Optimizing my Federal Tax Situation

[Wanna-Be-FI-Bri]

Base Salary $85,000
I live and work in Michigan
Mandatory Employer 401a contribution - 10% of base salary = $8,500
My employer also offers a 401a and 457b.

I am considering maxing my 457b ($19,000) (my employer may soon be offering a ROTH 457b, but doesn't yet).  However, I do not know how much I should contribute to my 401a (max contribution limit is $56,000 including the employer contribution).  I'm tempted to contribute enough to bring me down to the federal tax bracket (22%, $39,475).

I don't really need much of the money I'm making right now.  I am single.

Does anyone have a recommendation on what I should do for 2019?

[TheHardenedInvestor]

There are some other factors to consider like your age, how much after tax money you have, when you plan/want to retire, etc. However, all I will say is this, if I had more pre-tax accounts that I could contribute to, then I absolutely would be maxing then all out and reducing my tax obligation as much as possible.

[DadJokes]

Getting your taxable income to 39,475 sounds like a solid idea to me. That involves maxing the 457b, the mandatory 8,500 in the 401a, and an additional 5,825 in the 401a. After that, any additional investing could be a toss-up between traditional & Roth, in my opinion.

The huge jump between the 12% & 22% tax brackets makes getting down to that threshold very desirable.

[erutio]

We have marginal tax rates here in the US.  Why does getting "down a federal tax bracket" matter?

You should be trying to lower your AGI, regardless of the tax bracket you are in.

In your shoes, if all investment options are similar, you should be maxing the 457 first, then upping your contributions to the 401a as much as you can.  Once that is maxed,  try maxing the 403b?  You should probably also have a 403b available to you? (this is the equivalent to a 401k when you are a government worker)

[DadJokes]

We have marginal tax rates here in the US.  Why does getting "down a federal tax bracket" matter?

You should be trying to lower your AGI, regardless of the tax bracket you are in.

In your shoes, if all investment options are similar, you should be maxing the 457 first, then upping your contributions to the 401a as much as you can.  Once that is maxed,  try maxing the 403b?  You should probably also have a 403b available to you? (this is the equivalent to a 401k when you are a government worker)

Once you get down to 12% marginal bracket the advantage of pre-tax investments over a Roth becomes much less obvious. At that point, you have to speculate what future tax brackets will be, how much your own income is going to grow before you retire, and you have to keep RMDs in mind.

Yes, every available dollar should be invested, but the retirement vehicle used depends on the current marginal tax bracket (as well as expected tax brackets during withdrawal years).

Also, 401a and 403b accounts typically don't have very good investment options, so an IRA should be prioritized over them.

[erutio]

We have marginal tax rates here in the US.  Why does getting "down a federal tax bracket" matter?

You should be trying to lower your AGI, regardless of the tax bracket you are in.

In your shoes, if all investment options are similar, you should be maxing the 457 first, then upping your contributions to the 401a as much as you can.  Once that is maxed,  try maxing the 403b?  You should probably also have a 403b available to you? (this is the equivalent to a 401k when you are a government worker)

Once you get down to 12% marginal bracket the advantage of pre-tax investments over a Roth becomes much less obvious. At that point, you have to speculate what future tax brackets will be, how much your own income is going to grow before you retire, and you have to keep RMDs in mind.

Yes, every available dollar should be invested, but the retirement vehicle used depends on the current marginal tax bracket (as well as expected tax brackets during withdrawal years).

Also, 401a and 403b accounts typically don't have very good investment options, so an IRA should be prioritized over them.

Yeah, I'm with you on everything you wrote.  However, I didn't think OP is at that level of optimization yet, or at least that doesn't seem to be what he's asking.  It seemed that he was asking about reducing his AGI for the sake up getting under a certain tax bracket.

But I agree, once he's lowered his AGI enough, he can fill up his Roth IRA, and then if a Roth 403b is available, he can start directing his contributions there.

[Wanna-Be-FI-Bri]

Yes, I think this is what I'm going to do.  Getting my income down to $39,475 seems like the best option. 

Getting your taxable income to 39,475 sounds like a solid idea to me. That involves maxing the 457b, the mandatory 8,500 in the 401a, and an additional 5,825 in the 401a. After that, any additional investing could be a toss-up between traditional & Roth, in my opinion.

The huge jump between the 12% & 22% tax brackets makes getting down to that threshold very desirable.

[dandarc]

Be sure to factor in tax credits - you could hit the saver's credit at 10, 20 or even 50% if you really wanted to, for example. 12% federal tax saving + 4% state (been a while - is that the state income tax rate in Michigan)? + ~5% from the maximum saver's credit. Particularly if you're willing to re-locate to a state with no income tax in the draw-down phase, that might look like a pretty good deal.

