Author Topic: 403(b) or FU Money?  (Read 4502 times)

DougStache

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403(b) or FU Money?
« on: December 14, 2013, 08:31:17 AM »
Hey all,

I am working on my savings plan for 2014, and would appreciate a touch of advice from the pro's out there.  My real question is regarding the 403b vs a personal investment account, but if you have any other critique of something I might be over looking, please let me know.

I am a software developer, and my wife is currently a substitute teacher.  On top of our 6 month emergency fund, we have about 9k extra in savings that needs to be put somewhere productive and I have a bonus of ~10k coming in February.  On my 401k my employer matches 1.2x up to 5k/year (i.e. I put in 5k, they put in 6k), and offers awesome low expense vanguard funds.  Those are most of the pertinent details, so here is my plan:

Roth IRA:
- Early January, split 9k between my Roth IRA, and my wife's Roth IRA
- Contribute $500 to each Roth IRA at the end of January and February (Roth IRA's maxed)

401k:
- In January, up my contribution to 25% (~1550/month)
- Put 100% of my 10k bonus into the 401k
- This is maxed in May, with 17,500 of my funds, and 6,000 of my employers funds.

Once these two are maxed out, we will have $1400/month leftover in the summer (wife not working) and $2600/month leftover otherwise.  My current plan is to put this extra money into a vanguard account to have some easily accessible "fuck you" money.  However, I know my wife also has an option of a 403(b) but I don't know any details beyond the fact that there is no match offered.

Should I continue with my plan of a personal investment account, or more seriously consider the 403(b)?  Is there anything else I'm overlooking here?

Thanks!

Doug

brewer12345

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Re: 403(b) or FU Money?
« Reply #1 on: December 14, 2013, 09:20:31 AM »
What is your all-in marginal tax rate on the extra earnings?  That would drive my decision.

DougStache

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Re: 403(b) or FU Money?
« Reply #2 on: December 14, 2013, 09:40:17 AM »
If this year is any indicator, we'll bring in ~105k next year.  Subtract $17,500 for the 401k.  Subtract $2,000 for the 10% of my wife's paycheck that goes to her pension.  We're left with $85,500.  So approximately 12k will be taxed at 25%, and the rest at 15%.  Since the amount will be 20-25k, lets average them and say it'll be taxed at 20%.

However, I suppose we could change up our strategy and use IRA's instead of Roth IRA's. 
a) We'd only be taxed on ~$74,500 which puts us mostly being taxed at 15% on the extra, instead of 20%
b) We'd give up early access to our contributions but that may not matter as much if we're contributing to a FU money account. 
c) We couldn't do a big lump sum deposit.  Perhaps we could start the FU money account early, and feed a Traditional IRA through the year. 

This would save us ~$1250 on taxes, for the cost of giving up early access to contributions and the hassle of setting up new accounts.

Do you think that's the right road to go down?  I normally don't analyze the tax rates like that, so I'm a bit out of my comfort zone here.

DougStache

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Re: 403(b) or FU Money?
« Reply #3 on: December 14, 2013, 09:42:44 AM »
Actually, I got a bit derailed from my original question.  Dropping the $9,000 as a lump sum isn't an option if I go down the 403(b) road.  I suppose we'd have to deposit heavily into our savings accounts and live off the $9,000 in order to "deposit" it.

brewer12345

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Re: 403(b) or FU Money?
« Reply #4 on: December 14, 2013, 12:48:51 PM »
If this year is any indicator, we'll bring in ~105k next year.  Subtract $17,500 for the 401k.  Subtract $2,000 for the 10% of my wife's paycheck that goes to her pension.  We're left with $85,500.  So approximately 12k will be taxed at 25%, and the rest at 15%.  Since the amount will be 20-25k, lets average them and say it'll be taxed at 20%.

However, I suppose we could change up our strategy and use IRA's instead of Roth IRA's. 
a) We'd only be taxed on ~$74,500 which puts us mostly being taxed at 15% on the extra, instead of 20%
b) We'd give up early access to our contributions but that may not matter as much if we're contributing to a FU money account. 
c) We couldn't do a big lump sum deposit.  Perhaps we could start the FU money account early, and feed a Traditional IRA through the year. 

