Another "what to do with extra cash?" post

[Freedom2016]

Tl;dr: We have extra cash to invest this year. Should it go to our kids’ 529 plans, or into a taxable account?

The details:

DH and I are experiencing abnormally high income this year; by end-year I will have ~$750k-$1mm in gross distributions from my business. (Income in 2015 expected to be at a more normal level of $125-150k). With the excess income so far, we have:

•   Replenished our EF ($20,000)
•   Eliminated PMI ($37,400 principal paid down)
•   Paid off mother-in-law loan ($8000)
•   Maxed out 2013 retirement ($39,400) (I have a kind of solo 401k for partnerships)
•   Contributed to 2014 retirement ($25,000)
•   Earmarked additional for 2014 retirement, to contribute in Apr 2015 ($25,000)
•   Currently debating paying off my last student loan ($34,000)

After taxes, living expenses, and the above, we will still have ~$180-355k soldiers to put to work. FYI, we do not have an HSA available to us.

What should we do with the $180-355k?

It is a priority to pay for (most of) our kids’ undergraduate college education, so we are tempted to throw $75k into our 2-year old son’s 529 plan, and another $75k into a new 529 when Baby #2 is born (October). We could thus be done with college funding either entirely, or until they are closer to college age and we can see how close/far we are from having what we need.
 
That move would leave us with $30-205k to put into taxable investments for 2014, and after that, free up $6000/year that would otherwise go to 529 funding.

The debate/question in my mind is: should we do the opposite, and put $150k into taxable investments instead, and only fund the 529 accounts after that? I know people say there are loans, grants, and scholarships for college but not for retirement… but we’re already maxing out our tax-advantaged savings, so does this logic still apply?

For what it’s worth, early retirement isn’t a huge driver for us – I enjoy my work and have a lot of flexibility & autonomy, and my husband is loving being a stay-at-home dad. The fact that putting $150k into 529’s instead of taxable investments would push out our FI date by 2 years doesn’t upset me/us.

Or are we missing something else entirely? (“Above all else, you need to do X with that money!”)

[Lkxe]

I don't have an "above all else " for you but I funded my children's 529's.( from a house sale) I felt it was important to do so. If things get really bad you can retrieve that money later. It isn't as easy to get out as from a Roth but taxes on growth and a 10% penalty isn't the worst thing in the world. And if junior happens to get a full ride at the same time the penalty fee is waived.  My oldest did get a free ride but he may have graduate fees and his little brother has 10 years till his turn.

[MDM]

Back door Roth IRA?

Contribute somewhat less to the 529s and plan for your children to take at least some student loans and summer employment to cover total college costs (thereby giving them a well-earned sense of accomplishment)?

Pay off mortgage? (only if >3.5% interest or so)

Other than those (and they are only "things to consider", not "you must do"), you seem to have things covered well.

[William]

Get your kids to open a Roth IRA ASAP and get that fully funded.  Then 529.  Then taxable account for yourselves.  A Roth IRA will stick with them forever even if they don't need it for education.

Depending on their ages, you may have to get creative about how the Roth can be opened since you must prove they have an earned income.

[Freedom2016]

Get your kids to open a Roth IRA ASAP and get that fully funded.  Then 529.  Then taxable account for yourselves.  A Roth IRA will stick with them forever even if they don't need it for education.

Depending on their ages, you may have to get creative about how the Roth can be opened since you must prove they have an earned income.

My son is 2 and #2 isn't yet born - I don't think a Roth IRA is going to be feasible for them in the short term. I can't imagine what earned income we could claim for a toddler and an infant. :)

However, just so I'm clear, what is the benefit of a back door Roth over a 529? Wouldn't that actually take away from our own retirement savings? (Isn't the idea that you send money from a tax-advantaged account through a "back door" to a post-tax account that you can access penalty-free?) That seems like it harms our own retirement savings strategy, no?

Also we're in a high tax bracket now but will almost certainly be in a lower bracket during retirement, so doesn't that suggest we should avoid Roth IRA's anyway?

I must be missing something...

[smalllife]

Interested in having a rental property?  Depending on where you are that's a great starting point.

Is there any re-balancing of your portfolio that could be well served by a taxable account?

Depending on how secure your job/company is, you could pay off the mortgage or put a portion in a taxable account as an extra level of emergency fund.

[Freedom2016]

We've never thought about rental properties... we're in a HCOLA and don't have any experience with landlording so I'd be a bit wary. But not a bad idea to consider!

Our retirement portfolio is pretty well balanced right now - we're at 80% equities / 15% fixed income / 5% cash.

On mortgage repayment: we plan to move in 4-5 years so not sure about putting cash into an illiquid asset? Then again our interest rate is 4.875%.

[MDM]

Isn't the idea that you send money from a tax-advantaged account through a "back door" to a post-tax account that you can access penalty-free?

If you already have a "large" amount of money in a traditional IRA, the back door IRA won't be all that helpful.  But if you don't have much (or any) in a traditional IRA, the back door IRA is a way for you to get tax-advantaged savings regardless of what other investing you do. 
See http://blog.personalcapital.com/retirement-planning/backdoor-roth-ira-good-move/, or http://www.nerdwallet.com/blog/finance/advisorvoices/back-door-roth-ira-contributions/, etc. for more details.

