Author Topic: CASE STUDY: Student Loans Gone, Next Steps!  (Read 7348 times)

RabStache

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CASE STUDY: Student Loans Gone, Next Steps!
« on: August 19, 2014, 12:17:37 PM »
This week we pay off our final student loan!  My question is where do we start putting the money next.  Our goal is to retire around 40 (I'm 25 and she is 26).  My thought is to open Vanguard accounts for both of us but I'm not sure what type of IRA to put money into based on our income levels and current 401k contributions this year.  My wife is also pregnant and due in December so she will be taking a maternity leave for half of next year (cutting her salary in half and raising our insurance).

Income: I make 75k and my wife makes 36k.  I made 67k until July 7th where I received a promotion.

Current expenses:
  • Mortgage: $630 a month (30 year @ 3.65%)
  • Utilities: Around $130 a month (Water, Gas, Electric)
  • Phone: $65 a month (Going down to $30 in October)

Assets:
  • House @ $129,000
  • 401k(s) @ $27,000
  • I've put $6,270 into my 401(k) this year.

Please let me know if more information is required or would be helpful.

CowboyAndIndian

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #1 on: August 19, 2014, 12:21:02 PM »
Congratulations!!

Most important is getting started in saving. As you are saving, you can learn about asset allocation.
Also, understand the impact of fees on the performance of any funds you buy (Vanguard index funds are great, I use their ETF's).

I expect to see a $1MM net worth post here in about 7 years :-)

RabStache

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #2 on: August 19, 2014, 12:49:18 PM »
Thank you!  We feel like great and might even celebrate by going out to eat.  Probably not though, since that conflicts with our mustaches.  I plan on going with a low cost index fund for now through Vanguard but was wondering on Roth IRA vs Traditional IRA.  If we go Traditional we plan on doing the backdoor Roth in the future.  I just didn't know which made more sense financially at the moment with all things considered.

Gone Fishing

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #3 on: August 19, 2014, 01:38:12 PM »
If you plan on retiring early and living off an income significantly less than what you earn now, you are probably better off to max out the 401(k) and the traditional IRA, then use an IRA ladder http://www.madfientist.com/retire-even-earlier/ to roll your pretax money into a ROTH, where it can then be withdrawn at retirement in a hopefully lower tax bracket penalty free. 

That said, even though pretax may be the best numerical solution, some amount in a ROTH now will provide a little more flexibility.  Hopefully you'll be back soon saying you've maxed out all your retirement options and are having to invest in taxable accounts. 

It's a headache, but start studying your prior tax returns, 2014 brackets, and IRA rules(which may very well change).  Get a good working thought model of where you stand tax wise so you can project income, deductions/credits and plan for the future tax year an beyond.  Taxes are so convoluted, 98% of the population does not really understand what is going on, be one of the 2%.


marblejane

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #4 on: August 19, 2014, 01:45:33 PM »
Have you considered building an emergency fund? You are homeowners with a baby on the way, my personal preference in that situation would be to have a chunk of my assets liquid for unexpected hospital bills/home repairs.

RabStache

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #5 on: August 19, 2014, 02:00:23 PM »
Yeah, now that our last student loan will be paid off I would like to build up somewhat of an 'emergency fund'.  My thought was around $5,000 or so.  My options of what to do with the rest of the money are:

  • Max my 401k
  • Max both IRA
  • Max both Roth IRA
  • Let it sit in the bank!

I'm not sure which to do.  Both Roth and IRA have their perks.  The thought of having some wiggle room after 5 years (Roth) sounds nice.  But I'm wondering how much that would cost in the long run.  Maybe I'll do $5,500 in both.

Catbert

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #6 on: August 19, 2014, 03:41:37 PM »
Okay, for diversity sake I would put 401k money into a traditional (after tax) 401k and the IRA money into a Roth. 

In general many people use tax deductible 401k/IRAs for money otherwise in the 25% tax bracket and Roth's for money in the 15% or lower bracket.  In your case if you make substantial 401k contributions you're probably in the 15% marginal bracket.  Next year when you're wife isn't working for 1/2 the year make everything Roth's because of your lower tax bracket.  (Assuming her time off is unpaid.)

dandarc

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #7 on: August 19, 2014, 03:50:42 PM »
Congrats!  Many good things happening.