This would save us ~$1250 on taxes, for the cost of giving up early access to contributions and the hassle of setting up new accounts.

Do you think that's the right road to go down?  I normally don't analyze the tax rates like that, so I'm a bit out of my comfort zone here.

What counts is the marginal tax rate, not the average.  So the right rate to look at is 25%, not 20%.  Any state or local income taxes you would avoid by contributing to a 403B?

In a 25% bracket I would personally choose to do a traditional IRA/403B/401k rather than Roth.  I will be semi retiring next year and I can already see that our all-in tax rate will be laughingly low, so taking the deductions along the way was a good bet.  I can convert to Roth any time I like, and I can get money out before 59.5 years of age via the roth conversion pipeline or doing an SEPP/72T plan.

That said I think a blend of savings is most helpful of all.  I would contribute enough to traditional retirement plans until you have sheltered everything that would be taxed at 25% and then I would save the rest in a taxable account for maximum flexibility.  Roth if you really must, but I would suggest that at your marginal tax bracket and above, Roth is really most useful as a conversion vehicle.

DougStache

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Re: 403(b) or FU Money?
« Reply #5 on: December 14, 2013, 02:31:40 PM »
What counts is the marginal tax rate, not the average.  So the right rate to look at is 25%, not 20%. 
You lost me here.  Let me explain my logic, to see if I'm confused or if we're talking past one another.  I really do want to make sure I understand how this math works.

Let's say I have an extra 25k left to invest at the end of the year.  If I were to somehow tax shelter this 25k, our taxable income would be $105,000 - $17,500 - $25,000 = $62,500.  Now, if this were not tax sheltered the first $11,300 would be taxed at 15% (since that is how much is left in the 15% bracket) and the remaining $13,700 would be taxed at 25%.  As a whole, this $25,000 is taxed at  (11,300 * .15 + 13,700 * .25) / 25,000 = 20.48%.



Any state or local income taxes you would avoid by contributing to a 403B? 
I am not sure how to determine this.

In a 25% bracket I would personally choose to do a traditional IRA/403B/401k rather than Roth.  I will be semi retiring next year and I can already see that our all-in tax rate will be laughingly low, so taking the deductions along the way was a good bet.  I can convert to Roth any time I like, and I can get money out before 59.5 years of age via the roth conversion pipeline or doing an SEPP/72T plan.

That said I think a blend of savings is most helpful of all.  I would contribute enough to traditional retirement plans until you have sheltered everything that would be taxed at 25% and then I would save the rest in a taxable account for maximum flexibility.  Roth if you really must, but I would suggest that at your marginal tax bracket and above, Roth is really most useful as a conversion vehicle.
I believe our plan now is going to be using Traditional IRA's instead of Roth IRA's.  When I originally decided to use a Roth, I decided it because taxes are at a historic low and would most likely be higher when I retire.  However, now I'm seeing that my spending in retirement will be much lower than my income is today and that this previous decision was incorrect.

If we use traditional IRA's, we'll have 105,000 - 17,500 - 11,000 - 2,000 = 74,500 in taxable income, which puts 99% of our income in the 15% bracket.

So, our new plan is the same as the old one with the following exceptions:

1) At the start of the year $9,000 will go to a personal investment account
2) We'll begin using Traditional IRAs instead of Roth IRAs to be more tax efficient.

Thanks brewer12345 for the nudge in the right directions!

brewer12345

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Re: 403(b) or FU Money?
« Reply #6 on: December 14, 2013, 03:26:59 PM »
I think we are talking past each other on the bracket stuff.  You want to shelter any income that will be taxed at 25%, and I think you get that.  Double check whether you can contribute to a deductible IRA and a 401k.  My recollection is that you cannot.  If that is the case, the only way to shelter the money may be to utilize the 403B.

