Retirment Accounts

[MichelleT]

Hello all,

I am still very new here and really appreciate your suggestions on the topic of choosing appropriate retirement accounts. My husband and I do not have any retirement accounts set up at this point and it is our bad. That's why I am here to learn as much as I can from your wisdom. Since I start reading Mr. Money Mustache's blog the past month, I have been looking into the 401K option. However, my husband's employer do not offer any matching at this moment so I am not sure if it is wise for us to open a 401K account through his employment. I am self-employed and I don't know if I can even open a 401K for myself because I am the only employer of my LLC. We also look into traditional and Roth IRAs as alternatives. Can I have traditional and Roth IRAs at the same time? I have been trying to look up this information online, but was not able to find anything useful in this area. I only know that if my husband and I open 2 traditional IRA accounts, we can max them out at $5,500 each and be able to claim the full amount of $11,000 tax deduction as married and jointly filed for tax return this year. Do I understand it correctly? Can you share your thoughts on my situation?

Thank you.
Michelle 

[doublethinkmoney]

Hello all,

I am still very new here and really appreciate your suggestions on the topic of choosing appropriate retirement accounts. My husband and I do not have any retirement accounts set up at this point and it is our bad. That's why I am here to learn as much as I can from your wisdom. Since I start reading Mr. Money Mustache's blog the past month, I have been looking into the 401K option. However, my husband's employer do not offer any matching at this moment so I am not sure if it is wise for us to open a 401K account through his employment. I am self-employed and I don't know if I can even open a 401K for myself because I am the only employer of my LLC. We also look into traditional and Roth IRAs as alternatives. Can I have traditional and Roth IRAs at the same time? I have been trying to look up this information online, but was not able to find anything useful in this area. I only know that if my husband and I open 2 traditional IRA accounts, we can max them out at $5,500 each and be able to claim the full amount of $11,000 tax deduction as married and jointly filed for tax return this year. Do I understand it correctly? Can you share your thoughts on my situation?

Thank you.
Michelle

Roth IRAs are an AFTER tax contribution but then the interest it earns is tax free when you pull it out in retirement. You have to earn less than $175k (I believe) jointly to be able to contribute. Many people will use them as true emergency accounts (aka you only pull money back out if the shit hits the fan) because since the contributions are already taxed you can pull out those principle contributions early without a penalty. If you never have a true emergency than your money has had the opportunity to grow and work for you. But the INTEREST that has grown cannot be pulled out early without a penalty.

401k does the opposite, you get the tax deduction now but pay taxes when you withdraw in retirement.

I would suggest definitely contributing to the 401k at work if it's a decent one and has low expense ratio funds. Do you know who operates his 401k - fidelity? Vanguard?


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[terran]

Even without a match it might still be worth investing in your husbands 401k. Post the available investments and their expense ratios here and people can probably help you decide if it's worth using.

You can invest in both a traditional and a roth IRA, but they share the same $5500/person/year limit, so it wouldn't help with the amount you're able to invest. Since your husband is covered by a retirement plan at work (whether or not he choses to use it) you are subject to these income limits for making a deductible traditional IRA contribution: https://www.irs.gov/retirement-plans/2017-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work. You are subject to these income limits for the availability of roth contributions: https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2017. If you're over both those limits let us know as there are other options.

As a self employed person without any employees you can open a solo 401k at brokerages like vanguard and fidelity among others. If there's any chance you'll have employees other than yourself and your husband at any point you may not want to do this though, as you'll have to expand the plan to include them and that kind of plan is more expensive to run. In that case look into a SEP IRA or a Simple IRA.

After exhausting the available space in all those options, there's nothing wrong with investing in a regular taxable brokerage account.

[MichelleT]

Thank you very much for your responses. My husband just sent an email asking his company for a list of 401K investment options. I'll post it here tomorrow when I receive it. On the other note, for a solo 401K in my business, can I offer any matching to myself if I am the employee of my own LLC?

Thank you.

[MDM]

See
Investment Order,
To 401k or not to 401k? That is the question., and
Solo 401(k) plan - Bogleheads for some topical reading.

Those may answer some questions and prompt others.  Read, digest, and ask again as needed.  Good luck!

[terran]

On the other note, for a solo 401K in my business, can I offer any matching to myself if I am the employee of my own LLC?

Yes, about 20-25% plus the $18k employee contribution limit depending on if you LLC is passthrough or set up as an s-corp. The calculation is a little more complicated than that, but your accountant or tax software should be able to help with that (I know taxact does).

