Author Topic: U.S. tax withholding questions  (Read 30478 times)

rocksinmyhead

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U.S. tax withholding questions
« on: January 28, 2014, 08:47:09 AM »
this might be a pretty dumb question and I'm prepared to be embarrassed... but right now I'm just really confused.

here's the scenario:

1. I started my job in February 2012. I did not receive income in 2012 from any other jobs. I followed the instructions on the W-4 and ended up with 2 allowances or whatever they're called, one for myself since I'm not a dependent and one for being single and having only one job. I got a ~$600 refund in 2012.

2. I worked the same job in 2013. I did make a more money due to a small raise, working 12 months instead of 11, and a bonus, but I was in the same tax bracket. I did not change my withholding. Got a letter last week from the IRS saying I am now part of the withholding compliance program due to significant underwithholding in 2013. Did my taxes and this year I OWE ~$800.

I did the IRS withholding calculator on their website and it says I should get 0 allowances plus now have an extra $138/paycheck withheld.

questions are as follows, for tax professionals or just more-knowledgeable-than-me Mustachians:

1. why did this happen? what could have changed between 2012 and 2013 that I am not accounting for?

2. what the fuck is the point of the little calculation thing on the W-4 (get one allowance for yourself, one if single and only working one job, etc.) if they are completely inaccurate? just to be clear, I have NO other income besides my salary/bonus.

ahhh I'm so confused and annoyed. any help would be appreciated!

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #1 on: January 28, 2014, 09:09:51 AM »
Sorry to hear this. Maybe your new income affected your ability to claim certain deductions and since you lost those, your withholdings became irrelevant.

I don't mess around with the calculator.

Each year, I do an estimate of our taxes based on that year's expected income. Figure out my taxes for the year (dividends/interest earned, personal exemption, will we be standard vs. itemized deductions, etc.). I also adjust for health care, medical, 401k, and anything else tax free. Then I look at my what employer & my husband's employer is withholding per paycheck and multiply that by the pay periods. Then, as long as you are withholding at least 90% of your tax bill, then you don't pay penalties.

For example, here is what I do


Figure out estimated earned income, including bonuses (I also add in a modest amount for a pay increase that we typically get each year)
Subtract: 401k contributions, employer sponsored medical, flex spend contributions, dependent care contributions
Add back in: dividends, interest earned, any other income
This amount equals an approximate adjusted gross income

Subtract: standard ($12,400 for 2014) or itemized deductions if you have more deductions than $12,400; number of personal exemptions (2014 is $3950 per person)

Remaining amount is approximately your taxable income

From here, you can google the marginal tax rates for 2014 based on your filing status (married filed jointly, single, married filing separately). This is my favorite site for marginal tax rates since they already did the math and just find your taxable income: http://www.forbes.com/sites/kellyphillipserb/2013/10/31/irs-announces-2014-tax-brackets-standard-deduction-amounts-and-more/

This calculation should give you a rough idea of your federal tax bill for the year. Look at your paycheck and multiply your 2014 paycheck by the number of pay periods you have - that will tell you your estimated withholding. Add or decrease withholdings based on how far you are away from your estimated federal tax bill. I always make sure that I know the 90% rule to avoid penalties and add in some extra cushion in case things change throughout the year.

Hope this helps!

nordlead

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Re: U.S. tax withholding questions
« Reply #2 on: January 28, 2014, 09:19:16 AM »
The W-4 form only really works if you have no other income and not just from jobs. Rental income, interest income, and capital gains would all affect your total tax. Also, if the company failed to withhold 25% of the bonus (I believe that is the standard withholding rate) or if you're marginal bracket is greater than 25%, then that would massively throw things off.

For a simple return it would look like

Taxable Wages (as your company reports to the IRS)
+ Interest (everyone should have earned $0.01 from some bank account somewhere)
+ Taxable Refunds (state tax refund)
- deductions (itemized or standard)
- exemptions
= taxable income

Assuming your interest and taxable refunds aren't too high, the W-4 should work just fine. I personally claim 12 on the W-4 and next year might owe $2.20. I'm keeping an eye on it and I'll adjust my W-4 down by 1 in the summer if I think I'll be shorter than that.

Your best bet to understand this is to look at your actual numbers line by line to figure out what threw things out of whack. I use TaxAct and before filing my taxes I can see a summary that breaks everything down into categories nicely. Do that and you can find what caused you to be off.

EDIT:

I also have an excel spreadsheet that basically does my fairly easy taxes and I use it to estimate the next years taxes, so unless your taxes are complicated it is easy enough to grab the forms and do it by hand.

I will say, that figuring out exactly what 1 on a W-4 will cause your withholding to change by is a pain, so I just go the trial and error route. Make the adjustment, look at my pay stub, do a quick excel calculation and repeat.
« Last Edit: January 28, 2014, 09:22:34 AM by nordlead »

MustachianAccountant

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Re: U.S. tax withholding questions
« Reply #3 on: January 28, 2014, 09:25:16 AM »
As Nordlead said, you may have other income on your tax return, or your bonus may have been underwithheld. Schedule C income (income from a side business) is a likely culprit, since there would be SE tax due on top of your income tax.

Is your wage income (W-2) the only income on your tax return?
Was the federal withholding on your bonus approx 20-25% of the bonus?

Cromacster

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Re: U.S. tax withholding questions
« Reply #4 on: January 28, 2014, 09:49:21 AM »
You can try to figure out what your witholdings should be.  Read through this doc:

http://www.irs.gov/pub/irs-pdf/p15a.pdf

Page 27 is the start of the relevant information for this discussion.  I have it put into a spreadsheet that calculates mine, but for my situation it essentially boils down to this formula:

Bi Weekly pay period, Married Person: Each allowance is worth 151.90 (although I claim 0).

0-325: 0
1023-325:10% (or 69.80 if over)
3163-1023:15% (or 375 if over), I fall in this range

So for me, it Claimed 0, my withholdings will be:
69.80 + (Taxable Wage - 1023)*.15

I then need to align this with what I expect to pay in taxes for the year.  If I left it as is, I would end up paying around 1600 in federal taxes.  To avoid this I have an additional withholding of $60.


NOTE: I simplified this alot for this forum purpose.  Also, if you are married filing jointly and you both earn around the same amount and each claim 0; your withholding's are most likely short due to the way the w-4 is setup.

**EDIT**:  After review, this is actually much simplier than I made it out to be.  The end result is the same, but the table sets it all up for you.  For me my withholding's are simply:

(taxable income - 557.67)*.15

Same results as above, but I guess the IRS did the work for me, go figure.

« Last Edit: January 28, 2014, 09:59:39 AM by Cromacster »

mlipps

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Re: U.S. tax withholding questions
« Reply #5 on: January 28, 2014, 10:33:31 AM »
You can also use a paycheck calculator to estimate what changes in withholdings will do. I like this one from ADP: http://www.adp.com/tools-and-resources/calculators-and-tools/payroll-calculators/salary-paycheck-calculator.aspx

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #6 on: January 28, 2014, 10:41:03 AM »
I knew you guys would be super helpful! :) Thanks for all the tips. Definitely going to get a spreadsheet cranked up and sort of "do my taxes in advance" as some of you suggested.

My marginal rate is 28% and my bonus was withheld at 25%. So, there's $534 of what I ended up owing. My only other income was $30 of interest from my checking/savings accounts so there's another $8.50 I guess :) I am in a student loan debt emergency, so I don't have any of those other kinds of Mustachian income. Still not sure where the other ~$250 came from, but I am at least slightly less confused, and now I know to set aside the extra 3% myself assuming I get a bonus this year.

Sorry to hear this. Maybe your new income affected your ability to claim certain deductions and since you lost those, your withholdings became irrelevant.

I did the standard deduction both years, so that shouldn't have changed, right? I think the only thing I could ever even potentially deduct is student loan interest, and I can't do that because my income is too high.
« Last Edit: January 28, 2014, 10:48:14 AM by oscarsmom »

MustachianAccountant

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Re: U.S. tax withholding questions
« Reply #7 on: January 28, 2014, 11:03:50 AM »
So I know this is off topic, but I can't help myself.

