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After tax savings or pre-tax savings
Old 07-29-2014, 10:54 AM   #1
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After tax savings or pre-tax savings

I am 41 yo and about 15 years from FIRE. I can afford to save 25% of my income pre-tax. This would put me well over the 401k contribution limit for 2014. This is first year I could ever save this much.

I am in a situation where I am maxing out a traditional 401k
I have a Roth 401k option

I am brainstorming scenarios

a) max out pre-tax 401k and keep my taxes down, put extra money into savings (taxable)
b) lower pre-tax 401k such that Roth 401k is maxed and part of 25% savings rate went to taxes, part went to savings
c) part of my pay is variable, so while I can't predict tax brackets year over year, finding the sweet spot where I use traditional 401k to lower tax bracket, then Roth the rest of the way

If I cap out on my variable pay, I am looking at earning about $150k
My living expenses hover between $40-$75k. I have twin 6 year olds, paid for house and will need a new car within 24-36 months.

I am asking for opinions on scenarios, or other ideas.
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Old 07-29-2014, 11:23 AM   #2
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I would think your tax rate is probably at the point where you should stay with the pre-tax 401k and get the deduction. Do Roth conversions when you RE and may have a lower income for a few years. It all depends on how your tax rate with RMD's at 70 compares to your current tax rate, though equal rates favors the Roth. If you RE with the expenses you have, your retirement income and tax rate should be lower than your current marginal rate.

If you are close to a tax bracket, managing to stay under it with the 401k and then using the Roth is probably as good a strategy as any.

Go ahead and use a taxable account after maxing out your tax advantaged opportunities. Just try to minimize any selling, and perhaps avoid dividend payers and bonds that generate income in taxable accounts.

Look into a backdoor Roth contribution if you can't otherwise contribute to an IRA.
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Old 07-29-2014, 11:24 AM   #3
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If you're married, you're in the 25% tax bracket, so it probably makes sense to do as much pre-tax savings as possible. This is especially a good idea if you think you'll be spending in the 15% bracket in retirement. Having said that, if you can save greater than the 401(k) limit, contributing to a Roth IRA adds a nice balance between pre-tax and after tax "tax-free" savings. You can also grab these Roth IRA contributions back without penalty if you need to replace a car later. I'd also max a Health Savings Account if you have a high deductible health insurance plan at work... and invest the contributions, treating it like another tax-free retirement account.
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Old 07-29-2014, 11:26 AM   #4
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Originally Posted by jIMOh View Post
I am 41 yo and about 15 years from FIRE. I can afford to save 25% of my income pre-tax. This would put me well over the 401k contribution limit for 2014. This is first year I could ever save this much.

I am in a situation where I am maxing out a traditional 401k
I have a Roth 401k option

I am brainstorming scenarios

a) max out pre-tax 401k and keep my taxes down, put extra money into savings (taxable)
b) lower pre-tax 401k such that Roth 401k is maxed and part of 25% savings rate went to taxes, part went to savings
c) part of my pay is variable, so while I can't predict tax brackets year over year, finding the sweet spot where I use traditional 401k to lower tax bracket, then Roth the rest of the way

If I cap out on my variable pay, I am looking at earning about $150k
My living expenses hover between $40-$75k. I have twin 6 year olds, paid for house and will need a new car within 24-36 months.

I am asking for opinions on scenarios, or other ideas.
We were in a similar situation about 15 years ago. I ended up restructuring my relationship with my employer and became a consultant so that I got paid a 1099. Contracting rate was higher than salary to cover health insurance and SE Taxes, but no more than the fully burdened rate for the employer. This allowed me to put the 25% into a SEP account. I don't know if that's an option for you.
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Old 07-29-2014, 01:20 PM   #5
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I file taxes as head of household, I am not married.
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Old 07-29-2014, 07:46 PM   #6
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Given your income level, you're likely in a much higher tax bracket than when you retire, so I would max out tax-deferred savings first and then Roth and then taxable accounts.
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Old 07-29-2014, 07:51 PM   #7
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Originally Posted by pb4uski View Post
Given your income level, you're likely in a much higher tax bracket than when you retire, so I would max out tax-deferred savings first and then Roth and then taxable accounts.
+1
Filing head of household means you should be in an even higher tax bracket than my earlier estimate.
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Old 07-30-2014, 02:30 PM   #8
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I do own 3 LLCs in addition to my job which pays my salary. If anyone knows a creative way to funnel income through the LLC into something tax deferred, I'd be interested.

