Author Topic: Have i been doing it wrong?  (Read 9015 times)

jhartt3

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Have i been doing it wrong?
« on: February 04, 2014, 06:27:44 PM »
Ok so brief story:

I'm 27 my wife is 26 combined we make ~135k pre tax.  i had always been of the mindset Roth 401k and Roth IRA are better is this really true.  I have access to both i also have a company ESOP which ~ to a standard 401k.  I am maxing out my 401k and IRA every year.  Should I be putting this money into a standard 401k.  My wife only has the standard option.  (talk about a first world problem - roth or standard).  My plan is to start a cash account following this year.  but my thoughts were since its a roth 401k it rolls str8 to a roth IRA and now i have all the money i've put in that i can with draw tax/penalty free.  Is this the correct line of thinking or should i be splitting up my 401k contributions more evenly or go pure traditional for the tax breaks now while we make so much. 


Current life plan:
drop to 32 hour weeks in 4-5 years retire in 10-13 years before i'm 40.  currently well on my way to doing this.  assuming we dont hit that kids road bump to hard.

Eric

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Re: Have i been doing it wrong?
« Reply #1 on: February 04, 2014, 07:22:15 PM »
Are you planning on being in a lower tax bracket upon FIRE?  If so, it's generally more advantageous to pay taxes on your 401k earnings then as opposed to now.  Yes your Roth 401k with rollover to a Roth IRA and you can withdrawal that money tax free, but you've already paid taxes on it at your current high marginal rate.

Check this out:

http://www.madfientist.com/retire-even-earlier/

http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/


mxt0133

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Re: Have i been doing it wrong?
« Reply #2 on: February 04, 2014, 07:56:55 PM »
I would be cautious of participating in an company ESOP.  My old company was acquired and we were being introduced to the ESOP program.  I did not like what I was hearing so did some research.  My take away is you are putting too many eggs in one basket, if your employer tanks, your job and retirement savings are at risk.  ESOPs are a way for the owners to unload their shares without impacting the number of share at float.  I would recommend doing as much research on that and would instead participate in a traditional IRA or max your your wife's 401k.

foobar

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Re: Have i been doing it wrong?
« Reply #3 on: February 04, 2014, 08:05:15 PM »
I think the standard is a no brainer. You write it off as 25% now and take it out at <10% (assuming your taking out <100k/yr). Thats hard to beat. The key of course is taking the extra 4k or so that you have by doing the standard and investing it.
The downsides of the traditional
a) you don't get access to the principal until 59.5. See 72(t) or roth roll overs for how to work around that
b) RMD - Probably not much of an issue for early retirees.  Even if you have a 2 million dollar 401(k) (in todays dollars), you are still only taking out 73k to start with at 70.5 and at 80 you only have to take out 106k. If you end up having to pay a ton of taxes, you should feel ok about it. The goal isn't to avoid taxes. It is to have enough money to have lived your life.

You can definitely make some assumptions that make the Roth a big winner (i.e. you are in a higher tax bracket when you retire. You average 15% returns for the next 30 years ,... ) or the traditional (i.e you can cash out the side account tax free and suck out a good chunk of the ira at <10%) but in most cases you get almost  equal results. My general thought is that the roth maximizes the amount of money you can end up with in the good cases.. The traditional on the other hand makes the worst case a bit better. The math switches a bit more to the roth as you get younger (i.e all those capital gains are tax free) versus older (you will not have as much capital gains on the contributions and you get to take out those contributions at a lower rate) but it is pretty minor.


I sort of like hedging. You contribute to the ROTH IRA  and the traditional 401(k) every year. You are covered to some extend no matter what they do to the tax law.

I would pass on the ESOP but a lot depends on the exact plan terms. If you didn't work for the company, would you want to invest that amount of money in 1 stock and would that be the stock you picked? Now if they are just matching your contributions with stock, think of it as potential free money.

