401k/403b, IRA's, HSA and others: Do you max them out?

[Billy_McSkintos]

Good morning all,

Now that I am in a good financial position (emergency fund, buffered, debt free (except mortgage) I have begun looking at maximising my investments/retirement savings. I am struggling to find a way to maximize them (you know, life) so I am curious are you all?

• Who is using what investment vehicles?
  
• Are you maxing out annual contributions?
  
• How old are you (if willing to share)?
  

Individual Max Annual Contributions (2017):
401k: $18,000
Roth IRA: $5500
HSA: $3400

Total: $26900

Over 50/55 Additional Catch up (2017):
401k (50yrs): $6,000
Roth IRA (50yrs): $1000
HSA (55yrs): $1000

Total: $8000

[Joel]

My wife and I are maxing our 401ks, Roth IRAs, and HSA. It equates to $53,750. We live in California, so our marginal tax rate is 34.3% (25% federal and 9.3% state). That means it only actually costs us $39,087 out of our take-home pay to max our contributions (avoiding $14,663 in taxes - $42,750 * 34.3%). We are both 28, no children, no home loan or other debt. This equates to roughly 30% of our annual income.

As we start talking about having children (wife wants 3) and buying a house, I'm not sure if we will be able to maintain this level of contributions but it definitely is our goal. We did this by increasing our contributions with every raise instead of increasing our cost of living. It also helps I received a $40k pay bump in January 2016. Prior to the pay bump, I was maxing my own retirement accounts but my wife was not maxing hers (we got married October 2015 and my income is roughly 70% of total income).

I've got dreams to retire no later than 50.

In doing this exercise, I realized without any retirement contribution at all, our federal marginal tax rate would be 28% instead of 25%. So technically a bit more tax savings in there that I calculated.

[Billy_McSkintos]

@Joel Nice! Thats fantastic. Buying a home and kids/education will hinder but not kill that contribution.

Am I correct in thinking that an added benefit of saving for retirement is that my effective tax rate today could be reduced?

[Joel]

@Joel Nice! Thats fantastic. Buying a home and kids/education will hinder but not kill that contribution.

Am I correct in thinking that an added benefit of saving for retirement is that my effective tax rate today could be reduced?

Our goal was to get our retirement contributions maxed out as soon as possible, and then future raises and bonuses can go to increasing the cost of living (house, children, etc). We would like more house downpayment savings but we will slowly get there. We aren't at a point in our careers where we want to tie ourselves to a specific city in the greater metropolitan area that we live in yet. As some career moves happen in the next 3-5 years, we will hopefully get there. I'm also hoping for a dip in real estate prices as they are at 2007 levels in our area now days, and it's looking like the absolutely minimum we would pay right now for a house would be $500k.

And yes, the added benefit of saving for retirement (in your 401k, HSA, and traditional IRA) is that you reduce taxes paid now by your marginal tax rate. If you are in the federal 25% marginal tax bracket now, you should almost always take advantage of avoiding the taxes now as you will highly unlikely be taxed at a 25% marginal tax rate in retirement. You have to save up a large amount of tax-deferred savings (over 2m) to produce enough ordinary income to get into the 25% marginal tax bracket in retirement due to preferential tax treatment of social security income.

For most people, at a 15% marginal tax bracket it could be a wash. Someone early in their career who expects significant pay increases in the future may want to contribute to a roth at that time. But someone who has a stable career and doesn't expect much in the way of future raises who is in the 15% bracket is likely better off contributing to their traditional tax-deferred accounts.

For roth accounts, you pay taxes now and get tax-free withdrawal. So depending on your situation, it may be better off to put the money into your 401k that you were putting into your Roth IRA.

[Billy_McSkintos]

So, for the purposes of calculating my Fed annual taxable income and tax liability can I assume:

Salary - Std deduction - (Exemptions * #of exemptions) - Pre Tax Deductions (401k/HSA)

e.g. Single with 2 additional exemptions means I would only be taxed on:

$100,000 - $6350 - ($4050 *2) - $18000 = $67550

With a total liability of $12,788 and an effective tax rate of ~13%

[Joel]

So, for the purposes of calculating my Fed annual taxable income and tax liability can I assume:

Salary - Std deduction - (Exemptions * #of exemptions) - Pre Tax Deductions (401k/HSA)

e.g. Single with 2 additional exemptions means I would only be taxed on:

$100,000 - $6350 - ($4050 *2) - $18000 = $67550

With a total liability of $12,788 and an effective tax rate of ~13%

That's a way to come up with a rough estimate. Alternatively, you could look at your 2016 tax return to see what your taxable income was then. Your portion of medical insurance is also a pre-tax deduction. I'm not sure how you calculated your number though.

With 2 additional exemptions, I'm guessing you file as head of household vs. single. At $67,550 in taxable income you are at the 25% marginal tax rate (meaning each additional dollar earned is taxed at 25%). Your tax liability would be $11,185 if you contributed $18k to your 401k. Whereas, if you contribute nothing to your 401k, you would have $85,550 in taxable income and your tax liability would be $15,685. Therefore, you would realize a tax savings of $4,500 when comparing contributing $0 vs. $18k to your 401k. Meaning, you only need to come up with $13,500 of take-home pay to put $18,000 into your 401k.

