Author Topic: Should I max our 401K's?  (Read 4926 times)

Bootlip

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Should I max our 401K's?
« on: October 12, 2016, 09:33:05 AM »
My wife and I will be debt free other than our mortgage(117,000) in two months. I just turned 31yrs old and my wife is 29. We have a 50,000 saved between my Roth IRA, my 401K, and her 401K. So here's our goal. We'd like to save 40% of our gross income to become FI asap. Hopefully in 10yrs ish.

So here's the details...
We make 120,000 gross a year combined
-I currently do not contribute to my Roth IRA(20,000 balance)
-I have a 401K with no employer match that invests 11.83% of my gross into low cost index funds.(No decreasing this, I can only increase percentage saved being I'm in a union and thats our contract)
-My wife currently contributes up to the full match of 6% into her 401K and that's it.

So basically with money going into our accounts stated above, paying all our bills/expenses, we have about $45,000 (net) left over every year. With a savings goal of 40% of our gross($48,000). This additional savings should be easily doable.

My game plan is to fully fund my Roth and get my wife a Roth and fully fund that as well. That'll be $11,000. Then we currently have $11,171 a year going into our 401K's. So that'll be $22,171 total. So that leaves another $25,829 to invest. Should I just put this in our 401K's and max them out. Or is there a better route? Should I use another investment tool? Personal taxable accounts?


EDIT:   I would like to clarify that we have not blown our excess income. In two months we will have paid $85,000 in debt off in 2 years!! Also the my logic behind possibly not maxing the 401K's is because I don't know if the lower expense ratios paired with more options of a personal account will outweigh the advantages of putting it in our 401K's. That is all. Thanks for any help!
« Last Edit: October 12, 2016, 09:40:50 AM by Bootlip »

DrF

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Re: Should I max our 401K's?
« Reply #1 on: October 12, 2016, 09:42:59 AM »
MDM is always great with compiling the advice in one place. Basically, you want to take advantage of all pre-tax savings plans that you can. This way, you pay less taxes and can invest that money instead. Also read MadFientist. http://www.madfientist.com/retire-even-earlier/


Questions
- Am I wrong in thinking that every dollar invested into any of the tax-advantaged accounts is automatically receiving a guaranteed 25% return?
Yes, the "automatically" part is incorrect.

E.g., if you merely put the money into a money market paying ~0%, then withdraw it when you are paying the same marginal rate you saved for the initial investment, you have gained nothing at all.

Quote
- Should I be thinking about paying off the debt more quickly (6-9 months) instead of taking advantage of the tax-advantaged investment accounts?
I haven't seen this twist to the question (i.e. tax-advantaged accounts vs. debt payoff) answered very clearly before. Hopefully the Mustachian community has some thoughts?

Here is the "usual advice", current as of the posting date.  See the 'Investment Order' tab in the case study spreadsheet for the latest version.   
"Max..." means "contribute up to the maximum allowed for..., subject to your ability to pay day-to-day expenses."   
   
It is up to you whether to consider "saving for a house down payment" as a "day to day expense", vs. lumping the down payment savings in with "taxable investments" at the end.   
If you are renting, you may not be throwing away as much on rent as you might think.  See   
   http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/ for some thoughts.
   
In the lists below, thinking "first your 457 (if you have one), then your 401k and/or 403b" wherever "401k" appears is likely correct -   
   unless your 457 fund options are significantly worse than those in the 401k/403b -
   due to penalty-free access to 457 funds at retirement, even if younger than 59 1/2.
   
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).   
   
Current 10-year Treasury note yield is ~2%.  See   
   http://quotes.wsj.com/bond/BX/TMUBMUSD10Y
   
WHAT   
0. Establish an emergency fund to your satisfaction   
1. Contribute to 401k up to any company match   
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.   
3. Max HSA    
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level   
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)   
6. Fund mega backdoor Roth if applicable   
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.   
8. Invest in a taxable account with any extra.   
   
WHY   
0. Give yourself at least enough buffer to avoid worries about bouncing checks   
1. Company match rates are likely the highest percent return you can get on your money   
2. When the guaranteed return is this high, take it.   
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.   
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between (or see   
   http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/
   if you want even more details on that topic).  See also
   https://www.bogleheads.org/forum/viewtopic.php?f=2&t=182081,
   http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-overwhelming-student-loan-debt-how-would-you-get-started/msg868845/#msg868845
   and other posts in that thread about exceptions to the rule.
5. See #4 for choice of traditional or Roth for 401k   
6. Applicability depends on the rules for the specific 401k   
7. Again, take the risk-free return if high enough   
8. Because earnings, even if taxed, are beneficial   
   
The emergency fund is your "no risk" money.  You might consider one of these online banks:   
   http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001
      
If your 401k options are poor (i.e., high fund fees) you can check   
   http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/
for some thoughts on "how high is too high?"   
   
