Author Topic: Interest rate cost of NOT maxing 401k & HSA - what do YOU save by doing it?  (Read 5201 times)

J Boogie

  • Handlebar Stache
  • *****
  • Posts: 1531
So, had to share my joy after getting wife to sign off on ramping 401k contribution up from 4 grand to the full 18 and also the HSA at 6 grand.  She contributes 3% to get the match, but no more as her employer offerings are a doo doo pile of Franklin Templeton funds.  They aren't worthy to bear the name of the late great bifocal inventor.

Anyways, after doing the math, I realized we'd pay roughly $7,000 more in taxes a year if we did not do this.

The incentive would of course be to have the liquidity - but I imagine few calculate the unreal cost of that liquidity.

For us, the liquidity cost means we have $1500 less each month in our checking account. 

Therefore we'd be paying around $550 to have $1500.  Would anyone in their right mind borrow at that rate to have more liquidity?

The usual reasons (emergency fund, saving for a house) all tend to sound like valid counterpoints, but it makes a strong argument in favor of looking for more cash by cutting expenses or upping the side hustle rather than paying $7,000 more in taxes.

Anyways, most just looking to share my joy and gratitude in being able to do accomplish this step towards our goal.  How much pre-tax are YOU able to save? and how much more could you?
« Last Edit: March 02, 2015, 01:14:11 PM by J Welterweight »

mandy_2002

  • Bristles
  • ***
  • Posts: 291

Therefore we'd be paying around $550 to have $1500.  Would anyone in their right mind borrow at that rate to have more liquidity?

The usual reasons (emergency fund, saving for a house) all tend to sound like valid counterpoints, but it makes a strong argument in favor of looking for more cash by cutting expenses or upping the side hustle rather than paying $7,000 more in taxes.


Sadly, yes on that first point, but the "right mind" part may be where you get most people. :)

I don't know enough about the boards to know how much "under the table" talk is accepted, but legally that side cashflow would be taxed at your highest rate, just as the 401k is taken out of it, so if you're claiming it, it's not that great of a pull. 

The Dutchman

  • Stubble
  • **
  • Posts: 103
  • Location: Michigan
Yeah I recently came to this realization that I should NOT be putting money into a Roth without maxing out my 401k.  I feel like it was never presented that cleanly so I never grasped it. 

Anyway, I am socking away 13k per year in a 401k.  I am working to max it out over the next couple of years.  This was previously 4k (with another 9k going to Roth (I know stupid)) and as such from 2014 to 2015 I will save an additional 2.5k!!

So if you look at the numbers, after 2015, I have an additional 5k I can contribute to 401k.  Also, I may move to a HSA type medical plan next years since we are having our last in 2015.  That would be another 6k I could contribute to an HSA.  So if I can accomplish both of those over the next couple of years that is an additional 3k (11k * .28) I can keep from Uncle Sam for a while. 

Quick Numbers:
Currently saving 3k
Potential saving of 4k more

J Boogie

  • Handlebar Stache
  • *****
  • Posts: 1531
Yeah I recently came to this realization that I should NOT be putting money into a Roth without maxing out my 401k.  I feel like it was never presented that cleanly so I never grasped it. 

Anyway, I am socking away 13k per year in a 401k.  I am working to max it out over the next couple of years.  This was previously 4k (with another 9k going to Roth (I know stupid)) and as such from 2014 to 2015 I will save an additional 2.5k!!

So if you look at the numbers, after 2015, I have an additional 5k I can contribute to 401k.  Also, I may move to a HSA type medical plan next years since we are having our last in 2015.  That would be another 6k I could contribute to an HSA.  So if I can accomplish both of those over the next couple of years that is an additional 3k (11k * .28) I can keep from Uncle Sam for a while. 

Quick Numbers:
Currently saving 3k
Potential saving of 4k more


Well, the Roth definitely has the advantage of flexibility.  BTW, I thought the Roth limit was 5500/yr.  Did your partner also contribute to their Roth to get a household 9k?

Interesting you mention having children and the HSA - I am thinking in the next few years we'll probably try to get pregnant or adopt, and I should probably find a strategic time to switch plans for a couple years.  All the more reason to max out HSA contributions now since I won't be able to on a different plan.

And mandy_2002, that's a good point you bring up.  Cutting expenses definitely seems like the better route in any event, although more income, even taxed, gives you more breathing room to max out all the vehicles at your disposal.