This is going counter to what I was saying back in January in your first thread, but I'd lean towards the traditional IRA while you can.  What can I say?  The more I learn, the more the traditional makes sense to me.  We are pretty solidly in the 25% bracket - so we are saving a lot of taxes right now with traditional (assuming I can get our MAGI low enough to make traditional contributions this year) if you've got enough deductions to get down to the 15, 10, or 0 percent brackets the Roth looks better and better, but unless you're all the way down to 0%, a case can be made for traditional over Roth contributions.  Marginal rate on deposits vs effective rate on withdrawals.  State taxes play into this as well - assuming you can make more money by working in a high tax state maybe the plan would be to accumulate there, saving that much more on taxes by putting the money into the traditional IRA, then retire to a no-state-income-tax state when withdrawing.

Roth is more flexible in that you can withdraw contributions at any time, so there is that, but the higher your tax bracket today, the more that flexibility costs you.

MDM

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #8 on: August 19, 2014, 08:43:16 PM »
Yeah, now that our last student loan will be paid off I would like to build up somewhat of an 'emergency fund'.  My thought was around $5,000 or so.  My options of what to do with the rest of the money are:

  • Max my 401k
  • Max both IRA
  • Max both Roth IRA Max contribution of $5500 is total to all IRAs - once you do $5500/person to traditional you are done for the year.
  • Let it sit in the bank! Invest the rest, maybe in something similar to this

I'm not sure which to do.  Both Roth and IRA have their perks.  The thought of having some wiggle room after 5 years (Roth) sounds nice.  But I'm wondering how much that would cost in the long run.  Maybe I'll do $5,500 in both.

Good plan.  Some minor editorial thoughts above.  Good luck!

RabStache

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #9 on: August 20, 2014, 06:34:39 AM »
Yeah, now that our last student loan will be paid off I would like to build up somewhat of an 'emergency fund'.  My thought was around $5,000 or so.  My options of what to do with the rest of the money are:

  • Max my 401k
  • Max both IRA
  • Max both Roth IRA Max contribution of $5500 is total to all IRAs - once you do $5500/person to traditional you are done for the year.
  • Let it sit in the bank! Invest the rest, maybe in something similar to this

I'm not sure which to do.  Both Roth and IRA have their perks.  The thought of having some wiggle room after 5 years (Roth) sounds nice.  But I'm wondering how much that would cost in the long run.  Maybe I'll do $5,500 in both.

Good plan.  Some minor editorial thoughts above.  Good luck!

Thanks, I should have specified I meant either or!

Congrats!  Many good things happening.

This is going counter to what I was saying back in January in your first thread, but I'd lean towards the traditional IRA while you can.  What can I say?  The more I learn, the more the traditional makes sense to me.  We are pretty solidly in the 25% bracket - so we are saving a lot of taxes right now with traditional (assuming I can get our MAGI low enough to make traditional contributions this year) if you've got enough deductions to get down to the 15, 10, or 0 percent brackets the Roth looks better and better, but unless you're all the way down to 0%, a case can be made for traditional over Roth contributions.  Marginal rate on deposits vs effective rate on withdrawals.  State taxes play into this as well - assuming you can make more money by working in a high tax state maybe the plan would be to accumulate there, saving that much more on taxes by putting the money into the traditional IRA, then retire to a no-state-income-tax state when withdrawing.

Roth is more flexible in that you can withdraw contributions at any time, so there is that, but the higher your tax bracket today, the more that flexibility costs you.

As always, thank you for the advice - you are on top of it!  I was doing some calculations without fully understanding everything and here is what I came up with:

25% tax bracket for married filing jointly is $73,801.  Our income this year will be ~$107,000 (rough estimate with mid year promotion and my wife worked the summer).  If I max out my 401k and add the standard deduction (17,500 + 12,400 = 29,900) that would mean we would be at $77,100 so would still benefit in putting ~4,000 into an IRA as opposed to a ROTH IRA if I'm following the 15% rule.  I do like the thought of having some flexibility in case of an emergency.  What am i missing in my calculations?

