Author Topic: Streamline, pay off debt, start the 'Stash  (Read 1688 times)

actonyourown

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Streamline, pay off debt, start the 'Stash
« on: October 05, 2017, 07:49:48 AM »
I have been reading the blog for a few months and though I thought myself very knowledgeable on finance, some concepts on here and for ER blew my mind.  So I am looking to the community for help in order to be more efficient with some of my smaller choices right now and will look to write a case study hopefully in the future 

Little bit of info: 28 yr old/single with only $2,000 in savings

Long-term goals are:
1.   Pay off debts
2.   Begin creating a stash
3.   Be more efficient for tax purposes

The Good
Just over $1,000 per month to utilize for debts/stash building for the time being

The Bad
Debts are:
1.   $22,000+ of student loan debt with an effective rate of 5.447%, however, I have some as high as 6.8% and low as 3.5% - all federal loans
a.   I have paid 5 years on these and have 5 more years to go.  I would like to have them paid off by September 2019, however, that might not be realistic currently.
2.   $4,400+ of credit card debt that is 0% interest until December 2018
a.   I have hopped this balance from different credit cards the last 4 years but never have paid interest on it

Stash is:
$0.  I would like to have a second income stream, however, it can be put off if debt payments are the better way to go.  I would also take recommendations on brokerage accounts and possible funds to purchase to begin this journey (any opinions on PFF since I currently own some of it in a Roth IRA?)

401K Traditional vs. Roth Question

I put in 10% to my employer’s Roth 401k plan.  I currently make $44,600, so I’m in the 25% bracket. 
1.   Should I be putting this in the Traditional 401k plan?   
2.   Should I split my contributions between Tradtional to get below the 25% bracket and then the rest go to Roth?
3.   Should I reduce my contributions for now to the minimum to get the employer match and put the difference into my debt/stash payment recommendations from you?

So the overall question is, where do I put this money to best use for debt payments/stash building and how should I amend my 401k to assist?  Is debt my item to tackle before the stash building begins or do I split this up in some way?

wenchsenior

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Re: Streamline, pay off debt, start the 'Stash
« Reply #1 on: October 05, 2017, 08:48:56 AM »
For clarification,

Aren't you actually in the 15% tax bracket after the standard deduction and personal exemption? Unless 44 K is your take-home pay after taxes...?


actonyourown

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Re: Streamline, pay off debt, start the 'Stash
« Reply #2 on: October 05, 2017, 09:07:26 AM »
My gross is $44,600.  I was only looking at this table.

Table 1. Single Taxable Income Tax Brackets and Rates, 2017


Rate

Taxable Income Bracket

Tax Owed

10%
 $0 to $9,325 10% of Taxable Income

15%
 $9,325 to $37,950 $932.50 plus 15% of the excess over $9325

25%
 $37,950 to $91,900 $5,226.25 plus 25% of the excess over $37,950

28%
 $91,900 to $191,650 $18,713.75 plus 28% of the excess over $91,900

33%
 $191,650 to $416,700 $46,643.75 plus 33% of the excess over $191,650

35%
 $416,700 to $418,400 $120,910.25 plus 35% of the excess over $416,700

39.60%
 $418,400+ $121,505.25 plus 39.6% of the excess over $418,400

wenchsenior

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Re: Streamline, pay off debt, start the 'Stash
« Reply #3 on: October 05, 2017, 10:00:32 AM »
Someone who is more precise with taxes will likely be along at some point and will correct me if I'm wrong, but at this point, my understanding is you are likely actually paying an effective tax rate of just under 16% because of your deduction and exemptions (even though you are technically in the 25% bracket).

Check this quick and dirty calculator and compare it against what you paid in actual taxes to be sure.

https://www.taxact.com/tools/tax-bracket-calculator


https://blog.taxact.com/how-tax-brackets-work/

If you are actually in a low tax bracket now, and anticipate being in a higher one in retirement, conventional wisdom says to invest in either Roth IRA or Roth 401k (pay taxes now).

However, some people (many on this  board, me included) prefer a tax cut in hand now (Regular IRA and standard 401K), and plan to reduce their retirement taxes later using things like a Roth ladder etc.

