Saturday, February 15, 2014

Where to invest after maxing out 401k, IRA, and HSA?

Over at Bogleheads we came across the following disucssion: Where to invest after maxing out 401k, IRA, and HSA?


Hello Board,


My wife and I are 28 years old and are getting to the point where we will be maxing out both of our IRA's, 401k's, and our joint HSA. Looking ahead into the future, I was curious as to what other options are out there as our income increases? Should I consider buying non-tax advantaged index funds or are there other good tax-advantaged ways to invest? I could also choose to just pay the mortgage off early, which is a 30-year term, $170,000 @ 3.99%, though the low rate makes me think our money could be better invested elsewhere. Currently our IRA's and 401k's are both Roth, with the exception of the 4% match each of us receives from our companies which is traditional. Thanks for the help.
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Re: Where to invest after maxing out 401k, IRA, and HSA?by Laura » Thu Feb 13, 2014 9:39 pm

The next step is taxable investing.


4-Step Rule for Tax Efficient Fund Placement:


1. Put your most tax-inefficient funds in 401ks, 403bs, Traditional IRAs and similar retirement accounts. When full..
2. Put your next most tax-inefficient funds in your Roth(s). When your Roth(s) are full-
3. Put what's left into your taxable account.
4. Try to use only tax-efficient funds in taxable accounts.


Here is a list of securities in approximate order of their tax-efficiency. (Least tax efficient at the top.):
Hi-Yield Bonds
Taxable Bonds
TIPS
REIT Stocks
Stock trading accounts
Balanced Funds
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth Stocks
Most stock index funds
Tax-Managed Funds
EE and I-Bonds
Tax-Exempt Bonds



1. Invest as much as possible in your tax-deferred and tax-free accounts.
2. Put the most tax-inefficient funds in your tax-deferred and tax-free accounts.
3. Use only tax-efficient funds in taxable accounts.
4. If all else is equal, put funds with higher expected returns in tax-free (Roth) accounts in preference to tax-deferred (traditional 401(k), 403(b), traditional IRA) accounts.


By placing some international in taxable you can also benefit from the foreign tax credit. We usually suggest holding Total Intl Stock Market and Total Stock Market in taxable.


Laura
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Re: Where to invest after maxing out 401k, IRA, and HSA?by dharrythomas » Thu Feb 13, 2014 10:57 pm

The only I have to add to what Laura said is that paying down the mortgage is not a bad option. 3.99% is not a bad risk free rate. You'll probably do better, but no guarantees.


Good Luck!


Harry
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Re: Where to invest after maxing out 401k, IRA, and HSA?by retiredjg » Thu Feb 13, 2014 11:21 pm

The next step is usually either taxable investing or paying more on the mortgage. Or a combination.


Another possibility is to see if your 401k plan(s) offer the possibility of after tax "employee contributions". This is something different from Roth 401k and many people don't know about it, including many people who have it available. Ask your plan admins and look at your plan documents. If you have this available, more discussion can occur then. Short story is you can save more and it may roll out to Roth IRA (if not, you don't want to do this).



But....


ElectricalEgrMWB wrote:Currently our IRA's and 401k's are both Roth, with the exception of the 4% match each of us receives from our companies which is traditional. Thanks for the help.


If you are saving this much, you may be making a lot of money and in a high tax bracket. If that is the case, Roth 401k may not be your best choice. Do you know your marginal tax bracket?
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Re: Where to invest after maxing out 401k, IRA, and HSA?by DTSC » Thu Feb 13, 2014 11:35 pm

If you have children or plan to have children, or go back to school yourself, consider putting money in a 529 plan
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Re: Where to invest after maxing out 401k, IRA, and HSA?by ElectricalEgrMWB » Fri Feb 14, 2014 12:35 am

We are currently in the 28% tax bracket. We don't have any kids yet so I have not started a 529 plan yet, though I plan to start when we do have kids.


I am not sure if my 401k plan allows for the after-tax employee contributions above and beyond the $17,500 limit/person, but this does seem to be an interesting option. From what I have read, the interest on the after-tax contributions would be taxable, but if I switch companies (which allows me to roll my Roth 401k into my Roth IRA), the interest earned on the excess money I was able to contribute would no longer be taxable?
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Re: Where to invest after maxing out 401k, IRA, and HSA?by airahcaz » Fri Feb 14, 2014 12:53 am

ElectricalEgrMWB wrote:We are currently in the 28% tax bracket. We don't have any kids yet so I have not started a 529 plan yet, though I plan to start when we do have kids.