Priorities above apply when income is primarily through W-2 earnings.  For those running their own businesses (e.g., rental property owner, small business owner, etc.),   
   putting money into that business might come somewhere before, in parallel with, or after step 5.

seattlecyclone

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Re: Should I max our 401K's?
« Reply #2 on: October 12, 2016, 09:46:07 AM »
Yes, MDM's ordering is pretty good. Once you've gotten the full match from your 401(k), you should generally invest in IRAs next because of the reasons you state: more fund choices and often lower expenses. Once you've maxed those out, the next best place is to max out your 401(k) because the tax savings generally outweigh a lower amount of flexibility unless the funds in your 401(k) are truly terrible and you plan to remain in your current job for another decade or two.

Scandium

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Re: Should I max our 401K's?
« Reply #3 on: October 12, 2016, 10:34:52 AM »
Why Roth? After standard deductions and 401k contributions wouldn't your salary be below the deductible-IRA limit?

In general I'd prefer maxing 401k before Roth, as i value the tax deduction more than just avoiding tax on gains.

Bootlip

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Re: Should I max our 401K's?
« Reply #4 on: October 12, 2016, 11:06:17 AM »
Thanks for the info everyone!

Scandium- I'm not sure I understand the first part of your reply. And maybe it doesn't exactly matter because we'll be able to max both our 401K's and our Roths. Please explain?

So as long as we're maxing both our 401K's and Roths up to their limits each year, the order in which they are contributed to is irrelevant. Correct? Also am I correct in using the Roths for our IRA's over Traditional?



DrF

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Re: Should I max our 401K's?
« Reply #5 on: October 12, 2016, 11:08:03 AM »
Depending on your current and future tax situation, and any pensions, inheritances, or other windfalls, Traditional will allow you to save more money faster.

Scandium

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Re: Should I max our 401K's?
« Reply #6 on: October 12, 2016, 11:19:17 AM »
Thanks for the info everyone!

Scandium- I'm not sure I understand the first part of your reply. And maybe it doesn't exactly matter because we'll be able to max both our 401K's and our Roths. Please explain?

So as long as we're maxing both our 401K's and Roths up to their limits each year, the order in which they are contributed to is irrelevant. Correct? Also am I correct in using the Roths for our IRA's over Traditional?

Not in my opinion, I prefer traditional for an immediate tax deduction. Though this is a hotly debated topic. http://www.gocurrycracker.com/roth-sucks/
I can only do a backdoor roth myself, and I'm not sure I'll even bother and just stick it in taxable instead, since it's a hassle for small/dubious benefits.

The income limit for the IRA deduction will be $99k in 2017
https://thefinancebuff.com/2017-401k-403b-457-simple-roth-ira-limits.html

You'll have to look up the numbers and what is allowed, but I believe the standard deductions/exemptions will get your salary below this number. I'm not sure whether any 401k contributions count towards the limit. (MAGI vs AGI). If that's the case I would put $11k in traditional and get the tax deduction now. If you can't I would still max both 401ks before doing a Roth.

If you max two 401k and  can't do an IRA then maybe I'd recommend Roth.

JJsfr

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Re: Should I max our 401K's?
« Reply #7 on: October 12, 2016, 11:54:32 AM »
Thanks for the info everyone!

Scandium- I'm not sure I understand the first part of your reply. And maybe it doesn't exactly matter because we'll be able to max both our 401K's and our Roths. Please explain?

So as long as we're maxing both our 401K's and Roths up to their limits each year, the order in which they are contributed to is irrelevant. Correct? Also am I correct in using the Roths for our IRA's over Traditional?

Just in case... But there are both ROTH IRA's and Traditional IRA's. Traditional IRA's are tax deductible if you're under the phaseout range (which you will be if you both max 401k's). ROTH IRA's as you probably know allow you to earn gains without paying taxing on the gains. Contributions to either form of IRA cannot exceed $5,500 in a year, and combined they cannot exceed $5,500 in a year.