Your situation is complicated a bit by your current debt.  If I accurately estimated your current tax rate (~16%), you could save about 700$ per year in taxes by switching to a regular 401k.  And of course, as your income rises, this number will keep growing.  And this doesn't count any state tax benefits to sheltering income.  Personally, I would switch to a regular 401K and allocate that 700$ for whatever stage you are at in the list below.

Here is the generally recommended order of investing for US investors: ETA (This is not my work below, but is standardized info developed by the moderators)

*******
It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end.

If you are renting, you may not be throwing away as much on rent as you might think.  See           
   http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/         
for some thoughts.           
           
In the lists below, thinking "first your 457 (if you have one), then your 401k and/or 403b" wherever "401k" appears is likely correct -           
   unless your 457 fund options are significantly worse than those in the 401k/403b -         
   due to penalty-free access to 457 funds at retirement, even if younger than 59 1/2.
   "Max _____" means "contribute up to the maximum allowed for _____, subject to your ability to pay day-to-day expenses."           

The benefits of employee stock purchase plans (ESPPs) relative to other opportunities is highly dependent on tax rates, because ESPP benefits all occur in taxable accounts.
 - For someone paying 15% tax on ordinary income, and 0% on dividends and capital gains, ESPPs can be very favorable, perhaps competing with high interest rate loans in step 2.
 - For someone paying 25% tax on ordinary income, and 15% on dividends and capital gains, ESPPs are not as favorable, perhaps coming between steps 6 and 7.
         
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).           
           
Current 10-year Treasury note yield is ~2%.  See           
   http://quotes.wsj.com/bond/BX/TMUBMUSD10Y         
           
WHAT           
0. Establish an emergency fund to your satisfaction           
1. Contribute to your 401k up to any company match           
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.           
3. Max HSA             
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level           
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)           
6. Fund a mega backdoor Roth if applicable.         
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.           
8. Invest in a taxable account with any extra.           
           
WHY           
0. Give yourself at least enough buffer to avoid worries about bouncing checks           
1. Company match rates are likely the highest percent return you can get on your money           
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
    At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 25%; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise.
   See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
   See Traditional versus Roth - Bogleheads for even more details and exceptions.  State tax (or lack thereof) should also be considered.
   The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals*.
5. See #4 for choice of traditional or Roth for 401k.  In a 401k there are no income-based limits for deductions or contributions.     
6. Applicability depends on the rules for the specific 401k           
7. Again, take the risk-free return if high enough.  Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
   (e.g., target retirement date) that provides a blend of stock and bond returns.  If you wish to consider separate bond funds, compare the yield on a fund
   with a duration similar to the time remaining on the loan, and put your money toward the one with the higher interest/yield.
8. Because any earnings, even if taxed, will help your FI journey.

Similar to "put on your own oxygen mask before assisting others," you should fund your own retirement before funding 529 or similar plans for children's college costs.

The emergency fund is your "no risk" money.  You might consider one of these online banks:           
   http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001         
               
If your 401k options are poor (i.e., high fund fees) you can check           
   http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/         
for some thoughts on "how high is too high?"           
           
Priorities above apply when income is primarily through W-2 earnings.  For those running their own businesses (e.g., rental property owner, small business owner, etc.),           
   putting money into that business might come somewhere before, in parallel with, or after step 5.         
           
Why it is likely better to invest instead of paying a low interest rate mortgage early, if you have a long time until the mortgage is due:           
   http://allfinancialmatters.com/wp-content/uploads/2013/08/SandP500_5-Year_Rolling_Returns_with-CPI_calendar_year.pdf         
   http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html


*Estimating withdrawal tax rates is not an exact science, but here is one approach:
1) Include any guaranteed pension amount that you can't defer in return for higher payments when you do start
2) Take current traditional balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so.  Take 4% of that value as an annual withdrawal.
3) Take current taxable balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so.  Take 2% of that value as qualified dividends.
4a) Decide whether SS income should be considered, or whether you will be able to do enough traditional->Roth conversions before taking SS.
4b) Include SS income projections (using today's dollars) if needed from step 4a.
5) Calculate marginal rate using today's tax law on the numbers from step 1-4.
6) Make your traditional vs. Roth decision for this year's contribution
7) Repeat steps 1-6 every year until retirement

The steps above may look complicated at first, but you don't need great precision.  The answer will either be "obvious" or "difficult to choose".  If the latter, it likely won't make much difference which you pick anyway.

