Author Topic: Reader Case Study- On the verge of being out of debt, are Roths Overrated?  (Read 2171 times)

Neverstop

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Hello everyone, I am on the verge of being debt free and I am having trouble deciding how to go about from here in regards to my 2017 and on retirement investments.

Life Situation: Single Male, age 28, 0 dependents, Midwest USA

Gross wages: $60k

Deductions: $240/week for HSA until $2400 max(employer contributes $1k), currently not contributing to tIRA or 401k but planning on contributing $10k to tax deferred accounts for 2017.

AGI: for 2017-it should be $48k

Taxes: for 2017- FICA $4437, Fed $3582, State $2223

Expenses: for January 2017

AMEX            $1,070.00    
Capital One    $84.34
Cash Allowance    $55.00
Discover            $900.41
Food                    $204.24
Gas                    $89.82    
Internet         $52.00
Medical            $513.35
Miscellaneous    $73.21
Personal            $49.57
Phone                $12   
Supplements    $18.96    
Utilities            $200.00    
Vehicle costs    $39.67
Total:                 $3350.57
Assets:  HSA- $5528 total (VTI $4064, VEU $1024, VWO $350, MAGS $90)
                      401K- $2700 w/$1375 vested (30% bonds(PTTAX), 35% putnam(PEYAX), 35% JP Morgan(JAMCX))
                      checking account- $260
                      savings account- $800
                      Vanguard tIRA- $25
                      Vanguard roth IRA- $25
                      net worth- ~$7k

Liabilities: $800 American express CC @ 0%, Discover and medical costs will be 0 from here on out so will be capital one.

I am on the verge of becoming debt free and I need to start planning for my future financial goals. I have two goals, both short term(<5 years), and they are to return to college and save for down payment on home. For college I will need about $8k a year for the next three years to complete my major which will be engineering technology. My other goal is to save up for a home although I'm not sure how likely I am to stay in the area once I graduate. I am also currently staying at home so i can keep my costs low. I estimate my COL this year will be under $10k.

I have been thinking about attending graduate school which might post pone the home purchase but I also need to be willing and able to relocate for a job once I graduate, if need be. In essence I need to plan for a couple of forks in the road. In addition to that, I am currently working full time and I plan on going to school full time, but if things get too heavy for me my senior year(2019) I want to be able to have enough savings to be able to quit my job and take a year off to finish my degree so in my mind I need to keep most of my money liquid.

What I had planned thus far was to contribute enough to tax deferred accounts to keep me in the marginal 15% bracket, build up an e-fund with the remaining amount and keep it either in a Roth IRA or taxable account. I should have about $19k net after all my costs and deductions including tuition this year. I have also considered a high yield checking account like consumers credit union but a better return seems enticing. For some reason the tax free earnings on a roth IRA seems to be drawing my to it, I still have until the tax deadline to contribute for 2016 and unfortunately I will be owing about $200 due to obamacare and about $400 to state for 2016. Both the roth and the taxable will offer me the liquidity i need.

As far as tax deferred accounts go I think my plan of contributing enough to keep me in the marginal 15% bracket while saving liquid cash is sound considering my goals and plans. Since my 401k has high fee funds(no front load) I am leaning toward maxing my 2017 tIRA(index funds) and then another $4500 to the 401k.

My portfolio is currently 100% equities and I would like to switch over to a 10/90 split of bonds to equities. With my current allocations I should be right around this by the end of the year. I am shooting for a 60/40 split of domestic to foreign with foreign being 50/50 with veu and vwo.

