re: Canada, and probably other regions, too, I would make the following Step 2.
Find out which accounts offer matching grants from your employer or government, and optimize those.
This ordering is appropriate for investors in the US.
<snip/>
- For someone paying 25% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).
Current 10-year Treasury note yield is ~2%. See
http://quotes.wsj.com/bond/BX/TMUBMUSD10Y
WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.
<snip/>
I believe the ESPP belongs between 1 and 2, whatever your tax rate.You are correct that if one can swing the cash flow, getting in and out of an ESPP is ~"free money". But if one has to make a choice between deferring income in a 401k vs. taking the income and using it for an ESPP, it isn't the same.
ESPP | 401k | |
Initial cash | 5000 | 5000 |
Tax bite | -1500 | 0 |
Start | 3500 | 5000 |
Bonus | 525 | 0 |
Bonus tax | -157.5 | 0 |
Investment | 3867.5 | 5000 |
After 20 yrs | 13886 | 19348 |
Withdrawal tax | 380 | 3870 |
Net spendable | 13506 | 15479 |
cgt = capital gain tax rate, % | 5.0% |
d = annual dividend rate, % | 2.0% |
g = annual growth excluding dividends, % | 5.0% |
n = years invested, yr | 20 |
P = principal invested, $ | $3,868 |
t = tax rate on dividends, % | 20.0% |
e = tax-adjusted annual growth, % | 6.60% |
ecgt = tax-adjusted cap. gain tax rate, % | 3.788% |
F = Future, after tax, value | $13,506 |
I believe the ESPP belongs between 1 and 2, whatever your tax rate. For a typical plan, there is a 15% discount on the purchase price, which over a 6-month offering period with equal contributions each month, is equivalent to 6% per month, or 100% annualized return.You don't double your money from a 15% discount on ESPP stock purchases. You save 15%, and your $85 purchase of $100 worth of stock is like a +17.6% gain. You do not roll over this purchase or multiply it: you have a limit on how much you can buy, and you can't buy more. Each ESPP purchase is a separate decision, not something that multiplies each month.
Need some help here, guys and gals. My income is too high for a deductible IRA. I'm maxing out my pre-tax 401k and using the mega backdoor on after tax 401k contributions up to the 54k limit. Then I've been moving to a taxable account. I haven't put anything into a non-deductible IRA, ever, but reading this through I'm thinking I should be doing that too and using a backdoor roth conversion to get that into my Roth IRA too. Thoughts? Isn't the backdoor and mega back door basically doing the same thing for me in my case? Are there any limits or things I need to consider if using both those options in the same year?
I'm shooting for 75k/yr after tax income in retirement, so I'm not expecting super low or nonexistent federal taxes. Maybe that extra 5k is better off going into a taxable account because 1) both are after tax investments, 2) long term cap gains rate and my fire rate seem like they might be roughly similar, and 3) normal taxable account has no restrictions around withdrawals. That 3rd point, my taxable account, was my plan for covering a good part of my expenses for the years between 'retiring' and reaching 59.5 yrs old. Help!
Just re-read my post and to clarify my first question--does that 54k limit for 2017 include the IRA? If that's the case I'm guessing I was right to move to taxable, if not, I'm not so sure...No, it doesn't. 401k limits and IRA limits are separate.
Just re-read my post and to clarify my first question--does that 54k limit for 2017 include the IRA? If that's the case I'm guessing I was right to move to taxable, if not, I'm not so sure...No, it doesn't. 401k limits and IRA limits are separate.
Probably better to start a new thread, maybe in "Investor Alley" (or "Case Studies" if you want a full look), if you want to discuss specifics about your individual situation.
The benefits of employee stock purchase plans (ESPPs) relative to other opportunities is highly dependent on tax rates, because ESPP benefits all occur in taxable accounts.
- For someone paying 15% tax on ordinary income, and 0% on dividends and capital gains, ESPPs can be very favorable, perhaps competing with high interest rate loans in step 2.
- For someone paying 25% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
InAs edited, yes.the 15%[any] tax bracket, the ESPP is favorable to take part of simply to get the discounted stocks, but I should probably be selling and re-investing the money into a Traditional IRA or another taxable account such as my Vanguard indexes or even into my HSA account?
This ordering is appropriate for investors in the US.
It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end.
If you are renting, you may not be throwing away as much on rent as you might think. See
http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/
for some thoughts.
In the lists below, thinking "first your 457 (if you have one), then your 401k and/or 403b" wherever "401k" appears is likely correct -
unless your 457 fund options are significantly worse than those in the 401k/403b -
due to penalty-free access to 457 funds at retirement, even if younger than 59 1/2.
"Max _____" means "contribute up to the maximum allowed for _____, subject to your ability to pay day-to-day expenses."
The benefits of employee stock purchase plans (ESPPs) relative to other opportunities is highly dependent on tax rates, because ESPP benefits all occur in taxable accounts.
- For someone paying 15% tax on ordinary income, and 0% on dividends and capital gains, ESPPs can be very favorable, perhaps competing with high interest rate loans in step 2.
- For someone paying 25% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).
Current 10-year Treasury note yield is ~2%. See
http://quotes.wsj.com/bond/BX/TMUBMUSD10Y
WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.
WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.*
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between.
See Credits can make Traditional better than Roth for lower incomes (http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-overwhelming-student-loan-debt-how-would-you-get-started/msg868845/#msg868845) and other posts in that thread about some exceptions to the rule.
See Traditional versus Roth - Bogleheads (https://www.bogleheads.org/wiki/Traditional_versus_Roth) for even more details and exceptions.
The 'Calculations' tab in the Case Study Spreadsheet (http://forum.mrmoneymustache.com/forum-information-faqs/case-study-spreadsheet-updates/) can show marginal rates for savings or withdrawals.
5. See #4 for choice of traditional or Roth for 401k
6. Applicability depends on the rules for the specific 401k
7. Again, take the risk-free return if high enough
8. Because earnings, even if taxed, are beneficial
Similar to "put on your own oxygen mask before assisting others," you should fund your own retirement before funding 529 or similar plans for children's college costs.
The emergency fund is your "no risk" money. You might consider one of these online banks:
http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001
If your 401k options are poor (i.e., high fund fees) you can check
http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/
for some thoughts on "how high is too high?"
Priorities above apply when income is primarily through W-2 earnings. For those running their own businesses (e.g., rental property owner, small business owner, etc.),
putting money into that business might come somewhere before, in parallel with, or after step 5.
Why it is likely better not to pay a low interest rate mortgage early:
http://allfinancialmatters.com/wp-content/uploads/2013/08/SandP500_5-Year_Rolling_Returns_with-CPI_calendar_year.pdf
See http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html for some data on historical returns.
If you're going to retire early and do a Roth conversion I would think maxing out 401K and Trad IRA would be the way to go. Assuming your income lets you.Probably is. That's what the guidelines suggest, is it not?
InAs edited, yes.the 15%[any] tax bracket, the ESPP is favorable to take part of simply to get the discounted stocks, but I should probably be selling and re-investing the money into a Traditional IRA or another taxable account such as my Vanguard indexes or even into my HSA account?
Here's the short version: provided the employer imposes no restriction on the sale of the stock, you have a guaranteed return on your money so you should participate.Would you elaborate please?InAs edited, yes.the 15%[any] tax bracket, the ESPP is favorable to take part of simply to get the discounted stocks, but I should probably be selling and re-investing the money into a Traditional IRA or another taxable account such as my Vanguard indexes or even into my HSA account?
I have heard many different answers. A popular one I don't totally understand is I should hold the stocks for 12 months in order to avoid capital gains taxes (or something?). The other is that I should look at my entire portfolio of net worth and whenever my ESPP/RSU shares exceed 5% of our total stock investments i.e. ~5% of 80% and sell off down to 5%/reinvest into indexes or w/e. The other is to sell them immediately. I don't feel confident in making a decision on it besides continuing to purchase at 10% rate.