[Freedom2016]

Isn't the idea that you send money from a tax-advantaged account through a "back door" to a post-tax account that you can access penalty-free?

If you already have a "large" amount of money in a traditional IRA, the back door IRA won't be all that helpful.  But if you don't have much (or any) in a traditional IRA, the back door IRA is a way for you to get tax-advantaged savings regardless of what other investing you do. 
See http://blog.personalcapital.com/retirement-planning/backdoor-roth-ira-good-move/, or http://www.nerdwallet.com/blog/finance/advisorvoices/back-door-roth-ira-contributions/, etc. for more details.

Thanks, I'll check out the links. We have $325k in tIRA's and another $14k in an old Roth of my husband's - don't think we're allowed to contribute to it now given our income.

[milesdividendmd]

Congratulations on your bounty,

Frontloading the 529s is a great Idea, especially if you can carry forward the state tax break for the coming years in your state.

With that amount of money I would put the amount up toyour states tax break into your home states 529, and then the rest in a good plan like Utah or NY.

See:

http://www.hcplive.com/physicians-money-digest/personal-finance/The-Best-529-in-The-Country-Dahle

and don't forget to invest the 529 aggressively:  the more you make, the more you save.

http://whitecoatinvestor.com/3-reasons-why-you-can-take-more-risk-with-a-529/

I also think 11K in a back door Roth is a no brainer every year...just don't forget to roll over your other IRAs into your employer based plan first to avoid the pro-rata rule.

[MOD EDIT: Link removed.  Please stop spamming links promoting your own site.  A single link in your signature is sufficient, and will be under every post you make.  Thanks.]

After that I would invest in tax efficient ETFs in a taxable account, and not forget to tax loss harvest.

Alexi

[Freedom2016]

Thanks! Our state offers no tax breaks for 529 plans (boo) so we are in the NY one. Will continue that.

I'm still not sure why/how a backdoor Roth IRA benefits us when we're in such a high tax bracket now, guaranteed to be in a much lower tax bracket during retirement. ?

[MDM]

I'm still not sure why/how a backdoor Roth IRA benefits us when we're in such a high tax bracket now, guaranteed to be in a much lower tax bracket during retirement. ?

The big "if" here, as milesdividendmd alludes to in saying "just don't forget to roll over your other IRAs into your employer based plan first to avoid the pro-rata rule", is "if you don't have to pay any extra" taxes in the year you do the back door.

If you didn't have the $325k in tIRAs, or if you can get that out of the tIRA and into an employer-based plan, then you take money ($5500 for you and spouse, or $11K total) that would go into a completely taxable account anyway and, despite your high AGI, slip it into a Roth via the back door so you pay zero taxes whenever you withdraw the earnings.  But beware the "pro-rata rule"....

[milesdividendmd]

After you max out your workplace retirement accounts you can contribute another 11,000 after tax into a traditional IRA. 
When you back door this contribution into a Roth, this means you will pay no taxes on the money ever again, at a cost of exactly nothing! (assuming you don't run afoul of the pro-rata rule.) 

So say your traditional IRA money doubles and doubles again in 20 years.  You would have to pay taxes on 3/4 of your withdrawl amounts at your top marginal tax rate  in retirement.  With a roth you would pay zero in taxes, at no cost.

Also after 5 years you can pull the principle out tax free.  And there are no minimum disbursements in retirement (unlike in a traditional IRA.)

It is a big money move for high income earners like yourself.  Surpassed only by the HSA.  (You should campaign for a high deductible health plan option with your benefits administrator.)

Hope that helps,

Alexi

PS One neat option with the NY HSA is paying for your contributions with visa gift cards purchased with carefully selected credit cards in order to get an effective 4% cash back ( tax free) at the point of contribution.  You can do this with evolve money, but that's a whole other subject!

[Freedom2016]

Thanks mdmd and MDM - helpful stuff.

If I'm understanding how it works, DH would not be able to do a backdoor as he has deductible IRA assets and he's not working right now (i.e. no employer sponsored retirement plan to roll the IRA into).

I need to verify, but I don't think my work retirement plan allows roll-ins and if not, I have too many tIRA assets for backdoor to make sense.

[William]

Get your kids to open a Roth IRA ASAP and get that fully funded.  Then 529.  Then taxable account for yourselves.  A Roth IRA will stick with them forever even if they don't need it for education.

Depending on their ages, you may have to get creative about how the Roth can be opened since you must prove they have an earned income.

My son is 2 and #2 isn't yet born - I don't think a Roth IRA is going to be feasible for them in the short term. I can't imagine what earned income we could claim for a toddler and an infant. :)

I think all the other parts of your post got answered before I could get back to this thread.  But as far as proving earned income at that age... you'll have to get creative.  One guy I know puts his grandkids in his cheesy used car commercials to fund their Roth's.  Pays them an outrageous amount of $$, of course. :)

[SDREMNGR]

Make your babies spokesmodels for your business advertising and pay them ludicrous amounts, start a Roth IRA with their baby modeling income. DONE!