By my math, I can save about $17,500 into 401k
$5500 into a Roth or traditional
$6500 into a taxable account
and $6000 of the 25% savings rate will go to taxes right now

Does anyone see a way to not pay that $6000 in taxes?

Because this is a short year for me, the 25% to the 401k right now establishes I can live on less
however towards end of this year and 2015 I could not use such a high 401k contribution %.
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Old 07-31-2014, 02:44 PM   #9
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Do you earn income from the LLCs? You can set up a SEP-IRA and fund it with up to 25% of your net business income.
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Old 07-31-2014, 05:00 PM   #10
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Kind of in the same boat, my wife and I do traditional 403(b) to lower our taxable income, then contribute to Roth IRAs since we're not eligible for the tax credit on traditionals anyway. That $35,000 deduction keeps us below the 28% threshold, and we have a good balance of tax-deferred vs. after-tax investments. I suspect we will be in the 25% tax bracket when we retire, so the timing of a lot of things matters less right now, so long as we can stay out of the 28% bracket. We are working our plan to do Roth conversions on her relatively small traditional IRA as well. Probably will wait until our income is lower.
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Old 08-05-2014, 02:39 PM   #11
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With my salary I haven't qualified (AGI max) for a ROTH IRA in several years so I max out my 401k to lower my taxable income and the rest of the savings go into taxable brokerage account.

BTW JiMOh, I remember you from savingadvice.com board many years ago...like you I also suffered a divorce but from what I recall you fared much better financially than I did. Good to see you here
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Old 08-06-2014, 08:21 PM   #12
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Sorry if I'm hijacking this thread, but I swear this is a related topic. I've been dumping as much of my paycheck as possible into a Roth 401(k) because I want access to the principal when I ER. Is this wrong? Should I be putting it into the pre-tax 401(k) now and then converting to a Roth after I ER and find myself in a lower bracket?

P.S. I'm also currently contributing to a Roth IRA.
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Old 08-07-2014, 09:05 AM   #13
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Originally Posted by cooch96 View Post
Sorry if I'm hijacking this thread, but I swear this is a related topic. I've been dumping as much of my paycheck as possible into a Roth 401(k) because I want access to the principal when I ER. Is this wrong? Should I be putting it into the pre-tax 401(k) now and then converting to a Roth after I ER and find myself in a lower bracket?

P.S. I'm also currently contributing to a Roth IRA.
The real trick is to have 5 years of expenses in after tax money. If you can get to that it is a good tax move to put it in pre tax while you have high income.

Then when you ER you convert 1 year of expenses to Roth each year and pay the taxes on that wich will be low since it will be your only "income" while living off the 5 years of saved expenses.

After the 5 years of after tax money runs out you will have a ladder of money that will be seasoned and tax and penalty free. You can just take the original conversion from 5 years prev. out and live on it then continue this process until 59.5.
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Old 08-08-2014, 11:27 PM   #14
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I have been in a similar situation for about 10 years. I continue to max out my 401K and also invest in several after tax mutual funds automatically each month. Also in a high tax bracket so I am careful about moving around the after tax funds but do rebalance the 401k investments annually or when necessary. In 2015 I will retire so should be able rebalance my after tax investments in 2016 in a lower tax bracket. You may want to consider channeling some of your investments into residential real estate. Over the long run in the right areas, it is an appreciating asset which also provides some tax benefits and potential cash flow in the short run. We did this for several years and it worked for us but got out of it completely in 2007. If you do so, I would suggest minimal cash investment with maximum debt which the rental income would service. There are lots of pitfalls such as toxic renters, declining property values, and drops in rental demand so it is not for everyone. Timing and luck play a big factor in your success. In our case it probably far out weighed any brilliant business acumen. Hey we got out in 2007 but by no means saw the real estate crisis coming. Just dumb luck .
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