So question on this. In the original list (for the US), it has #4 as an IRA (either traditional or Roth), and #5 as maxing out your 401k. My husband and I make too much money for the traditional IRA to be deductible. I have been working towards maxing out my 401K (not there yet, but getting there), but haven't looked into a Roth IRA. What is the benefit of doing a Roth IRA ahead of maxing out your 401K?Good question.
I believe the ESPP belongs between 1 and 2, whatever your tax rate.You are correct that if one can swing the cash flow, getting in and out of an ESPP is ~"free money". But if one has to make a choice between deferring income in a 401k vs. taking the income and using it for an ESPP, it isn't the same.
Assumptions:
- 30% current tax (e.g., 25% federal, 5% state)
- 20% 401k withdrawal tax (e.g., 15% federal, 5% state)
- 5% taxable withdrawal tax (e.g., 0% federal, 5% state)
- 20% tax on dividends in taxable (e.g., 15% federal, 5% state); all dividends reinvested
- total return of 7%, 5% from growth and 2% from dividends
- 15% "bonus" from ESPP
- 20 years growth
Starting with a $5000 initial pre-tax amount available, one gets the results below, indicating the tax-advantaged account would be better.
For California residents where HSAs are not recognized by the state and therefore are treated as taxable accounts on a state level, should HSAs still be maxed so highly on the investment order list?It's less advantageous than it would be if it were deductible at the state level, but you do avoid all federal tax - both at contribution and at withdrawal - assuming the money can be attributed to medical expenses. Because federal taxes are usually more onerous than state taxes, the HSA probably remains a better deal.
I just opened an HSA via my employer with Optum Bank. They made their contribution and I made my first. But now that I have learned that CA doesn't recognize it, should I actually go with a Traditional 401k @ Vanguard first?
For California residents where HSAs are not recognized by the state and therefore are treated as taxable accounts on a state level, should HSAs still be maxed so highly on the investment order list?
I just opened an HSA via my employer with Optum Bank. They made their contribution and I made my first. But now that I have learned that CA doesn't recognize it, should I actually go with a Traditional 401k @ Vanguard first?
For California residents where HSAs are not recognized by the state and therefore are treated as taxable accounts on a state level, should HSAs still be maxed so highly on the investment order list?
I just opened an HSA via my employer with Optum Bank. They made their contribution and I made my first. But now that I have learned that CA doesn't recognize it, should I actually go with a Traditional 401k @ Vanguard first?
I think you mean traditional IRA?
i would love someone from the UK to do this for us UKer's - i am too noobie at the moment for this myself!
Canada - invest in non registered accounts under certain circumstances first. The correct order depends on income, its not universal.
For example if you earn under $42,000/year in Ontario dividends are taxed at -6.83% (that's a negative tax rate). In Alberta its -0.03%, basically zero. That's a case where non-registered come first (low income spouse scenario).
Low income earners should tackle TFSA/nonregistered while high income earners benefit from RRSP. Eligible dividends are held outside and non-eligible held inside TFSA. That's the basic rule.
Hooray for tax laws ;) Not every Canadian should be following the same order, don't forget to tailor to your own province. It gets more complicated when you add in the clawbacks for children (depends on number and age of kids). there's a $65,000 tax bracket, because of the clawback percentage change, that most people are unaware of. I've used RRSP contributions to increase benefits, in later years I won't get benefits (as kids age), then the allocation shifts again to be optimal.
Canada - invest in non registered accounts under certain circumstances first. The correct order depends on income, its not universal.
For example if you earn under $42,000/year in Ontario dividends are taxed at -6.83% (that's a negative tax rate). In Alberta its -0.03%, basically zero. That's a case where non-registered come first (low income spouse scenario).
Low income earners should tackle TFSA/nonregistered while high income earners benefit from RRSP. Eligible dividends are held outside and non-eligible held inside TFSA. That's the basic rule.
Hooray for tax laws ;) Not every Canadian should be following the same order, don't forget to tailor to your own province. It gets more complicated when you add in the clawbacks for children (depends on number and age of kids). there's a $65,000 tax bracket, because of the clawback percentage change, that most people are unaware of. I've used RRSP contributions to increase benefits, in later years I won't get benefits (as kids age), then the allocation shifts again to be optimal.
CANADA
What:
0: Pay off any high interest debts and establish emergency fund based on your risk tolerance
1: Max out your contributions to your TFSA
2: Contribute to your RRSP (remember that $25,000 can be used for a down payment through the first time home buyer's plan if you have not owned a house in the last 4 or 5 years)
3: Pay off your mortgage and low interest debt
4: Invest in non-registered funds
Why:
0: High interest debt is a huge drag on your money, and you'll be much happier without it. An emergency fund is a fairly personal decision, if you are risk averse or work in a boom/bust industry then a substantial emergency fund can help you sleep at night. If you have a very stable career and are comfortable with 'springy debt' as described in the Australia section you probably don't need much.
1: The TFSA is a pretty amazing investment vehicle, particularly if you're young. You contribute after tax dollars and never pay tax again on the money, regardless of how much it grows. You have the option of withdrawing money and preserving the contribution room in the following year, but withdrawals should be avoided unless there's a really good reason for it (people often invest their mortgage downpayment in their TFSA, which may be appropriate if you're planning on buying 'in a few years').
2: RRSP are a reasonable tax deferred investment vehicle, you don't pay tax (or are refunded taxes if you contribute after tax dollars) on the contributions, but do pay tax when the money is withdrawn. You will pay taxes on the withdrawn money as income, rather than potentially more favourable capital gains and dividend tax rates. In general, the fact that your RRSP can grow for years tax free should balance the potential tax consequences. If you are discovering MMM after working for a few years, you will probably find that you have fairly vast contribution room in your RRSP (it grows at 18% of your salary/yr).
3: Low interest in this context means 'close to or less than the expected return on your investments'. Less debt is pretty great. You may decide to invest in non-registered (taxable) accounts rather than paying off your mortgage at this phase, either way is fine and it will depend primarily on your risk tolerance and what your best guesses are on what your interest rate will be.
4: Shovel money into your taxable accounts. Remember that eligible Canadian dividends are taxed at a preferential rate (as are dividends from VCN or similar index funds), but that this is not true of international dividends.
Possible Variations:
- If your income in retirement is likely to be higher than your working income, you should avoid investing in your RRSP. This is possible if you have a lot of money in your RRSP, a relatively low income and are approaching 71, when you you will be required to start withdrawing a percentage of your RRSP. You can probably avoid this by retiring earlier and drawing down your RRSP in a controlled manner prior to control your taxes.
- If your income is very high, and you expect it to be lower in retirement (eg. you started saving late in life but have a high salary) then it might be optimal to be contributing to your RRSP before your TFSA.
- RRSP income is considered as 'income' for tax purposes, as is your Canadian Pension Plan (CPP). In a perfect world you'll be able to keep your income below ~ $71,000/yr after you reach 65 years so that you can receive the Old Age Supplement. It's hard to know whether this program will change if you're currently relatively young, but if you're in your 50s then it's worth looking at your taxes pretty carefully to try and make sure you're not inadvertently limiting your wealth by having a suboptimal withdrawal strategy.
- Mortgage choices are pretty personal and depend on a great deal on where you live. Between the TFSA and First Time Home Buyer Plan you should be well on your way to a downpayment if you don't own a house. If a purchase is imminent (6 months or a year?) then you should be invested in something very safe (eg. GICs) or in cash.
For California residents where HSAs are not recognized by the state and therefore are treated as taxable accounts on a state level, should HSAs still be maxed so highly on the investment order list?
I just opened an HSA via my employer with Optum Bank. They made their contribution and I made my first. But now that I have learned that CA doesn't recognize it, should I actually go with a Traditional 401k @ Vanguard first?
I think you mean traditional IRA?
Yes, I meant Traditional IRA. Thanks.
Aga_Rockstar, many of us follow the simple stuff nicely laid out here:
http://canadiancouchpotato.com/model-portfolios-2/
Personally, I do Option 3. You can select these at TD Direct Investing, RBC Direct Investing, etc.
