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How to approach taxable savings
Old 12-03-2019, 09:53 AM   #1
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How to approach taxable savings

I have been spending some time lately assessing how to approach our taxable savings situation. For some context and background....

I am 37, wife is 36. We have a 3 year old. We are likely to be in the 24% tax bracket. We may slip down into the 22% bracket depending on where my wife's earnings shake out. She is an RN who works hourly and this can influence her hours. Based on how her hours/income fluctuate and where my income sits we typically end up around the edge of the 22 and 24% brackets.

To date we have built up the following retirement portfolio:

Traditional Retirement savings (IRA, 401K, 403B): $278,000

Roth: $23,000

Wife's Pension: $36,500 (right now this acts as a bond in our portfolio as it pays a set return based on bond rates, but we will roll to an IRA when she eventually leaves her current employer)

HSA Investments: $14,000
Note - we max our HSA yearly and pay some medical expenses as we go out of pocket. We pay bigger ones with our yearly HSA contributions. There is another $4k in HSA money in our HSA not invested that we have, and as I said we plan to max our HSA annually.

Taxable savings: ~$24k
This works out to about 5 months living expenses, including daycare costs for our 3 year old daughter


We made the conscience decision the last few years to pay off debt. May 1st 2020 (assuming we do not hit a financial disaster or job loss) we will make the final payment on my student loan, which was $99,000 in October 2016, and $118,000 in October 2014. We have previously paid off $17,500 in credit card debt, as well as paid off two car payments over $10k. All of this since 2014.

This doesn't count the poor financial choices I made in my 20s and early 30s which included buying a house I could not afford and paying off roughly $12k of credit card debt on two separate occasions.

We are really excited about getting over this debt hump. After paying off my student loan off this will free up around $2k of cash each month. I have considered what to do with that extra money. Some of it will go towards some QOL things we have forgone in recent years, like actually taking a vacation and traveling (in moderation). But I also want use the extra cash flow to build up some taxable savings.

I know being in the 24% bracket the conventional wisdom is to defer and save in our 401k to reduce the tax burden. I generally agree with this, but keep coming back to the idea of "what helps me sleep at night."

After spending pretty much my entire adult life paying off debt and seeing a light at the end of the tunnel, I have realized that I have never reached a point where I was comfortable with the level of savings I have available to me. Even now, owning a more affordable house and having roughly 5 months of savings, I still worry about needing to replace something big (roof, furnace, etc) and how uncomfortable I would feel having to pull that money out of our savings. Some of that I just need to get over as that is what the money is there for. But I also believe having a bigger cushion in taxable accounts would alleviate some of that.

We have a nice chunk of money in retirement or retirement like accounts, and will continue to get our employer matches (and in the case of HSA max out), but I also recognize that money is not easily accessible without penalty (or other financial impacts) at this point.

So despite paying additional taxes, I am thinking about using the extra cash flow after we pay off the student loan debt to build up our taxable savings. Preferably I'd like to get up to 9 to 12 months of cash in a money market. 12 months would put us in a position where if one of us lost our job we could probably stretch our 9 months worth of savings for a year, and have the remaining 3 months of cash available to cover a big purchase (something like a new car, furnace, roof, etc) if needed.

I have also considered using the extra cash to fund a Roth (after building up our emergency fund a bit more) and then have the contributions accessible to withdraw at any time. I realize there is more risk here since presumably in a Roth the money would be invested which would open it up to more volatility.

I guess I am just looking to get any thoughts or ideas on how others have built their emergency fund/taxable savings. I hate to leave tax deferred space out there, but my gut tells me that I will feel more secure forgoing some tax deferred space in the short term to build up more after tax savings that is accessible. Thanks for any feedback.
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Old 12-03-2019, 10:08 AM   #2
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I think you might get some feedback if you shortened this up and were a bit more concise
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Old 12-03-2019, 10:31 AM   #3
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The level of detail is fine.

First, nice job getting things on track.

It's a bit of a guessing game whether to defer income now or not. Depends on what you project to be paying in retirement. Taxes may revert to the old brackets, and you may be paying 25% when you pull them out, which means you would not have wanted to defer at 22% or 24%. It's probably not going to be a huge difference either way. I see nothing wrong with deferring income at the match rate, and not beyond, but can't guarantee that will work out right.

I would max out Roth contributions. You can always take back contributions without tax or penalty. If you don't need them, they grow tax free. When you do need them, they are accessible.

Also you don't have to have it in volatile investments just because it's in a Roth. However, I would follow the advice in https://www.bogleheads.org/wiki/Tax-...fund_placement for how to place your investments. Even though you can't tap the deferred accounts, you can leave them in bonds or fixed income, while investing stocks in the Roth. If you find you need money out of the Roth, sell the amount of stocks you need, and buy the appropriate amount of stocks in your tax deferred accounts to get back to your desired AA. Or if you feel the market is high, you don't have to rebuy them in the deferred account.

