Making sure I understand "Investment Order" within context of our income

[ReP]

Hi all -
I apologize if these questions are already represented in a previous thread. I checked & couldn't figure it out. My partner earns approx 135K (varies each year because of annual bonus) and I earn 43K. AGI ~ Questions/comments to see if we're understanding this correctly -

WHAT           
0. Establish an emergency fund to your satisfaction 
DONE         
1. Contribute to your 401k up to any company match     
Matching up to federal limit (and employer matches 50% - pretty rad)       
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
Only debts student and car loans between 1.9-3.73% so we're skipping this           
3. Max HSA             
Question - we should just ask our HR, but can you invest only PART of your HSA? Employer contributes 2K annually and we contribute the difference up to our annual out-of-pocket maximum. We've had some significant healthcare costs lately so this strategy is getting us a tax break but nothing else. We can afford to fully fund it but I don't like the idea of having to add a healthcare fund to our regular budget if we can't invest partially. 
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
Here's where the bulk of the questions are. At our AGI, we are not eligible for tax deductions on our IRAs. However, as far as I understand partner's employer allows backdoor Roth (they say you can contribute up to 20K after tax and convert to Roth - that's what a BD Roth is right?) so the first step is opening a TIRA for partner in order to do BD Roth. I have a SIMPLE IRA and since the contributions aren't deductible, am not sure if we should be fully funding this or investing in a taxable account after meeting the company match
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)           
6. Fund mega backdoor Roth if applicable   
I don't know if this is applicable because I cannot figure out the difference between a regular and "mega" BD Roth.          
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
N/A           
8. Invest in a taxable account with any extra.
We'll see what we have left - our spending is ridiculous so as we look where to cut serious fat, I certainly hope so at this income level!

Extra comment/question - we should be doing the Dependent Care FSA (we have a 2 yo in daycare) right? The only thing is, it's a bit of a headache - the max contribution is $5000 which is less than 1/3 of our total daycare costs - so there is a lot of $ moving in order to make the payments. And that kind of payroll deduction only gains us about ~$900 year at our effective tax rate. But when I think "would I pay someone $75/month to orchestrate these payments" I feel like an idiot. Maybe this is my mustache growing.

TIA!!

[VoteCthulu]

4) You are under the $184k limit for normal Roth contributions, so both you and your partner should contribute the limit of $5500 to it.

6) This is what you were describing in (4), where you contribute after tax dollars to your 401k and then convert it to a Roth. Make sure you each max your normal $18k employer plans before this so you get them max income tax deduction you can.

[dandarc]

You described the Megabackdoor Roth.  You contribute after-tax (not Roth) to your 401K, then convert it into your Roth IRA.

Regular backdoor is similar procedure, but it is done entirely within your IRAs to get around the income limits on Roth IRA contributions, which as VoteCthulu pointed out, you are under, so no need to worry about this.  If you ever find yourself over the MAGI limit for Roth IRA contributions, please read up on the backdoor Roth before doing it - there are some gotchas there, particularly given your employer-provided retirement is a SIMPLE.

Also - SIMPLE IRA is always deductible.  Your W-2 wages already have this excluded for income tax purposes.  So when you see SIMPLE, think 401k - works about the same way.  Unless the fees are truly ridiculous, this would be a good thing to max up to the $12,500 you're allowed.

[ReP]

4) You are under the $184k limit for normal Roth contributions, so both you and your partner should contribute the limit of $5500 to it.

Thank you. So obviously my husband needs to open a Roth in order to do the Mega BD Roth backdoor - but if I'm going to open an IRA separate from my SIMPLE IRA - since it's not part of a back door plan or anything -  shouldn't be Traditional given our tax bracket, even if the contributions aren't deductible? We assume we'll be paying much lower taxes in retirement. Despite all the debate, I thought this is what it boiled down too.

[ReP]

You described the Megabackdoor Roth.  You contribute after-tax (not Roth) to your 401K, then convert it into your Roth IRA.

Regular backdoor is similar procedure, but it is done entirely within your IRAs to get around the income limits on Roth IRA contributions, which as VoteCthulu pointed out, you are under, so no need to worry about this.  If you ever find yourself over the MAGI limit for Roth IRA contributions, please read up on the backdoor Roth before doing it - there are some gotchas there, particularly given your employer-provided retirement is a SIMPLE.

Thanks for the clarification

Also - SIMPLE IRA is always deductible.  Your W-2 wages already have this excluded for income tax purposes.  So when you see SIMPLE, think 401k - works about the same way.  Unless the fees are truly ridiculous, this would be a good thing to max up to the $12,500 you're allowed.

Yay! Best news all day! Can't believe I couldn't figure this out - thanks for tolerating my beginner questions.

[ReP]

If you ever find yourself over the MAGI limit for Roth IRA contributions, please read up on the backdoor Roth before doing it - there are some gotchas there, particularly given your employer-provided retirement is a SIMPLE.

Oops - forgot about this - I do anticipate we'll go up to the 184K limit by 2018. Maybe it's time we hire a tax professional...