Why do you only have $30 in interest, considering your high income?
Is ALL your retirement savings in retirement accounts? I would think you would max those out pretty quickly, and you would have to put the extra saved money into taxable accounts...

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #8 on: January 28, 2014, 11:20:32 AM »
So I know this is off topic, but I can't help myself.

Why do you only have $30 in interest, considering your high income?
Is ALL your retirement savings in retirement accounts? I would think you would max those out pretty quickly, and you would have to put the extra saved money into taxable accounts...

totally legitimate question! (and I would love to hear advice or facepunches... actually I really need to post a budget on here at some point and I KNOW it will invite facepunches)

when I finished grad school and started my job in 2012 I had $70k of student loan debt. some of it was >8% so that had to go first. I have been contributing enough to my 401k to get the full match (8% to my 8% contribution) and after that $1500/month goes to student loans. it should probably be more going to student loans, but that is the budget post I need to make I guess :) currently my highest student loan rate is 7.65%, so in my mind it still makes sense to be contributing to that rather than the 401k. I'm not sure at what interest rate I'll feel comfortable enough to switch to minimum payments... I am risk averse and psychologically I would prefer to just not have any student loan debt!

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #9 on: January 28, 2014, 11:21:46 AM »
I knew you guys would be super helpful! :) Thanks for all the tips. Definitely going to get a spreadsheet cranked up and sort of "do my taxes in advance" as some of you suggested.

My marginal rate is 28% and my bonus was withheld at 25%. So, there's $534 of what I ended up owing. My only other income was $30 of interest from my checking/savings accounts so there's another $8.50 I guess :) I am in a student loan debt emergency, so I don't have any of those other kinds of Mustachian income. Still not sure where the other ~$250 came from, but I am at least slightly less confused, and now I know to set aside the extra 3% myself assuming I get a bonus this year.

Sorry to hear this. Maybe your new income affected your ability to claim certain deductions and since you lost those, your withholdings became irrelevant.

I did the standard deduction both years, so that shouldn't have changed, right? I think the only thing I could ever even potentially deduct is student loan interest, and I can't do that because my income is too high.


Ok, I hope I don't come off sounding like a jerk, but if you are in the 28% marginal tax bracket as a single person, then you must be clearing over 6 figures gross income after your deductions. Your federal tax bill is over $18K a year!!!!!!!!!! 

I would recommend stop playing around with withholding calculators and sit down to do the math as suggested by me and other posters above to figure this out. It will take you a few minutes and once you set it up, you can easily replicate for future years. Your explanation above sounds like you do not really understand how the marginal tax rates work and why you were penalized. You could perhaps save yourself a lot of money by doing the 10 minute set of calculations to understand how your federal tax bill is created.

Additionally, your math is not making sense.

I say this with the sincerest and nicest way as I have made plenty of tax mistakes (hint: not being strategic enough and overpaying when I could have strategically planned it out better) before finally figuring out that our federal tax bill is MORE than everything else COMBINED that we spend in a year. Spending the time in learning about your taxes will save you more per hour than trying to clip a $1.00 off coupon off of your toothpaste.

You are obviously very bright if you are 25 and earning over six figures, so congrats there, but please, do some more reading on this subject. Use this as a learning lesson.

Are you maxing out 401k already? What about a traditional IRA? It's not too late to do a IRA for 2013 to get your 2013 tax bill down. This might get you into the student loan deduction withholding before phase outs.

mlipps

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Re: U.S. tax withholding questions
« Reply #10 on: January 28, 2014, 11:27:10 AM »
There's an income cap for traditionalnIRA contributions which OP is well over.

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #11 on: January 28, 2014, 11:28:48 AM »
So I know this is off topic, but I can't help myself.

Why do you only have $30 in interest, considering your high income?
Is ALL your retirement savings in retirement accounts? I would think you would max those out pretty quickly, and you would have to put the extra saved money into taxable accounts...

totally legitimate question! (and I would love to hear advice or facepunches... actually I really need to post a budget on here at some point and I KNOW it will invite facepunches)

when I finished grad school and started my job in 2012 I had $70k of student loan debt. some of it was >8% so that had to go first. I have been contributing enough to my 401k to get the full match (8% to my 8% contribution) and after that $1500/month goes to student loans. it should probably be more going to student loans, but that is the budget post I need to make I guess :) currently my highest student loan rate is 7.65%, so in my mind it still makes sense to be contributing to that rather than the 401k. I'm not sure at what interest rate I'll feel comfortable enough to switch to minimum payments... I am risk averse and psychologically I would prefer to just not have any student loan debt!

Oscar -  I was virtually in the same spot a few years ago as a single lady, except I had $89K student loan debt (thankfully it was gone within 2.5 yrs of graduating) and my own 6 figure salary.

Others may disagree with me, but consider that you are paying 28% on every last dollar that you don't shelter from taxes by not maxing your 401k and doing a traditional IRA. Not sure if you pay state taxes too, but you could be paying 32% on that after tax money to save 7.65% in interest. You seriously might want to sit down and look at the how much in student loan interest you are paying vs. how much extra (yes, I said EXTRA) in taxes you are paying because you are not tax sheltering some of your money. Worth a thought or a calculation.... 

MustachianAccountant

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Re: U.S. tax withholding questions
« Reply #12 on: January 28, 2014, 11:32:17 AM »
It's not too late to do a IRA for 2013 to get your 2013 tax bill down. This might get you into the student loan deduction withholding before phase outs.

Sounds like she makes too much money to get a tax benefit from contributing to an IRA.

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #13 on: January 28, 2014, 11:33:05 AM »
There's an income cap for traditionalnIRA contributions which OP is well over.

Good point. Sounds like it is too late for 2013 since your agi is too high and may not be possible for 2014 even if you max out 401k. Always worth the calculation. ;0)

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #14 on: January 28, 2014, 11:34:08 AM »
Ok, I hope I don't come off sounding like a jerk, but if you are in the 28% marginal tax bracket as a single person, then you must be clearing over 6 figures gross income after your deductions. Your federal tax bill is over $18K a year!!!!!!!!!! 

I would recommend stop playing around with withholding calculators and sit down to do the math as suggested by me and other posters above to figure this out. It will take you a few minutes and once you set it up, you can easily replicate for future years. Your explanation above sounds like you do not really understand how the marginal tax rates work and why you were penalized. You could perhaps save yourself a lot of money by doing the 10 minute set of calculations to understand how your federal tax bill is created.

...

I say this with the sincerest and nicest way as I have made plenty of tax mistakes (hint: not being strategic enough and overpaying when I could have strategically planned it out better) before finally figuring out that our federal tax bill is MORE than everything else COMBINED that we spend in a year. Spending the time in learning about your taxes will save you more per hour than trying to clip a $1.00 off coupon off of your toothpaste.

I actually really appreciate this comment. bear in mind this is my second year in this job. previously, I was a college student and then went straight to grad school where I was a TA making $21k (which I thought was awesome, so not complaining). having an income high enough to warrant strategizing about taxes is SO new to me. also, my parents weren't the type to instill in me any kind of financial knowledge (which is probably why I ended up with so many loans from undergrad). I know that is a shit ton of excuses and I have been a dumbass, which I'm going to change starting now, just trying to explain where I'm coming from :)

actually, my boyfriend has badgered me since I got the job to talk to some kind of financial adviser, but lazily searching on the internet it seemed like most specialized in older people or people with higher net worth, plus I am loathe to spend money on that kind of thing anyway. realizing I could probably get some advice on here and then do it myself for free is kind of an epiphany! and yes, realizing that my federal tax bill in 2013 was almost enough to buy my (new) car in cash, twice, was also an epiphany. so I appreciate all of this :)

and yes, like I said I am planning on setting up a spreadsheet to plan this shit out like you guys recommended.

Additionally, your math is not making sense.

which part? (not doubting it but I'm just trying to figure all this out)

Are you maxing out 401k already? What about a traditional IRA? It's not too late to do a IRA for 2013 to get your 2013 tax bill down. This might get you into the student loan deduction withholding before phase outs.