Personally, I'm glad to have it set up automatically like this to avoid lifestyle inflation.  Long days at the office are bad but it's a huge consolation to know you're making progress and not burning through all your hard earned money, and you don't even have to think about it.

NonprofitER

  • Stubble
  • **
  • Posts: 246
  • Location: Texas
  • Reaching FIRE w/ High Purpose (Low Pay) Nonprofit
I've been trying to run some calculations to compare scenarios like this - IE, what we would save on taxes by maxing my DH's 401k, versus paying down the last of our low interest SL debt.  Especially because we got bumped to a 25% bracket in 2014.  I can't find a single calculator that helps me conceptualize the if,then's very well. 

Does anyone know of a good tool I can use to compare the tax savings of maxing out the 401k (potentially including investment gains) versus paying down the SL debt?  There's tons of mortgage vs. debt calculators out there, but that's not really what I'm looking at and the variables are so different....

While my excel skills have grown substantially since finding/ focusing on FIRE 15 months ago, I'm not quite skilled enough to set up all the variables myself yet...

I'm a red panda

  • Walrus Stache
  • *******
  • Posts: 8186
  • Location: United States
My husband and I have a 403b (me) a 401k (him), both have roth IRA, and we use taxable investment accounts.

We max the Roth, but not the 403b and 401k. 
I can put another $6,000 into my 403b; quite honestly, I have no idea what he puts into his 401k, but I'm guessing it is somewhat similar.

We have the money to be maxing these, possibly from diverting to taxable accounts, or maybe even additional investments (I think we have too much in cash, but I am so risk adverse, logically I can't convince myself that risk of inflation is higher than risk of a crash). He just doesn't want it "tied up" in retirement accounts, which is why we have equities instead. 

Is it crazy to be using taxable accounts instead? 

J Boogie

  • Handlebar Stache
  • *****
  • Posts: 1531
Hey NonprofitER, this is what I used to get a quick snapshot - lets you enter in your state so it's nice and easy.

http://www.irscalculators.com/tax-brackets-calculator.php

I don't know about any more complex calculators or formulas for determining which is a better option.. paying off low interest debt tends to offer more personal satisfaction, but in the long run I think that money would grow more in a 401k.  You might be able to get a similar psychological benefit from hitting the zero mark (assuming your equity does not already exceed your debt) though.

As far as doing those if then scenarios go, I think you'll probably have to create your own spreadsheet.  Let me know if you find one though, doesn't seem like it'd be too hard to make a customizable template.

J Boogie

  • Handlebar Stache
  • *****
  • Posts: 1531

Is it crazy to be using taxable accounts instead?

Not if there are some big moves you want to make or if you just want to have that option in the near future.

I sometimes consider the opportunity cost of maxing 401k/HSA vs saving for a down payment on a house - but there's too much up in the air in terms of family/career/lifestyle for me and my wife to feel confident about buying or building a house anytime soon.

We're both interested in starting businesses, but nothing that require all that much capital especially at first.  So for us it works for now - just making sure we take advantage of these crucial DINK years.

Cwadda

  • Handlebar Stache
  • *****
  • Posts: 2178
  • Age: 29
Congratulations, OP. You save loads of taxes by maxing out those accounts. That's why a 401(k) is very high up on the totem pole to contribute to first. Also, "when you contribute to your HSA via an automatic payroll deduction, you are able to avoid paying FICA taxes (i.e. Social Security and Medicare) on your contributions" (Mad Fientist, 2013)!

ioseftavi

  • Bristles
  • ***
  • Posts: 401
  • Location: NYC
Anyways, most just looking to share my joy and gratitude in being able to do accomplish this step towards our goal.  How much pre-tax are YOU able to save? and how much more could you?

Huge congrats to you welterweight, on the 401(k) and HSA funding you're doing.  You're gonna come out a million miles ahead.  Smart job on computing the "what would it cost me if I didn't" numbers, as well.  Most people never do them!

As of this year, we do:

My SIMPLE-IRA: $12,500
Wife 401(k): $18,000
My HSA: $3,350
Wife HSA: $3,350
NY State 529 [State tax deductible only, no federal break.  Just started this year]: $10,000

Total comes in at just over $47,000.  We have always favored tax-advantaged accounts to a huge degree - the vast majority of our savings is in qualified accounts.

