wife likes to use our tax refund for home improvement projects (back yard fence, shed, etc) so I'll have to figure out how to explain to her why we're not getting a refund if we decide to go this route.

There is no advantage unless you anticipate making over $130k as a couple in the future. Adjust your withholding. You should not be getting a tax refund!

Sorry, where's the 130k come from?...tax bracket?...I get:
$75,900 + $12,600 (deduction) + $16,200 (exemptions) = $104,700

...above that I'd be in the 25% bracket, right?...I'm probably missing something obvious...

Quote
In the 15% tax bracket it doesn't really matter. I would just stick it in a traditional and work toward maxing this out at 18k per person.

I should be working to max out IRA contributions before 401k...just because of investment choices...I can get index funds in an IRA but only expensive mutual funds in the 401k.  That sound right?  I'm currently contributing to 401k primarily for company match.

Quote
Research the roth IRA ladder or sepp distributions from your 401k.

Will do...I thought the Roth IRA ladder was essentially converting from pre-tax IRA to Roth IRA which is why I was asking some of the above questions...I need to do some more research.

Thanks again!

TDWagner

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #5 on: June 21, 2017, 11:27:26 AM »

Expenses:

$40,000 last year ($3300-3400 per month)
Does this include any of the listed items (e.g., mortgage, insurance, etc.) or is this in addition to all of those?

That's expenses spent from take-home pay (based on a report out of YNAB)...so that includes mortgage, but not health insurance (deducted from paycheck before take-home)

Quote
Your 50s are ~15 or more years away.  For at least the next 10 years, just save as much as practical and use the marginal rate comparison - notice a trend? ;) - described in Traditional versus Roth - Bogleheads to choose between traditional and Roth.

See also Investment Order.

Gotcha, I'll do some research on marginal rates, thanks!!

TDWagner

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #6 on: June 21, 2017, 11:33:33 AM »
...
If you don't want to retire early, that's ok! If you do, it's simply a matter of reducing your expenses until the pain balances the  joy of your future freedom.

Thanks for all the advice!  Expense reduction is always an ongoing effort, it's come WAY down since finding MMM a few years ago...there was a lot of low-hanging fruit, but now it's getting really tough to continue reducing.  Hey, at least we're totally debt-free besides the mortgage!! :)

MDM

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #7 on: June 21, 2017, 11:58:37 AM »
Gotcha, I'll do some research on marginal rates, thanks!!
Due to the opportunity for the saver's and earned income credits, your situation is not straightforward at all.  E.g., compare your marginal rates vs. contributions to
-  HSA
-  t401k
-  tIRA
using the spreadsheet or full tax software.

As already suggested, the HSA (if your HSA allows good investment options) may be your best option - but check.

TDWagner

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #8 on: June 21, 2017, 12:42:32 PM »
As already suggested, the HSA (if your HSA allows good investment options) may be your best option - but check.

My HSA is definitely not an investment account currently.  It's some sort of checking account or something at a local credit union...I get "Dividends" but we're talking like 0.5% APY.  I'll have to look into whether it's possible to move it to some sort of investment account...

Heroes821

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #9 on: June 21, 2017, 12:59:13 PM »
As already suggested, the HSA (if your HSA allows good investment options) may be your best option - but check.

My HSA is definitely not an investment account currently.  It's some sort of checking account or something at a local credit union...I get "Dividends" but we're talking like 0.5% APY.  I'll have to look into whether it's possible to move it to some sort of investment account...

Usually it's an option inside that checking account.  Some companies require 1,3, or 5000 in cash to stay in that account while the rest can be invested. The power of HSA first is that instead of being JUST pre income tax, it's pre- social security and medicare (~7% of w2 income) and pre-income tax.

So instead of making $75,000 before any taxes you're making (with family plan) $68,250. 

That means your FICA taxes @68k are $4777.5 instead of $5,250. 
Now for income tax you then start at 68k instead of 75k and then subtract your 401k, but only your contributions NOT the match. If you can please edit your OP to show how much the employer match is.

If your wife is non-working you can pay into an IRA for her as well.

Since you are asking solely about Tax focused retirement accounts your eligibility for 2017 should look something like this:

HSA: $6,750 max
401k: $18,000
His tIRA: $5,500 fully deductible at that income level
Her tIRA: $5,500 fully deductible at that income level

Totally: $35,750

So taxable income would be roughly $40,000 now spending aside maxing all those vehicles would probably get you close to a 0 dollar income tax bill, that with 2 children and refundable credits would still give you a refund. 

That being said I'm no MDM, or CPA.  If you're IRAs are at Vanguard regardless of the options inside your 401k it's probably in your best interest to do your company match then both IRAs after the HSA.

MDM

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #10 on: June 21, 2017, 01:30:31 PM »
The power of HSA first is that instead of being JUST pre income tax, it's pre- social security and medicare (~7% of w2 income) and pre-income tax.
Yes.  HSAs are indeed usually better.  Depending on OP's exact numbers (which is why OP really needs to do this, rather than have us guess from the approximate numbers given), contributions to 401ks and IRAs might save an extra 10% or more (i.e., more than the FICA savings for an HSA) due to the saver's credit. 