I was just throwing everything I could at the student loans (after getting employer 401k match) because the rates are sort of high and I really want them gone. I didn't think about using 401k contributions to lower income enough to get the student loan interest deduction... I guess I would have to do the math to figure out if it'd be worth it? Another complicating factor in this scenario is that some of my loans (including the 7.65% one I mentioned) are actually Parent PLUS loans in my dad's name, so I can't deduct that interest regardless of my income.

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #15 on: January 28, 2014, 11:35:15 AM »
Oscar -  I was virtually in the same spot a few years ago as a single lady, except I had $89K student loan debt (thankfully it was gone within 2.5 yrs of graduating) and my own 6 figure salary.

Others may disagree with me, but consider that you are paying 28% on every last dollar that you don't shelter from taxes by not maxing your 401k and doing a traditional IRA. Not sure if you pay state taxes too, but you could be paying 32% on that after tax money to save 7.65% in interest. You seriously might want to sit down and look at the how much in student loan interest you are paying vs. how much extra (yes, I said EXTRA) in taxes you are paying because you are not tax sheltering some of your money. Worth a thought or a calculation....

hmmm... this makes me sound like a total idiot but I never thought of it like that. definitely going to run the numbers on all of this! thank you guys so much!!!

ETA - and oh god looking at pay stubs I just realized where some of the other tax I owed came from... another somewhat unusual bonus we got later in the year that also only got withheld at 25%. this is all so embarrassing but I guess it needed to happen, haha.
« Last Edit: January 28, 2014, 11:39:49 AM by oscarsmom »

MustachianAccountant

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Re: U.S. tax withholding questions
« Reply #16 on: January 28, 2014, 11:38:37 AM »
totally legitimate question! (and I would love to hear advice or facepunches... actually I really need to post a budget on here at some point and I KNOW it will invite facepunches)


You should do that. Paying down your student loan debt is good, as is the point made by Nottoolatetostart - that you get a sort of 28% return on all money sheltered from tax. Especially since you're getting no benefit from a Student Loan Interest deduction. I'm betting there's room in your budget to do both, if you trim some expenses.

I'm sure plenty of people will have plenty of advice. Just make sure you read the "How To Write A Case Study" at the top of the Ask a Mustachian forum first.

oldtoyota

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Re: U.S. tax withholding questions
« Reply #17 on: January 28, 2014, 12:12:30 PM »
Sorry to hear this. Maybe your new income affected your ability to claim certain deductions and since you lost those, your withholdings became irrelevant.

I don't mess around with the calculator.

Each year, I do an estimate of our taxes based on that year's expected income. Figure out my taxes for the year (dividends/interest earned, personal exemption, will we be standard vs. itemized deductions, etc.). I also adjust for health care, medical, 401k, and anything else tax free. Then I look at my what employer & my husband's employer is withholding per paycheck and multiply that by the pay periods. Then, as long as you are withholding at least 90% of your tax bill, then you don't pay penalties.

For example, here is what I do


Figure out estimated earned income, including bonuses (I also add in a modest amount for a pay increase that we typically get each year)
Subtract: 401k contributions, employer sponsored medical, flex spend contributions, dependent care contributions
Add back in: dividends, interest earned, any other income
This amount equals an approximate adjusted gross income

Subtract: standard ($12,400 for 2014) or itemized deductions if you have more deductions than $12,400; number of personal exemptions (2014 is $3950 per person)

Remaining amount is approximately your taxable income

From here, you can google the marginal tax rates for 2014 based on your filing status (married filed jointly, single, married filing separately). This is my favorite site for marginal tax rates since they already did the math and just find your taxable income: http://www.forbes.com/sites/kellyphillipserb/2013/10/31/irs-announces-2014-tax-brackets-standard-deduction-amounts-and-more/

This calculation should give you a rough idea of your federal tax bill for the year. Look at your paycheck and multiply your 2014 paycheck by the number of pay periods you have - that will tell you your estimated withholding. Add or decrease withholdings based on how far you are away from your estimated federal tax bill. I always make sure that I know the 90% rule to avoid penalties and add in some extra cushion in case things change throughout the year.

Hope this helps!

This is an excellent tutorial. Someone should make this a blog post!

I went through the steps above and found it very helpful. Thank you!

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #18 on: January 28, 2014, 12:25:00 PM »
Ok, I hope I don't come off sounding like a jerk, but if you are in the 28% marginal tax bracket as a single person, then you must be clearing over 6 figures gross income after your deductions. Your federal tax bill is over $18K a year!!!!!!!!!! 

I would recommend stop playing around with withholding calculators and sit down to do the math as suggested by me and other posters above to figure this out. It will take you a few minutes and once you set it up, you can easily replicate for future years. Your explanation above sounds like you do not really understand how the marginal tax rates work and why you were penalized. You could perhaps save yourself a lot of money by doing the 10 minute set of calculations to understand how your federal tax bill is created.

...

I say this with the sincerest and nicest way as I have made plenty of tax mistakes (hint: not being strategic enough and overpaying when I could have strategically planned it out better) before finally figuring out that our federal tax bill is MORE than everything else COMBINED that we spend in a year. Spending the time in learning about your taxes will save you more per hour than trying to clip a $1.00 off coupon off of your toothpaste.

I actually really appreciate this comment. bear in mind this is my second year in this job. previously, I was a college student and then went straight to grad school where I was a TA making $21k (which I thought was awesome, so not complaining). having an income high enough to warrant strategizing about taxes is SO new to me. also, my parents weren't the type to instill in me any kind of financial knowledge (which is probably why I ended up with so many loans from undergrad). I know that is a shit ton of excuses and I have been a dumbass, which I'm going to change starting now, just trying to explain where I'm coming from :)

actually, my boyfriend has badgered me since I got the job to talk to some kind of financial adviser, but lazily searching on the internet it seemed like most specialized in older people or people with higher net worth, plus I am loathe to spend money on that kind of thing anyway. realizing I could probably get some advice on here and then do it myself for free is kind of an epiphany! and yes, realizing that my federal tax bill in 2013 was almost enough to buy my (new) car in cash, twice, was also an epiphany. so I appreciate all of this :)

and yes, like I said I am planning on setting up a spreadsheet to plan this shit out like you guys recommended.

Additionally, your math is not making sense.

which part? (not doubting it but I'm just trying to figure all this out)

Are you maxing out 401k already? What about a traditional IRA? It's not too late to do a IRA for 2013 to get your 2013 tax bill down. This might get you into the student loan deduction withholding before phase outs.

I was just throwing everything I could at the student loans (after getting employer 401k match) because the rates are sort of high and I really want them gone. I didn't think about using 401k contributions to lower income enough to get the student loan interest deduction... I guess I would have to do the math to figure out if it'd be worth it? Another complicating factor in this scenario is that some of my loans (including the 7.65% one I mentioned) are actually Parent PLUS loans in my dad's name, so I can't deduct that interest regardless of my income.

Your income may be still too high to claim student loan deduction, that would be just gravy on top. The point is that wouldn't you rather keep the money for yourself to add to your net worth rather than KNOWINGLY paying the government more?

Slow day at work, so I ran some calculations and assuming your gross  income is 120K, keeping everything else constant (standard deduction, 1 personal exemption, $30 in earned interest), the difference between the 8% match and maxing out at $17.5 would decrease your fed tax bill by a little more than $2K. Your exact figures may vary, but let's work with me on this scenario. So you are effectively paying $2K more per year to the fed govt (not counting whatever you may to your state taxes) to pay your SL's off a little earlier. I'd rather keep that money in my net worth. Assuming your income @ $120K, the difference in 8% and maxing out your 401K is around $7900 more tucked into your 401k. Diverting that 7900 to your 401k instead of SLs meant that you paid, at most 7.65% is 604 more (7900 * 7.65%)  in SL interest. So, put another way, you saved $604 in SL interest just to turn around and pay an extra $2100 in federal taxes. You are not coming out ahead like you think you are...