Ok so brief story:

I'm 27 my wife is 26 combined we make ~135k pre tax.  i had always been of the mindset Roth 401k and Roth IRA are better is this really true.  I have access to both i also have a company ESOP which ~ to a standard 401k.  I am maxing out my 401k and IRA every year.  Should I be putting this money into a standard 401k.  My wife only has the standard option.  (talk about a first world problem - roth or standard).  My plan is to start a cash account following this year.  but my thoughts were since its a roth 401k it rolls str8 to a roth IRA and now i have all the money i've put in that i can with draw tax/penalty free.  Is this the correct line of thinking or should i be splitting up my 401k contributions more evenly or go pure traditional for the tax breaks now while we make so much. 


Current life plan:
drop to 32 hour weeks in 4-5 years retire in 10-13 years before i'm 40.  currently well on my way to doing this.  assuming we dont hit that kids road bump to hard.

chucklesmcgee

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Re: Have i been doing it wrong?
« Reply #4 on: February 04, 2014, 10:19:23 PM »
My general thought is that the roth maximizes the amount of money you can end up with in the good cases.. The traditional on the other hand makes the worst case a bit better.

Depends. Imagine the bad case where the government raises taxes significantly right before you retire because of debt concerns. Here, you'd do much better with a Roth and skip out on the tax hikes whereas you'd be hit hard with a traditional account. Roth makes for one less variable when attempting to determine if your savings are enough to get by in retirement.

MissPeach

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Re: Have i been doing it wrong?
« Reply #5 on: February 04, 2014, 10:49:28 PM »
I'll preface in that I don't know a lot about ESOPs from an investment standpoint. My experience with ESOPS is that the rules change pretty frequently on them. A company I used to work for set one up as a way to divert profits to a non-taxable entity. A lot of companies did this which is why the rules seem to change every year as the rules are changed to discourage this. I also knew of other companies who used ESOPS in this manner. I used to do a lot of paperwork for this which is how I know this. My advice is if you are thinking about it is to really check it out as I have known of several companies doing legal but gray area things through ESOPS.

As for taxable versus non taxable I would look at your adjusted income as a guide and also if it impacts the amount you can save tax free since iras have lower maximums than 401k (but I'll admit I'm not too familiar with Roth 401k). The reason I ask is if with maxing out 401k,what does that do to your taxable income and taxes? Does it bring you into any lower tax bracket? I would focus here overlong term assuming in retirement you will be in an even lower bracket tax wise. Even if you go traditional,there are still ways to convert the to Roth as long as you'll willing to pay tax during the conversion. You also didn't mention if you had a match. If so, contribute to max that out too.
« Last Edit: February 04, 2014, 10:56:45 PM by MissPeach »

jhartt3

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Re: Have i been doing it wrong?
« Reply #6 on: February 05, 2014, 04:21:15 AM »
my company is the best ESOP in the country it costs me nothing to get the shares and you have to get them if you are a non contract employee.  we bought ourselves 25 years ago and they maintain very strict policies to protect our shares.  the ESOP isnt up for debate really i get it for working there.  and it is very stable from my review of it 


so do you rule out the esop as being tax diversified?  i think i may switch to half traditional half roth 401k for now.  that should split me 50 50 in the tax diversified front.

roth 401k is basically the same as an IRA my company matches 50% of to 6.5% of my salary so by maxing it out i get this match.
« Last Edit: February 05, 2014, 04:26:30 AM by jhartt3 »

jhartt3

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Re: Have i been doing it wrong?
« Reply #7 on: February 05, 2014, 05:19:41 AM »
we wont be going full on mustashian i estimate expenses of ~50-60k per year in retirement  in 2014 dollars

foobar

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Re: Have i been doing it wrong?
« Reply #8 on: February 05, 2014, 10:07:55 AM »
The counter argument is that the government gets rid of the income tax and replaces it with national sales tax. Or they decide any roth balance over 500k is excessive and they apply a 15% tax to it. This will happen when we learn that Zuckerburg donated a bunch of .0001 shares to his ROTH and now has one with 5 billion dollars in it:). You make up cases where either works out. Personally I would be shocked at a major increase in taxes on people making <~60k but it is definitely possible. 40+ years is a long time.....