Of course, the HSA will not be taxed at all on withdrawal (if used for medical costs) so it's probably still better - just not clearly better as usual.

TDWagner

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #11 on: June 21, 2017, 01:34:52 PM »

Usually it's an option inside that checking account.
Thanks, I'll check out my options.

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If you can please edit your OP to show how much the employer match is.
Done, roughly $275/$225 contribution/match.

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If your wife is non-working you can pay into an IRA for her as well.
She doesn't have a job, but she works awful hard taking care of the kids! :)  Thanks, this is a helpful tip!

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If you're IRAs are at Vanguard
Of course! :)

Thanks again!

MDM

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #12 on: June 21, 2017, 02:10:03 PM »
Quote
If your wife is non-working you can pay into an IRA for her as well.
She doesn't have a job, but she works awful hard taking care of the kids! :)  Thanks, this is a helpful tip!
And particularly important that she actually does make contributions to her own account if you want to maximize your saver's credit.  See 2016 Form 8880 - f8880.pdf and note lines 6 and 7.

Heroes821

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #13 on: June 21, 2017, 02:42:43 PM »

Usually it's an option inside that checking account.
Thanks, I'll check out my options.

Quote
If you can please edit your OP to show how much the employer match is.
Done, roughly $275/$225 contribution/match.

Quote
If your wife is non-working you can pay into an IRA for her as well.
She doesn't have a job, but she works awful hard taking care of the kids! :)  Thanks, this is a helpful tip!

Quote
If you're IRAs are at Vanguard
Of course! :)

Thanks again!

In response to the MDM post above this might be useful: https://www.irs.gov/uac/save-twice-with-the-savers-credit.

Looking at those numbers 275/225 it looks like 4.4% of your salary to get 3.6% match? That seems odd.  Maybe it's like 3% 100% match then the next 1% gets matched .5% or w/e.

The point I'm making is that once your figure out how to Max your HSA at $6750 for the year, I would dial down your 401k Match to exactly the minimum needed for the full free money from your employer and then fund those IRAs.  The IRAs will give you better control, like admiral funds with 0.04% expense ratios and work toward the saver's credit.  Then go back to the 401k contributions if possible.

TDWagner

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #14 on: June 21, 2017, 03:13:22 PM »
Looking at those numbers 275/225 it looks like 4.4% of your salary to get 3.6% match? That seems odd.  Maybe it's like 3% 100% match then the next 1% gets matched .5% or w/e.
Yea, you're on the right track...100% of first 3%, 50% of next 2%

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I would dial down your 401k Match to exactly the minimum needed for the full free money from your employer and then fund those IRAs.
Yep, that's exactly where I am now.  Full free match, no more.

TDWagner

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #15 on: June 21, 2017, 03:15:25 PM »
Depending on OP's exact numbers (which is why OP really needs to do this, rather than have us guess from the approximate numbers given)
Working on this, that spreadsheet is a little...intimidating...at first

MDM

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #16 on: June 21, 2017, 03:52:50 PM »
Working on this, that spreadsheet is a little...intimidating...at first
Any thoughts on how to make it less intimidating are appreciated.  You have the benefit of seeing with fresh eyes what someone who has seen it often may overlook.

Ichabod

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #17 on: June 21, 2017, 04:00:21 PM »
Based on your family size and insurance costs, you should prioritize 401k contributions over IRA. You're on the edge of EITC territory, and 401k contributions reduce earned income, but IRA contributions don't. I would still do HSA first.
This poster explains it better: https://forum.mrmoneymustache.com/ask-a-mustachian/earned-income-tax-credit-how-much-can-you-actually-make-but-receive-this/msg256085/#msg256085

If I'm wrong I hope someone corrects me, because I'm in a similar situation.

Heroes821

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Re: Case Study - 401K, IRA, Roth, and Taxes
« Reply #18 on: June 22, 2017, 06:36:08 AM »
Based on your family size and insurance costs, you should prioritize 401k contributions over IRA. You're on the edge of EITC territory, and 401k contributions reduce earned income, but IRA contributions don't. I would still do HSA first.
This poster explains it better: https://forum.mrmoneymustache.com/ask-a-mustachian/earned-income-tax-credit-how-much-can-you-actually-make-but-receive-this/msg256085/#msg256085

If I'm wrong I hope someone corrects me, because I'm in a similar situation.

Here's the relevant IRS link too https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/do-i-qualify-for-earned-income-tax-credit-eitc
Quote
Income Earned During 2016
•Your tax year investment income must be $3,400 or less for the year.
•Must not file Form 2555, Foreign Earned Income or Form 2555-EZ, Foreign Earned Income Exclusion.
•Your total earned income must be at least $1.
•Both your earned income and adjusted gross income (AGI) must be no more than:

Married Filing Jointly: Two Children $50,198 

Since that is a refundable credit, it might be worth going after it by upping 401k before IRAs. For most people here the $3,400 in investment income part probably disqualifies them regardless.