Your commitment to get these puppies paid off is admirable and you will get there with your focus. But as others have mentioned, try cutting your expenses a bit more, live your $21K TA lifestyle that you mentioned. Definitely post your budget so others can help you.

Oh and be weary of financial planners....may not be most supportive of you putting cash into a 401K or paying off your SL's. Most financial advisors don't make money that way, but rather with the funds you invest with them.

My SL's were 6.8%-8.25% (half were 8.25%), so I know were you are coming from....but hopefully you don't mind this advice coming from someone that is just a few years older than you. Nice job though!

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #19 on: January 28, 2014, 03:02:06 PM »
oh my gosh you guys.

so I set up a couple spreadsheets... I am suspicious there are errors in there somewhere since I did it kind of quickly over my lunch hour, but if they are even close to be accurate, by keeping my budget the exact same and just maxing out my 401k instead of putting that money into student loans, I will save $2700 in taxes and only pay ~$200 extra in interest. that is ridiculous!!! you all may have just saved me $2500 in 2014, for one hour of work! I went over and changed my 401k contribution and student loan autopayments right away. I guess I will find out on my next payday how accurate my estimates of the effect on my take-home pay were...

the only super painful part is that now instead of paying off 3 of my 5 remaining loans this year, I will have NONE of them paid off. that hurts, man. I just have to keep telling myself that my 401k will be a lot bigger, so it's not like that money is just disappearing! my net worth will still get bigger! and, I calculated the student loan payments without a bonus or any other extra payments figured in (but I did figure in an estimated bonus to determine my tax savings), so hopefully that will help.

also, I think this will really help improve my overall savings/discipline. I was getting kinda complacent about my sloppy budget (spend waaaaaayyyy too much going out to the bar, and I really don't need to buy clothes ever anymore at this point, so I should just stop) because I felt so good about my progress on my student loans. hopefully this will psychologically put the pressure on to be able to throw more at those, while I have maxing out the 401k on automatic. wish me luck!!!

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #20 on: January 28, 2014, 03:24:58 PM »
Oscar - I am SO excited for you!!!!!!!!!!   I got similar-ish numbers of you using $120K as an estimate, so I am sure your math is right or in the ballpark.

Keep learning...there's so much awesome content in these forums and other sites too.

As far as the loans, have you been to the 'throw down the gauntlet' board? There are a ton of challenges ongoing right now that could help you save money on groceries, stop buying clothes for 2014, selling crap around your house, or a million other things that might be of interest. Just because some of your SL money has been reallocated, does not mean that you are not doomed from not getting one of the SL's paid off. The folks over on that board have been awesome and will also motivate you to meet your goal each day. Love them!

BE MORE CREATIVE! 

You need to poke holes in EVERY expense you have at this point. I was able to find a lot of things to cut saving us even more this year - saving us thousands for this year alone - we switched from AT&&T to Ting saving $50/month (& my husband got an iphone in the process vs. his old dumb phone), cut our home security system, raised our deductibles on some insurance, cut some insurance, sell a bunch of stuff, make nearly all our meals at home from scratch, got super creative for an upcoming vacation, learned more about our tax situation with daycare and flex spend accounts so we could save even more...the list goes on and on. I think if all goes well, we would have cut $10K from our budget this year alone and hardly noticed it and improved our quality of life.

oldtoyota

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Re: U.S. tax withholding questions
« Reply #21 on: January 28, 2014, 06:00:41 PM »

You need to poke holes in EVERY expense you have at this point. I was able to find a lot of things to cut saving us even more this year - saving us thousands for this year alone - we switched from AT&&T to Ting saving $50/month (& my husband got an iphone in the process vs. his old dumb phone), cut our home security system, raised our deductibles on some insurance, cut some insurance, sell a bunch of stuff, make nearly all our meals at home from scratch, got super creative for an upcoming vacation, learned more about our tax situation with daycare and flex spend accounts so we could save even more...the list goes on and on. I think if all goes well, we would have cut $10K from our budget this year alone and hardly noticed it and improved our quality of life.

You guys are awesome..spreadsheets at lunch. Love it!

You are so right about the savings. Last year, I examined EVERYTHING and reduced our budget by $14,000. The expenses just crept up on us over time. I am *still* working on reducing expenses too.

If you want, join a bunch of us over on the No Clothes in 2014 thread. =-)

marblejane

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Re: U.S. tax withholding questions
« Reply #22 on: January 28, 2014, 06:15:03 PM »
This thread is awesome. I'm crossing six figures in taxable income for the first time this year, and this thread inspired me to run the numbers on my own debt/tax situation. It looks like maxing out my 401(k) will save me paying $6,500 in federal and state taxes in 2014. I have credit card debt at 10.24% and 11.99%, but even at those rates, I still would save $3,500 maxing out my 401(k) versus paying off the credit cards (which I will still do, albeit more slowly).

This has been really eye-opening. Thank you so much!

fodder69

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Re: U.S. tax withholding questions
« Reply #23 on: January 28, 2014, 08:26:19 PM »
Just have to add another 'Great Job!' on the lunchtime spreadsheeting. It really is amazing what you can do when you sit down and look at the numbers. The mental drag of the student loans hurts but if you set a plan in place and let it go on auto pilot, the will get paid off. What is that a saying, 'A watched pot never boils, unless you wait a little longer'. Or something like that :-).

nordlead

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Re: U.S. tax withholding questions
« Reply #24 on: January 29, 2014, 09:20:32 AM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

gecko10x

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Re: U.S. tax withholding questions
« Reply #25 on: January 29, 2014, 10:41:44 AM »
Figure out estimated earned income, including bonuses (I also add in a modest amount for a pay increase that we typically get each year)
Subtract: 401k contributions, employer sponsored medical, flex spend contributions, dependent care contributions
Add back in: dividends, interest earned, any other income
This amount equals an approximate adjusted gross income

Subtract: standard ($12,400 for 2014) or itemized deductions if you have more deductions than $12,400; number of personal exemptions (2014 is $3950 per person)

Remaining amount is approximately your taxable income

From here, you can google the marginal tax rates for 2014 based on your filing status (married filed jointly, single, married filing separately). This is my favorite site for marginal tax rates since they already did the math and just find your taxable income: http://www.forbes.com/sites/kellyphillipserb/2013/10/31/irs-announces-2014-tax-brackets-standard-deduction-amounts-and-more/

This calculation should give you a rough idea of your federal tax bill for the year. Look at your paycheck and multiply your 2014 paycheck by the number of pay periods you have - that will tell you your estimated withholding. Add or decrease withholdings based on how far you are away from your estimated federal tax bill. I always make sure that I know the 90% rule to avoid penalties and add in some extra cushion in case things change throughout the year.

Hope this helps!

My Lazy-person version of this is:
1. Complete taxes for previous year
2. Adjust income (or other numbers) based on estimates for current year
3. Look at paycheck and calculate estimated withholding for the year. If it is <100% of previous year tax paid (from tax return), calculate the difference and increase your withholding. See Topic 306 - Penalty for Underpayment of Estimated Tax

desrever

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Re: U.S. tax withholding questions
« Reply #26 on: January 29, 2014, 11:43:32 AM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

This, above, is very good advice. You defer taxes in a 401k, so its not right to regard your present year tax bill reduction as savings or free money.

If your plan allows it (and the fees are not prohibitive), I would recommend taking a loan from your 401k to pay down your debt. This kind of gives you the best of both worlds: you get to fully utilize your maximum annual contribution, but also you get the guaranteed return (and badassity cred) of paying down your debt in the short term. Your interest rates are high and you need to decapitate those interest payments ASAP. It is amazing how quickly your stash starts to grow when you are not making debt payments every month. The main risk you'd have with a 401k loan is the balloon payment that comes due happen if your employment ends during the term of the loan, so that's something to plan for.

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #27 on: January 29, 2014, 11:44:41 AM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

This, above, is very good advice. You defer taxes in a 401k, so its not right to regard your present year tax bill reduction as savings or free money.