My general thought is that the roth maximizes the amount of money you can end up with in the good cases.. The traditional on the other hand makes the worst case a bit better.

Depends. Imagine the bad case where the government raises taxes significantly right before you retire because of debt concerns. Here, you'd do much better with a Roth and skip out on the tax hikes whereas you'd be hit hard with a traditional account. Roth makes for one less variable when attempting to determine if your savings are enough to get by in retirement.

foobar

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Re: Have i been doing it wrong?
« Reply #9 on: February 05, 2014, 10:13:32 AM »
The thing with ESOP is that you are at the mercy of one company. Great companies go on 5 year bad runs and disappear. Over even just have a flat stock for 15 years. Treat them like stock options. It is great when they turn into real money, but it isn't something that you can really count on until you can sell them.  It is fine when the company is giving you a contribution (I might prefer a 401(k) match) as it is a chance to make money. Just don't sink your cash into it.

my company is the best ESOP in the country it costs me nothing to get the shares and you have to get them if you are a non contract employee.  we bought ourselves 25 years ago and they maintain very strict policies to protect our shares.  the ESOP isnt up for debate really i get it for working there.  and it is very stable from my review of it 


so do you rule out the esop as being tax diversified?  i think i may switch to half traditional half roth 401k for now.  that should split me 50 50 in the tax diversified front.

roth 401k is basically the same as an IRA my company matches 50% of to 6.5% of my salary so by maxing it out i get this match.

jhartt3

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Re: Have i been doing it wrong?
« Reply #10 on: February 05, 2014, 10:51:58 AM »
Not possible to buy extra shares.  i've heard much of doom and gloom around ESOPs but take it as you may we arent the 14th best company to work for in america and the best ESOP in america for no reason. 

They do provide 401k match as well. 

jhartt3

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Re: Have i been doing it wrong?
« Reply #11 on: February 05, 2014, 11:25:52 AM »
but for all the reasons you state about not liking ESOPs.  all the reason to retire from one earlier. 

ender

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Re: Have i been doing it wrong?
« Reply #12 on: February 05, 2014, 12:07:48 PM »
My general thought is that the roth maximizes the amount of money you can end up with in the good cases.. The traditional on the other hand makes the worst case a bit better.

Depends. Imagine the bad case where the government raises taxes significantly right before you retire because of debt concerns. Here, you'd do much better with a Roth and skip out on the tax hikes whereas you'd be hit hard with a traditional account. Roth makes for one less variable when attempting to determine if your savings are enough to get by in retirement.

Keep in mind this perspective for most people planning on ER is completely different than the general public. Most couples here making $135k/year are intending on spending much, much, much less than that per year in ER.

So the actual question is more, "will taxes on a couple making $40k a year be lower in 30 years than taxes are currently for a couple making $135k/year."

Substitute whatever MMM spending you want for $40k, that's higher than most of those here probably plan on spending. When you look at it this way though you realize how absurdly smart the traditional 401k/IRA becomes, especially since you can slowly convert it to Roth during your ER years as well.

jhartt3

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Re: Have i been doing it wrong?
« Reply #13 on: February 05, 2014, 12:09:54 PM »
yeah thats what i'm starting to notice... even if i plant to spend 70k a year its still in that 15% tax bracket making the savings huge over the 25% i'm paying now

ender

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Re: Have i been doing it wrong?
« Reply #14 on: February 05, 2014, 12:11:26 PM »
yeah thats what i'm starting to notice... even if i plant to spend 70k a year its still in that 15% tax bracket making the savings huge over the 25% i'm paying now

Not to mention state/city taxes, especially if you are willing to move for ER you can really save a lot of money.

My marginal income tax rate between state/federal is about 33% right now (not including FICA).

jhartt3

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Re: Have i been doing it wrong?
« Reply #15 on: February 05, 2014, 01:21:54 PM »
i'm around 28.5% right now. 