This whole 'not spending all of your income and then some' leaves some interesting possibilities, even at high incomes.

[Wanna-Be-FI-Bri]

The $8,500 is my employER 401a contribution.  It's additional money from my $85,000 salary.

I believe the math should like something like this:

Salary - $85,000
457b contribution - $19,000
HSA contribution - $3,500
401a contribution - $23,025

This should put me right a $39,475.

Getting your taxable income to $39,475 sounds like a solid idea to me. That involves maxing the 457b, the mandatory 8,500 in the 401a, and an additional 5,825 in the 401a. After that, any additional investing could be a toss-up between traditional & Roth, in my opinion.

The huge jump between the 12% & 22% tax brackets makes getting down to that threshold very desirable.

[dandarc]

And just in case the Roth 457B happens - probably wouldn't do that personally, and just be sure to know how the specifics of how Roth 457B's work before making your decision. Sounds like a great idea for an early retiree at first glance, but when you realize the "457-ness" only applies to the penalty for early withdrawal and you still have to wait until 59.5 for tax-free withdrawals and it is like a 401K in that if you withdraw directly from it you're hit by the pro-rata rule, it isn't quite as great as it might seem initially.

The way to use it would be either as additional Roth space for 59.5+ or to plan on rolling it over to a Roth IRA where you get more favorable early-withdrawal rules. I'm personally in the very-pro-traditional camp though.

[Wanna-Be-FI-Bri]

So what would the math look like trying to utilize the saver's credit?  I am unmarried.  Michigan's income tax rate is 4.25%.


Below is information I found from the IRS' website.
2019 Saver's Credit
Credit Rate   Married Filing Jointly   Head of Household   All Other Filers*
50% of your contribution   AGI not more than $38,500   AGI not more than $28,875   AGI not more than $19,250
20% of your contribution   $38,501 - $41,500   $28,876 - $31,125   $19,251 - $20,750
10% of your contribution   $41,501 - $64,000   $31,126 - $48,000   $20,751 - $32,000
0% of your contribution   more than $64,000   more than $48,000   more than $32,000

And just in case the Roth 457B happens - probably wouldn't do that personally, and just be sure to know how the specifics of how Roth 457B's work before making your decision. Sounds like a great idea for an early retiree at first glance, but when you realize the "457-ness" only applies to the penalty for early withdrawal and you still have to wait until 59.5 for tax-free withdrawals and it is like a 401K in that if you withdraw directly from it you're hit by the pro-rata rule, it isn't quite as great as it might seem initially.

The way to use it would be either as additional Roth space for 59.5+ or to plan on rolling it over to a Roth IRA where you get more favorable early-withdrawal rules. I'm personally in the very-pro-traditional camp though.

[Wanna-Be-FI-Bri]

To get to the 50% ($2,000 tax credit) bracket of the Saver's Credit, I have to get my income to $19,250.

Is this what you are proposing?


Salary - $85,000
457b contribution - $19,000
HSA contribution - $3,500
401a contribution - $43,225

This should put me right a $19,250.  Is the $2,000 credit worth it?  How does Michigan income tax come into play here?

[dandarc]

Don't forget about the standard deduction - that's another $12,200 before you get to "taxable income"

So your math to get to the end of the 12% bracket is more like:

Salary - $85,000
457b contribution - $19,000
HSA contribution - $3,500
401a contribution - $10,825
Standard Deduction - $12,200

Keep in mind, health, dental, vision insurance premiums reduce this. So would any FSA's if you choose to use them. Student loan interest you might be paying. traditional IRA contributions potentially.

[dandarc]

As to your savers credit, targeting the 50% tax credit. I used the calculator here: https://www.irscalculators.com/tax-calculator. Note that it looks pretty good to me, but has the 2018 saver's credit rather than 2019, so I adjusted for that. Do your own math. I also don't know all the details of Michigan income tax, but I did enter $4,400 - 1 exemption - instead of the default $20K there.

With an income of 51,675 - gets you to AGI of 39,475, you pay tax as follows:

Federal: $4,543.00
State: $2009.19

Total: $6,552.19

If we then add $20,225 of "Health / Retirement contributions" the tax is:

Federal: $1,116.00
State: $1,149.63

Total: $2265.63

Difference in tax paid: $4,286.56

Marginal Rate: 21.2% ($4,286.56 / $20,225)

Now, if you're planning on staying where you are in retirement, then the state tax isn't really a factor as you'll pay it on withdrawal. But if "Retire to Florida" is in the cards, the state tax component on withdrawal could be 0%.

[dandarc]

Also note - some cities in Michigan have local income taxes (I know because I used to live/work in one). Generally not a ton, but another 1 or 2% tax or whatever is when that you can get away from by moving.