Hello, here is another question for fellow Canadians (hopefully you are staying warm, it's snowing again here!!) What do you think about Robo-Advisors??? I just learned about this, still reading The Internet :)
here is the site that I have found to be quite useful: https://youngandthrifty.ca/complete-guide-to-canadas-robo-advisors/
Thank you!
Hello, here is another question for fellow Canadians (hopefully you are staying warm, it's snowing again here!!) What do you think about Robo-Advisors??? I just learned about this, still reading The Internet :)
here is the site that I have found to be quite useful: https://youngandthrifty.ca/complete-guide-to-canadas-robo-advisors/
Thank you!
i dont think its a country specific question - so i'll chime in... robo advisors are decent but will charge you a higher rate than any value they provide. You're at this site and have passed the pack by getting here. You should manage the money yourself and you'll save alot of fees over time.
Hello, here is another question for fellow Canadians (hopefully you are staying warm, it's snowing again here!!) What do you think about Robo-Advisors??? I just learned about this, still reading The Internet :)
here is the site that I have found to be quite useful: https://youngandthrifty.ca/complete-guide-to-canadas-robo-advisors/
Thank you!
i dont think its a country specific question - so i'll chime in... robo advisors are decent but will charge you a higher rate than any value they provide. You're at this site and have passed the pack by getting here. You should manage the money yourself and you'll save alot of fees over time.
Thank you!! I am still very very new at this :). I am trying to understand and learn on how to actually do it myself, don't feel confident enough yet. BUT i have to move my investments asap, since we are currently with someone that is charging a lot. So I was thinking to get a robo-advisor for now, and continue to gain knowledge until I can just do it myself.
Maybe someone from Canada will chime in with the equivalent of dump it into vtsax and forget about it but that's what I'd do while I was learning. Not pay higher fees in between.
Maybe someone from Canada will chime in with the equivalent of dump it into vtsax and forget about it but that's what I'd do while I was learning. Not pay higher fees in between.
CANADA
What:
0: Pay off any high interest debts and establish emergency fund based on your risk tolerance
1: Max out your contributions to your TFSA
2: Contribute to your RRSP (remember that $25,000 can be used for a down payment through the first time home buyer's plan if you have not owned a house in the last 4 or 5 years)
3: Pay off your mortgage and low interest debt
4: Invest in non-registered funds
Why:
0: High interest debt is a huge drag on your money, and you'll be much happier without it. An emergency fund is a fairly personal decision, if you are risk averse or work in a boom/bust industry then a substantial emergency fund can help you sleep at night. If you have a very stable career and are comfortable with 'springy debt' as described in the Australia section you probably don't need much.
1: The TFSA is a pretty amazing investment vehicle, particularly if you're young. You contribute after tax dollars and never pay tax again on the money, regardless of how much it grows. You have the option of withdrawing money and preserving the contribution room in the following year, but withdrawals should be avoided unless there's a really good reason for it (people often invest their mortgage downpayment in their TFSA, which may be appropriate if you're planning on buying 'in a few years').
2: RRSP are a reasonable tax deferred investment vehicle, you don't pay tax (or are refunded taxes if you contribute after tax dollars) on the contributions, but do pay tax when the money is withdrawn. You will pay taxes on the withdrawn money as income, rather than potentially more favourable capital gains and dividend tax rates. In general, the fact that your RRSP can grow for years tax free should balance the potential tax consequences. If you are discovering MMM after working for a few years, you will probably find that you have fairly vast contribution room in your RRSP (it grows at 18% of your salary/yr).
3: Low interest in this context means 'close to or less than the expected return on your investments'. Less debt is pretty great. You may decide to invest in non-registered (taxable) accounts rather than paying off your mortgage at this phase, either way is fine and it will depend primarily on your risk tolerance and what your best guesses are on what your interest rate will be.
4: Shovel money into your taxable accounts. Remember that eligible Canadian dividends are taxed at a preferential rate (as are dividends from VCN or similar index funds), but that this is not true of international dividends.
Possible Variations:
- If your income in retirement is likely to be higher than your working income, you should avoid investing in your RRSP. This is possible if you have a lot of money in your RRSP, a relatively low income and are approaching 71, when you you will be required to start withdrawing a percentage of your RRSP. You can probably avoid this by retiring earlier and drawing down your RRSP in a controlled manner prior to control your taxes.
- If your income is very high, and you expect it to be lower in retirement (eg. you started saving late in life but have a high salary) then it might be optimal to be contributing to your RRSP before your TFSA.
- RRSP income is considered as 'income' for tax purposes, as is your Canadian Pension Plan (CPP). In a perfect world you'll be able to keep your income below ~ $71,000/yr after you reach 65 years so that you can receive the Old Age Supplement. It's hard to know whether this program will change if you're currently relatively young, but if you're in your 50s then it's worth looking at your taxes pretty carefully to try and make sure you're not inadvertently limiting your wealth by having a suboptimal withdrawal strategy.
- Mortgage choices are pretty personal, and depend a great deal on where you live. Between the TFSA and First Time Home Buyer Plan you should be well on your way to a downpayment if you don't own a house. If a purchase is imminent (6 months or a year?) then you should be invested in something very safe (eg. GICs) or in cash.
What's the thinking for choosing Roth over tIRA under the new tax brackets? Choose Roth at 12 percent and under, and tIRA for 22 percent and up, all else being equal?Unfortunately all else can be difficult to define and rarely equal.
I propose adding a step for USA investment order. The last step before funding a taxable account should be to fund a 529 plan, if applicable.See updated version. Does that capture it well enough?
I've been researching this since the new tax law went into effect, and it seems to be the right move in my situation and likely for many others as well. If you plan to help your children pay for college (or private K-12 with new law), stashing money in a 529 plan is better than a taxable account.
I understand this isn't for everyone, but I think people can benefit from this investment advice. I think some of the other buckets like mega backdoor and HSA are fantastic, but probably applicable to fewer people than 529s.
Of course there are some risks associated with 529s that could trigger tax penalties if the money isn't used for education. Even with that risk, most parents who plan to help their children pay for education should consider funding a 529 after other tax advantaged accounts are funded.
I understand the rationale for funding your own retirement first, and generally agree with that sentiment. For those planning to help children with educational costs during early retirement, the 529 is a valuable tool that will reduce your overall tax burden. When you get to the bottom of the list and are funding the taxable account, you're doing pretty well anyways. I'm thinking most parents who are well off enough to retire before their kids finish high school will want to help their kids pay for education. There's no reason why you can't save for both goals.
I just came to do my taxes and realize that the Traditional IRA is not deductible (seemingly due to our maxing out of the 401k), so the plan is to convert these to Roth.More likely it's because your income exceeds the IRS limits for IRA deduction. Having access to a 401(k) through work alters the income limit, but it shouldn't matter if you contribute or not.
Once one contributes $1 to a 401k, for that year contributing the maximum amount can only help make a tIRA deductible.I just came to do my taxes and realize that the Traditional IRA is not deductible (seemingly due to our maxing out of the 401k), so the plan is to convert these to Roth.More likely it's because your income exceeds the IRS limits for IRA deduction. Having access to a 401(k) through work alters the income limit, but it shouldn't matter if you contribute or not.
https://www.irs.gov/retirement-plans/2017-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work
I just came to do my taxes and realize that the Traditional IRA is not deductible (seemingly due to our maxing out of the 401k), so the plan is to convert these to Roth.More likely it's because your income exceeds the IRS limits for IRA deduction. Having access to a 401(k) through work alters the income limit, but it shouldn't matter if you contribute or not.
https://www.irs.gov/retirement-plans/2017-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work
...even after 401k and a potential 403b/457 max, our AGI will still be above the max (lucky us) - so really the traditional IRA has no value in this case and we should resort to Roth right?Yes, if you are above the tIRA deductibility limit but below the Roth contribution limit.
Should the roth IRA take priority over 403b/457 - i know the investment order post suggests so, and that's what we currently have as our priority.If you can max a 401k and 403b/457 and still be above the tIRA deductibility limit, you should probably be doing all the above.
How about maxing out 403b/457 vs paying off mortgage to remove PMI?Depends on the PMI interest rate.