I am not sure if my 401k plan allows for the after-tax employee contributions above and beyond the $17,500 limit/person, but this does seem to be an interesting option. From what I have read, the interest on the after-tax contributions would be taxable, but if I switch companies (which allows me to roll my Roth 401k into my Roth IRA), the interest earned on the excess money I was able to contribute would no longer be taxable?



Plenty on the topic of after tax contributions and roll over to Roth:




1) Invest you must 2) Time is your friend 3) Impulse is your enemy 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course. (Plagiarized, but worth stealing)
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Re: Where to invest after maxing out 401k, IRA, and HSA?by retiredjg » Fri Feb 14, 2014 11:32 am

ElectricalEgrMWB wrote:We are currently in the 28% tax bracket.


In the 28% tax bracket, you should consider traditional 401k in my opinion. It is likely that you will be in a lower bracket in retirement. Why pay 28% now when you could pay less than 28% later?


From what I have read, the interest on the after-tax contributions would be taxable, but if I switch companies (which allows me to roll my Roth 401k into my Roth IRA), the interest earned on the excess money I was able to contribute would no longer be taxable?


You're headed down the wrong track with the second part of that statement. This has nothing to do with changing companies or rolling Roth 401k anywhere.


As for the first part...If you can make the after tax contributions and if you are allowed to roll that money out to Roth IRA while still working, you will pay tax on the earnings that have occurred. If you do the transfers regularly, there should not be a lot of earnings so the tax is not too great.
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Re: Where to invest after maxing out 401k, IRA, and HSA?by NorCalDad » Fri Feb 14, 2014 2:04 pm

If you are dead-set opposed to taxable investing, I would split between mortgage paydown and a 529. You can start a 529 now in your name and change the beneficiary once your child arrives. If you are already in the 28% bracket and assume no major drop in income, you'll probably end up paying full price for college.


I agree with retiredjg that you should consider a traditional 401k in the 28% tax bracket, especially if you have state income tax on top of that.
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Re: Where to invest after maxing out 401k, IRA, and HSA?by feh » Fri Feb 14, 2014 2:53 pm

When we ran out of tax-advantaged space, we did 2 things: began taxable investing and paid ahead on our mortgage.


Personally, the thought of having a 30 year long obligation makes me queasy.
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Re: Where to invest after maxing out 401k, IRA, and HSA?by letsgobobby » Fri Feb 14, 2014 3:26 pm

retiredjg wrote:
ElectricalEgrMWB wrote:We are currently in the 28% tax bracket.


In the 28% tax bracket, you should consider traditional 401k in my opinion. It is likely that you will be in a lower bracket in retirement. Why pay 28% now when you could pay less than 28% later?


I agree with retiredjg, this is really important.


The chances that you'll pay 28% on every dollar you withdraw in the future is very low. Chances are that some of your withdrawals will be in the 0%, 10%, 15%, and 25% tax brackets. Thus by choosing Roth over traditional you are voluntarily choosing to overpay taxes.


re: your question, you may find this thread helpful:


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Re: Where to invest after maxing out 401k, IRA, and HSA?by Kevin M » Fri Feb 14, 2014 3:32 pm

One more vote for carefully considering traditional 401k. Suggest you read these two blog posts by forum member tfb (Harry Sit):




Note that some of Harry's assumptions about tax code changes in the second blog post did not materialize, so factor that into your thinking.


Also another vote for considering using 529 now. That gives you more Roth-like space, increasing the sensibility of using traditional 401k. I especially like the Colorado 529 Stable Value Plus plan, which currently yields 2.64%. Hard to beat that rate for an extremely low-risk, potentially tax-free return; it gets into the ballpark of the after-tax return on paying down your mortgage, while retaining more liquidity. Due to the high limits, you can pump a lot of money into a 529 plan.


Even if you withdraw the money for non-qualified expenses, you only pay taxes and a 10% penalty on earnings, hence the comment above about liquidity. Unless you have a good stable value fund in your tax-advantaged plans earning more than 2.64%, you could use the CO SV fund for much of your fixed income allocation. You could then use another 529 plan with the best stock funds for additional contributions. Of course if you live in a state that offers a tax deduction for 529 contributions, your state plan might be a good choice for at least some of your 529 money.


Harry also published a blog post about the Stable Value Plus plan: Colorado Stable Value Plus 529 Plan: 2.64% Return Guaranteed Through December 31, 2014


Nothing wrong with taxable investing using tax-efficient investments after all of your tax-advantaged space is filled. And as others have pointed out, a 3+% risk-free, after-tax return on paying down a mortgage is hard to beat in the current environment. SEC yield on Vanguard Long-Term Tax-Exempt fund is 3.2%, and although it is not risk-free, some forum members have argued that as long as the duration of the fund (in this case, 7.7 years) is less than that of your mortgage, the risk is comparable.


Kevin

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