What Scandium is suggesting is to fund a tIRA instead of the ROTH for the immediate tax benefits. You can have both a tIRA and a ROTH IRA in your portfolio.

MDM

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Re: Should I max our 401K's?
« Reply #8 on: October 12, 2016, 04:39:43 PM »
Not in my opinion, I prefer traditional for an immediate tax deduction. Though this is a hotly debated topic.
Indeed it is.  One can read https://www.bogleheads.org/wiki/Traditional_versus_Roth for a decent explanation of when one should choose which.

DavidAnnArbor

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Re: Should I max our 401K's?
« Reply #9 on: October 14, 2016, 08:18:51 AM »
I'm not sure whether any 401k contributions count towards the limit. (MAGI vs AGI).

Contributing to the 401k will lower your AGI and therefore lower the MAGI for determining eligibility for the tIRA.

rockstache

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Re: Should I max our 401K's?
« Reply #10 on: October 14, 2016, 09:47:51 AM »
I'm not sure whether any 401k contributions count towards the limit. (MAGI vs AGI).

Contributing to the 401k will lower your AGI and therefore lower the MAGI for determining eligibility for the tIRA.

Does the HSA do this as well?

seattlecyclone

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Re: Should I max our 401K's?
« Reply #11 on: October 14, 2016, 09:49:39 AM »
I'm not sure whether any 401k contributions count towards the limit. (MAGI vs AGI).

Contributing to the 401k will lower your AGI and therefore lower the MAGI for determining eligibility for the tIRA.

Does the HSA do this as well?

Yes.

MVal

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Re: Should I max our 401K's?
« Reply #12 on: October 14, 2016, 09:55:34 AM »
I have a question along these lines... If you can't afford to max out both your 401K and your IRA, what should you do? Say I anticipate investing only $17K next year. Should I max the 401K and put nothing in the IRA, or max the IRA and put the remainder in the 401K?

MDM

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Re: Should I max our 401K's?
« Reply #13 on: October 14, 2016, 09:57:08 AM »
I'm not sure whether any 401k contributions count towards the limit. (MAGI vs AGI).

Contributing to the 401k will lower your AGI and therefore lower the MAGI for determining eligibility for the tIRA.

Does the HSA do this as well?
Yes.

rockstache

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Re: Should I max our 401K's?
« Reply #14 on: October 14, 2016, 10:15:25 AM »
Hooray! Thanks MDM and Seattle, you two are SO helpful. With this open season coming up, I am wanting to dig into the HSA and see if a HDHP is right for me. I know there have been some great threads on that (for a beginner) and I don't want to hijack this one, so if anyone has searchy skills and can point me in the right direction, please do!

DrF

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Re: Should I max our 401K's?
« Reply #15 on: October 14, 2016, 10:16:53 AM »
I have a question along these lines... If you can't afford to max out both your 401K and your IRA, what should you do? Say I anticipate investing only $17K next year. Should I max the 401K and put nothing in the IRA, or max the IRA and put the remainder in the 401K?

It depends on which account gives you the better options. Some employers have great 401ks with lots of low cost index funds (fees below retail rate, institutional negotiation). If your 401k is crap, then contribute enough to get the match, then fill up your and your spouse's traditional IRAs, then anything else above that put into your 401k.

MVal

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Re: Should I max our 401K's?
« Reply #16 on: October 14, 2016, 10:29:17 AM »
I have a question along these lines... If you can't afford to max out both your 401K and your IRA, what should you do? Say I anticipate investing only $17K next year. Should I max the 401K and put nothing in the IRA, or max the IRA and put the remainder in the 401K?

It depends on which account gives you the better options. Some employers have great 401ks with lots of low cost index funds (fees below retail rate, institutional negotiation). If your 401k is crap, then contribute enough to get the match, then fill up your and your spouse's traditional IRAs, then anything else above that put into your 401k.

Good to know. I've not delved into the actual records in my actual 401K, but on the Personal Capital fee analyzer, it shows my 401K annual fees are 0.36% and that I lose 7% of my earnings to fees. I'll have to see how that compares to a Vanguard IRA invested in VTSAX or VTSMX.

teen persuasion

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Re: Should I max our 401K's?
« Reply #17 on: October 14, 2016, 01:06:46 PM »
I have a question along these lines... If you can't afford to max out both your 401K and your IRA, what should you do? Say I anticipate investing only $17K next year. Should I max the 401K and put nothing in the IRA, or max the IRA and put the remainder in the 401K?