How much more could we do:  The only thing I can think of is two non-deductible IRA contributions for us.  Non-deductible IRA contributions are of fairly limited utility for us, and they're also a pain in the ass.  We are also aiming to buy a property this year, so we'd rather set aside taxable cash above and beyond what we're doing.  Hopefully the property depreciation and expenses will provide a bit of a tax shield on the money we've invested there.
« Last Edit: March 03, 2015, 11:09:38 AM by ioseftavi »

dunhamjr

  • Stubble
  • **
  • Posts: 241
  • Age: 48
  • Location: Kent, WA (Seattle)
  • mustachian in training est. July 14
Anyways, most just looking to share my joy and gratitude in being able to do accomplish this step towards our goal.  How much pre-tax are YOU able to save? and how much more could you?

congrats!  being able to save that much in tax is especially nice.

my pre tax is maxed unfortunately :(  $18k (+$2k empl match) into 401k, $2500 into DC FSA, and $5150 into HSA (+1500 empl match)

my wife just bumped her pre-tax Defined Contribution to the max at 15% (was 10), and also sends $2500 into DC FSA.
the only place we really have left is my wife's 403b, which I looking to fund by the end of the year,still trying to wrangle in the last little bit of debt(student loans, 1 car note) and working on spending cuts.

adding that up we are at about $42k pre-tax planned for this year, 2015.

i have never checked the actually % saves doing this, but anything i can save is awesome.
and because of where my income falls, having this money lower my AGI is important for taking certain other tax credits/deductions into account, which means the savings is even more than just the taxes we DON'T pay on the money directly.
« Last Edit: March 03, 2015, 11:53:27 AM by dunhamjr »

bzzzt

  • Bristles
  • ***
  • Posts: 303
  • Location: Chicago
  • 5v to Lightning Bolts...
I ran the numbers also when I found out my wife has a 457 plan available. She and her co-workers all call it Deferred Comp. I never knew what it was until I was looking for ways to lower our tax liability. Basically, we're fortunate to make great money combined, but I'd have to have an extra $2200/year withheld to not owe come tax time.

The plan is to have her max it out this year but she ran up a 0% card at Christmas time (which we've since had a discussion about) and won't start until April. Now, she's waffling because "my checks will be too small". I didn't want joint finances at first just to keep her from deciding how to spend the 'stache I had built up before we married (~$100k vs -$35k). Now, she doesn't want to combine because I save/invest so much and she doesn't want to match it. I tried to offer to cover the "short fall" by transferring money into her account, but she doesn't want me to "bail her out again" (I paid her CC debt after college and SLs before we married).

Anyone else ever ran into this problem with a spouse? Resolutions?

beltim

  • Magnum Stache
  • ******
  • Posts: 2957
Therefore we'd be paying around $550 to have $1500.  Would anyone in their right mind borrow at that rate to have more liquidity?

The usual reasons (emergency fund, saving for a house) all tend to sound like valid counterpoints, but it makes a strong argument in favor of looking for more cash by cutting expenses or upping the side hustle rather than paying $7,000 more in taxes.

Anyways, most just looking to share my joy and gratitude in being able to do accomplish this step towards our goal.  How much pre-tax are YOU able to save? and how much more could you?

I don't want to rain on your parade, but a 401k is only a tax-deferred account.  So sure, you're saving $7,000 per year in taxes now, but you'll pay back a portion of that when you withdraw the amount.  This of course doesn't change the wisdom of your strategy – it just changes the amount.

rpr

  • Guest
The thing is that even under the worst circumstances, you will always be able to access your 401K. Sure you will pay taxes and possibly penalties if you withdraw. But in a real long-lasting emergency, you probably don't care. Even the illiquidity barrier can be overcome in a 401K.

Also, most 401Ks provide the abilities to take loans.

We are currently maxing out 2 403Bs and 2 IRAs. Unfortunately, no HSAs as no HDHPs are offered by employer.

The Dutchman

  • Stubble
  • **
  • Posts: 103
  • Location: Michigan
....
Well, the Roth definitely has the advantage of flexibility.  BTW, I thought the Roth limit was 5500/yr.  Did your partner also contribute to their Roth to get a household 9k?

