Tuesday, February 4, 2014

Help with basic tax strategy

Over at Bogleheads we came across the following discussion: help with basic tax strategy

help with basic tax strategyby TylerDavis » Tue Feb 04, 2014 3:35 pm

I have a company 401k to which I contribute 6% of my gross income. Company matches 100% up to 4%.
I also have 529 accounts for my kids.
Given a fixed savings rate, salary below the max limits, can someone give me a basic strategy rundown for tax advantages of the various account types?
I have read through this:
but still a little foggy.
I understand 401k is invested pre-tax, then withdrawals are taxed at the going rate at the time.
529 is invested post-tax, contributions are state-deductible but not federal deductible. Withdrawals for education expenses are tax-free.
I have read and heard of Roth 401k, Roth IRA and traditional IRA, but I'm not sure I understand when those are a good option. I gather that Roth401k and 529 have same tax structure (minus 529 state advantage), main difference is the purpose for education vs retirement.
Isn't it a reasonable assumption that my tax bracket in retirement will be very low (zero salary income) compared to current tax bracket? So why would you want to pay taxes up front, as in an IRA?
Is an IRA only necessary once I exceed the $17,500 yearly contribution for the 401k?
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Re: help with basic tax strategyby House Blend » Tue Feb 04, 2014 4:25 pm

TylerDavis wrote:basic strategy rundown for tax advantages of the various account types?
I have read through this:
I have read and heard of Roth 401k, Roth IRA and traditional IRA, but I'm not sure I understand when those are a good option. I gather that Roth401k and 529 have same tax structure (minus 529 state advantage), main difference is the purpose for education vs retirement.



Have you read the wiki on Traditional vs. Roth?
Isn't it a reasonable assumption that my tax bracket in retirement will be very low (zero salary income) compared to current tax bracket? So why would you want to pay taxes up front, as in an IRA?



Low, yes. Generally you wouldn't want to pay taxes in advance. Main danger, which doesn't affect everyone to the same degree, is that you have to take Required Minimum Distributions (RMDs) from your tax-deferred accounts. If they are big enough, you could pay taxes at the same or a higher rate. (Generally a problem only if you are a workaholic with a high savings rate, or have a pension on top.) Also, the quirky way that SS income gets taxed means that you could be in what looks like the 15% Federal bracket, but have your RMDs taxed at a marginal rate of 27.75%.
But yes, for many Bogleheads, especially ubersaving, early-retiring, LBYM, pension-free, Roth-convert-later Bogleheads, tax-deferred retirement savings in a 401k or IRA are a better deal than their Roth counterparts.


Is an IRA only necessary once I exceed the $17,500 yearly contribution for the 401k?
If your 401k doesn't offer low-cost funds covering every asset class you need, you might want to use an IRA for those asset classes even before you max out the 401k.
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Re: help with basic tax strategyby BolderBoy » Tue Feb 04, 2014 4:31 pm

TylerDavis wrote:Isn't it a reasonable assumption that my tax bracket in retirement will be very low (zero salary income) compared to current tax bracket? So why would you want to pay taxes up front, as in an IRA?
Is an IRA only necessary once I exceed the $17,500 yearly contribution for the 401k?
You have some more reading to do. There is a different between a Roth IRA and a Traditional IRA and they are both different than a 401k. I don't have kids so know nothing about 529s.
In general, your in-retirement tax rate MIGHT be lower than your present tax rate - tough to know. But you need to plan NOW for your assumption THEN and it may be safe to say your in-retirement tax rate will be lower (or equal.)
In prep for that day, you should max out your workplace 401k plan then, max out either tIRAs or rIRAs for you and your wife. Whether to use rIRA or tIRA now depends upon your income now. If high income and can benefit from the tax deduction, use tIRA. If low income and can afford it, use rIRA.
But more reading will help you decide. This website has a wiki with lots of answers to your questions.
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Re: help with basic tax strategyby Kevin M » Tue Feb 04, 2014 4:34 pm

House Blend covered it well, but to expand on the last point, some 401k plans offer only high-cost, actively-managed funds. In that case favoring IRA contributions could make sense after you maximize your employer match.
If your income is below the limit for getting a full deduction on traditional IRA contributions, then for non-matched contributions the tIRA has the same tax benefits as a traditional 401k.
If above that limit, then a Roth IRA may make sense, but as you say, if your effective tax rate in retirement is much lower than your marginal tax rate now, then contributing more to the traditional 401k could still make sense, even with no inexpensive index fund choices.
Kevin ||.......|| Suggested format for Asking Portfolio Questions (edit original post)
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Re: help with basic tax strategyby sunnyday » Tue Feb 04, 2014 4:49 pm

I don't want to add confusion, but it's usually recommended that you fund your retirement accounts fully before funding a 529.http://www.forbes.com/2010/03/16/colleg ... first.html

Posted on 7:21 PM | Categories:

Maxing 401k into the 15% bracket vs taxable

Over at Bogleheads we came across the following discussion: Maxing 401k into the 15% bracket vs taxable