If your plan allows it (and the fees are not prohibitive), I would recommend taking a loan from your 401k to pay down your debt. This kind of gives you the best of both worlds: you get to fully utilize your maximum annual contribution, but also you get the guaranteed return (and badassity cred) of paying down your debt in the short term. Your interest rates are high and you need to decapitate those interest payments ASAP. It is amazing how quickly your stash starts to grow when you are not making debt payments every month. The main risk you'd have with a 401k loan is the balloon payment that comes due happen if your employment ends during the term of the loan, so that's something to plan for.

who is this referring to, me or the poster with the CC debt?

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #28 on: January 29, 2014, 12:00:55 PM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

This, above, is very good advice. You defer taxes in a 401k, so its not right to regard your present year tax bill reduction as savings or free money.

If your plan allows it (and the fees are not prohibitive), I would recommend taking a loan from your 401k to pay down your debt. This kind of gives you the best of both worlds: you get to fully utilize your maximum annual contribution, but also you get the guaranteed return (and badassity cred) of paying down your debt in the short term. Your interest rates are high and you need to decapitate those interest payments ASAP. It is amazing how quickly your stash starts to grow when you are not making debt payments every month. The main risk you'd have with a 401k loan is the balloon payment that comes due happen if your employment ends during the term of the loan, so that's something to plan for.

OK, this seems crazy and risky WHEN, especially WHEN, the OP has stated she could cut her clothing and partying a bit to throw more towards her SL's. It does not seem like she is there yet. If she diverting an extra $10K/yr to her 401K instead of her SL's....we are talking about finding an extra $800 a month to make her neutral. That could be pretty doable since she mentions she still has some fluff in her budget.

To the OP, I would still suggest cutting where you can before resorting to these other tactics. There are some risks on the back end that you require you to pay back your 401K loan ASAP.

TrulyStashin

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Re: U.S. tax withholding questions
« Reply #29 on: January 29, 2014, 12:04:33 PM »
Great thread.  I need to run these calculations too.  This year, I contributed the bare minimum to my 401k under the same rational as OP --  because I have SL and CC debt that I'm trying to crush.  As a result, my AGI is just under the 6-figure mark and I make too much to write of my SL interest (paid $9k!); too much to take the child tax credit of $1,000; and too much to write off any traditional IRA contributions.

My fed/ state tax bill for 2013 is just under $20k.  Holy fuck.

beltim

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Re: U.S. tax withholding questions
« Reply #30 on: January 29, 2014, 12:10:37 PM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

This is a very, very good point.  When oscarsmom calculated a $2500 net gain by increasing 401k contributions, she only took into account this year.  But some of that $2700 tax savings will be offset by taxes paid on the 401k withdrawals in retirement.  I think an estimate of the offset would be your marginal tax rate in retirement - in other words, your current year savings can be approximated as:
 (Tax savings from this year's 401k contribution) * (current marginal tax rate - marginal tax rate in retirement) - interest savings on student loan debt. 

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #31 on: January 29, 2014, 12:27:39 PM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

This is a very, very good point.  When oscarsmom calculated a $2500 net gain by increasing 401k contributions, she only took into account this year.  But some of that $2700 tax savings will be offset by taxes paid on the 401k withdrawals in retirement.  I think an estimate of the offset would be your marginal tax rate in retirement - in other words, your current year savings can be approximated as:
 (Tax savings from this year's 401k contribution) * (current marginal tax rate - marginal tax rate in retirement) - interest savings on student loan debt.

It depends on if her plan is to ER. If she is going the traditional route of retiring at 59.5 or 65, then yeah, your calculation would apply. But good god, the girl is 25.

We are planning on ER in 6 years before we turn 40 - I worked this plan over with my CPA so I am confident it will work - and rolling over a moderate amount each year (right now, I've pegged around $40-$47K of Roth laddering conversions each year with my little kids giving us some tax exemptions/credits, assuming we don't earn another dime elsewhere, so of course, we will adjust late December of each year) until we are 70 plus any dividends (which can be tax free depending on your income), our MARGINAL tax rate will be in the 10%, but with other credits we will be entitled to, like child tax credit, our resulting tax bill will be less than $100 per year. So my EFFECTIVE tax rate is pretty much zero. 

If was in the OP's shoes (which I was 4 years ago, as a six figure income single girl with close to $90K of SL debt at 8.25%)....if I would have thought more about the taxes before the extra interest I was paying on the SL's, we would be closer to FI than we are.

If she plans this well, she really could take that money out tax free at a later time.

You are also forgetting about compounding, which your formula, does not take into consideration. My 401K made 10% in 2012 and 31% in 2013 (I didn't track 2009-2011). Obviously, past performance is no indication of future performance, but those savings will continue to compound.

The biggest lesson I've learned of MMM and other awesome bloggers is to mind my taxes to save more and keep more. This stuff can be difficult to wrap your head around, but once you do, it is really quite mind blowing of how strategic you can be.

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #32 on: January 29, 2014, 12:37:19 PM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

This is a very, very good point.  When oscarsmom calculated a $2500 net gain by increasing 401k contributions, she only took into account this year.  But some of that $2700 tax savings will be offset by taxes paid on the 401k withdrawals in retirement.  I think an estimate of the offset would be your marginal tax rate in retirement - in other words, your current year savings can be approximated as:
 (Tax savings from this year's 401k contribution) * (current marginal tax rate - marginal tax rate in retirement) - interest savings on student loan debt.

put another way, do you mean

(additional 401k contribution this year in excess of match) * (current marginal tax rate - marginal tax rate in retirement) - additional interest paid on student loan debt

as opposed to what I calculated, which was

(additional 401k contribution this year in excess of match) * (current marginal tax rate) - additional interest paid on student loan debt

?? that makes sense to me. so, say I went from contributing $7,760 annually to the 401k to contributing $17,500, and my marginal tax rate in retirement is 20%. the extra student loan interest paid in 2014 on this plan is $217. (17500-7760)*(0.28-0.20)-217=$562, so I'm really only saving $562, instead of $2500?

but like nottoolatetostart said, this doesn't take into account any deductions I might have in the future (kids, etc.), or the compounding of the 401k... hmmm.

(edited to fix an error)
« Last Edit: January 29, 2014, 02:26:34 PM by oscarsmom »

beltim

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Re: U.S. tax withholding questions
« Reply #33 on: January 29, 2014, 12:43:04 PM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

This is a very, very good point.  When oscarsmom calculated a $2500 net gain by increasing 401k contributions, she only took into account this year.  But some of that $2700 tax savings will be offset by taxes paid on the 401k withdrawals in retirement.  I think an estimate of the offset would be your marginal tax rate in retirement - in other words, your current year savings can be approximated as:
 (Tax savings from this year's 401k contribution) * (current marginal tax rate - marginal tax rate in retirement) - interest savings on student loan debt.

It depends on if her plan is to ER. If she is going the traditional route of retiring at 59.5 or 65, then yeah, your calculation would apply. But good god, the girl is 25.

We are planning on ER in 6 years before we turn 40 - I worked this plan over with my CPA so I am confident it will work - and rolling over a moderate amount each year (right now, I've pegged around $40-$47K of Roth laddering conversions each year with my little kids giving us some tax exemptions/credits, assuming we don't earn another dime elsewhere, so of course, we will adjust late December of each year) until we are 70 plus any dividends (which can be tax free depending on your income), our MARGINAL tax rate will be in the 10%, but with other credits we will be entitled to, like child tax credit, our resulting tax bill will be less than $100 per year. So my EFFECTIVE tax rate is pretty much zero. 

If was in the OP's shoes (which I was 4 years ago, as a six figure income single girl with close to $90K of SL debt at 8.25%)....if I would have thought more about the taxes before the extra interest I was paying on the SL's, we would be closer to FI than we are.

If she plans this well, she really could take that money out tax free at a later time.

You are also forgetting about compounding, which your formula, does not take into consideration. My 401K made 10% in 2012 and 31% in 2013 (I didn't track 2009-2011). Obviously, past performance is no indication of future performance, but those savings will continue to compound.