Edit to say: oh nevermind. I think it would be a while before our actual AGI (not net) income goes up to 184K.

[dandarc]

The only valid use of a non-deductible traditional IRA is as a vehicle for a backdoor Roth.  In a non-deductible tIRA, when you withdraw, you only pay taxes on the gains, but you pay ordinary income rates.  There is some benefit to the tax-deferred growth, but that is offset and then some for most by paying higher taxes on withdrawal.  If I were you, I'd do this:

Max both the 401K and the SIMPLE IRA - these save you a high tax rate today
2X Roth IRAs - not eligible to deduct, so you can start building a pile of tax-free withdrawal money - this compares favorably to a taxable account
Megabackdoor Roth since you have access to that - ditto to the above
Taxable account

[dandarc]

If you ever find yourself over the MAGI limit for Roth IRA contributions, please read up on the backdoor Roth before doing it - there are some gotchas there, particularly given your employer-provided retirement is a SIMPLE.

Oops - forgot about this - I do anticipate we'll go up to the 184K limit by 2018. Maybe it's time we hire a tax professional...

Is that gross?  Because to compute MAGI for this purpose, you take your salaries and subtract - 401K, SIMPLE IRA, Health insurance / dental / vision premiums, HSA and FSA contributions.  Probably a few other things - but basically, you've got at least $30K less than your gross salaries and bonuses if you max the 401K and the SIMPLE.

[Aggie1999]

HSA answers:

Most HSA plans allow you to invest some portion of your balance in tranditional funds, similar to a 401k. For example, my HSA plan allows anything over $2k to be invested. Annoys me that I have to keep $2k in cash but nothing I can do about it.

As far as spending money out of the HSA, don't do it unless your are strapped for cash. Always better to pay for medical bills out of after tax dollars. That allows your HSA funds to continue to grow tax free. Save all receipts and then when you are ready (i.e. old) you reimburse yourself for all the expenses.

[NoStacheOhio]

Child care expenses are deductible at the end of the year if you don't elect an FSA contribution. So if doing the FSA is too much hassle, just plug in the amount at the end of the year.

[ReP]

If you ever find yourself over the MAGI limit for Roth IRA contributions, please read up on the backdoor Roth before doing it - there are some gotchas there, particularly given your employer-provided retirement is a SIMPLE.

Oops - forgot about this - I do anticipate we'll go up to the 184K limit by 2018. Maybe it's time we hire a tax professional...

Is that gross?  Because to compute MAGI for this purpose, you take your salaries and subtract - 401K, SIMPLE IRA, Health insurance / dental / vision premiums, HSA and FSA contributions.  Probably a few other things - but basically, you've got at least $30K less than your gross salaries and bonuses if you max the 401K and the SIMPLE.

Yes I edited too late for you to see but I figured out we're pretty far from 184K gross. Based on my estimates (subtracting all the things you mentioned - except premiums which are totally covered by partner's employer) we're around 130K. That includes the standard deduction too - we never qualify for anything different.

Next step is to figure out the budget given the gut punch our take-home pay is about to take (yes, I realize how stupid that sounds given our high income).

[ReP]

Child care expenses are deductible at the end of the year if you don't elect an FSA contribution. So if doing the FSA is too much hassle, just plug in the amount at the end of the year.

Yep - according to my calculations though, we get a lot more benefit out of the tax shelter from the FSA contributions than the tax credit at the end of the year (because of our income level).

[ReP]

HSA answers:

Most HSA plans allow you to invest some portion of your balance in tranditional funds, similar to a 401k. For example, my HSA plan allows anything over $2k to be invested. Annoys me that I have to keep $2k in cash but nothing I can do about it.

As far as spending money out of the HSA, don't do it unless your are strapped for cash. Always better to pay for medical bills out of after tax dollars. That allows your HSA funds to continue to grow tax free. Save all receipts and then when you are ready (i.e. old) you reimburse yourself for all the expenses.

Blech ok - I know it's just psychological and we're spending that money on health care either way but this is not what I wanted to hear because I'm not so great at managing cash flow out of our main checking. (Actually, I'm pretty good at it but I hate doing it). Maybe I'll open a no-fees checking account to manage that shite.

[Heroes821]

Be aware that HSA contributions are also pre-FICA taxes not just income taxes so even more incentive to cap.

I haven't been able to confirm this because I haven't started investing my HSA yet, but Discovery Benefits appears to let me invest the entire balance no minimum.

Also as mentioned above, my HSA strat is to leave it completely alone and pay medical bills with out of pocket already taxed income until I'm past normal retirement age while it gets all that good tax free growth.

[dandarc]

If you ever find yourself over the MAGI limit for Roth IRA contributions, please read up on the backdoor Roth before doing it - there are some gotchas there, particularly given your employer-provided retirement is a SIMPLE.

Oops - forgot about this - I do anticipate we'll go up to the 184K limit by 2018. Maybe it's time we hire a tax professional...