17 posts • Page 1 of 1

Maxing 401k into the 15% bracket vs taxableby Hub » Tue Feb 04, 

2014 1:12 am

For 2014 with another exemption due this summer (it's a boy) on top of this being a bunched deductions year, we're maxing 2 401ks, an HSA, a dependent care FSA, and have one defined contribution plan. This all has us down to $59k in taxable income, $13,500 worth down into the 15% bracket. I'm kicking around the thought of backing off the 401ks to have taxable income fill up the 15% bracket and instead investing this after tax equivalent in taxable investments. Both Roths are maxed so that's not a consideration.
All this adds up to $58k in tax advantaged space which leaves me very little left to invest in taxable (projected extra of $4500 this year). I have nothing in taxable at this point and like the various benefits that would come with it such as liquidity for real estate investments, ability to tax loss harvest, and flexibility in early retirement instead of Roth principal.
I anticipate having the ability to stay in the 15% bracket for 2014,2015 and maybe 2016 but probably not after that. I mention due to the consideration of taxes on dividends.
Thoughts?
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Re: Maxing 401k into the 15% bracket vs taxableby inbox788 » 

Tue Feb 04, 2014 1:18 am

Sounds good. What do you predict your maximum marginal rate to be in retirement?
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Re: Maxing 401k into the 15% bracket vs taxableby poker27 » Tue 

Feb 04, 2014 1:19 am

If you have nothing in taxable, I could see the want/need to begin contributing. Like you said, down the road if you need money for a new house, or early retirement, you can take it out. However, on the flip side, investing in taxable will not only cost you tax $ this year, it will every year moving forward once you start earning dividends and such.
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Re: Maxing 401k into the 15% bracket vs taxableby Hub » Tue Feb 

04, 2014 1:23 am

inbox788 wrote:Sounds good. What do you predict your maximum marginal rate to be in retirement?
The current plan is to semi-retire as young as possible and fill up the 15% bracket every year with some combination of wages and annual IRA to Roth IRA conversions.
The risk there is that my new semi-retirement career takes off and I don't get to convert to Roth in a low tax bracket as planned. In that scenario, I'll wish I had pre-paid the 15%. Well, I don't know that I'll wish that, but it would have likely been optimal to prepay it now.
Last edited by Hub on Tue Feb 04, 2014 1:24 am, edited 1 time in total.
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Re: Maxing 401k into the 15% bracket vs taxableby NorCalDad » 

Tue Feb 04, 2014 1:24 am

Congrats on the boy!
My first thought is that you're investing with a long-term horizon but only envision being in the 15% bracket for 2.5-3 years. It doesn't seem to me that you're going to be able to take advantage for very long, at least from a tax rate perspective. As for the other reasons you mentioned, a taxable account may provide additional flexibility in retirement.
If you're still hunting for tax-advantaged space after maxing out everything in sight, what about a 529 plan and/or Coverdell for your kid?
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Re: Maxing 401k into the 15% bracket vs taxableby Hub » Tue Feb 

04, 2014 1:29 am

NorCalDad wrote:Congrats on the boy!
My first thought is that you're investing with a long-term horizon but only envision being in the 15% bracket for 2.5-3 years. It doesn't seem to me that you're going to be able to take advantage for very long, at least from a tax rate perspective. As for the other reasons you mentioned, a taxable account may provide additional flexibility in retirement.
If you're still hunting for tax-advantaged space after maxing out everything in sight, what about a 529 plan and/or Coverdell for your kid?
Thanks! We're doing the $2,000 ESA max for both kids annually, but in a non-income tax state I get nothing out of this except for the sting of college expenses 18 years early.
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Re: Maxing 401k into the 15% bracket vs taxableby fdeanw » Tue 

Feb 04, 2014 1:34 am

Wouldn't it make more sense to fill up the 15% bracket by converting some tax-advantaged to a Roth rather than backing off and investing an equivalent amount in taxable? My sense is that Roth gives you even more flexibility as you move forward, because it's not too difficult to pull the contributions out if you need them for a house purchase or something else.
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Re: Maxing 401k into the 15% bracket vs taxableby Hub » Tue Feb 

04, 2014 1:40 am

poker27 wrote:However, on the flip side, investing in taxable will not only cost you tax $ this year, it will every year moving forward once you start earning dividends and such.
I really don't have a good handle on what this ends up looking like.
Say I scrape together $40k in taxable investments over the next 3 years and then hit the 25% bracket. TSM style investment returns dividends of maybe 2.5%, so $1,000 annual dividends hits me at 15% or $150 additional tax in year 3 and more after. Could have been completely avoided. Though this can be offset with only about $600 each year in tax loss harvesting, a technique which is currently unavailable to me. Hmm...
Last edited by Hub on Tue Feb 04, 2014 1:47 am, edited 2 times in total.
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Re: Maxing 401k into the 15% bracket vs taxableby Hub » Tue Feb 