How about maxing out 403b/457 vs paying off mortgage to remove PMI?Depends on the PMI interest rate.
It would take around 60k to have paid down enough to remove PMI, but i'm struggling to get my head around the math of how much i would save in taxes and compound interest if this was all going in a 457b in VTSMX for the same period to determine if i should just let it run....See PMI Payoff ROI? (https://forum.mrmoneymustache.com/ask-a-mustachian/pmi-payoff-roi/) and Getting rid of PMI? What % "return" would I get for paying down my mortgage? (https://forum.mrmoneymustache.com/ask-a-mustachian/getting-rid-of-pmi-what-'return'-would-i-get-for-paying-down-my-mortgage/) for some thoughts.
It would take around 60k to have paid down enough to remove PMI, but i'm struggling to get my head around the math of how much i would save in taxes and compound interest if this was all going in a 457b in VTSMX for the same period to determine if i should just let it run....See PMI Payoff ROI? (https://forum.mrmoneymustache.com/ask-a-mustachian/pmi-payoff-roi/) and Getting rid of PMI? What % "return" would I get for paying down my mortgage? (https://forum.mrmoneymustache.com/ask-a-mustachian/getting-rid-of-pmi-what-'return'-would-i-get-for-paying-down-my-mortgage/) for some thoughts.
Radioherd88 - They might require an appraisal before they drop PMI. I doubt they will accept your property tax bill's figure (with it's automatic appraisal), but it might be worth sending them a letter with a copy of that information and requesting they drop PMI since you have 20% equity. A letter is a bit better from a legal point of view, and might get a better response. You can call them, but it's in their best interest to stall (in terms of money, not in terms of customer service).
This ordering is appropriate for investors in the US.
[stuff deleted]
4. Max Traditional IRA or Roth (or backdoor Roth (https://www.bogleheads.org/wiki/Backdoor_Roth_IRA)) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
It's that the "more desirable investment options" are usually associated with IRAs, not 401ks.This ordering is appropriate for investors in the US.
[stuff deleted]
4. Max Traditional IRA or Roth (or backdoor Roth (https://www.bogleheads.org/wiki/Backdoor_Roth_IRA)) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
Please clarify why you advise maxing a traditional IRA before maxing your employer sponsored 401k (403(b) or 457). Is it simply a matter of you get to choose which company to invest in and therefore can choose more desirable investment options (e.g. my 403(b) doesn't have Vanguard associated investment options (VTSAX), but if I set up a traditional IRA through Vanguard, I'd have access to VTSAX)? Or is this simply an admonishment that when you have the option, you should avoid employer sponsored options?
Hello, here is another question for fellow Canadians (hopefully you are staying warm, it's snowing again here!!) What do you think about Robo-Advisors??? I just learned about this, still reading The Internet :)
here is the site that I have found to be quite useful: https://youngandthrifty.ca/complete-guide-to-canadas-robo-advisors/
Thank you!
i dont think its a country specific question - so i'll chime in... robo advisors are decent but will charge you a higher rate than any value they provide. You're at this site and have passed the pack by getting here. You should manage the money yourself and you'll save alot of fees over time.
Thank you!! I am still very very new at this :). I am trying to understand and learn on how to actually do it myself, don't feel confident enough yet. BUT i have to move my investments asap, since we are currently with someone that is charging a lot. So I was thinking to get a robo-advisor for now, and continue to gain knowledge until I can just do it myself.
Maybe someone from Canada will chime in with the equivalent of dump it into vtsax and forget about it but that's what I'd do while I was learning. Not pay higher fees in between.
Would the investment order be different for a family that is trying to use Public Service Loan Forgiveness (PSLF)? e.g. would maxing out a 401K then move up in priority since adjusted gross income and thus income-based payments be lower?At a quick glance I'd say "no" because
USA-specific question:I would think that student loans that might qualify for PSLF wouldn't have interest rates high enough to place paying them off above tax advantaged savings. While it is true that you could slightly reduce the payments to the loans by lowering AGI, I don't think it would be worth the cost of the extra interest on the high interest loans (hair on fire debt that should have been avoided) especially after considering the tax impact of the increased balance of the loans at forgiveness. At most adjusting for a PSLF strategy would increase the threshold interest rate for the first loan payoff line a little bit.
Would the investment order be different for a family that is trying to use Public Service Loan Forgiveness (PSLF)? e.g. would maxing out a 401K then move up in priority since adjusted gross income and thus income-based payments be lower?
This ordering is appropriate for investors in the US.
In the lists below, thinking "first your governmental 457 (if you have one), then your 401k/403b/SIMPLE/etc." wherever "401k" appears is likely correct -
unless your governmental 457 fund options are significantly worse than those in the 401k/403b -
due to penalty-free access to governmental 457 funds at retirement, even if younger than 59 1/2.
Non-governmental 457b plans have deficiencies, including the inability to roll the balance into an IRA.
"Max _____" means "contribute up to the maximum allowed for _____, subject to your ability to pay day-to-day expenses."
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).
Current 10-year Treasury note yield is ~3%. See
http://quotes.wsj.com/bond/BX/TMUBMUSD10Y
WHAT
0. Establish an emergency fund (https://www.bogleheads.org/wiki/Emergency_fund) to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.
3. Max Health Savings Account (https://www.bogleheads.org/wiki/Health_savings_account) (HSA) if eligible.
4. Max Traditional IRA or Roth (or backdoor Roth (https://www.bogleheads.org/wiki/Backdoor_Roth_IRA)) based on income level
5. Max 401k (if
- 401k fees are lower than available in an IRA, or
- you need the 401k deduction to be eligible for (and desire) a tIRA deduction, or
- your earn too much for an IRA deduction and prefer traditional to Roth, then
swap #4 and #5)
6. Fund a mega backdoor Roth (https://www.bogleheads.org/wiki/After-tax_401(k)) if applicable.
7. Pay off any debts with interest rates ~3% or more above the current 10-year Treasury note yield.
8. Invest in a taxable account and/or fund a 529 with any extra.
WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 22% or higher; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise.
For those willing to expend a little more energy than it takes to flip a coin, consider comparing current marginal tax saving rate vs. predicted marginal withdrawal tax rate.
If current > predicted, use traditional. Otherwise use Roth.
See Credits can make Traditional better than Roth for lower incomes (http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-overwhelming-student-loan-debt-how-would-you-get-started/msg868845/#msg868845) and other posts in that thread about some exceptions to the rule.
See Traditional versus Roth - Bogleheads (https://www.bogleheads.org/wiki/Traditional_versus_Roth) for even more details and exceptions. State tax (or lack thereof) should also be considered.
The 'Calculations' tab in the Case Study Spreadsheet (http://forum.mrmoneymustache.com/forum-information-faqs/case-study-spreadsheet-updates/) can show marginal rates for savings or withdrawals*.
5. See #4 for choice of traditional or Roth for 401k. In a 401k there are no income-based limits for deductions or contributions.
6. Applicability depends on the rules for the specific 401k. See Mega Backdoor Roth IRA (https://www.bogleheads.org/wiki/After-tax_401(k)).
7. Again, take the risk-free return if high enough. Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
(e.g., target retirement date) that provides a blend of stock and bond returns. If you wish to consider separate bond funds, compare the yield on a fund
with a duration similar to the time remaining on the loan, and put your money toward the one with the higher after-tax interest/yield.
8. Because taxable earnings will still help your FI journey. If your own retirement is in good shape, and you choose to provide significant help for children's college costs,
a 529 plan (https://www.bogleheads.org/wiki/529_plan) may be appropriate. Similar to "put on your own oxygen mask before assisting others," do consider funding your own retirement before funding 529 plans for children's college costs.
Speaking of things to do first, see Getting started - Bogleheads (https://www.bogleheads.org/wiki/Getting_started) if this is all new. Working through that post and the links therein is also a good refresher, even if personal finance isn't completely new to you.
The emergency fund is your "no risk" money. You might consider one of these online banks:
http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001
It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end.
If you are renting, you may not be throwing away as much on rent as you might think. See
http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/
for some thoughts.