I would also try to avoid spending down the HSA if at all possible. Save and document your receipts so you can withdraw against past medical expenses anytime, but the longer you can let it grow tax exempt, the better. Certainly given the choice between putting more in tax deferred and paying large medical expenses from the HSA vs. deferring less and using that money to pay those medical expenses, I'd do the latter. I'd much rather have the money in question in the HSA, which grows tax free, instead of in tax deferred, where it will eventually be taxed. It's also another source for emergency funds, as you can withdraw anything you have medical receipts for at any time, tax and penalty free.
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on the right track
Old 12-03-2019, 10:43 AM   #4
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on the right track

Well first congrats on building a respectable net worth!

I think the answer to your question is to build taxable savings for emergency cash. I think you have a good target there for someone at your stage.

You will have this for the long-term, so as it grows I would consider allocating some to conservative investments other than cash. Otherwise I think it is too much of a drag on your overall portfolio over decades of your work life.

In fact, I think putting SOME of it in the Roth can make some sense. I assume your Roth is mainly invested for longterm growth. But you could allocate some new funds to conservative equities/bond funds. Save some taxes that way.

One other note: I would re-think cashing out that pension. A pension is like gold. Probably hard to see this now-it was for me when i cashed out my wife's pension-twice-years ago. These were small but it cost me in these ways:

1. She is an educator. When she returned to the workforce (after kids) she was treated pension-wise like a new employee (same school system) since her tiny pension had been cashed out-less than $2000. This costs us every year in reduced contribution, "diet" cola, etc since she now qualifies for reduced benefits (very small pension we view as longevity insurance). Having cashed out also disqualified her from lifetime health care (not free, but very good). Never thought of her going back to work-we do not know the future.

2. When we considered moving back to Texas, the fact we had cashed her pension meant we would have to buy back her old service at actuarial rates (after window closed).

We were able through some machinations to make some hay out of her prior service. And of course I invested her funds in what what as that time the greatest bull market in US history, so I am sure it was not as bad a loss as it seemed when i discovered it.

Some diversity of revenue streams can be important.

Good Luck.
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Old 12-03-2019, 10:46 AM   #5
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In your shoes I would max out the 401k/403b, contribute to a Roth, and throw anything you have left in taxable savings. Do you own a house? Think about a HELOC that you leave untapped.
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Old 12-03-2019, 11:04 AM   #6
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You're doing great and the level of detail is fine.

Your relectuance to touch your savings isn't unusual, but is unproductive. You saved that money for emergencies, so if an emergency arises and you need to use it then that is fine, and you just replenish it since the money for the emergency has to come from somewhere. IOW, you didn't save it to hoard it, you saved it to use if needed.

Tax-deferred savings if great... especially if your marginal tax rate in retirement is lower than your current marginal tax rate of 24%. However, a lot of us here saved on a tax-deferred basis back when we were working expecting our marginal tax rate in retirement to be lower and were more financially successful than we expected and are now paying tax at the same or higher rates... a nice problem to have to deal with but one to be cognizant of.

So beyond a certain point, taxable savings or tax-free Roths can be useful. The conventional wisdom for taxable savings is equities cause income and long-term capital gains are at a lower tax rate... and that is great, until you have purchase lots that are worth twice or more what you paid for them so in order to get $1 to spend you end up paying 7c in tax (50c gain * 15% capital gains tax rate).... again, a nice problem to have.

Another good investment for taxable savings are tax-free municipal bonds of muni-bond funds.

and +1 with brewer... when I was working we had an untapped HELOC on our home equity for emergencies... only used it once as I recall but it was nice knowing that it was there.
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Old 12-03-2019, 11:28 AM   #7
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Thanks to those who provided meaningful responses. Definitely some things for me to think about.

Would someone be willing to elaborate on the HELOC idea? I have heard this mentioned before and have never quite understood the appeal. I understand a HELOC will have a lower rate than a credit card, but beyond that I am not sure I understand the approach.
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Old 12-03-2019, 11:35 AM   #8
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Banks and credit unions will generally let you set up a HELOC for free. My strategy has been to set one up and then leave it alone. If something comes up that can't or don't want to handle with cash on hand, you tap the HELOC and then pay it down with your cash flow. This will be rare, twice in 15 years for me. It ensures you have ample liquidity without costing you anything or forcing you to keep a ton of low yielding cash on hand.
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Old 12-03-2019, 12:01 PM   #9
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Our ratio of taxable account/HSA & retirement account balances is 40/60. DH has contributed up to the company match in his 401k for 33 years. We've funded 2 Roth IRAs and 2 HSAs (1 for spousal catch-up) up to the legal limits. Point being that as long as you consistently have extra money to save, those taxable balances will continue to grow, even as you fund your other accounts. It's important to have enough of a taxable balance to tap into when you aspire to retire early.
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Old 12-03-2019, 12:08 PM   #10
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I appreciate the need for savings, my BF who has some severe ADHD tends not to keep jobs for long and so is often out of work every 8-14 months sometimes for a few weeks sometimes for months on end.

He is sitting on 8 months of saving, 401k has 10% contribution and ROTH is fully funded from a house sale this year.

I'll give you the same advice I did for him, keep 4 months on hand, then max out your ROTH because you can always take it back out, then max out 401k then taxable.

Are you really wiling to just hand the govt 24 cents of every dollar just in case you happen to need it, even while you are sitting on 4 months plus your ROTH as cushion? When you worry about risk do you take that into account.. the risk fo missing out on the ROTH, the risk of paying too much in taxes, etc
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