Author Topic: $9500 raise. Now what?  (Read 3814 times)

monstermonster

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$9500 raise. Now what?
« on: April 29, 2015, 01:47:15 PM »
I'm a big fan of mustachianism and have lurked on the forums but this is my first post!

Why? I just got a $9500 raise yesterday (particularly notable given that I am in the nonprofit sector.) For context I should mention I'm 27 years old with no debt.

Now that I have a raise, I'm making sure I immediately allocate most of it to retirement/savings but I'm struggling with something that no amount of googling has really given me confidence in: 401(k) vs Roth IRA when you have no match BUT your work covers the fees. Not while I'm not shooting to ever "retire" (I love what I do and want to do it until I'm not physically able), I am striving for financial independence through frugalism and boring investment.

1) I currently have a Roth IRA that I now have enough income to max out at $5500 a year. I like the allocation and limited fees I have and my income is low enough (just under $40K with the raise now) that it's likely I'll move up a different tax bracket at retirement age (if I do things right).

2) My work does not match 401(K) at all but they do cover the fees, making it an essentially fee-free. The advantages of automatic deduction, no fees, and lowering my taxable income are tempting.

My temptation, based on extensive reading, is to max out my roth IRA and then give 2%-5% to my 401(K) on top of that. I'm also considering putting it in an index EFT since that's available sooner than 40 years from now.

Thoughts? Disadvantages? Should I put it into something more flexible given that I'm currently saving $380/month for a house down payment as well? (In 18 months I get a $6000 matching grant for the down payment due to a savings program I am, making my return over 100%)

Thanks for all your thoughts. Mustachians are the best.

JLee

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Re: $9500 raise. Now what?
« Reply #1 on: April 29, 2015, 01:52:47 PM »
I am not as financially well-versed as many people here, but my first thought is to contribute enough to your 401k to duck out of the 25% tax bracket entirely, and then fund your Roth IRA.

nereo

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Re: $9500 raise. Now what?
« Reply #2 on: April 29, 2015, 01:58:41 PM »

1) I currently have a Roth IRA that I now have enough income to max out at $5500 a year. I like the allocation and limited fees I have and my income is low enough (just under $40K with the raise now) that it's likely I'll move up a different tax bracket at retirement age (if I do things right).

My temptation, based on extensive reading, is to max out my roth IRA and then give 2%-5% to my 401(K) on top of that. I'm also considering putting it in an index EFT since that's available sooner than 40 years from now.

Thoughts? Disadvantages? Should I put it into something more flexible given that I'm currently saving $380/month for a house down payment as well? (In 18 months I get a $6000 matching grant for the down payment due to a savings program I am, making my return over 100%)
Congrats on the raise, and welcome to the forum (at least posting to it)
First, I would question your assumptions for #1).  The reason is that you get a tax-break on the last-dollar-in (highest tax bracket, for you 15%), whereas when you take funds out you are taxed on the first-dollar-out.  Basically I think there's a high likelihood that you will pay less in taxes overall with a t-IRA, even making $40k/year. 

Besides that, I would recommend putting as much as possible into your 401(k) - the tax deduction now is nice, but tax-free growth can be even more powerful over time.  Don't worry about funds not being available until "40 years from now".  If you stick with the ROTH you can withdraw contributions fairly easily, and you can either convert or use SEPP to get money out of your 401(k), all before you turn 59.5

keep it up and good luck.

JLee

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Re: $9500 raise. Now what?
« Reply #3 on: April 29, 2015, 02:20:22 PM »

2) My work does not match 401(K) at all but they do cover the fees, making it an essentially fee-free. The advantages of automatic deduction, no fees, and lowering my taxable income are tempting.

My temptation, based on extensive reading, is to max out my roth IRA and then give 2%-5% to my 401(K) on top of that. I'm also considering putting it in an index EFT since that's available sooner than 40 years from now.