For those concerned about "locking up" money in retirement accounts until age 59.5, see How to withdraw funds from your IRA and 401k without penalty before age 59.5 (https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/).
If one can swing the cash flow, getting in and out of an ESPP is ~"free money". But if one has to make a choice between deferring income in a 401k vs. taking the income and using it for an ESPP, it isn't the same. The benefits of employee stock purchase plans (ESPPs) relative to other opportunities is highly dependent on tax rates, because ESPP benefits all occur in taxable accounts.
- For someone paying 12% tax on ordinary income, and 0% on dividends and capital gains, ESPPs can be very favorable, perhaps competing with high interest rate loans in step 2.
- For someone paying 22% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
If your 401k options are poor (i.e., high fund fees) you can check
http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/
for some thoughts on "how high is too high?"
The MAGI calculation for Roth IRA purposes is https://www.irs.gov/publications/p590a#en_US_2017_publink1000230985
Then see Retirement Topics IRA Contribution Limits | Internal Revenue Service (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits).
The MAGI calculation for traditional IRA purposes is https://www.irs.gov/publications/p590a#en_US_2017_publink1000230489.
Then see IRA Deduction Limits | Internal Revenue Service (https://www.irs.gov/retirement-plans/ira-deduction-limits)
Priorities above apply when income is primarily through W-2 earnings. For those running their own businesses (e.g., rental property owner, small business owner, etc.),
putting money into that business might come somewhere before, in parallel with, or after step 5.
Why it is likely better to invest instead of paying a low interest rate mortgage early, if you have a long time until the mortgage is due:
https://www.thebalance.com/rolling-index-returns-1973-mid-2009-4061795
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
*Estimating withdrawal tax rates is not an exact science, but here is one approach:
1) Estimate any guaranteed income. E.g., pension you can't defer in return for higher payments when you do start, rentals, etc.
2) Take current traditional balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so. Take 4% of that value as an annual withdrawal.
3) Take current taxable balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so. Take 2% of that value as qualified dividends.
4a) Decide whether SS income should be considered, or whether you will be able to do enough traditional->Roth conversions before taking SS.
4b) Include SS income projections (using today's dollars) if needed from step 4a.
5) Calculate marginal rate on withdrawals from traditional accounts using today's tax law on the numbers from step 1-4.
6) Make your traditional vs. Roth decision for this year's contribution
7) Repeat steps 1-6 every year until retirement
The steps above may look complicated at first, but you don't need great precision. The answer will either be "obvious" or "difficult to choose". If the latter, it likely won't make much difference which you pick anyway.
Note the possibility of self-defeating predictions:
a) predict high taxable retirement income > contribute to Roth > get low taxable retirement income
b) predict low taxable retirement income > contribute to traditional > get high taxable retirement income
Also, if you pick traditional and that ends up being wrong it will be because you have "too much money" - not the worst problem.
If you pick Roth and that ends up being wrong it will be because you have "too little money" - that can be a real problem.
Thus using traditional is a "safer" choice.
Hello, I am hoping to get advice on where to invest next:It would be better to ask this in the Case Studies (https://forum.mrmoneymustache.com/case-studies/) board.
I have already saved an Emergency Fund, paid off all debt, have about $60K in index funds, and maxed out my TSP (401K). I work for the Federal Government and don't have the ability to contribute to an HSA or do a mega back door roth. I make $160K and therefore can't contribute to a Roth and won't get a deduction for a traditional IRA. Is it still worth contributing to a traditional IRA or should I stick with taxable accounts? I have $100K in savings and can't decide whether to buy a place or invest. I would really appreciate any advice you fellow mustachians have!
Hello, I am hoping to get advice on where to invest next:It would be better to ask this in the Case Studies (https://forum.mrmoneymustache.com/case-studies/) board.
I have already saved an Emergency Fund, paid off all debt, have about $60K in index funds, and maxed out my TSP (401K). I work for the Federal Government and don't have the ability to contribute to an HSA or do a mega back door roth. I make $160K and therefore can't contribute to a Roth and won't get a deduction for a traditional IRA. Is it still worth contributing to a traditional IRA or should I stick with taxable accounts? I have $100K in savings and can't decide whether to buy a place or invest. I would really appreciate any advice you fellow mustachians have!
See How To: Write a Case Study Topic (https://forum.mrmoneymustache.com/case-studies/how-to-write-a-'case-study'-topic/). Good luck!
I’ve got a mate from the UK that would be interested in an investment order for that. Anyone got one?You can check out the UK Tax discussion (https://forum.mrmoneymustache.com/uk-tax-discussion/) board. Unfortunately the dominance of North Americans in the general areas has our UK mustachians using it as a pretty general place for UK discussion (their only sticky is a directory to UK based journals).
This ordering is appropriate for investors in the US.
In the lists below, thinking "first your governmental 457 (if you have one), then your 401k/403b/SIMPLE/etc." wherever "401k" appears is likely correct -
unless your governmental 457 fund options are significantly worse than those in the 401k/403b -
due to penalty-free access to governmental 457 funds at retirement, even if younger than 59 1/2.
Non-governmental 457b plans have deficiencies, including the inability to roll the balance into an IRA.
"Max _____" means "contribute up to the maximum allowed for _____, subject to your ability to pay day-to-day expenses."
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).
Current 10-year Treasury note yield is ~3%. See
http://quotes.wsj.com/bond/BX/TMUBMUSD10Y
WHAT
0. Establish an emergency fund (https://www.bogleheads.org/wiki/Emergency_fund) to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.
3. Max Health Savings Account (https://www.bogleheads.org/wiki/Health_savings_account) (HSA) if eligible.
4. Max Traditional IRA or Roth (or backdoor Roth (https://www.bogleheads.org/wiki/Backdoor_Roth_IRA)) based on income level
5. Max 401k (if
- 401k fees are lower than available in an IRA, or
- you need the 401k deduction to be eligible for (and desire) a tIRA deduction, or
- your earn too much for an IRA deduction and prefer traditional to Roth, then
swap #4 and #5)
6. Fund a mega backdoor Roth (https://www.bogleheads.org/wiki/After-tax_401(k)) if applicable.
7. Pay off any debts with interest rates ~3% or more above the current 10-year Treasury note yield.
8. Invest in a taxable account and/or fund a 529 with any extra.
WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 22% or higher; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise.
For those willing to expend a little more energy than it takes to flip a coin, consider comparing current marginal tax saving rate vs. predicted marginal withdrawal tax rate.
If current > predicted, use traditional. Otherwise use Roth.
See Credits can make Traditional better than Roth for lower incomes (http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-overwhelming-student-loan-debt-how-would-you-get-started/msg868845/#msg868845) and other posts in that thread about some exceptions to the rule.
See Traditional versus Roth - Bogleheads (https://www.bogleheads.org/wiki/Traditional_versus_Roth) for even more details and exceptions. State tax (or lack thereof) should also be considered.
The 'Calculations' tab in the Case Study Spreadsheet (http://forum.mrmoneymustache.com/forum-information-faqs/case-study-spreadsheet-updates/) can show marginal rates for savings or withdrawals*.
5. See #4 for choice of traditional or Roth for 401k. In a 401k there are no income-based limits for deductions or contributions.
6. Applicability depends on the rules for the specific 401k. See Mega Backdoor Roth IRA (https://www.bogleheads.org/wiki/After-tax_401(k)).
7. Again, take the risk-free return if high enough. Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
(e.g., target retirement date) that provides a blend of stock and bond returns. If you wish to consider separate bond funds, compare the yield on a fund
with a duration similar to the time remaining on the loan, and put your money toward the one with the higher after-tax interest/yield.
8. Because taxable earnings will still help your FI journey. If your own retirement is in good shape, and you choose to provide significant help for children's college costs,
a 529 plan (https://www.bogleheads.org/wiki/529_plan) may be appropriate. Similar to "put on your own oxygen mask before assisting others," do consider funding your own retirement before funding 529 plans for children's college costs.
Speaking of things to do first, see Getting started - Bogleheads (https://www.bogleheads.org/wiki/Getting_started) if this is all new. Working through that post and the links therein is also a good refresher, even if personal finance isn't completely new to you.
