Author Topic: Quick 401(k) checkup: Very low income. Any reason to not go 100% Roth?  (Read 1754 times)

dustbreeding

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Hello everyone! I'm relatively new to Mustachianism (although definitely not new to frugality). The blog has been amazingly helpful from a big picture standpoint, and just recently learned that these forums are great from a minute detail standpoint. This, along with a multitude of other factors, has given me the kick I need to really commit to investing in my future and becoming FI early, and hopefully VERY early.

Without further ado, here is the question: I only make around $25k a year (well below the next tax bracket, 25% at $37k), and I live in a state with no income tax (Nevada). Although the pay is dreadful and I'm working on getting out, the company that I currently work for matches 100% up to 6% and the custodian service (T. Rowe Price) recently began to allow their users to diversify between Roth and traditional contributions into the 401(k), at an allocation of your choice. My current contributions to this plan are 35% of my paycheck going in Roth, and 25% going in traditional. The answer seems quite obvious to me, but I just wanted to double check before I made any long-ish term decisions: I should be contributing 100% Roth due to a mixture of my low income and lack of state income tax, correct?

I chose the 35/25 split somewhat sheepishly, seeing the benefits of Roth contributions, but also seeing many informational sources treat the Roth choice as a wary exception, rather than a confidently superior choice (given, the people who were writing about it, as well as their colleagues, are almost surely well into higher tax brackets than me and would probably benefit more from the tax-advantage of traditional contributions).

Thank you everyone, and sorry for the noob question!

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Also, bonus question for those who don't mind: I'm currently 22, and while my pay is quite terrible (especially among the Mustached crowd it seems), I plan on getting into a better field in the coming years, and have been blessed enough to be able to save like mad the last couple years. This year I started with about $25k cash in savings (I know... Personal Capital has already yelled at me!), and since wising up to the Mustachian / FIRE / Boglehead mindset, have already capped my current year + prior year Roth IRA contributions at Vanguard ($11k) with my savings. I also plan on maxing my 401(k) contributions this year, or getting very close (my current projection is about $17.7 - $18k estimating only on base pay), by taking home very small paychecks and using my excess cash savings to supplement my living expenses in the mean time. After all is said and done, I will still have about $10k in savings, drifting slowly downwards over the course of the year or more until I eventually reach an equilibrium.

Should I chop off, say, $5-$7k of this and invest it into a taxable Vanguard account for the time being? I still live with my parents, so realistically my emergency fund, although I don't overlook it, would not be a life-or-death factor. I also plan on continuing this for several years, or at least until I can get into a field / job that pays decently (right now moving out would probably mean cutting my savings at least in half. I love living with my family and don't plan on sacrificing my financial advantage for a lower standard of living AND lower savings rate). The only medium to long-term expense / purchase that I am planning for is in-state college starting next semester, of which a decent chunk should be subsidized by my company's tuition reimbursement ($5.3k annual for full-time employees).

I know conventional wisdom is to max 401(k), then max Roth IRA, then dabble in taxable options, but I feel like my situation is a little exceptional, and I don't want to miss out on the early advantage I have available to me despite my mediocre pay. Any ideas on this would be greatly appreciated!
« Last Edit: March 05, 2017, 04:28:00 PM by dustbreeding »

Paul der Krake

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Everything else equal, you should massage your AGI to maximize the savers credit:

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit

It's not refundable though. You should do a dryrun of your taxes to find the sweet spot.

dustbreeding

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Everything else equal, you should massage your AGI to maximize the savers credit:

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit

It's not refundable though. You should do a dryrun of your taxes to find the sweet spot.

Wow, this is really good to know. I actually got a (very small) portion of this credit on my 2016 taxes, but didn't realize that's how that worked. So basically, do as much Roth as possible while still having enough traditional to lower my AGI to <$18,500?

Edit: Or at least <$20k, since 20% of ~$18k in contributions is still well over the $2,000 cap
« Last Edit: March 05, 2017, 03:43:11 PM by dustbreeding »

Radagast

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That was a pretty useful post PDK. I got a tiny savers credit last year and figured it was akin to magic.

Another tip: if you go to a community college be sure to get the American Opportunity Tax Credit. That can add up to another few thousand.

dustbreeding

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That was a pretty useful post PDK. I got a tiny savers credit last year and figured it was akin to magic.

Another tip: if you go to a community college be sure to get the American Opportunity Tax Credit. That can add up to another few thousand.

It really is a wonderful thing, and a glimmer of positivity when comparing myself to the other wages I see here. Should be about a $1/hr raise just for doing something I was going to do regardless, haha.

Thank you for the heads up. I knew there was some kind of tax-incentive for going to school (barring the Pell Grant, which I think I'm ineligible for due to household income). Between this and my company's reimbursement, I think I should be able to go through it more-or-less for free, or at least be able to polish off the difference with my savings before it hits "typical student loan" territory (which, incidentally, is one of the reasons I waited on school).

Paul der Krake

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Everything else equal, you should massage your AGI to maximize the savers credit:

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit

It's not refundable though. You should do a dryrun of your taxes to find the sweet spot.

Wow, this is really good to know. I actually got a (very small) portion of this credit on my 2016 taxes, but didn't realize that's how that worked. So basically, do as much Roth as possible while still having enough traditional to lower my AGI to <$18,500?

Edit: Or at least <$20k, since 20% of ~$18k in contributions is still well over the $2,000 cap
Not quite- what you are ultimately shooting for is having just enough income tax that can be entirely offset by the savers credit, resulting in a $0 income tax bill.

That means that you are putting as much money in the Roth 401(k) as possible, but not so much that it would have been better to lower your AGI by putting more in the traditional 401(k), which isn't as good for someone who has the option of paying no tax at all.

Makes sense? :)

Again, I encourage you to do a dryrun of your taxes, because only you know the entire picture of your tax situation. Understanding the tax code well is one of the most financially rewarding things you can do in your spare time, aside from working on increasing your income.

It really is a wonderful thing, and a glimmer of positivity when comparing myself to the other wages I see here. Should be about a $1/hr raise just for doing something I was going to do regardless, haha.
Don't be fooled by the few high earners you see here. This board has a very wide income spectrum: some folks make $20k/year, some $500k/year, and everyone coexists in relative peace and harmony.

MDM

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Below is a view of the 2016 results for a single person earning exactly $25K/yr and no other pre-tax deductions:


If you can handle the cash flow implications, contributing exactly $6500 to the traditional 401k would have given you ~27% saving's rate and that seems best.

One could contribute even more and get the earned income credit at some point, but that's only ~7.65% and Roth is likely better for you beyond the $6500.

See the case study spreadsheet if you want to enter your exact numbers.

dustbreeding

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PDK and MDM, thank you guys so much for the thoughts and resources. I'm going to run some numbers and see how I can most closely follow that allocation, but funnily enough, it seems like the 35/25 split I originally had is actually pretty close to the proper threshold for the savers credit. On top of the $1,300 I'll be contributing to my HSA this year, I should be on the right track, and can adjust my Roth / traditional allocation more precisely as the year comes closer to ending.

Thanks y'all. I'm really glad I asked this question now!