04, 2014 1:43 am

fdeanw wrote:Wouldn't it make more sense to fill up the 15% bracket by converting some tax-advantaged to a Roth rather than backing off and investing an equivalent amount in taxable? My sense is that Roth gives you even more flexibility as you move forward, because it's not too difficult to pull the contributions out if you need them for a house purchase or something else.
This is a great thought and really makes me kick myself yet again for rolling over my wife's old 401k to her current one. We have no tIRA's, just 2 401k's and neither allow in service withdrawals.
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Re: Maxing 401k into the 15% bracket vs taxableby mnvalue » 

Tue Feb 04, 2014 1:53 am

Does either of your 401k plans offer a Roth 401k option?
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Re: Maxing 401k into the 15% bracket vs taxableby Hub » Tue Feb 

04, 2014 2:03 am

Yes. My wife's does. Something I haven't considered, and I don't even know how a Roth 401k works exactly. Your thoughts?
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Re: Maxing 401k into the 15% bracket vs taxableby Ketawa » Tue 

Feb 04, 2014 2:24 am

Don't forgo the tax-advantaged space, especially if you have a Roth 401k available. Use that to fill up the 15% bracket instead. IMO, withdrawing Roth contributions or taking a 401k loan would both be better options if you need money for something like a down payment.
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Re: Maxing 401k into the 15% bracket vs taxableby mnvalue » 

Tue Feb 04, 2014 2:44 am

Hub wrote:I don't even know how a Roth 401k works exactly.
Exactly like a Traditional 401k, except you contribute and withdraw after-tax dollars instead of pre-tax dollars. (It's the 401k equivalent of a Roth IRA.) So instead of reducing your, your wife's, or both 401k contributions by $13,500 and putting $11,475 (ignoring state income tax) into a taxable brokerage account, your wife would reduce her 401k contributions by $13,500 (e.g. stop them after $4,000 was put in) and then contribute $11,475 in Roth 401k contributions. This has the same tax effects now, but money ends up in a Roth 401k instead of a taxable account, so the growth on that portion is never taxed again. In contrast, in a taxable account, the dividends and capital gains would be taxed.
If she leaves the job, you have similar rollover options: Leave it in the existing plan, roll to another Roth 401k, or roll to a Roth IRA.
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Re: Maxing 401k into the 15% bracket vs taxableby Hub » Tue Feb 

04, 2014 2:51 am

Interesting. I'll have to read up on that, but I'm assuming I could contribute the whole $13,500 to the Roth 401k (understanding that this lowers my take-home). I'm also assuming that this doesn't affect her ability to contribute to a Roth IRA? Then when she quits this job I'm further assuming that the Roth 401k portion can roll over to a Roth IRA just like a 401k portion rolls over to a tIRA.
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Re: Maxing 401k into the 15% bracket vs taxableby mnvalue » 

Tue Feb 04, 2014 2:54 am

Hub wrote:Interesting. I'll have to read up on that, but I'm assuming I could contribute the whole $13,500 to the Roth 401k (understanding that this lowers my take-home). I'm also assuming that this doesn't affect her ability to contribute to a Roth IRA? Then when she quits this job I'm further assuming that the Roth 401k portion can roll over to a Roth IRA just like a 401k portion rolls over to a tIRA.
Yes, the limit is $17,500 nominal dollars. Yes, the IRA limits are unaffected. Yes, you can rollover to a Roth IRA; my edit to add this last point crossed with your response.

EDIT: I should add, though, that contributing above the $11,475 in Roth would mean you're doing Roth on 25% dollars. (Assuming your math is correct; I didn't double-check it.) So you may want to contribute some more pre-tax 401k dollars such that you stay just at the top of the 15% bracket (or as close as you can predict).
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Re: Maxing 401k into the 15% bracket vs taxableby Hub » Tue Feb 

04, 2014 3:10 am

Welp, I came here hoping you guys would let me invest in taxable, left having found an additional $2,025 of tax advantaged.
Honestly I feel good about prepaying 15% marginal into a Roth any day of the week.
Thanks so much for the help.
EDIT: I see what you're saying about the 25%. I'll need to know my exact tax situation before 12/1/14 to make sure to avoid too many 25% roth dollars. Less OK with that pre-pay.
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Re: Maxing 401k into the 15% bracket vs taxableby slow n steady 

» Tue Feb 04, 2014 6:37 am

Hub wrote:Welp, I came here hoping you guys would let me invest in taxable, left having found an additional $2,025 of tax advantaged.
Honestly I feel good about prepaying 15% marginal into a Roth any day of the week.
Thanks so much for the help.
EDIT: I see what you're saying about the 25%. I'll need to know my exact tax situation before 12/1/14 to make sure to avoid too many 25% roth dollars. Less OK with that pre-pay.

I ride the 15/25% line as well. I wait until all my tax information is in and put my money in a Roth or traditional Ira to get myself just under the 25% bracket. Just make sure you will be able to make a deductible Ira contribution. So I will be making my 2013 contributions pretty soon.
Ehh, I think I'll just toss it all in a Target Retirement Fund... seriously.
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