The emergency fund is your "no risk" money. You might consider one of these online banks:
http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001
It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end.
If you are renting, you may not be throwing away as much on rent as you might think. See
http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/
for some thoughts.
For those concerned about "locking up" money in retirement accounts until age 59.5, see How to withdraw funds from your IRA and 401k without penalty before age 59.5 (https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/).
If your 401k options are poor (i.e., high fund fees) you can check
http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/
for some thoughts on "how high is too high?"
The MAGI calculation for Roth IRA purposes is https://www.irs.gov/publications/p590a#en_US_2018_publink1000230985
Then see Retirement Topics IRA Contribution Limits | Internal Revenue Service (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits).
The MAGI calculation for traditional IRA purposes is https://www.irs.gov/publications/p590a#en_US_2018_publink1000230489.
Then see IRA Deduction Limits | Internal Revenue Service (https://www.irs.gov/retirement-plans/ira-deduction-limits)
If one can swing the cash flow, getting in and out of an ESPP is ~"free money". But if one has to make a choice between deferring income in a 401k vs. taking the income and using it for an ESPP, it isn't the same. The benefits of employee stock purchase plans (ESPPs) relative to other opportunities is highly dependent on tax rates, because ESPP benefits all occur in taxable accounts.
- For someone paying 12% tax on ordinary income, and 0% on dividends and capital gains, ESPPs can be very favorable, perhaps competing with high interest rate loans in step 2.
- For someone paying 22% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
Priorities above apply when income is primarily through W-2 earnings. For those running their own businesses (e.g., rental property owner, small business owner, etc.),
putting money into that business might come somewhere before, in parallel with, or after step 5.
Why it is likely better to invest instead of paying a low interest rate mortgage early, if you have a long time until the mortgage is due:
https://www.thebalance.com/rolling-index-returns-1973-mid-2009-4061795
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
*Estimating withdrawal tax rates is not an exact science, but here is one approach:
1) Estimate any guaranteed income. E.g., pension you can't defer in return for higher payments when you do start, rentals, etc.
2) Take current traditional balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so. Take 4% of that value as an annual withdrawal.
3) Take current taxable balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so. Take 2% of that value as qualified dividends.
4a) Decide whether SS income should be considered, or whether you will be able to do enough traditional->Roth conversions before taking SS.
4b) Include SS income projections (using today's dollars) if needed from step 4a.
5) Calculate marginal rate on withdrawals from traditional accounts using today's tax law on the numbers from step 1-4.
6) Make your traditional vs. Roth decision for this year's contribution
7) Repeat steps 1-6 every year until retirement
The steps above may look complicated at first, but you don't need great precision. The answer will either be "obvious" or "difficult to choose". If the latter, it likely won't make much difference which you pick anyway.
Note the possibility of self-defeating predictions:
a) predict high taxable retirement income > contribute to Roth > get low taxable retirement income
b) predict low taxable retirement income > contribute to traditional > get high taxable retirement income
Also, if you pick traditional and that ends up being wrong it will be because you have "too much money" - not the worst problem.
If you pick Roth and that ends up being wrong it will be because you have "too little money" - that can be a real problem.
Thus using traditional is a "safer" choice.
457 b governemtnal vs: non governmental.If the employer is a private company, it's not governmental. If the employer is government run (e.g., a school district) it is governmental.
some ppl say that if yours has a Roth option, then it is definitely governemtal (altho some gov't 457s do not have ROth). is there another way to tell? and , why does it matter?
This ordering is appropriate for investors in the US.
0. Establish an emergency fund (https://www.bogleheads.org/wiki/Emergency_fund) to your satisfaction
8. Invest in a taxable account and/or fund a 529 with any extra.
Newby questions hereYes to all the above.
I’m trying to do calculations to estimate my withdrawal tax rates:
Step #2: Does take “current traditional balance” mean just your pre-tax 401k & traditional IRA balance?
Step #3: Does take “current taxable balance” mean just your brokerage account money?
Step #5:Does "traditional accounts" mean just your pre-tax 401k & traditional IRA balance? (Same as Step#2)
@MDM, in the WHY section, step 4, you may consider adding a note that effects on ACA subsidies and FAFSA EFC function as separate parallel taxation systems and thus can add to the overall marginal tax rates, which affect the current vs. future marginal rate evaluation.Good point.
Although that adds to the complication of an already fairly complicated rule of thumb post, so I will respectfully leave it up to you to decide if the addition is worth the increase in complexity.
Last year with my personal tax situation the combined effect of ACA+FAFSA seemed to be about 12 percentage points of marginal rate, so it can be a fairly significant factor. But I am FIREd with kids in college, which may be a small target audience.
Is the FAFSA EFC calculable from entries already needed, and calculations already made, by the CSS? Or does it require significantly more inputs?Based on https://ifap.ed.gov/efcformulaguide/attachments/1920EFCFormulaGuide.pdf, it appears to require
Unless there is a way around the above (e.g., someone already has a CSS-compatible spreadsheet and is willing to share), I don't see the EFC being included in the CSS marginal rate calculation. But a note about that effect in the IO post seems doable.
Modified version below. Further suggestions welcome.Unless there is a way around the above (e.g., someone already has a CSS-compatible spreadsheet and is willing to share), I don't see the EFC being included in the CSS marginal rate calculation. But a note about that effect in the IO post seems doable.
Agreed. Thanks.
Has anyone considered where or when an Indexed Universal Life LIRP (Life Insurance Retirement Plan) belongs in the order?It does not belong. If you would like to discuss "Insurance Order" feel free to start such a thread.
Has anyone considered where or when an Indexed Universal Life LIRP (Life Insurance Retirement Plan) belongs in the order?It does not belong. If you would like to discuss "Insurance Order" feel free to start such a thread.
Has anyone considered where or when an Indexed Universal Life LIRP (Life Insurance Retirement Plan) belongs in the order?It does not belong. If you would like to discuss "Insurance Order" feel free to start such a thread.
That sounds like a terrible thread, but I am actually surprised there isn't one already....
Yes, obviously it is insurance, but is no one considering long term care insurance to protect their portfolio from being pilfered in such a scenario? Or are we all happy to self insure by not paying an insurance premium and put more into taxable accounts to grow?
What interests me in the UIL LIRP and makes me think this becomes a conversation between the taxable brokerage account is the 0 loss aspect that can help protect against market crashes and bring your $ out ahead of a taxable brokerage - and you can touch it without counting as provisional income in RMD years - it has it's advantages if you stick with it long term?
Has anyone considered where or when an Indexed Universal Life LIRP (Life Insurance Retirement Plan) belongs in the order?It does not belong. If you would like to discuss "Insurance Order" feel free to start such a thread.
That sounds like a terrible thread, but I am actually surprised there isn't one already....
Yes, obviously it is insurance, but is no one considering long term care insurance to protect their portfolio from being pilfered in such a scenario? Or are we all happy to self insure by not paying an insurance premium and put more into taxable accounts to grow?
What interests me in the UIL LIRP and makes me think this becomes a conversation between the taxable brokerage account is the 0 loss aspect that can help protect against market crashes and bring your $ out ahead of a taxable brokerage - and you can touch it without counting as provisional income in RMD years - it has it's advantages if you stick with it long term?
Insurance products may be "meh" as in investment if you are in the highest tax bracket, and already using every single tax-deferment strategy, and you have a long time horizon, and you've talked to a fee-only financial advisor who suggests you look into one. Otherwise they are usually bad. You can google this, but it's generally true that the return on life insurance products is low, lower than you'd think. You might as well be in US bonds.
The cliche is that life insurance products are usually sold, not bought.
You may wish to read this series: https://www.whitecoatinvestor.com/debunking-the-myths-of-whole-life-insurance/
Has anyone considered where or when an Indexed Universal Life LIRP (Life Insurance Retirement Plan) belongs in the order?It does not belong. If you would like to discuss "Insurance Order" feel free to start such a thread.
That sounds like a terrible thread, but I am actually surprised there isn't one already....