[aceyou]

Welcome! 

A note regarding the Roth IRA.  This doesn't come from your paycheck.  If you have money in your checking or saving that exceeds what you need, you can just do that right now.  You can call vanguard on the phone, tell them you want to set up a Roth IRA and are a total novice, and they will walk you step by step though the entire process.  Within an hour, you could pretty much have everything set up to get your $5,500 there, and ditto for your spouse. 

Then you can set up your 401k's through your work.  You basically have to make a top priority of getting any match offered, but it's still totally worth it to contribute as much as possible regardless (in my opinion), unless the fees are just atrocious.  For example, as teachers, my wife and I get no matches, but are still opting to max out both of our 403b's. 

Some things you will want to answer for yourself each year to make the optimal decision about how much and in what bucket to invest (roth or 401):

- How much will you earn combined?  You want to make sure you aren't paying fed income taxes in the 25% bracket.  The 401k's are your tool to make sure your adjusted gross income falls into the 15% or lower bracket. 

- What is your spending and how much can you get it down to for the year?  This will inform you how much you can allocate to the roths and 401's in total.  Ideally it gets lower each year as you tweak things little by little. 

- will you have incomes in retirement.  For example, if are planning on a lucrative pensions, social security, or some other retirement hobby that pays you, then you'd lean even more towards heavy in the roth becuase your tax bracket may stay high in retirement.  But if you will have little other income, then a 401k is really sweet, because you'll be in a really low tax bracket anyway when you take it out.  For example, as teachers, I have a high value on the roth, because the negative of teaching is relatively lower pay now, but the positive is a nice pension (fingers crossed) in the future.  So you just have to think about situation future you is most likely to be in. 

Some things that people new to this stuff should keep in mind to ease their mind:
- Regarding 401k's, anytime you switch employment, you can immediately move all your 401k funds from that employer straight to Vangaurd.  So, if you are paying high fees, it's very often still best to contribute, because you may not need to keep it there for that many years anyways...just punish them by leaving the first moment you can

- If you retire early, there's ways to get the 401k money out penalty free before you reach 59.5 years of age.  Head to the mad fientist blog if you want to learn more. 

- What to invest in and where to invest can be really simple.  So, you don't have to become an expert to be awesome.  In fact, the simplest stuff is actually the highest performing anyway usually.  jlcollinsnh has the best explanation why in his stock series. 

Good luck!!!

[RedmondStash]

Yes, you can have both a Roth IRA and a traditional IRA at the same time. You can also have 401k's at the same time. They're all just different types of retirement accounts; they are not mutually exclusive. Typically, retirement accounts have some kind of tax advantage over non-retirement accounts.

Roth IRAs have post-tax money (never taxed again), and traditional IRAs have pre-tax money (to be taxed when it's taken out, but to grow tax-free until then). You contribute to both of those directly, as opposed to going through your employer.

You contribute to your 401k through your employer, up to $18k/year if you're under 50 and $24k/year if you're over 50, and it functions like a traditional IRA: pre-tax money goes into it, and grows tax-free until you take it out. Honestly, I wish I'd figured all this stuff out many years ago; I kick myself for all the years of tax-free growth I could have had on that money. I now max out my 401k every year, because it comes with the fun perk of reducing your taxable income for that year. So if you make $58k/year, and you put $18k into your 401k, you only get taxed on $40k as income for that year. It's a sweet way to reduce taxable income for that year. Yes, you pay taxes on it eventually, when you take the money out of the 401k, but the gamble there is that you'll have lower income overall, be in a lower tax bracket, and thus pay less in tax.

Also be aware that with 401k's and IRAs, when you reach age 70.5, you must start taking a required minimum distribution (RMD), which is a specified annual amount you can determine with a specific formula. But that's a ways off.

The other thing you can do if you're self-employed is set up an SEP IRA, which is like a self-employed 401k. There's a formula that tells you how much you can contribute based on your earnings. Any money you contribute to that is pre-tax, just like an IRA or 401k. I know you can do that with a sole proprietorship; not sure about an LLC. But there's probably some kind of retirement account you can contribute to through work via an LLC.

And the cool thing is that if you max out your 401k or SEP IRA -- so you contribute to your retirement accounts through employment -- you can *also* still contribute that $5500/year ($6500 if you're over 50), but it has to be as post-tax money. That means you might as well put it into your Roth IRA, where it will grow and grow and never be taxed again. Basically, you can contribute a maximum of $5500 (or $6500) of pre-tax money to any pre-tax retirement account. If you contribute less than that to a pre-tax account, you can contribute the rest to a Roth (post-tax) account.