I don't care about my effective tax rate personally. It's all about comparing your marginal tax rate now vs. your marginal tax rate in retirement. And your marginal tax rate in retirement starts at 0% until you build up enough tax-deferred assets that will generate enough ordinary income to move you up marginal tax brackets. In order to provide a certain dollar amount each year, you need roughly 25x the amount in investments. Said another way,  your investments should produce 4% annually. If you have Roth IRA assets, that's a portion of your income in retirement that will not be taxable. Further, social security income is not always taxable either. At most, 85% is taxable, but many people may be taxed on less social security income depending on their income.

With all that said, in your situation, the best bet would be to put the max into your tax-deferred 401k and HSA as well as your Roth IRA. That way you have some tax diversification as tax rates change.

None of this considers the ability to do catch-up contributions.

[Billy_McSkintos]

Thank you @Joel!

Do you or anyone else know of any other tax advantaged vehicles the lay person can utilize?

[Joel]

Thank you @Joel!

Do you or anyone else know of any other tax advantaged vehicles the lay person can utilize?

401k, IRA, and HSA are the main accounts available for your typical w2 employee.

If you buy a house, you can likely itemize your deductions instead of taking the standard deduction. It's not necessarily a tax advantaged vehicle, but it's another common tax break that normal people qualify for.

And more kids, but not necessarily when you are 50+ ha!

[brennan]

I started working about a year and a half ago (I'm 25) and last year and after maxing out my Roth IRA and Roth 403b I actually started putting money towards an appropriately named Mega Backdoor Roth IRA. Essentially, if your work allows, you can put money into a Taxable 401k/403b and convert it to a Roth 401k/403b every pay period without any tax penalties.

Basically, the total contribution limit for your tax deferred accounts is $54,000. So the amount that you can do this backdoor is: Total Contribution Limit ($54,000) - Roth IRA ($5,500) - Max of 401k/403b ($18,000) - Employer contribution (for me ~$10,000) = Amount you can do the backdoor ($20,500)

Last year was a trial run, so I didn't put as much as I could, but I didn't owe anything at tax time after doing this with ~$10,000! I don't know about HSA's though or if they contribute to the amount your tax deferred accounts in this way (I can't get one). I also made sure to ask the financial people at my work to double-check this was all legal. They said they had never heard of anyone doing this, but it all checks out!

[Billy_McSkintos]

I get paid every other week. After running the numbers I would need to increase my contributions to my 403b by $265.39 and to my HSA by $78.84 per pay period ($344.23).

However, due to the extra contributions I (should) pay $87.06 less tax per pay period so my take home only suffers by $257.17.

Where can I reduce my budget by $514.34 per month....

[Joel]

I get paid every other week. After running the numbers I would need to increase my contributions to my 403b by $265.39 and to my HSA by $78.84 per pay period ($344.23).

However, due to the extra contributions I (should) pay $87.06 less tax per pay period so my take home only suffers by $257.17.

Where can I reduce my budget by $514.34 per month....

How big of a tax refund are you receiving for 2016? instead of getting a large refund next year, can you reduce your withholdings to free up some money?

Instead of contributing to the Roth IRA, can you make 401k and hsa contributions instead? I know you still want to max all, but I would max those first. And you can make your Roth IRA contributions until 4/15 the following year.

Do you get an annual bonus during the year? Can you allocate a large percentage of the bonus to your 401k and hsa?

[Billy_McSkintos]

I try to make sure I get every dime in my pay check and avoid giving the government a loan. It's been harder to calculate this year due to getting some state disability for parental bonding. (Love CA!)

I am planning on maxing my 403b and My HSA first, yes. Happy that the impact isn't too bad.

[jenmas]

I don't have access to an HSA in my current job. I max out one of my IRAs each year (my ability to contribute to a Roth IRA can vary from year to year and my traditional IRA is pretty big so the backdoor conversion doesn't make sense right now). 2012-2015 I maxed out my 401(k). I was unemployed from September 2015 - mid-March 2016 so I didn't max it out last year, but based on the percentage I have taken out, if I had been working for 12 months in 2016, it would have been maxed out. I also have $200/mo taken from my checking account and deposited into my investment accounts.

If I did have an HSA, I wouldn't be using it as a retirement vehicle until I had a pretty large chunk of money saved up for actual medical expenses. Right now, my Out of Pocket Max is $2000/year so I have the full amount for this year (Oct 1 2016 - Sep 30 2017), minus the $12 I've spent so far on prescriptions and I have $1000 saved for next year (Oct 1 2017 - Sep 30). As I receive FSA reimbursements (I pay on a card with 2% cashback and submit claims), I usually budget them to the next year's OOPM category. So between the $800 in FSA that I have for the current plan year and unused medical category expenditures for this year, by the time the new plan year starts, I'll have all of the 2017/2018 OOPM saved plus a chunk of 2018/2019. My company locked in the insurance rates through 2019 or 2020 I believe. Of course if I leave this job I may end up somewhere else that has a higher OOPM and I'll have to shift around. I'm not looking to leave my company, but we implement government contracts so I go where the contracts go which could mean changing employers.

[Joel]

Depending on the state you live in, you may also be able to get a tax deduction for 529 contributions (college funds)