The biggest lesson I've learned of MMM and other awesome bloggers is to mind my taxes to save more and keep more. This stuff can be difficult to wrap your head around, but once you do, it is really quite mind blowing of how strategic you can be.

Re: Roth laddering, I'm hesitant to make long-term plans based on what is quite clearly a loophole (it's called a "backdoor Roth" for a reason).  I certainly wouldn't recommend others do it without substantial warnings.

 My little formula takes into account all of your comments regarding tax rates and early or late retirement.  If the marginal tax rate will be 0, that's fine.  If the marginal tax rate is 15%, the formula takes that into account.

I debated including something about compounding, but the short answer is that the only compounding that matters here is the difference between long term investment returns (specifically, over the length that the OP will take to pay off her loans) and the interest rates on the student loans (as OP said, the highest is 7.65%).  Sure, you could make more over the next 5 years in the stock market than 7.65% annually... but it's hardly a sure thing.  "Compounding" could just as easily work against the OP as work for her in this situation.

beltim

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Re: U.S. tax withholding questions
« Reply #34 on: January 29, 2014, 12:47:27 PM »
put another way, do you mean

(additional 401k contribution this year in excess of match) * (current marginal tax rate - marginal tax rate in retirement) - additional interest paid on student loan debt

as opposed to what I calculated, which was

(additional 401k contribution this year in excess of match) * (current marginal tax rate - marginal tax rate in retirement) - additional interest paid on student loan debt

?? that makes sense to me. so, say I went from contributing $7,760 annually to the 401k to contributing $17,500, and my marginal tax rate in retirement is 20%. the extra student loan interest paid in 2014 on this plan is $217. (17500-7760)*(0.28-0.20)-217=$562, so I'm really only saving $562, instead of $2500?

but like nottoolatetostart said, this doesn't take into account any deductions I might have in the future (kids, etc.), or the compounding of the 401k... hmmm.

Aside from the fact that you posted the same formula twice, yes.  Predicting the future is always hard, and tax brackets and levels are always subject to change, so this sort of prognostication is highly variable.  You can play around with different possibilities of future deductions, tax brackets and tax deductions to see a range of savings.  I suspect it will still be worth it to you to contribute more to the 401k instead of paying off your student loans, but perhaps not by quite as much as your original calculation.

nordlead

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Re: U.S. tax withholding questions
« Reply #35 on: January 29, 2014, 01:13:33 PM »
My post about savings with a 401(k) wasn't necessarily for the OP, and I wasn't saying not to contribute to a 401(k).

I saw people get excited about tax savings and didn't want a random reader to think that is always the best option for them. You need to look at the whole picture and looking at this years tax savings while ignoring future tax expenses may improperly influence someone to stop paying down a high interest debt. Like I said, if you can max a 401(k) and pay down debt, that is the way to go. It gets more complicated if you can't max out your tax advantaged accounts and you owe high interest debt. If maxing your tax advantaged accounts means paying 20% interest on a large CC balance for the next 5 years it just doesn't make sense to me.


rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #36 on: January 29, 2014, 02:29:24 PM »
put another way, do you mean

(additional 401k contribution this year in excess of match) * (current marginal tax rate - marginal tax rate in retirement) - additional interest paid on student loan debt

as opposed to what I calculated, which was

(additional 401k contribution this year in excess of match) * (current marginal tax rate) - additional interest paid on student loan debt

?? that makes sense to me. so, say I went from contributing $7,760 annually to the 401k to contributing $17,500, and my marginal tax rate in retirement is 20%. the extra student loan interest paid in 2014 on this plan is $217. (17500-7760)*(0.28-0.20)-217=$562, so I'm really only saving $562, instead of $2500?

but like nottoolatetostart said, this doesn't take into account any deductions I might have in the future (kids, etc.), or the compounding of the 401k... hmmm.

Aside from the fact that you posted the same formula twice, yes.  Predicting the future is always hard, and tax brackets and levels are always subject to change, so this sort of prognostication is highly variable.  You can play around with different possibilities of future deductions, tax brackets and tax deductions to see a range of savings.  I suspect it will still be worth it to you to contribute more to the 401k instead of paying off your student loans, but perhaps not by quite as much as your original calculation.

oops, fixed it.

darn, this is all a bit disheartening... but, I'm thinking in my position, with fixed interest rates on my debt of <8% and some fluff in my budget that I will hopefully be pushed to eliminate with a smaller take-home amount, maxing out the 401k will still be the right choice (and I will still be making an extra ~$500 over the minimum payments on the loans, hopefully more when I trim the budget fluff, and plus any bonuses).
« Last Edit: January 29, 2014, 02:37:07 PM by oscarsmom »

Mazzinator

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Re: U.S. tax withholding questions
« Reply #37 on: January 29, 2014, 02:40:18 PM »

nottoolatetostart

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Re: U.S. tax withholding questions
« Reply #38 on: January 29, 2014, 03:45:48 PM »
put another way, do you mean

(additional 401k contribution this year in excess of match) * (current marginal tax rate - marginal tax rate in retirement) - additional interest paid on student loan debt

as opposed to what I calculated, which was

(additional 401k contribution this year in excess of match) * (current marginal tax rate) - additional interest paid on student loan debt

?? that makes sense to me. so, say I went from contributing $7,760 annually to the 401k to contributing $17,500, and my marginal tax rate in retirement is 20%. the extra student loan interest paid in 2014 on this plan is $217. (17500-7760)*(0.28-0.20)-217=$562, so I'm really only saving $562, instead of $2500?

but like nottoolatetostart said, this doesn't take into account any deductions I might have in the future (kids, etc.), or the compounding of the 401k... hmmm.

Aside from the fact that you posted the same formula twice, yes.  Predicting the future is always hard, and tax brackets and levels are always subject to change, so this sort of prognostication is highly variable.  You can play around with different possibilities of future deductions, tax brackets and tax deductions to see a range of savings.  I suspect it will still be worth it to you to contribute more to the 401k instead of paying off your student loans, but perhaps not by quite as much as your original calculation.

oops, fixed it.

darn, this is all a bit disheartening... but, I'm thinking in my position, with fixed interest rates on my debt of <8% and some fluff in my budget that I will hopefully be pushed to eliminate with a smaller take-home amount, maxing out the 401k will still be the right choice (and I will still be making an extra ~$500 over the minimum payments on the loans, hopefully more when I trim the budget fluff, and plus any bonuses).

I still don't think this is apples to apples because your tax bill will literally be 2500 less when you file 2014 taxes. Like literally you could get the figures in Turbotax to see how the picture changes. In today's dollars. As my husband always says "a bird in the hand is better than one in the bush". You don't know what the marginal tax rates are going to be in the future.
Also, there isn't a 20% marginal tax bracket like you used in your calculations....it's 10, 15, 25, 28, 33, and so on.

Still goes back to original argument of you could write a check to the government for $2500 more (which they would happily accept) to just turn around and save $217  in SL's. Penny wise, dollar foolish, but whatever, I guess it depends on your level of comfort and what you are willing to accept.

Will need to read Mazzinator's link later - looks like a good one. Thanks!


Cheddar Stacker

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Re: U.S. tax withholding questions
« Reply #39 on: January 29, 2014, 04:45:44 PM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

This is a very, very good point.  When oscarsmom calculated a $2500 net gain by increasing 401k contributions, she only took into account this year.  But some of that $2700 tax savings will be offset by taxes paid on the 401k withdrawals in retirement.  I think an estimate of the offset would be your marginal tax rate in retirement - in other words, your current year savings can be approximated as:
 (Tax savings from this year's 401k contribution) * (current marginal tax rate - marginal tax rate in retirement) - interest savings on student loan debt.

It depends on if her plan is to ER. If she is going the traditional route of retiring at 59.5 or 65, then yeah, your calculation would apply. But good god, the girl is 25.

