Author Topic: New to this: Order of Contribution - Tax Sheltered to Taxable  (Read 516 times)

SamBea

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New to this: Order of Contribution - Tax Sheltered to Taxable
« on: February 27, 2019, 07:20:21 PM »
Hey!

I'm 27 and have been contributing to a 401k through work and then placing the remaining in a taxable Vanguard account (both accounts are 100% in VTSAX). If i'm understanding the other posts correctly, my order of allocation should be first max out 401k, then max out Roth or Traditional IRA (any reccos on which?) and then put remaining in a taxable account. Is this correct?

This leads to a follow up question. How does one retire early when contributions are capped? When would it be better to shovel as much money in a taxable account knowing that that money could build a larger principle and compound quicker.

Thanks!
Sam

ILikeDividends

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Re: New to this: Order of Contribution - Tax Sheltered to Taxable
« Reply #1 on: February 27, 2019, 07:26:35 PM »
See this thread to address your first question:
https://forum.mrmoneymustache.com/investor-alley/investment-order/

To your second question, yes, once you have maxed out your annually capped contributions to tax advantaged accounts, plow as much additional into your taxable account as you can after that.

TheHardenedInvestor

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Re: New to this: Order of Contribution - Tax Sheltered to Taxable
« Reply #2 on: February 28, 2019, 02:29:41 PM »
Go Curry Cracker suggests this basic breakdown, which I’m about 98% in agreement with. Individual priorities could alter this slightly.

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For a rule of thumb, I would save funds into accounts in this order during the working years:
401k up to company match
HSA
401k up to maximum
Traditional IRA if tax deductible (subject to MAGI thresholds)
Brokerage account
Maybe $5k in a Roth (subject to MAGI thresholds)
Maybe after-tax contributions to a 401k for Backdoor Roth (pros/cons)
Source: https://www.gocurrycracker.com/roth-sucks/

Boofinator

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Re: New to this: Order of Contribution - Tax Sheltered to Taxable
« Reply #3 on: February 28, 2019, 02:44:33 PM »
Verify whether you can deduct the Traditional IRA: https://www.irs.gov/retirement-plans/ira-deduction-limits

My opinion of Roth is similar to GCC (unless you are making so little money that your tax bill is zero). If you cannot deduct Traditional IRA, I would try to invest at least $20k per year in a taxable account before I fund a Roth IRA in order to tax loss harvest.

MDM

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Re: New to this: Order of Contribution - Tax Sheltered to Taxable
« Reply #4 on: February 28, 2019, 09:52:38 PM »
When would it be better to shovel as much money in a taxable account knowing that that money could build a larger principle and compound quicker.
That's not how compounding works.

A bunch of smaller accounts grow just as fast as one large account, assuming the same investments in each.  Try some quick calculations to prove it to yourself if needed.

MDM

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Re: New to this: Order of Contribution - Tax Sheltered to Taxable
« Reply #5 on: February 28, 2019, 10:02:52 PM »
I'm 27 and have been contributing to a 401k through work and then placing the remaining in a taxable Vanguard account (both accounts are 100% in VTSAX). If i'm understanding the other posts correctly, my order of allocation should be first max out 401k, then max out Roth or Traditional IRA (any reccos on which?) and then put remaining in a taxable account. Is this correct?
It can be, but see the investment order post linked previously for details.  Often maxing an IRA comes before maxing the 401k.

The choice of Roth vs. traditional depends on your income.  See Traditional versus Roth - Bogleheads.  If it's clear to you after reading that, go forth and do what is clear.  If it's still a little murky, you might take your best guess and reply with "I think I should choose ______ now because _______."  You'll likely get good feedback, with reasons.

Assuming investment gains, taxable is never better than Roth.  Whether traditional is better than Roth and taxable depends on your current marginal tax rate vs. the marginal tax rate when you would withdraw traditional funds.  For most - but not all - traditional, particularly in the 22% and higher brackets, will be better than both Roth and taxable.

Boofinator

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Re: New to this: Order of Contribution - Tax Sheltered to Taxable
« Reply #6 on: March 01, 2019, 11:10:49 AM »
Assuming investment gains, taxable is never better than Roth.  Whether traditional is better than Roth and taxable depends on your current marginal tax rate vs. the marginal tax rate when you would withdraw traditional funds.  For most - but not all - traditional, particularly in the 22% and higher brackets, will be better than both Roth and taxable.

Unless you tax loss harvest. Depending on your tax bracket, the return on investment can be quite significant (especially up-front), and all you have to beat is the 0.3% or so annual dividend tax. This assumes you would pull funds out during early retirement, when you're taxed 0% on qualified dividends and long-term cap gains. (This also assumes you would be willing to put in the little bit of extra effort required to TLH.)

MDM

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Re: New to this: Order of Contribution - Tax Sheltered to Taxable
« Reply #7 on: March 01, 2019, 02:49:20 PM »
Assuming investment gains....
Unless you tax loss harvest.
But that violates the assumption. :)

Yes, in a random year (e.g., 2018) one may have significant TLH opportunities.  But in the long run, anyone paying tax on LTCGs and QDs will likely be better having money in Roth instead of taxable.

Even if one does not pay tax directly on LTCGs and QDs, those count toward the taxability of SS benefits, but Roth withdrawals do not.

Boofinator

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Re: New to this: Order of Contribution - Tax Sheltered to Taxable
« Reply #8 on: March 01, 2019, 04:10:06 PM »
Assuming investment gains....
Unless you tax loss harvest.
But that violates the assumption. :)

Yes, in a random year (e.g., 2018) one may have significant TLH opportunities.  But in the long run, anyone paying tax on LTCGs and QDs will likely be better having money in Roth instead of taxable.

Even if one does not pay tax directly on LTCGs and QDs, those count toward the taxability of SS benefits, but Roth withdrawals do not.

I honestly haven't done a long-term evaluation of what comes out better. If I did, SS benefits would be the least of my concerns (it is so far in the future for most that the net present value of the change in these benefits is likely insignificant, plus I'm not super familiar with the SS pay structure). So my question would be: over the long term (30+ years), what provides a better return, assuming in taxable you get roughly 0.3% drag + $750 per year in TLH (25% federal and state)? 0.3% would begin exceeding $750 when the total amount invested in taxable exceeds $250k.

To me the answer isn't clear-cut without a deep-dive, but fortunately I earn enough money to invest in both Roth IRA and taxable so I really haven't had the urge to go off the deep end. My advice would be they probably have similar outcomes, but with Roth winning over very long terms and taxable winning over short terms.