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Re: Have i been doing it wrong?
« Reply #16 on: February 05, 2014, 02:56:58 PM »
You've built a nice amount into your Roth accounts which can be used long before you're 59.5.

Your tax rate is 28.5%.

Switch all contributions to traditional if you can. You will save so much in taxes it's ridiculous. You can get it back out at a much lower rate 0-15% later.

jhartt3

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Re: Have i been doing it wrong?
« Reply #17 on: February 05, 2014, 03:04:09 PM »
yes i have approx. 26k in the ira and around 45 in the 401k

jhartt3

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Re: Have i been doing it wrong?
« Reply #18 on: February 05, 2014, 03:10:55 PM »
so here is my full life to date and future plan story i have so far ... feel free to pick it apart too

I'm new here and just feeling my way around.  I have been adamantly saving since i graduated from college 3.5 years ago.  Including my home equity my wife and i have around 210k saved up for retirement.  This is all in 401k's, Roth IRA, Home equity, and my company ESOP plan.  If i remove my equity we have 158K in those retirement accounts.  I'm 27 years old now and until i ran across this blog had assumed i would need about 5MM a saved minimum to retire.  and had my sights set on retiring at 45.  After seeing this blog and understanding how many of these habbits I already use.  I believe 35-40 could be a realistic option.  My only current problem is convincing my wife. 

My non mustachian habits:

-I am an avid wakeboarder - i own a boat - i live in a lake community (though this is the most affordable lake community in the- KC area)  ---- The boat i own actually has equity in it as i bought an older one at a very good price. 
-We travel a ton.  Probably to the tune of how much MMM traveled in his early days.  I try to do this as affordably as possible and having thousands of airline miles and a SW companion pass helps most of this be very cheap.  we probably spend 400/month on travel
-car loans - my wife has 3.5 years left on her ford escape (2010) not going to be able to convince her to get rid of this... but the interest rate is 0 so i'll let her pay that off and cont. My truck (UGHHH) i got a ford escape hybrid last year with the intent to sell my truck as i dont need it.  Still havent sold it but i can get 45 MPGs in my hybrid driving correctly.  Just really need to ditch this truck
- we probably spend a bit too much at bars with friends each month 100 a week maybe.  This is insane and I will put a stop to it

Current goals:
Go to 4 day 32 hour weeks by 32 so i can spend time with my future kids.  (this has been my biggest worry as i have a higher stress, travel alot engineering job.)
Thanks everyone for reading glad i found this forum

Cheddar Stacker

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Re: Have i been doing it wrong?
« Reply #19 on: February 05, 2014, 03:12:34 PM »
yes i have approx. 26k in the ira and around 45 in the 401k

So you have $71K that you won't touch for 10-15 years since you'll be working part time which will pay all expenses. That $71K in Roth's will be well over $200-250K during that timeframe if you don't touch it and it averages a 7.5% return. I'd say it's time to defer as much tax as possible.

It's not a terrible problem to have, so I wouldn't say you've been doing it wrong, but if you read that madfientist thread suggested at the top you likely would've come out ahead if you went traditional. Good mistake to have though, $250K tax free when you want it (only the principal can be taken out before 59.5, but still).

jhartt3

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Re: Have i been doing it wrong?
« Reply #20 on: February 05, 2014, 03:18:29 PM »
thanks for that insight cheddar.. any other comments on my life post about everything i've got so far?

Cheddar Stacker

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Re: Have i been doing it wrong?
« Reply #21 on: February 05, 2014, 03:42:08 PM »
You're ahead of where I was at your age; I'm 35 and was roughly in your financial position at about 32 maybe.

All my comments I'm sure you already know:

You need to sell the truck. I sold an F-150 in 2008 via a third party sale. I was handed 75 $100 bills which felt much better than a 3rd vehicle in the driveway. Your SUV's can tow the boat.

The 2 SUV's (although they're small ones), the boat, the vacations, and the $100 bar tabs are all going to delay your progress. It doesn't sound like you're in a big hurry to get to FI, so if they make you happy just try to do them as economically as you can. Most forum readers will crucify you for these enormous wastes of money, but I'm cool with them based on your income levels.