Advice?

edit: forgot a couple of accounts and added more info.
edit: changed 401k funds
« Last Edit: February 16, 2017, 06:39:58 AM by Neverstop »

MDM

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I have two goals, both short term(<5 years), and they are
1) to return to college and save for down payment on home. For college I will need about $8k a year for the next three years to complete my major which will be engineering technology.
2) My other goal is to save up for a home although I'm not sure how likely I am to stay in the area once I graduate.
...
Advice?
Here is one approach to consider:
1) Put the money you need for college into the highest guaranteed savings account you can find.  That might be a local credit union or one of The 5 Best Online Savings Accounts - MagnifyMoney.
2) After that, follow the prioritization listed in Investment Order.  Only you can answer how high to prioritize the down payment savings.

zolotiyeruki

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Personally, I think Roth IRAs are overrated (compared to traditional, taxable investments like an index fund) under the following conditions:
1) you expect tax law to not change a whole lot between now and retirement
2) you expect your retirement income to fall within the 10% or 15% tax brackets

With those two conditions, you'll be taxed the same (0%) on Roth withdrawals or investment withdrawals, but you have a lot more flexibility with the traditional investments.  No age limit on withdrawals, no penalties, no limits on contributions.

Neverstop

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My whole reasoning behind wanting to contribute to the Roth is that even if my tax bracket stays the same or goes up I win either way.

What do you suggest in regards to the $10k I plan on putting into tax deferred accounts? After that I will have an additional $15k left over after building up my e fund, I forgot to mention I have to build up my e fund, Im shooting for at least $2k. I may also purchase a beater commuter car to cut down on gas costs. I commute about 250 miles per week. If I do that will drop to $12k

I can do:

A) $10k 401k(high fee), $8500 Roth ira 2016 & 2017(index funds), $6500 taxable(index funds)

B) $4500 401k, $5500 tIRA, $3k 2016 Roth IRA, $12k taxable.

C) $4500 401k, $5500 tIRA, $15k taxable.

zolotiyeruki

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Single and making 60k/year?  Yeah, I think pre-tax is the way to go.  MDM's link on investment order is a good one.  Personally, I'd do it in this order:
1) contribute to the 401k enough to maximize the match.  If there's no match, skip this step.
2) max out tIRA contributions for 2016
3) if you can, max out your tIRA contributions for 2017

After all your deductions/exemptions, are you in the 15% tax bracket?  If yes, then go for either Roth or taxable.

It's good that you're thinking ahead about saving up for a down payment, but I think you should avoid purchasing a home until you've graduated and you've landed a job.  Even then, you don't have to immediately buy a house.  You can rent until you know the area better and can make that purchase.

prognastat

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If you ahem a high SWR like many mustachios do then traditional is a lot more beneficial Roth.

Only if you end up paying more taxes in retirement would the Roth be beneficial. If you don't have a huge income and low taxes now and don't save much and plan on building up their retirement over a long time then Roth is better. However most mustachios don't fall in to this category.

Verdure

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You say you live in MidWest USA. If that happens to be Indiana, and you are definitely going to school, you should consider putting 5K a year into a 529. Indiana has an amazing tax incentive for these.  You get a tax credit of 20% of your 529 savings up to $5000, so you get $1000 back, which is a pretty great ROI. 

Neverstop

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I am in Indiana and I was not aware of the 529 credit. I think I am better off with the lifetime learning credit on my federal return as opposed to the state return since its a higher tax rate.

hashbrowns

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I can't provide financial advice, but I'm essentially completing a engineering tech degree on my way to an engineering degree.
You may be able to handle the two full time schedules in the lower level classes, but full time once you start getting into higher level classes will crush you. Plan on having no free time.
This is all assuming you're learning ability is similar to mine, so it'll probably be easier for you.
I took Physics 1, Engineering programming, and a History elective, and will not attempt that again.

Verdure

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I'm no expert, but as far as I know you can get the Indiana 529 credit and also take the federal Lifetime learning credit. There is a double dipping rule for the federal return where you can't take the lifetime learning, and also count any earnings from your 529 as non-taxable income. But for me the amount of 529 earnings has been negligible anyway, because I have only used it as short-term savings.

As long you have at least $1000 of tax liability in Indiana, which based on your income you very likely do, this credit is hard to beat. Basically free money.