It depends on which account gives you the better options. Some employers have great 401ks with lots of low cost index funds (fees below retail rate, institutional negotiation). If your 401k is crap, then contribute enough to get the match, then fill up your and your spouse's traditional IRAs, then anything else above that put into your 401k.

Are you eligible for the EITC?  Contributions to your 401k decrease both your line 7 income and AGI.  TIRA contributions only reduce your AGI, and the EITC tests both.  So you can better maximize your credit thru 401k contributions.

Of course, if the credits and tax savings are large enough, you can use that $ to also fund an IRA (we do).

MVal

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Re: Should I max our 401K's?
« Reply #18 on: October 14, 2016, 01:28:00 PM »
I have a question along these lines... If you can't afford to max out both your 401K and your IRA, what should you do? Say I anticipate investing only $17K next year. Should I max the 401K and put nothing in the IRA, or max the IRA and put the remainder in the 401K?

It depends on which account gives you the better options. Some employers have great 401ks with lots of low cost index funds (fees below retail rate, institutional negotiation). If your 401k is crap, then contribute enough to get the match, then fill up your and your spouse's traditional IRAs, then anything else above that put into your 401k.

Are you eligible for the EITC?  Contributions to your 401k decrease both your line 7 income and AGI.  TIRA contributions only reduce your AGI, and the EITC tests both.  So you can better maximize your credit thru 401k contributions.

Of course, if the credits and tax savings are large enough, you can use that $ to also fund an IRA (we do).

Since I am single, child free and make more than the limit, I am not eligible for the EITC. This year I am maxing out 401K, IRA and HSA and will have an AGI hopefully under $18.5K so I can at least get the Saver's credit.

teen persuasion

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Re: Should I max our 401K's?
« Reply #19 on: October 15, 2016, 03:28:22 PM »
I have a question along these lines... If you can't afford to max out both your 401K and your IRA, what should you do? Say I anticipate investing only $17K next year. Should I max the 401K and put nothing in the IRA, or max the IRA and put the remainder in the 401K?

It depends on which account gives you the better options. Some employers have great 401ks with lots of low cost index funds (fees below retail rate, institutional negotiation). If your 401k is crap, then contribute enough to get the match, then fill up your and your spouse's traditional IRAs, then anything else above that put into your 401k.

Are you eligible for the EITC?  Contributions to your 401k decrease both your line 7 income and AGI.  TIRA contributions only reduce your AGI, and the EITC tests both.  So you can better maximize your credit thru 401k contributions.

Of course, if the credits and tax savings are large enough, you can use that $ to also fund an IRA (we do).

Since I am single, child free and make more than the limit, I am not eligible for the EITC. This year I am maxing out 401K, IRA and HSA and will have an AGI hopefully under $18.5K so I can at least get the Saver's credit.

Yep, that makes the decision easier.  Grab the free money first (employer's match), then fill whichever one is better (lower cost, better fund choices), then move down the ladder as you exhaust options.

You can still get the Saver's credit above $18.5k, it will just be lower.  If you do reach that level ($18.5k) you probably can't actually get the full credit - your tax will be lower than the credit.

ender

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Re: Should I max our 401K's?
« Reply #20 on: October 16, 2016, 08:29:00 PM »
I have a question along these lines... If you can't afford to max out both your 401K and your IRA, what should you do? Say I anticipate investing only $17K next year. Should I max the 401K and put nothing in the IRA, or max the IRA and put the remainder in the 401K?

Generally, I would say you should always do 401k first.

The tax benefits of a 401k are slightly better, as it has better impact on AGI than an IRA deduction does.

But the key is you can always choose to put $5500 into an IRA, up until taxes are due the following year. A 401k is tied to your income and much less flexible in this regard.

MVal

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Re: Should I max our 401K's?
« Reply #21 on: October 17, 2016, 09:43:51 AM »
Great views on both sides of the issue. I think I'll front load the 401K the first two or three months of next year and then slow back down to just the match level while I focus on the IRA. If I wind up having funds leftover, I'll up the contributions to my 401K.

chasesfish

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Re: Should I max our 401K's?
« Reply #22 on: October 18, 2016, 05:38:28 AM »
I'm a fan of having some money invested in a taxable account, enough that you can get to if you are in a pinch.  Other than that, my opinion is you need to maximize the tax deferred accounts once your income gets over the 15% tax bracket ($75,300 per year)