However, If you're serious about cutting back at work when kids come along, I would close the bar tab right away. You're spending $5K/year on alcohol. This could be put to much better use, and if you or your wife will stop working you're not going to be able to carry that expense once the kids come along. You also won't have the time to go to the bars either, but that's another story.

jhartt3

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Re: Have i been doing it wrong?
« Reply #22 on: February 05, 2014, 04:52:35 PM »
i private sell all my vehicles and will private sell it. 

SUVs - my wife's yeah its bad

Mine - i dont understand how it isnt on his list... what does his minivan get in the mpg dept? not 45.  i got it from my company fleet for 5400 cash.  its still worth more than i paid and i dont think you'll find a car that gets that kinda mpg especially with the room of a small SUV. 

the bar tab has been stopped i have limited myself to 100 a month 

neither of us plan to 100% stop working.  i plan to work tues-friday and her mon - thursday.  we will either negotiate some work from home days or just pay daycare for those 12 days a month. 

The boat is actually going to become a revenue generator this summer when i offer lessons to people. 

You're correct i dont want to go full on mustashian.  a couple reasons

1. i cant convince my wife its doable (and she loves her job (maybe i can be stay at home papa))
2. my wakeboarding habit.  this actually causes 2 things 1) the obvious one is a boat 2) work commute of 60 daily for wife and 40 daily for me.

we do however save 50-60% of our income outside of all of this including our trips.  which puts us at around 50-60k a year to retire which makes it about 10-12 years to FI which is 14-16 years of working which i'm ok with and i have a hunch my wife wont retire.  I also have a great safety net being an engineer i can go work contract after retirement for some extra fun money


jhartt3

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Re: Have i been doing it wrong?
« Reply #23 on: February 05, 2014, 06:57:52 PM »
are traditional accounts immune from all tax or just federal?

foobar

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Re: Have i been doing it wrong?
« Reply #24 on: February 05, 2014, 07:28:27 PM »
In every state I am aware of you, you don't pay stat taxes on traditional 401(k) contributions. I wouldn't bet my life that there isn't a state out there that does tax them. You do have to pay SS+medicare taxes though.


are traditional accounts immune from all tax or just federal?

Cheddar Stacker

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Re: Have i been doing it wrong?
« Reply #25 on: February 05, 2014, 09:17:22 PM »
In every state I am aware of you, you don't pay stat taxes on traditional 401(k) contributions. I wouldn't bet my life that there isn't a state out there that does tax them. You do have to pay SS+medicare taxes though.


are traditional accounts immune from all tax or just federal?

What foobar said. I don't think there's a chance any state would tax your 401K contributions. IRA's might be a little different in some states since they don't come directly out of your paycheck, but I'm not aware of any states that tax them.

jhart you said you're near KC - Missouri side or Kansas side? I'm in STL so I know MO laws well, but not so much in KS. In MO, the starting point on your state return is the federal AGI, which excludes both 401K contributions, and Traditional IRA contributions.

jhartt3

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Re: Have i been doing it wrong?
« Reply #26 on: February 06, 2014, 04:45:44 AM »
so i still pay ss and medicare.  damn i have to recalc this thing today.  and yeah i'm on the MO side
i hope it helps me avoid the 1% tax for working in KC

Cheddar Stacker

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Re: Have i been doing it wrong?
« Reply #27 on: February 06, 2014, 06:42:39 AM »
If it works like STL, it's an earnings tax and it should be based on your Box 1 wages on the W-2, which means a traditional 401K would reduce the net earnings that are taxed.

jhartt3

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Re: Have i been doing it wrong?
« Reply #28 on: February 13, 2014, 07:04:22 AM »
Ok so i have switched my work plan to max out the traditional 401k.  but my wife and I's MAGI is to high to contribute to traditional IRAs is there a way around this or should i just continue to fund my Roth IRAs?