*Edit - Also our child is due mid December so we SHOULD have her in 2014.  I'm not sure what that does to the calculations.
« Last Edit: August 20, 2014, 06:36:18 AM by RabStache »

Manguy888

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #10 on: August 20, 2014, 07:48:42 AM »
just a note - and maybe it was said already on this thread - but in your situation your traditional IRA contributions are only tax deductible if your taxable income is less than 95k. It doesn't work like a 401k where the money disappears before it is taxed. you pay taxes and then, if you qualify, you get the deduction afterwards. If you don't get the deduction, it seems like a no brainer to go with the Roth IRA instead.

If I'm wrong here, please correct me.

dandarc

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #11 on: August 20, 2014, 07:50:27 AM »
You're forgetting personal exemptions - for 2014 you, your wife, and new baby each add 3950 to your standard deduction, when determining your taxable income.  Your daughter might even be worth even more with tax credits you may qualify for.  So if you max that 401K, take standard deduction / exemptions, you're in the 15% bracket, even if your daughter doesn't get here till January, when it comes to your IRA decision - case can still be made for traditional, but 15% is pretty low so it is a less compelling case than at 25% - particularly given that we can't know what the rates will be in 10 years or whatever the time-frame is.  Remember to account for state income taxes, if applicable - if you're in California, for example, that adds 9.3% to the equation.

http://rootofgood.com/make-six-figure-income-pay-no-tax/ is a great post showing just how little income tax you can pay if you take advantage of all of the perks the system provides.


dandarc

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #12 on: August 20, 2014, 07:53:36 AM »
just a note - and maybe it was said already on this thread - but in your situation your traditional IRA contributions are only tax deductible if your taxable income is less than 95k. It doesn't work like a 401k where the money disappears before it is taxed. you pay taxes and then, if you qualify, you get the deduction afterwards. If you don't get the deduction, it seems like a no brainer to go with the Roth IRA instead.

If I'm wrong here, please correct me.

Right, but in OP's case, he's got no problem getting under the limit for this year - you subtract health insurance premiums, HSA contributions, and your 401K deferrals, and I think even student loan interest - most above the line deductions - and compare that to the 95K limit.

RabStache

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #13 on: August 20, 2014, 07:56:11 AM »
just a note - and maybe it was said already on this thread - but in your situation your traditional IRA contributions are only tax deductible if your taxable income is less than 95k. It doesn't work like a 401k where the money disappears before it is taxed. you pay taxes and then, if you qualify, you get the deduction afterwards. If you don't get the deduction, it seems like a no brainer to go with the Roth IRA instead.

If I'm wrong here, please correct me.

Hmm I would be interested to hear more on this.  As it stands now I'm leaning towards maxing my 401k and going Roth for our IRA's but I just want to be sure that is the best choice.  I'll definitely be doing that next year but this year when we are both making a full salary I'm undecided.

Manguy888

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #14 on: August 20, 2014, 08:22:16 AM »
http://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits

It sounds like, based on the other comments, that you fall under the 95k, so trad. IRA would be a good options for now. Once you get over that limit, though, it doesn't really have any benefit until you make over 188k (then you can use the trad. IRA as a way to backdoor into a Roth).

I'm not the most mustachian person on here - I worry a little that people try to perfectly optimize these tax strategies based on rules that can (and will) change by the IRS. I forego the perfect strategy and instead try to spread my money between tax deferred, roth, and taxable. I keep things like SEPP and Roth ladders in my back pocket, but I don't base a whole retirement strategy on them, because at any time the IRS can decimate them.

dandarc

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #15 on: August 20, 2014, 08:25:45 AM »
Manguy beat me to the link regarding IRA deduction limit but one thing:

I was wrong earlier about student loan interest - you add that back to AGI to arrive at MAGI for this purpose.

[edit: adding link] https://www.wellsfargoadvisors.com/financial-services/investment-products/iras/traditional-ira.htm

One notable absence from the list of things you add back in is your 401K contributions - so if you're going to be close, and you want to do a traditional IRA, you might bump up that 401K contribution to the extent you can.
« Last Edit: August 20, 2014, 08:30:36 AM by dandarc »

Cheddar Stacker

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #16 on: August 20, 2014, 08:48:56 AM »
RabStache, play with this: https://turbotax.intuit.com/tax-tools/calculators/taxcaster/

Obviously having the child in 2014 is a big variable, but let's assume you get a new tax deduction for Christmas. Your number was $77,100, but as dandarc mentioned you forgot exemptions of $3,950/person so $3,950 * 3 = $11,850. This puts your taxable income at $65,250 which is solidly in the 15% bracket. In addition to the extra exemption, you will receive a $1,000 child tax credit. This doesn't affect your tax rate (15%/25%) but it reduces your tax due by $1,000 just like federal withholdings. After the child tax credit your total taxes would come in just under $8,000 without any Traditional IRA's.