Note the possibility of self-defeating predictions:
a) predict high taxable retirement income > contribute to Roth > get low taxable retirement income
b) predict low taxable retirement income > contribute to traditional > get high taxable retirement income

Also, if you pick traditional and that ends up being wrong it will be because you have "too much money" - not the worst problem.
If you pick Roth and that ends up being wrong it will be because you have "too little money" - that can be a real problem.
Thus using traditional is a "safer" choice.



.   
« Last Edit: October 05, 2017, 11:14:01 AM by wenchsenior »

Laura33

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Re: Streamline, pay off debt, start the 'Stash
« Reply #4 on: October 05, 2017, 01:13:23 PM »
So, first, you are in the 15% bracket.  Your gross income is $44,600; you get to deduct from that (i) one personal exemption ($4,050) and (ii) the standard deduction ($6,350).  This will reduce your taxable income to $34,200 (unless you get a bonus or have capital gains/interest, etc.), which is below the $37,950 threshold for the 25% tax bracket.  See https://www.forbes.com/sites/kellyphillipserb/2016/10/25/irs-announces-2017-tax-rates-standard-deductions-exemption-amounts-and-more/#495230225701

At your income level, I would stay with a Roth, unless you have a screaming need for the extra money from the tax deduction now.  Basically, at the 15% bracket, every dollar you put into a traditional 401(k) means you pay $0.15 less in federal taxes -- so if you contribute $5K to a traditional IRA, you will pay $750 less in federal taxes (plus whatever the state taxes work out to).  But then you pay taxes on your contributions + earnings when you withdraw the money in retirement, at whatever your tax rate is then.  At your current low tax bracket, it will probably work out in your favor to do the Roth now.  But if you really need/want the extra $750 now (or whatever it ends up being given how much you decide to save), then go ahead and switch to a traditional 401(k).

For you, I would focus on paying off that 6.8% student loan for sure -- you have reasonable cash on-hand to cover a car repair or whatever, so go ahead and throw all your extra at that loan until it is gone.  Once you start talking about loans that are 3.5-4%, it is generally more beneficial to keep them given the low interest rates and invest your money instead -- especially since you have plenty of room left to put that money in a tax-protected account (401(k)/Roth 401(k)) (see the order of investment wenchsenior posted).  But this is an emotional issue for many people; if you really want to be debt-free, then go ahead and pay off everything.

And definitely get that CC paid off before the 0% rate expires, or have another transfer lined up.

Honestly, I think you're in a decent position.  With a little work, you can have a totally clean slate by 30, and then start building your 'stache in earnest.  If you want to speed that up, post your expenses for folks to whack at, and/or look at a side hustle (and adjust your 401(k) as needed to stay in the 15% bracket!). 

frugaliknowit

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Re: Streamline, pay off debt, start the 'Stash
« Reply #5 on: October 05, 2017, 02:32:43 PM »
Your debt is $26,400.  Your income is $44,000.  That's a crazy 60% (none of it mortgage...)!!!

401K, are you kidding?  Maybe the match but that's IT!

Cut your lifestyle to working, eating, breathing, exercising...THAT'S IT!

freemonk

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Re: Streamline, pay off debt, start the 'Stash
« Reply #6 on: October 07, 2017, 06:02:35 AM »
Your debt is $26,400.  Your income is $44,000.  That's a crazy 60% (none of it mortgage...)!!!

401K, are you kidding?  Maybe the match but that's IT!

Cut your lifestyle to working, eating, breathing, exercising...THAT'S IT!

Exactly, there has been no behavioral changes for sometime. We are moving CC debit and kicking the can down the road, robbing Peter to pay Paul.