What I meant by the state or local income tax question was simply this: do you pay a state or city income tax, and if so do you get a deduction against that tax by contributing to a 401k, IRA or 403B?  Throughout my working life I have had a state and/or local tax to pay on top of federal which made any income I could shelter a very high priority.

I think you have a sound plan overall.

DougStache

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Re: 403(b) or FU Money?
« Reply #7 on: December 14, 2013, 04:18:23 PM »
I think we are talking past each other on the bracket stuff.  You want to shelter any income that will be taxed at 25%, and I think you get that.  Double check whether you can contribute to a deductible IRA and a 401k.  My recollection is that you cannot.  If that is the case, the only way to shelter the money may be to utilize the 403B.

What I meant by the state or local income tax question was simply this: do you pay a state or city income tax, and if so do you get a deduction against that tax by contributing to a 401k, IRA or 403B?  Throughout my working life I have had a state and/or local tax to pay on top of federal which made any income I could shelter a very high priority.

I think you have a sound plan overall.
It looks like I would only be eligible for a partial deduction, since our Modified Adjusted Gross Income will be more than $96,000 (first world problems, right?) we would only be eligible for a partial deduction.  According to a calculator on Fidelity, half of it would be tax deductible.  I'd also need to file form 8606 to track the non-deductible contributions to ensure I don't pay taxes on that money when it comes out.

So at the end of the day switching from roth to traditional IRAs only shelters $5,500 instead of $11,000, leaving us with $6,200 being taxed at 25% instead of 15%.  I think I may look into what sort of investments are offered through my wife's 403(b), and if there's any low expense index funds I'll go that way.  If all they have are crappy 2%+ expense ratio funds, taking the tax hit might be worth it.

brewer12345

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Re: 403(b) or FU Money?
« Reply #8 on: December 14, 2013, 04:29:52 PM »
I think the 403B is worth looking into.  If it sucks badly I would do traditional IRas up to the limit of deductibility and put the balance in Roths.

DougStache

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Re: 403(b) or FU Money?
« Reply #9 on: December 14, 2013, 04:33:15 PM »
Well, shit. 

The only two options for a 403(b) in our school district are AIG and ING, and a quick googling shows them both shamelessly raping their 403(b) clients' accounts with expenses.  I don't think I will even consider that an option anymore.

I think you're correct, the final answer is to put $2,750 in both roths, then put the rest into traditional IRAs.  It's definitely more complexity than before, but should save around a grand on taxes this year.  I've done a lot more work, for a lot less savings in the past.

Thanks again for your help in sorting this out, I really appreciate it!

brewer12345

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Re: 403(b) or FU Money?
« Reply #10 on: December 14, 2013, 04:48:00 PM »
Too bad the 403Bs are a screw job.  I will confess to not being real up on 403bs, but I have a hazy notion that they have features that 401ks do not have.  I want to say that they may have an option to transfer the money out to another provider or an IRA while you remain employed.  It might be worth doing a little research to see if my recollections are correct because that could open up the 403B.

Happy to help.  Might as well play the game as well as you can.

DougStache

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Re: 403(b) or FU Money?
« Reply #11 on: December 18, 2013, 04:59:37 PM »
Alright, I just got off the phone with Vanguard and I may change my plan.

If I open an account with them, they require an initial deposit of $1000 for target retirement funds and $3000 for most other funds.  I was really hoping not to put post-tax money into these accounts even if I'll get a tax deduction on it a year later.

When discussing this the other day, we never really talked about the standard deduction.  If we make 105k, then contribute a total of 19.5k to pre-tax accounts, and have a standard deduction of 12.2k that puts us at a taxable income of 73.3k which neatly fits inside the 15% bracket.  I'm thinking with that, these traditional IRA shenanigans aren't worth the effort of making a deposit / waiting til next year for part back / setting up 2 new accounts / settings up paycheck deductions. 

Am I being reasonable, or should I reread http://www.mrmoneymustache.com/2011/04/24/unleash-your-inner-hasselhoff-for-greater-riches/?