In general, the discussion of 401k vs. Roth IRA for retirement savings boils down to:
1) what tax bracket you expect to retire in
2) how (un)favorable are the available fund options and expense ratios in the 401k

I assume "work covers all the fees" means something like they pay the 401k administrator $5/month or whatever to maintain your account. That's very common and I've never heard of a 401k plan where individuals have to pay account fees. The fees you should be concerned with are expense ratios (what % of assets does the 401k administrator charge for to cover the overhead costs of each fund). One of the main arguments for funding a Roth IRA first is that you can choose the account custodian with the best, lowest-cost index funds.

It's a mistake to use taxable investments (the index EFTs) to save for retirement before maxing out tax-advantaged and tax-deferred space. Even if you decide to retire earlier ("access the money sooner than 40 years from now"), there are 72(t) SEPP withdrawals or a 401k to Trad IRA to Roth IRA conversion pipeline that you can use to access that money.

The way I see it, if you put the $9500 straight into the 401k you increase your savings by $9500. If you put it into your Roth IRA, assuming you're in the 25% bracket and have no state taxes, you have $7125 to invest in savings. The true advantage of using the 401k is not so much the tax break now, but the extra money that would have been taxed as earned income growing for 40+ years with no capital gains tax.

The OP is under $40k/yr, so he's only ~$2k into 25% territory ($37,450). If he anticipates higher income later in his career, wouldn't the Roth be advantageous now?  That was my line of thought - but come to think of it, if he's anticipating staying in the 15% bracket for retirement, then traditional may be the way to go.

monstermonster

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Re: $9500 raise. Now what?
« Reply #4 on: April 29, 2015, 02:33:41 PM »
Thanks y'all. I also see one of the advantages of the 401(k) as the fact that it's just MAGIC and I won't be tempted into any lifestyle inflation if it's deducted and invested before I get my paycheck.

Yup, I'm barely into the 25% range with my day job income, but I should mention that I also work contract work on the side pretty often (which is *ohsofun* at tax time) so I usually have about $2-7K of contract income, depending on the year. So for 2015 I may have over $4-9K in the 25% range, but I don't know right now. I often can write off a lot of work travel for the contract work, further complicating it.

I live in a city with one of the tightest rental markets in the country (my rent has been jumping 5-10% annually and I still pay vastly below market so if I had to move it would nearly double), so saving for a down payment is definitely a high priority for me, making me wonder if I should allocate a larger portion of my income towards the down payment savings now, while I can. But that compound interest in the 401(k)...

(Not to mention that as someone who gives 10% of my income to charity, if I owned a home I'd be able to itemize, and then those donations would be worth some deduction $$.)

monstermonster

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Re: $9500 raise. Now what?
« Reply #5 on: April 29, 2015, 03:23:28 PM »
The mortgage interest tax deduction is a bad way to rationalize buying a home. It's a definite tax advantage, but not one that should make you alter your savings strategy.
I definitely agree with that, and am definitely not using it to rationalize the buying of a home. But the combination of the mortgage interest deduction + my 10% charitable donations I can't currently tax deduct (because I take the standard deduction) seems like a worthwhile consideration when it comes to considering buying a home *sooner*. But now that I do the math, $3900/year of charitable giving is still only $390/year of tax savings, even in the best case scenario...

If you are already saving 10% for retirement, I'd say you could decide to increase your savings for a home down payment at that point. If you are saving less than 10%, I'd suggest bumping up to there before saving for other goals.
I save 14% for retirement already, so this is a decent yardstick. Thanks.

mxt0133

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Re: $9500 raise. Now what?
« Reply #6 on: April 29, 2015, 04:18:15 PM »
Read this article if you are still debating between 401k vs Roth IRA.

http://www.gocurrycracker.com/roth-sucks/

Again this is only for funds that you would be using for "retirement" and assumes that you will be withdrawing funds when you are generative very low earned income.

SpicyMcHaggus

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Re: $9500 raise. Now what?
« Reply #7 on: April 29, 2015, 10:38:38 PM »
Put all the extra into 401k. You didn't need it before, you don't need it now.