We are planning on ER in 6 years before we turn 40 - I worked this plan over with my CPA so I am confident it will work - and rolling over a moderate amount each year (right now, I've pegged around $40-$47K of Roth laddering conversions each year with my little kids giving us some tax exemptions/credits, assuming we don't earn another dime elsewhere, so of course, we will adjust late December of each year) until we are 70 plus any dividends (which can be tax free depending on your income), our MARGINAL tax rate will be in the 10%, but with other credits we will be entitled to, like child tax credit, our resulting tax bill will be less than $100 per year. So my EFFECTIVE tax rate is pretty much zero. 

If was in the OP's shoes (which I was 4 years ago, as a six figure income single girl with close to $90K of SL debt at 8.25%)....if I would have thought more about the taxes before the extra interest I was paying on the SL's, we would be closer to FI than we are.

If she plans this well, she really could take that money out tax free at a later time.

You are also forgetting about compounding, which your formula, does not take into consideration. My 401K made 10% in 2012 and 31% in 2013 (I didn't track 2009-2011). Obviously, past performance is no indication of future performance, but those savings will continue to compound.

The biggest lesson I've learned of MMM and other awesome bloggers is to mind my taxes to save more and keep more. This stuff can be difficult to wrap your head around, but once you do, it is really quite mind blowing of how strategic you can be.

Re: Roth laddering, I'm hesitant to make long-term plans based on what is quite clearly a loophole (it's called a "backdoor Roth" for a reason).  I certainly wouldn't recommend others do it without substantial warnings.

 My little formula takes into account all of your comments regarding tax rates and early or late retirement.  If the marginal tax rate will be 0, that's fine.  If the marginal tax rate is 15%, the formula takes that into account.

I debated including something about compounding, but the short answer is that the only compounding that matters here is the difference between long term investment returns (specifically, over the length that the OP will take to pay off her loans) and the interest rates on the student loans (as OP said, the highest is 7.65%).  Sure, you could make more over the next 5 years in the stock market than 7.65% annually... but it's hardly a sure thing.  "Compounding" could just as easily work against the OP as work for her in this situation.

I'm with Nottoolate on this - COMPLETELY. One correction Beltim - Roth laddering is completely different than a backdoor Roth. They are both good strategies under the right circumstances, and both perfectly legal.

A Roth ladder = slowly converting your IRA/401K into Roth funds each year to then withdraw the principal after 5 years without penalty prior to age 59.5. You can do this as Nottoolate suggested and pay very little in tax which is effectively not tax deferral, it's completely legal tax avoidance.

A Backdoor Roth contribution = you are over the Roth and the deductible IRA limits so you make a non-deductible IRA contribution then convert it the next day to a Roth. Perfectly legal, not a loophole, and not what Nottoolate was suggesting.

OP should read what Nottoolate said above as it would be a great ER strategy for her. It's what I plan to do, and I'm a CPA so I am confident the numbers are correct.

And if you haven't already everyone should read mazzinator's link. SeattleCyclone's posts have very pertinent information related to this discussion of tax planning.

beltim

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Re: U.S. tax withholding questions
« Reply #40 on: January 29, 2014, 06:16:38 PM »
One correction Beltim - Roth laddering is completely different than a backdoor Roth. They are both good strategies under the right circumstances, and both perfectly legal.

A Roth ladder = slowly converting your IRA/401K into Roth funds each year to then withdraw the principal after 5 years without penalty prior to age 59.5. You can do this as Nottoolate suggested and pay very little in tax which is effectively not tax deferral, it's completely legal tax avoidance.

A Backdoor Roth contribution = you are over the Roth and the deductible IRA limits so you make a non-deductible IRA contribution then convert it the next day to a Roth. Perfectly legal, not a loophole, and not what Nottoolate was suggesting.

Yes and no.  Yes, they're different; yes, they're legal; and yes, both can be a good strategy. 

No:  they rely on the same mechanism (being able to do rollovers regardless of income level).  Considering that this mechanism is clearly outside of the legislative intent (after all, if Congress didn't intend for there to be an income restriction on Roth IRAs, they wouldn't have specifically put one in), it is clearly a loophole.

Personally, I would be hesitant to place my retirement strategy in the hands of a loophole.  Some loopholes in the tax code survive a very long time, but some don't.  I can easily imagine Congress closing the loophole that enables anyone to contribute to a Roth IRA (backdoor Roth), and in so doing, eliminate the ability to carry out a Roth ladder.

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #41 on: January 30, 2014, 08:33:02 AM »
I still don't think this is apples to apples because your tax bill will literally be 2500 less when you file 2014 taxes. Like literally you could get the figures in Turbotax to see how the picture changes. In today's dollars. As my husband always says "a bird in the hand is better than one in the bush". You don't know what the marginal tax rates are going to be in the future.
Also, there isn't a 20% marginal tax bracket like you used in your calculations....it's 10, 15, 25, 28, 33, and so on.

Still goes back to original argument of you could write a check to the government for $2500 more (which they would happily accept) to just turn around and save $217  in SL's. Penny wise, dollar foolish, but whatever, I guess it depends on your level of comfort and what you are willing to accept.

Will need to read Mazzinator's link later - looks like a good one. Thanks!

oh don't worry, I agree with your reasoning and I'm definitely still doing it :)

I'm with Nottoolate on this - COMPLETELY. One correction Beltim - Roth laddering is completely different than a backdoor Roth. They are both good strategies under the right circumstances, and both perfectly legal.

A Roth ladder = slowly converting your IRA/401K into Roth funds each year to then withdraw the principal after 5 years without penalty prior to age 59.5. You can do this as Nottoolate suggested and pay very little in tax which is effectively not tax deferral, it's completely legal tax avoidance.

A Backdoor Roth contribution = you are over the Roth and the deductible IRA limits so you make a non-deductible IRA contribution then convert it the next day to a Roth. Perfectly legal, not a loophole, and not what Nottoolate was suggesting.

OP should read what Nottoolate said above as it would be a great ER strategy for her. It's what I plan to do, and I'm a CPA so I am confident the numbers are correct.

And if you haven't already everyone should read mazzinator's link. SeattleCyclone's posts have very pertinent information related to this discussion of tax planning.

Thanks for this explanation!

Cheddar Stacker

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Re: U.S. tax withholding questions
« Reply #42 on: January 30, 2014, 10:22:42 AM »
One correction Beltim - Roth laddering is completely different than a backdoor Roth. They are both good strategies under the right circumstances, and both perfectly legal.

A Roth ladder = slowly converting your IRA/401K into Roth funds each year to then withdraw the principal after 5 years without penalty prior to age 59.5. You can do this as Nottoolate suggested and pay very little in tax which is effectively not tax deferral, it's completely legal tax avoidance.

A Backdoor Roth contribution = you are over the Roth and the deductible IRA limits so you make a non-deductible IRA contribution then convert it the next day to a Roth. Perfectly legal, not a loophole, and not what Nottoolate was suggesting.

Yes and no.  Yes, they're different; yes, they're legal; and yes, both can be a good strategy. 

No:  they rely on the same mechanism (being able to do rollovers regardless of income level).  Considering that this mechanism is clearly outside of the legislative intent (after all, if Congress didn't intend for there to be an income restriction on Roth IRAs, they wouldn't have specifically put one in), it is clearly a loophole.

Personally, I would be hesitant to place my retirement strategy in the hands of a loophole.  Some loopholes in the tax code survive a very long time, but some don't.  I can easily imagine Congress closing the loophole that enables anyone to contribute to a Roth IRA (backdoor Roth), and in so doing, eliminate the ability to carry out a Roth ladder.

I agree completely this can all be changed as the wind blows and congress gets a wild hair. You mentioned legislative intent, and while none of us can really understand why DC does what it does, I believe a strong motivation for the mechanism was to bring in a substantial amount of tax revenue ASAP when the Treasury needed it most (2010-2012). I have many clients that converted very, very large sums of money and were happy to do it and pay the tax since the values of their holdings were deflated at that time. The treasury took a huge hit in my opinion, but they were willing to do it. I haven't seen any signs they intend to reverse this trend, but you are correct it can happen.