It seems like there is only a 15% benefit to using Traditional IRA's. At that point, most people don't think it's worth it, and they would choose a Roth IRA. But then there's this: http://www.madfientist.com/retire-even-earlier/

Good luck figuring out your optimal path.

chemgeek

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #17 on: August 20, 2014, 08:57:24 AM »
I'm confused by the limits on the traditional IRA deductions. My husband has a 401k. I have nothing through work. There seem to be two limits, the 95k and then the 181k. If I don't have a 401k, and I contribute up to the $5,500 to a trad IRA in my name, am I sill eligible for the deduction?

( This is what I'm staring at trying to decide. http://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits)

I have a PhD in chemistry, and feel like I need another PhD to understand all this tax nonsense!

Manguy888

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #18 on: August 20, 2014, 09:03:15 AM »
http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/2014-IRA-Contribution-and-Deduction-Limits---Effect-of-Modified-AGI-on-Deductible-Contributions-if-You-are-NOT-Covered-by-a-Retirement-Plan-at-Work

chemgeek - if you do not have a retirement plan at work but your spouse DOES, you can deduct the full 5500 unless you make over 181k. After that amount, your deduction starts to shrink

The 95k limit for any deduction only applies if BOTH you and your spouse had a 401k or similar retirement plan at your work

Cheddar Stacker

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #19 on: August 20, 2014, 09:05:19 AM »
He is a "covered" employee, and you are a "non-covered" employee. This is just a fancy way to say he has a 401k and you don't. Married Filing Jointy, the limits are around the numbers you listed. So if your total AGI is > $95K, he can't make a T.IRA contribution but you can.

Make sense?

chemgeek

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #20 on: August 20, 2014, 09:46:12 AM »
Yes that makes sense! That's what I was interpreting as but wanted to verify. Thanks!

RabStache

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #21 on: August 22, 2014, 06:35:14 PM »
RabStache, play with this: https://turbotax.intuit.com/tax-tools/calculators/taxcaster/

Obviously having the child in 2014 is a big variable, but let's assume you get a new tax deduction for Christmas. Your number was $77,100, but as dandarc mentioned you forgot exemptions of $3,950/person so $3,950 * 3 = $11,850. This puts your taxable income at $65,250 which is solidly in the 15% bracket. In addition to the extra exemption, you will receive a $1,000 child tax credit. This doesn't affect your tax rate (15%/25%) but it reduces your tax due by $1,000 just like federal withholdings. After the child tax credit your total taxes would come in just under $8,000 without any Traditional IRA's.

It seems like there is only a 15% benefit to using Traditional IRA's. At that point, most people don't think it's worth it, and they would choose a Roth IRA. But then there's this: http://www.madfientist.com/retire-even-earlier/

Good luck figuring out your optimal path.

Just so I'm clear on the math - the standard deduction and personal exemptions stack onto each other? 

For numbers sake:
Total Income: ~$107,000
Standard Deduction: -$12,400
Personal Exemptions: -$11,850
401k Contributions: -$17,500
= $65,250 (The number Cheddar Stacker came up with, but just making sure my number he used was correct)

If this is true, and I think it is, I think for our IRA's we will utilize a ROTH.  It's such a hard choice!


ShortInSeattle

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #22 on: August 22, 2014, 06:41:34 PM »
Congrats on your loan payoff! That must feel great.

If you are getting serious about your investing, consider putting together an investing policy statement. It's like a written plan for your investments, and by filling one out you answer a lot of questions about priorities and risk.

Here are some samples: http://www.bogleheads.org/wiki/Investment_Policy_Statement

Hallihunter

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Re: CASE STUDY: Student Loans Gone, Next Steps!
« Reply #23 on: August 22, 2014, 09:25:09 PM »
IMHO Maybe build your emergency fund up quite a bit more than 5k,
6 to 9 mo. of your expenses, latter some CDs and utilize VFSTX, FFRHX,
and OSTIX for some gains on that hunk of money.