Yes, obviously it is insurance, but is no one considering long term care insurance to protect their portfolio from being pilfered in such a scenario? Or are we all happy to self insure by not paying an insurance premium and put more into taxable accounts to grow?
What interests me in the UIL LIRP and makes me think this becomes a conversation between the taxable brokerage account is the 0 loss aspect that can help protect against market crashes and bring your $ out ahead of a taxable brokerage - and you can touch it without counting as provisional income in RMD years - it has it's advantages if you stick with it long term?
Insurance products may be "meh" as in investment if you are in the highest tax bracket, and already using every single tax-deferment strategy, and you have a long time horizon, and you've talked to a fee-only financial advisor who suggests you look into one. Otherwise they are usually bad. You can google this, but it's generally true that the return on life insurance products is low, lower than you'd think. You might as well be in US bonds.
The cliche is that life insurance products are usually sold, not bought.
You may wish to read this series: https://www.whitecoatinvestor.com/debunking-the-myths-of-whole-life-insurance/
I'm aware insurance is bad, mmmkay - i dislike insurance - i have highest deductibles where possible just to protect against catastrophe and reduce premiums.
What attracts me to the Indexed Universal Life LIRP is that it unlocks the potential to have a portion of your portfolio that is invincible to market crashes - meaning if that happens when you are about to FIRE, you can draw on that portion and wait for the market to recover before you touch the rest. There are plans that provide 0 loss indexes in down years (capped return at 12-14% on the plus years), and over the life of the insurance the premium cost is the equivalent of 1.5%. Yes 1.5% is still high compared to the index funds i currently invest in, but for a fee of 1.5% to unlock a 0 loss option, and provide long term care and death benefit, I figured there's be some that this appeals to..... apparently not!
Thanks for this investment order write-up! I think the US Investment order would benefit from a few additional options:While I see value in discussing the merits of purchasing various series of government bonds, the investment order is about what accounts to fund, not what investments to purchase within those accounts. They would probably be better discussed in a different thread.
(i) Series I bonds (as referenced). Even though these bonds currently offer zero premium to inflation, tracking inflation on a tax-deferred basis is a very good offering in today's low rate environment.
(ii) Series EE bonds. If you can hold for 20 years, you'll double your money and earn a ~3.5% pre-tax return. Pretty interesting for high income individuals.
(iii) Coverdell ESA. Education savings account that is more flexible on spending than 529, but only offers tax-free gains (no deductions).
I hit on all these US options in the calculator I built that personalizes the investment order: TheSavingMenu.com (http://TheSavingMenu.com)
I just wanted to share some gratitude for the work that went into creating the US investment order list (and probably the others too, although less relevant for me). It’s the most value I feel like I’ve gotten from this community to date... this thread has practically become my investing bible. I love how simple and well-researched it is. It’s among the first posts I share with friends interested in improving their personal financial health, as it provides substantial relief to young people like me who can get stuck in the weeds of over optimization in the wrong areas. So yeah... thanks again @MDM and others. For someone who’s never taken a personal finance class, this thread was truly enlightening.
While I see value in discussing the merits of purchasing various series of government bonds, the investment order is about what accounts to fund, not what investments to purchase within those accounts. They would probably be better discussed in a different thread.
I'm curious if there's an investment order for those who are self employed?With the availability of Solo 401(k) plans (https://www.bogleheads.org/wiki/Solo_401(k)_plan), it's not clear how that would differ. What do you have in mind?
I'm curious if there's an investment order for those who are self employed?With the availability of Solo 401(k) plans (https://www.bogleheads.org/wiki/Solo_401(k)_plan), it's not clear how that would differ. What do you have in mind?
Solo 401k, SEP, and SIMPLE IRAs would all fall under the "401k" label as they are "employer plans" as opposed to "regular" IRAs that one opens separate from any particular employer, and are covered by "SIMPLE/etc." in the first sentence of the post (after the "appropriate for investors in the US" intro).There aren't any other investment vehicles to add into the mix? SEP IRA, how to use profit sharing for maximizing tax sheltered $, how to get a health insurance plan that allows for HSA?I'm curious if there's an investment order for those who are self employed?With the availability of Solo 401(k) plans (https://www.bogleheads.org/wiki/Solo_401(k)_plan), it's not clear how that would differ. What do you have in mind?
This ordering is appropriate for investors in the US.
In the lists below, thinking "first your governmental 457 (if you have one), then your 401k/403b/SIMPLE/etc." wherever "401k" appears is likely correct -
unless your governmental 457 fund options are significantly worse than those in the 401k/403b -
due to penalty-free access to governmental 457 funds at retirement, even if younger than 59 1/2.
Non-governmental 457b plans have deficiencies, including the inability to roll the balance into an IRA.
"Max _____" means "contribute up to the maximum allowed for _____, subject to your ability to pay day-to-day expenses."
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).
The 10-year Treasury note yield over the past year has been ~1.0%. See http://quotes.wsj.com/bond/BX/TMUBMUSD10Y.
WHAT
0. Establish an emergency fund (https://www.bogleheads.org/wiki/Emergency_fund) to your satisfaction
1. Contribute to your 401k (traditional or Roth - see "Why #4" below) up to any company match
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.
3. Max Health Savings Account (https://www.bogleheads.org/wiki/Health_savings_account) (HSA) if eligible.
4. Max Traditional IRA or Roth (or backdoor Roth (https://www.bogleheads.org/wiki/Backdoor_Roth_IRA)) based on income level
5. Max 401k (if
- 401k fees are lower than available in an IRA, or
- you need the 401k deduction to be eligible for (and desire) a tIRA deduction, or
- you earn too much for an IRA deduction and prefer traditional to Roth, then
swap #4 and #5)
6. Fund a mega backdoor Roth (https://www.bogleheads.org/wiki/After-tax_401(k)) if applicable.
7. Pay off any debts with interest rates ~3% or more above the current 10-year Treasury note yield.
8. Invest in a taxable account and/or fund a 529 with any extra.
WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 22% or higher; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise.
For those willing to expend a little more energy than it takes to flip a coin, consider comparing current marginal tax saving rate vs. predicted marginal withdrawal tax rate.
If current > predicted, use traditional. Otherwise use Roth.
See Credits can make Traditional better than Roth for lower incomes (http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-overwhelming-student-loan-debt-how-would-you-get-started/msg868845/#msg868845) and other posts in that thread about some exceptions to the rule.
See Traditional versus Roth - Bogleheads (https://www.bogleheads.org/wiki/Traditional_versus_Roth) for even more details and exceptions.
The 'Calculations' tab in the Case Study Spreadsheet (http://forum.mrmoneymustache.com/forum-information-faqs/case-study-spreadsheet-updates/) (CSS) can show marginal rates for savings or withdrawals*.
Remember to include all income-dependent effects in your marginal tax rate (https://www.bogleheads.org/wiki/Marginal_tax_rate).
The CSS does include most federal and state brackets, credits (Child Tax, Education, ACA, Earned Income, etc.), phase-ins, phase-outs, and IRMAA tiers.
It may not include some state tax details, FAFSA Expected Family Contribution, and other items irrelevant to most but important to some.
5. See #4 for choice of traditional or Roth for 401k. In a 401k there are no income-based limits for deductions or contributions.
6. Applicability depends on the rules for the specific 401k. See Mega Backdoor Roth IRA (https://www.bogleheads.org/wiki/After-tax_401(k)).
7. Again, take the risk-free return if high enough. Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
(e.g., target retirement date) that provides a blend of stock and bond returns. If you wish to consider separate bond funds, compare the yield on a fund
with a duration similar to the time remaining on the loan, and put your money toward the one with the higher after-tax interest/yield.
8. Because taxable earnings will still help your FI journey. If your own retirement is in good shape, and you choose to provide significant help for children's college costs,
a 529 plan (https://www.bogleheads.org/wiki/529_plan) may be appropriate. Similar to "put on your own oxygen mask before assisting others," do consider funding your own retirement before funding 529 plans for children's college costs.