All that said though, I'd still rather not pay the tax now with the intent to not pay the tax later. If they change the rules, I'll pay the tax later unless I find another way around it. Either way, I will still pay a lower tax in the future since I'm earning a large income that will disappear in FIRE and my tax rate will be a maximum of 10-15%. I think OP, and many others that read this forum are in the same boat.

Cheddar Stacker

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Re: U.S. tax withholding questions
« Reply #43 on: January 30, 2014, 10:27:44 AM »
I still don't think this is apples to apples because your tax bill will literally be 2500 less when you file 2014 taxes. Like literally you could get the figures in Turbotax to see how the picture changes. In today's dollars. As my husband always says "a bird in the hand is better than one in the bush". You don't know what the marginal tax rates are going to be in the future.
Also, there isn't a 20% marginal tax bracket like you used in your calculations....it's 10, 15, 25, 28, 33, and so on.

Still goes back to original argument of you could write a check to the government for $2500 more (which they would happily accept) to just turn around and save $217  in SL's. Penny wise, dollar foolish, but whatever, I guess it depends on your level of comfort and what you are willing to accept.

Will need to read Mazzinator's link later - looks like a good one. Thanks!

oh don't worry, I agree with your reasoning and I'm definitely still doing it :)

I'm with Nottoolate on this - COMPLETELY. One correction Beltim - Roth laddering is completely different than a backdoor Roth. They are both good strategies under the right circumstances, and both perfectly legal.

A Roth ladder = slowly converting your IRA/401K into Roth funds each year to then withdraw the principal after 5 years without penalty prior to age 59.5. You can do this as Nottoolate suggested and pay very little in tax which is effectively not tax deferral, it's completely legal tax avoidance.

A Backdoor Roth contribution = you are over the Roth and the deductible IRA limits so you make a non-deductible IRA contribution then convert it the next day to a Roth. Perfectly legal, not a loophole, and not what Nottoolate was suggesting.

OP should read what Nottoolate said above as it would be a great ER strategy for her. It's what I plan to do, and I'm a CPA so I am confident the numbers are correct.

And if you haven't already everyone should read mazzinator's link. SeattleCyclone's posts have very pertinent information related to this discussion of tax planning.

Thanks for this explanation!

Glad to hear you plan to max the 401K. I hope you also plan to cut expenses and knock down the SL debt to a reasonable amount as well. Good luck!

beltim

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Re: U.S. tax withholding questions
« Reply #44 on: January 30, 2014, 11:57:04 AM »
I agree completely this can all be changed as the wind blows and congress gets a wild hair. You mentioned legislative intent, and while none of us can really understand why DC does what it does, I believe a strong motivation for the mechanism was to bring in a substantial amount of tax revenue ASAP when the Treasury needed it most (2010-2012). I have many clients that converted very, very large sums of money and were happy to do it and pay the tax since the values of their holdings were deflated at that time. The treasury took a huge hit in my opinion, but they were willing to do it. I haven't seen any signs they intend to reverse this trend, but you are correct it can happen.

I think this legislative history makes future changes MORE likely.  For most of the history of Roth IRAs (1998-2010), rollovers were subjected to income limits.  Bringing in short-term additional revenue, as you suggested, is a good explanation for why the rule was changed.  Now, however, I would argue that this conversion serves no societal good (encouraging retirement savings); instead, such rollovers now serve only to (legally) reduce one's lifetime tax burden on funds already earmarked for retirement savings.

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Re: U.S. tax withholding questions
« Reply #45 on: January 30, 2014, 12:12:18 PM »
I agree completely this can all be changed as the wind blows and congress gets a wild hair. You mentioned legislative intent, and while none of us can really understand why DC does what it does, I believe a strong motivation for the mechanism was to bring in a substantial amount of tax revenue ASAP when the Treasury needed it most (2010-2012). I have many clients that converted very, very large sums of money and were happy to do it and pay the tax since the values of their holdings were deflated at that time. The treasury took a huge hit in my opinion, but they were willing to do it. I haven't seen any signs they intend to reverse this trend, but you are correct it can happen.

I think this legislative history makes future changes MORE likely.  For most of the history of Roth IRAs (1998-2010), rollovers were subjected to income limits.  Bringing in short-term additional revenue, as you suggested, is a good explanation for why the rule was changed.  Now, however, I would argue that this conversion serves no societal good (encouraging retirement savings); instead, such rollovers now serve only to (legally) reduce one's lifetime tax burden on funds already earmarked for retirement savings.

That's one way to look at it and I'm sure many people plan to reduce tax burden in this way. Many people did not use it this way. They paid a lot of tax to the Treasury over the last few years.

Another way to look at it is our government is a mess (no offense if you or others work in gov't) and they need money. There is pressure from everywhere to decrease the deficit, and changing this law back would only serve to increase the deficit by reducing potential tax revenues. Tax law changes have to be revenue neutral, meaning they can't really decrease taxes in one way without increasing them equally in another way to keep the gov't funded. This is why the Bush era tax cuts had to expire in 2010 (although they extended many by adding revenues elsewhere).

You and I understand how this rule can be used to avoid taxes. Maybe they see that, and maybe not, but I would bet they see the law change as an opportunity to collect tax quicker, and I don't think they'll want to change it. I hope I'm right, but even if I'm wrong I'd still rather defer as much tax now at 25% knowing I will only pay 10-15% after FIRE if they do change this rule.


beltim

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Re: U.S. tax withholding questions
« Reply #46 on: January 30, 2014, 03:23:34 PM »
You and I understand how this rule can be used to avoid taxes. Maybe they see that, and maybe not, but I would bet they see the law change as an opportunity to collect tax quicker, and I don't think they'll want to change it. I hope I'm right, but even if I'm wrong I'd still rather defer as much tax now at 25% knowing I will only pay 10-15% after FIRE if they do change this rule.

This is a nice way to bring the conversation back to my original point: the savings isn't necessarily what the OP calculated.  Again, I think she'll save money by contributing more to her 401k this year, but I was trying to give a more accurate picture of what those savings are.  My formula, by the way, is still correct we've just been discussing ways to change that "marginal tax rate in retirement" term.

Cheddar Stacker

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Re: U.S. tax withholding questions
« Reply #47 on: January 30, 2014, 04:12:19 PM »
Agreed. Your formula is accurate and a very good point. It's just that question mark of "What will the marginal tax rate in retirement" be? That's what none of us know, and that's why I'd prefer the sure thing of tax deferral now. It sounds like we're roughly on the same page, just slightly different view of future tax legislation perhaps.

Good discussion I think. Thanks.

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Re: U.S. tax withholding questions
« Reply #48 on: January 30, 2014, 11:35:35 PM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

I was going to say the same thing. You are not saving the full amount in taxes. You are just deferring the taxes.

rocksinmyhead

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Re: U.S. tax withholding questions
« Reply #49 on: January 31, 2014, 07:13:15 AM »
One thing that you should note. Saving $ in reduced taxes by contributing to a 401k only means you deferred the taxes. You'll pay them eventually when you withdraw from the 401k. Granted, you'll probably pay less later since the first dollar out isn't taxed at the highest tax bracket. So, you could save yourself 30% in taxes, or cost yourself 10%, as it all depends on the withdrawal (really, it should never cost you more as you should plan ahead).

So, you either pay the taxes now, or you pay them later. Paying later is generally preferred. However, I would really think twice before contributing to a 401k if you have CC debt, especially if the interest rate could climb to 20%. If you can max out of your 401(k) and pay down your debt at the same time, then that is worth it, as you only have a limited amount of space in your 401(k) per year, but if you couldn't max it out without the debt it is probably better to get the company match, then pay down the CC debt first and then throw more at the 401(k).

I was going to say the same thing. You are not saving the full amount in taxes. You are just deferring the taxes.

right. but I am confident my tax rate in retirement will be <28%, and I don't have CC debt, I have fixed rate student loan debt at <8%. plus, what about the time value of money? $2500 today is worth more to me than $2500 20-30 years from now.*

*edited: assuming I put it somewhere that it makes enough money to outpace inflation
« Last Edit: January 31, 2014, 07:20:49 AM by oscarsmom »