Where to put money if I already pay no taxes?

[zolotiyeruki]

Here are the basics:

Age: 33 goal is to retire at 51
Salary: $86k
Income taxes: $0 federal (thanks to an abundance of deductions and children), $3500 state
Current retirement savings: About $250k, about 50% IRA, 40% Roth, 5% 401(k), 5% mutual fund
Current 401(k) contributions: about $7200/year (5% + 4% company match)

Right now, we're in negative territory for Federal Income tax, i.e. we pay nothing and get a refund, thanks to the Additional Child Tax Credit.  Our taxable income is in the 10% bracket, but the tax credits push our taxes below 0.  In other words, if our taxable income goes down by $1000, our refund increases by $100.

Next year, due to various circumstances, we may have several thousand dollars of surplus income that I could put towards retirement.  I plan to use a Roth ladder when I FIRE.  The question is:  Where do I put next year's cash? 

Option 1) increase 401(k) or IRA contributions.  This would also reduce my income as taxable by the state, so it's really a 15% boost.
Option 2) Roth IRA.  Since our current tax rate is low, we could fund our Roth IRAs now and withdraw those contributions in the first few years of retirement while we build the rest of the ladder.  IOW, no need for traditional investments.
Option 3) Traditional investments, for filling the 5-year gap while I build my Roth ladder.
Option 4) Spend it on things that have been on our wish list, like finishing the basement :)

I know which option my wife would vote for.  What do y'all think I should do?

[Catbert]

I would do Roth conversions to fill up your 0% bracket assuming it didn't otherwise screw things up.  (I'm not familiar with Child Tax Credits so I don't know if more income would screw it up.)  That should cost you nothing.  Build your ladder now - no need to wait until you're retired.

If there is any match still be had then I would up my 401k contributions.  That would give you even more room to do Roth conversions. 

Then I would do Roth contributions for you and spouse for 2014 and 2015.

[Ricky]

I see retirement accounts only as tax advantaged entities you should take advantage of to reduce tax liability as a high income earner. Since you already pay such little in tax, I see no reason to not pour everything in non-retirement accounts. It will be easier to get the money too at age 51.

[seattlecyclone]

I like the idea of more Roth contributions/conversions. Those tax deductions kids won't live with you forever, so you might as well take advantage of your 10% tax rate while you have it.

[fartface]

How many children do you have? Are you married filing jointly?

How does that land you in 10% bracket? I'm curious b/c my husband and I (married-filing-jointly) have an AGI of less than $73,000 which puts us in the 15% tax bracket.

Even with an "abundance" of deductions how do you get to 0% at $86K (I'm assuming that's your AGI)?

Thanks!

[MDM]

The question is:  Where do I put next year's cash? 

Option 1) increase 401(k) or IRA contributions.  This would also reduce my income as taxable by the state, so it's really a 15% boost.
Option 2) Roth IRA.  Since our current tax rate is low, we could fund our Roth IRAs now and withdraw those contributions in the first few years of retirement while we build the rest of the ladder.  IOW, no need for traditional investments.
Option 3) Traditional investments, for filling the 5-year gap while I build my Roth ladder.
Option 4) Spend it on things that have been on our wish list, like finishing the basement :)

Not #3 - definitely the last choice, because if you can have some tax advantage (either traditional or Roth) you should take it.

Maybe #1, if you think that in retirement you will be paying <15%.

#2 or #4 (or some combination thereof) seems best from my perception of your situation.  Depends on the importance of your current vs. future wish lists - that's for you to decide.

[Philo Beddoe]

I want to preface this by saying I am posting here in hopes of possibly learning something.

It looks like almost all of your retirement savings is locked up in things you cannot access without penalties until you reach 59 1/2. What do you plan to live on from age 51 to 59 1/2? Ok...read about laddering...interesting (already learning.) But still, the contributions cannot be accessed for 5 years, so that puts you at 56. Don't you still need investments to live on during the 5 years in between?

[MDM]

But still, the contributions cannot be accessed for 5 years, so that puts you at 56. Don't you still need investments to live on during the 5 years in between?

Contributions made directly to a Roth IRA may be withdrawn at any time without penalty and without tax.

Rollover contributions from a traditional to a Roth, however, are subject to a 5 year waiting period.  See http://www.investopedia.com/ask/answers/05/waitingperiodroth.asp and https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/ for two similar articles on this topic.

[Philo Beddoe]

Ahh....good to know.

Thanks

[zolotiyeruki]

@mary w - Although we get a net tax refund, our *marginal* rate is 10% because our taxable income is around $25k.  I've maxed the 401(k) match.

@fartface - we have 6 kids (5 for last year's return).  How do we end up in the 10% bracket?  Well, gross salary is $86k, AGI is in the low-to-mid $70k range (sorry, I don't have my returns in front of me), about $25k in itemized deductions and another ~$27k in exemptions.  That took us down to the mid-$20k taxable income range.  The child tax credit wiped out the tax liability on that $25k or so, and the Additional child tax credit resulted in a refund.  In retrospect, I guess we're technically in the 15% bracket, but not by a whole lot.

@MDM - since I'm planning on a Roth ladder in retirement, I expect my (federal) tax rate to be 0%.

I like seattlecyclone's suggestion of additional rollovers.  I'm thinking there's no way to avoid the 10% 15% marginal rate impact, however (unless my taxable income were somehow <$0.....hmmm, I wonder if I could somehow finagle that....).  Not to mention Illinois' 5% income tax (which is based on AGI, so all those delicious deductions and exemptions don't help).  So the total marginal tax rate is 20%.

For the 2014 tax year, I'm expecting a net refund of about $4k.  That means I could roll over about $20k without paying anything out of pocket (the refund would cover the taxes).

Now, I just have to figure a way to pitch the idea to my wife....