Interesting you mention having children and the HSA - I am thinking in the next few years we'll probably try to get pregnant or adopt, and I should probably find a strategic time to switch plans for a couple years.  All the more reason to max out HSA contributions now since I won't be able to on a different plan.
....

Yes, wife and I both have a ROTH.  I did it because my investment options with my old employer were crap.  However, now that I understand it I should have still socked as much as possible in 401k.  Live and Learn

Also, if you have not done the HSA previously then there is a learning curve.  Ask around on here to see how people are doing it.  I had a kid on an HSA.  I talked to the hospital ahead of time and set up a payment plan to pay it off prior to having the kid.  Obviously it was just a ball park number since you don't know what services are actually needed months before.  However, the difference was stunning.  I shelled out like 3k in advance and another 1k after the fact; if I waited till after it could have been a little more.  Basically you get a discount for paying cash (on your HSA card) and not going through insurance; you also (in some cases like mine) can negotiate down further if you pay up front.  I asked what the cost is to insurance companies out of curiocity and it was like 7k or 8k; CRAZY. 

I don't want to rain on your parade, but a 401k is only a tax-deferred account.  So sure, you're saving $7,000 per year in taxes now, but you'll pay back a portion of that when you withdraw the amount.  This of course doesn't change the wisdom of your strategy – it just changes the amount.

This is a good point for people to remember.  We are not "saving" that full amount in the long run.  However, what you are doing with a 401k is assuming that your tax bracket will be less in retirement.  So instead of getting taxed at 28% today I am hoping it will be in the 15% range at retirement time.

J Boogie

  • Handlebar Stache
  • *****
  • Posts: 1531
I don't want to rain on your parade, but a 401k is only a tax-deferred account.  So sure, you're saving $7,000 per year in taxes now, but you'll pay back a portion of that when you withdraw the amount.  This of course doesn't change the wisdom of your strategy – it just changes the amount.

Word.  I think most of us plan on withdrawing from our 401ks to be taxed in the lowest tax brackets and withdraw any extra we need from our Roths.  Hard to say 30 years out what tax policy will look like.  I think the premise of 401k being a better option that Roth is the compound interest you'd earn on that extra untaxed 25% will have greater yields even after you tax the withdrawls.  Is that a generally accepted premise or can it be disproved with certain circumstances?

Sid Hoffman

  • Pencil Stache
  • ****
  • Posts: 928
  • Location: Southwest USA
Yes, wife and I both have a ROTH.  I did it because my investment options with my old employer were crap.  However, now that I understand it I should have still socked as much as possible in 401k.

I see a few mentions of not wanting to contribute to a 401k because people didn't like the options.  However, even a 1-2% expense ratio is nothing compared to potentially saving 18-40% in taxes.  Furthermore, I quoted the post above because it said "my old employer".  In the modern world, people change jobs all the time.  I couldn't find government stats on the topic, but my Googling led me to articles implying that many employees switch jobs every 4 years or so.  I know at least one of my co-workers who's around 40 has never stayed with one company more than 5 years and pretty openly stated that's her plan so that she's constantly advancing and expanding her skillset.

So with that in mind, it should be viewed that you're saving 18-40% or so in taxes in the initial year, maybe paying 1-2% more per year in expenses than an index fund, but after 5 years you'll be on to your next company and can roll over the 401k into a traditional IRA.  I suspect that many here reached that same conclusion; that since you don't stay at your employer for life, it's better to donate as much as you can afford and roll it over to something like a Vanguard IRA every time you leave your old employer.

beltim

  • Magnum Stache
  • ******
  • Posts: 2957
I don't want to rain on your parade, but a 401k is only a tax-deferred account.  So sure, you're saving $7,000 per year in taxes now, but you'll pay back a portion of that when you withdraw the amount.  This of course doesn't change the wisdom of your strategy – it just changes the amount.

Word.  I think most of us plan on withdrawing from our 401ks to be taxed in the lowest tax brackets and withdraw any extra we need from our Roths.  Hard to say 30 years out what tax policy will look like. I think the premise of 401k being a better option that Roth is the compound interest you'd earn on that extra untaxed 25% will have greater yields even after you tax the withdrawls.  Is that a generally accepted premise or can it be disproved with certain circumstances?

Regarding the bolded portion: a 401k is advantageous when you save money on taxes compared to a Roth.  It doesn't have anything to do with compound interest.

 

Wow, a phone plan for fifteen bucks!