Is that gross?  Because to compute MAGI for this purpose, you take your salaries and subtract - 401K, SIMPLE IRA, Health insurance / dental / vision premiums, HSA and FSA contributions.  Probably a few other things - but basically, you've got at least $30K less than your gross salaries and bonuses if you max the 401K and the SIMPLE.

Yes I edited too late for you to see but I figured out we're pretty far from 184K gross. Based on my estimates (subtracting all the things you mentioned - except premiums which are totally covered by partner's employer) we're around 130K. That includes the standard deduction too - we never qualify for anything different.

Next step is to figure out the budget given the gut punch our take-home pay is about to take (yes, I realize how stupid that sounds given our high income).

Good - but you don't subtract your standard or itemized deductions or personal exemptions for this purpose.

[ReP]

Good - but you don't subtract your standard or itemized deductions or personal exemptions for this purpose.

[/quote]


So AGI is just net - 401K/HSA/FSA/SIMPLE etc. and I would use THAT number to estimate tax liability? Uggghghghg I definitely need to go to a tax professional because we screwed up our allowances this year as well and have a small tax bill.

[dandarc]

AGI - Adjusted Gross Income - bottom of the front of your 1040.

Now, to determine eligibility for an IRA deduction or Roth IRA contribution, we look at MAGI - Modified Adjusted Gross Income.  Start with AGI, add a few things back - Tuition deduction, student loan interest, and IRA deduction are the big ones.  http://fairmark.com/retirement/roth-accounts/contributions-to-roth-accounts/modified-adjusted-gross-income/

I personally prefer to look at it the other direction - start with my gross and what can I subtract to get to MAGI, then AGI, eventually taxable income.

I mean, if you want to pay a CPA or similar to look at your taxes, by all means do so, but most people's taxes really aren't that complicated - just doing your return by hand a few times will help learning this.  Also, shopping-mall tax service is not tax advice worth paying for.  Sure they'll prepare your taxes, but they are at least as likely as you are to make a mistake, in my experience.

[ReP]

AGI - Adjusted Gross Income - bottom of the front of your 1040.

Now, to determine eligibility for an IRA deduction or Roth IRA contribution, we look at MAGI - Modified Adjusted Gross Income.  Start with AGI, add a few things back - Tuition deduction, student loan interest, and IRA deduction are the big ones.  http://fairmark.com/retirement/roth-accounts/contributions-to-roth-accounts/modified-adjusted-gross-income/

I personally prefer to look at it the other direction - start with my gross and what can I subtract to get to MAGI, then AGI, eventually taxable income.

I mean, if you want to pay a CPA or similar to look at your taxes, by all means do so, but most people's taxes really aren't that complicated - just doing your return by hand a few times will help learning this.  Also, shopping-mall tax service is not tax advice worth paying for.  Sure they'll prepare your taxes, but they are at least as likely as you are to make a mistake, in my experience.

I mean, I definitely don't WANT to pay someone to do it but I am getting overwhelmed. However, I realized I had AGI and taxable income conflated (and hadn't even realized that MAGI was another category even though every table I looked at for Roth stuff said "modified" Ayee!) I was trying to estimate my taxable income in order to calculate take home pay where as the MAGI/AGI are used to determine eligibility for various stuff.

So my SIMPLE plan contributions are considered a salary deferral just like 401K contributions and wouldn't affect my MAGI, right? (I mean they will, because they reduce my overall income but they don't count as something I have to add BACK in because they're not a deduction).

Thanks for ALL your help.

[dandarc]

Exactly - you don't add back in SIMPLE or 401K to make that computation.  Only traditional IRA deductions, of the usual retirement accounts - kind of makes sense, you can't "qualify" to take the IRA deduction by taking the deduction itself.

[Brilliantine]

My employer provides the exact same benefits. ;)

I just withhold the max for my HSA and forget about it. And I invest all that is in the HSA. I just pay for our healthcare costs out of pocket. The claims page you get to from the Benefits portal acutally allows me to "save to HSA" for claims, so that I can reimburse myself for those claims anytime in the future. I'd strongly recommend taking full advantage of that. All that being said, yes, I'm pretty sure you can invest whatever sum you want out of your HSA.

You forgot ESPP! :) Do put the max allowed into his ESPP and collect that additional free money.

[ReP]

You forgot ESPP! :) Do put the max allowed into his ESPP and collect that additional free money.

Yes I think you might have figured out where one of us works. Sweet Poirot pic BTW! We definitely want to do the ESPP but need to do some serious budget trimming otherwise we won't have any left over after the previously recommended steps.

[Brilliantine]

We definitely want to do the ESPP but need to do some serious budget trimming otherwise we won't have any left over after the previously recommended steps.

I hear you; I am trying to take advantage of all these benefits and my take-home paycheck is about 35% of my gross.

With regards to the ESPP, I do have cash cushion so I dip into that if necessary and then replenish when I sell the ESPP shares. I recommend doing that. Even if you don't have the cushion, you can do what MMM says, use springy debt. At your husband's eligible income (the annual bonus is eligible income) the ESPP brings an additional $2000 a year; nothing to sneeze at.