Speaking of things to do first, see Getting started - Bogleheads (https://www.bogleheads.org/wiki/Getting_started) if this is all new. Working through that post and the links therein is also a good refresher, even if personal finance isn't completely new to you.
The emergency fund is your "no risk" money. You might consider one of these online banks: http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001, or possibly use a Roth IRA as an emergency fund (https://www.bogleheads.org/wiki/Roth_IRA_as_an_emergency_fund).
It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end.
If you are renting, you may not be throwing away as much on rent as you might think. See http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/ for some thoughts.
For those concerned about "locking up" money in retirement accounts until age 59.5, see How to withdraw funds from your IRA and 401k without penalty before age 59.5 (https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/).
If your 401k options are poor (i.e., high fund fees) you can check the Expensive or mediocre choices (https://www.bogleheads.org/wiki/401(k)#Expensive_or_mediocre_choices) section of the Bogleheads 401(k) wiki for some thoughts on "how high is too high?"
See MAGI - Bogleheads (https://www.bogleheads.org/wiki/MAGI) for the MAGI calculations applicable to Roth IRA contributions and traditional IRA deductions.
Then see IRA Contribution Limits (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits) and IRA Deduction Limits (https://www.irs.gov/retirement-plans/ira-deduction-limits) for the IRS limits on those MAGI amounts.
If one can swing the cash flow, getting in and out of an ESPP is ~"free money". But if one has to make a choice between deferring income in a 401k vs. taking the income and using it for an ESPP, it isn't the same. The benefits of employee stock purchase plans (ESPPs) relative to other opportunities is highly dependent on tax rates, because ESPP benefits all occur in taxable accounts.
- For someone paying 12% tax on ordinary income, and 0% on dividends and capital gains, ESPPs can be very favorable, perhaps competing with high interest rate loans in step 2.
- For someone paying 22% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
Priorities above apply when income is primarily through W-2 earnings. For those running their own businesses (e.g., rental property owner, small business owner, etc.),
putting money into that business might come somewhere before, in parallel with, or after step 5.
Why it is likely better to invest instead of paying a low interest rate mortgage early, if you have a long time until the mortgage is due:
https://www.thebalance.com/rolling-index-returns-1973-mid-2009-4061795
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
*Estimating withdrawal tax rates is not an exact science, but here is one approach:
1) Estimate any guaranteed income. E.g., pension you can't defer in return for higher payments when you do start, rentals, etc.
2) Take current traditional balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so. Take 4% of that value as an annual withdrawal.
3) Take current taxable balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so. Take 2% of that value as qualified dividends.
4a) Decide whether SS income should be considered, or whether you will be able to do enough traditional->Roth conversions before taking SS.
4b) Include SS income projections (using today's dollars) if needed from step 4a.
5) Calculate marginal rate on withdrawals from traditional accounts using today's tax law on the numbers from step 1-4.
6) Make your traditional vs. Roth decision for this year's contribution
7) Repeat steps 1-6 every year until retirement
The steps above may look complicated at first, but you don't need great precision. The answer will either be "obvious" or "difficult to choose". If the latter, it likely won't make much difference which you pick anyway.
You may want to do more complicated planning if you expect your earning history to vary greatly over the course of your career. The usual example is "MDs still in residency" but if you reasonably expect your inflation-adjusted annual earnings to increase by, say, a factor of 3 or more this may apply. See Estimating withdrawal tax rates (https://forum.mrmoneymustache.com/investor-alley/estimating-withdrawal-tax-rates/) for more discussion.
Note the possibility of self-defeating predictions:
a) predict high taxable retirement income > contribute to Roth > get low taxable retirement income
b) predict low taxable retirement income > contribute to traditional > get high taxable retirement income
Also, if you pick traditional and that ends up being wrong it will be because you have "too much money" - not the worst problem.
If you pick Roth and that ends up being wrong it will be because you have "too little money" - that could be a problem.
Thus using traditional is a "safer" choice.
I'm currently wondering about the pointThere is this: "Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.
I have a loan with 3.19% interest rate. So far I've been investing any spare money instead of paying off the loan above the required monthly payment. Inflation currently is higher than the interest rate. Our 10y government bonds have negative return.
Recently I'm wondering if 3.19% guaranteed return is actually not quite acceptable given the current market valuations as well as the possible rate hikes.
Any thoughts on this subject?
I'm currently wondering about the point
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.
I have a loan with 3.19% interest rate. So far I've been investing any spare money instead of paying off the loan above the required monthly payment. Inflation currently is higher than the interest rate. Our 10y government bonds have negative return.
Recently I'm wondering if 3.19% guaranteed return is actually not quite acceptable given the current market valuations as well as the possible rate hikes.
Any thoughts on this subject?This ordering is appropriate for investors in the US.
CANADA
What:
0: Pay off any high interest debts and establish emergency fund based on your risk tolerance
1: Max out your contributions to your TFSA
2: If you are saving for a downpayment of your first home, max out FHSA in 2023 (link below)
3: Contribute to your RRSP (remember that $25,000 can be used for a down payment through the first time home buyer's plan if you have not owned a house in the last 4 or 5 years)
4: Pay off your mortgage and low interest debt
5: Invest in non-registered funds
Why:
0: High interest debt is a huge drag on your money, and you'll be much happier without it. An emergency fund is a fairly personal decision, if you are risk averse or work in a boom/bust industry then a substantial emergency fund can help you sleep at night. If you have a very stable career and are comfortable with 'springy debt' as described in the Australia section you probably don't need much.
1: The TFSA is a pretty amazing investment vehicle, particularly if you're young. You contribute after tax dollars and never pay tax again on the money, regardless of how much it grows. You have the option of withdrawing money and preserving the contribution room in the following year, but withdrawals should be avoided unless there's a really good reason for it (people often invest their mortgage downpayment in their TFSA, which may be appropriate if you're planning on buying 'in a few years').
2: If it is as advertised in 2023, FHSA is just as good as TFSA if you are a first time home buyer, and want to buy a home.
3: RRSP are a reasonable tax deferred investment vehicle, you don't pay tax (or are refunded taxes if you contribute after tax dollars) on the contributions, but do pay tax when the money is withdrawn. You will pay taxes on the withdrawn money as income, rather than potentially more favourable capital gains and dividend tax rates. In general, the fact that your RRSP can grow for years tax free should balance the potential tax consequences. If you are discovering MMM after working for a few years, you will probably find that you have fairly vast contribution room in your RRSP (it grows at 18% of your salary/yr).
4: Low interest in this context means 'close to or less than the expected return on your investments'. Less debt is pretty great. You may decide to invest in non-registered (taxable) accounts rather than paying off your mortgage at this phase, either way is fine and it will depend primarily on your risk tolerance and what your best guesses are on what your interest rate will be.
5: Shovel money into your taxable accounts. Remember that eligible Canadian dividends are taxed at a preferential rate (as are dividends from VCN or similar index funds), but that this is not true of international dividends.
Possible Variations:
- If your income in retirement is likely to be higher than your working income, you should avoid investing in your RRSP. This is possible if you have a lot of money in your RRSP, a relatively low income and are approaching 71, when you you will be required to start withdrawing a percentage of your RRSP. You can probably avoid this by retiring earlier and drawing down your RRSP in a controlled manner prior to control your taxes.
- If your income is very high, and you expect it to be lower in retirement (eg. you started saving late in life but have a high salary) then it might be optimal to be contributing to your RRSP before your TFSA.
- RRSP income is considered as 'income' for tax purposes, as is your Canadian Pension Plan (CPP). In a perfect world you'll be able to keep your income below ~ $71,000/yr after you reach 65 years so that you can receive the Old Age Supplement. It's hard to know whether this program will change if you're currently relatively young, but if you're in your 50s then it's worth looking at your taxes pretty carefully to try and make sure you're not inadvertently limiting your wealth by having a suboptimal withdrawal strategy.
- Mortgage choices are pretty personal, and depend a great deal on where you live. Between the TFSA and First Time Home Buyer Plan you should be well on your way to a downpayment if you don't own a house. If a purchase is imminent (6 months or a year?) then you should be invested in something very safe (eg. GICs) or in cash.