So for instance, if you can afford it, if your husband works for an employer, he can max out his 401k up to $18k/year, and if you're self-employed, you can max out your SEP (or an equivalent), and then you can both still contribute $5500/year to your Roth IRAs. That $5500 doesn't save you on taxes now, but once that money is in the Roth IRA, it is never taxed again.

I did a deep dive into this stuff a couple of years ago. There's still tons I don't know, but knowing the basics makes a huge difference.

Good luck.

[terran]

RedmondStash, this might not be what you're saying at all, but there is no connection between whether or how much you contribute to a 401k or SEP and whether you can contribute to a Traditional IRA or only a Roth IRA. The only factor determining what kind(s) of IRA you're eligible to contribute to is the income limits I posted above.

[RedmondStash]

RedmondStash, this might not be what you're saying at all, but there is no connection between whether or how much you contribute to a 401k or SEP and whether you can contribute to a Traditional IRA or only a Roth IRA. The only factor determining what kind(s) of IRA you're eligible to contribute to is the income limits I posted above.

It's true, Terran, but whether you can contribute pre-tax or post-tax dollars to a personal retirement account does depend on whether you've contributed more than $5500 (or $6500) to a pre-tax retirement account through your work, like a 401k or an SEP. That's the distinction I was trying to make. Yes, you can always contribute $5500 per year to a personal retirement account (outside of work). But if you have already contributed more than $5500 in pre-tax dollars to an employment-related retirement account, that $5500 contribution outside work is in post-tax dollars. You could technically still contribute it to your IRA instead of a Roth IRA, but that would lead to fussy bookkeeping, and I think you still get taxed on it when you take it out later, which removes any tax advantage. It's much easier just to put that money into a Roth IRA, where you do get the tax advantage.

[MDM]

RedmondStash, this might not be what you're saying at all, but there is no connection between whether or how much you contribute to a 401k or SEP and whether you can contribute to a Traditional IRA or only a Roth IRA. The only factor determining what kind(s) of IRA you're eligible to contribute to is the income limits I posted above.

It's true, Terran, but whether you can contribute pre-tax or post-tax dollars to a personal retirement account does depend on whether you've contributed more than $5500 (or $6500) to a pre-tax retirement account through your work, like a 401k or an SEP. That's the distinction I was trying to make. Yes, you can always contribute $5500 per year to a personal retirement account (outside of work). But if you have already contributed more than $5500 in pre-tax dollars to an employment-related retirement account, that $5500 contribution outside work is in post-tax dollars. You could technically still contribute it to your IRA instead of a Roth IRA, but that would lead to fussy bookkeeping, and I think you still get taxed on it when you take it out later, which removes any tax advantage. It's much easier just to put that money into a Roth IRA, where you do get the tax advantage.

RedmondStash, terran is correct.

To take your example from above, someone who makes $58K may contribute $18K to a traditional 401k and deduct a $5500 contribution to a traditional IRA.

At higher incomes, even a $1 contribution to a 401k may cause the tIRA to be non-deductible, but that's a different issue.

[RedmondStash]

RedmondStash, this might not be what you're saying at all, but there is no connection between whether or how much you contribute to a 401k or SEP and whether you can contribute to a Traditional IRA or only a Roth IRA. The only factor determining what kind(s) of IRA you're eligible to contribute to is the income limits I posted above.

It's true, Terran, but whether you can contribute pre-tax or post-tax dollars to a personal retirement account does depend on whether you've contributed more than $5500 (or $6500) to a pre-tax retirement account through your work, like a 401k or an SEP. That's the distinction I was trying to make. Yes, you can always contribute $5500 per year to a personal retirement account (outside of work). But if you have already contributed more than $5500 in pre-tax dollars to an employment-related retirement account, that $5500 contribution outside work is in post-tax dollars. You could technically still contribute it to your IRA instead of a Roth IRA, but that would lead to fussy bookkeeping, and I think you still get taxed on it when you take it out later, which removes any tax advantage. It's much easier just to put that money into a Roth IRA, where you do get the tax advantage.

RedmondStash, terran is correct.

To take your example from above, someone who makes $58K may contribute $18K to a traditional 401k and deduct a $5500 contribution to a traditional IRA.

At higher incomes, even a $1 contribution to a 401k may cause the tIRA to be non-deductible, but that's a different issue.

Huh. I stand corrected. Not sure where I got the idea it was the other way around, but that's actually good news for taxes for this year.