Newbie Budget Round 2

Smonet · November 2013

Thank you for all the input on round 1 of my budget makeover. I took many things and acted upon them. I let the cleaning company go +$140.00/mo, cancelled me and LO's portion of the gym +$128.00/mo, started saving for a boat trailer to eliminate boat storage as of next October +150.00/mo. I've also tracked where our money goes, and made some guidelines in our spending to stay within reasonable means on things. We have cut eating lunches out during the work week and shopping for groceries on a day by day basis.

We've decided to make my current automobile that is paid off work as long as possible instead of saving for a bigger SUV. We have decided to stay at our home on the lake, but not try to rebuild.

Now on to the second part. I am contributing 4% to my 401k. My employer matches 3, but will be matching 4 next year. Here is the depressing part...I logged in to DH's account and for the past ten years he has only been contributing 1%!!! He thought it was 4%, his employer matches 4%.

I have 15,000 in my account and I'm 31 and contributing 4% that will be matched

DH has 54,000 in his account (35,000 is profit sharing) he is 33 and contributing 1%. In 2014 DH will be offered a Roth as well and his employer will match 4% between the two accounts.

I also have 15,000 in apple stock that I plan to sell some of and contribute to possibly a roth.

We are in the 28% tax bracket. Do I really want to put a ton in a roth (besides the stock money)? Obviously I should meet the match at DH's employer. But do I match the 401K or Roth?

I've been watching Suze Orman, and I like the idea of keeping money I will want to access if need be in an emergency in a Roth, but is a roth the best idea if I'm at probably the highest tax bracket I'll ever be in now?

I'm trying to learn more each day, but what would you do?

TIA

hoffse · November 2013

OK I'm going to try to answer most of your questions in order:

1) First - kudos to you on taking a hard look at all of this! I personally love the idea of saving for a boat trailer. Docking fees are really expensive, and that trailer will pay for itself sooner rather than later.

2) Do you want to put money into a Roth while you're in the 28% tax bracket? Yes, you do. First, most people's tax brackets actually increase in retirement. It's hard to predict where this will go 30 years from now, but I'm betting taxes go up. Eventually we will have to pay for all this debt our fabulous government is accruing.

Second, your EARNINGS in Roths grow tax-free. When you have 30-40 years for your earnings to grow tax-free, you would have to be in a stupid high tax bracket right now to offset your tax savings in retirement. 28% is not a stupid high tax bracket (even if it might feel like it is).

The average return of the market has been about 10% since the beginning. At a 10% return, your money doubles every 7 years. You have about 35 years of work left... I don't need to do that math for you. Think about how much you will earn in the market, and ALL of it is tax-free under the Roth scheme (assuming the law stays the same).

3) Keep in mind that Roth IRA's have annual contribution limits. For 2013 and 2014 these limits are $5,500/person at your age. So you can't contribute an enormous amount of money anyway any given year. You will need to supplement the Roth IRA with other retirement savings.

4) Both you and your DH need to get the maximum employer match with your 401(k)s. An employer match is free money. Do check and see if there is a vesting schedule - many employers require you to work there a certain number of years for the match to actually become yours.

Employer matches will always go into a regular 401(k) account. But I do believe they can match against your contributions to a Roth 401(k). Double check that with your employer, though.

Again, I'm a fan of Roths and prefer the Roth 401(k) over a regular 401(k). Just like a Roth IRA, a Roth 401(k) grows tax free. A regular 401(k) does give you a deduction in this tax year, but then BOTH your contributions AND your earnings are taxed at ordinary income rates when you withdraw them in retirement. Like I said, most people's marginal tax brackets actually go up in retirement.

But the worst part about regular 401(k)s, to me, is that at age 70 you have to start taking distributions from your 401(k), whether you need that money or not. For a Roth 401(k) this rule has no tax consequence - because you aren't paying taxes on the back end regardless. But for a regular 401(k) you have to pay those taxes, and you can't avoid them by leaving that account as the very last one you tap before you die. If you live long enough, you WILL be paying those taxes, even if you don't actually need the money to live on.

H and I usually put the lion's share into Roth accounts. One really nice thing is that the Roth 401(k) and the regular 401(k) contribution limits are actually the same - for 2013 it's $17,500/person annually. This is in addition to what you might put away into a Roth IRA. So if you are maxing out both, you can actually put away $23,000/year per person into tax-free accounts.

5) One other point about Roths - a Roth 401(k) has no income limit. However, a Roth IRA does actually have an income limit, and if you make more than that limit you can't contribute directly. For 2013 the income limit is $178,000 if you are married filing jointly. But never fear! You can get around this rule and still fund your Roth IRA by using the "back door" method. This means you fund a regular IRA first (which has no income limits), and then you immediately rollover the regular IRA to a Roth IRA. There are no income limits to do a rollover. You can even do them back-to-back... which means you should owe about $0.22 in taxes when all is said and done. It's really stupid, but it's the rule - and any investment banker will know how to do it. They figured out this loophole about 30 seconds after Congress passed the law.

hoffse · November 2013

By the way - I'm not sure if I've ever told you this, but your baby is ridiculously cute. And that outfit is also ridiculously cute. He looks so serious in that picture!

Sisugal · November 2013

ROTHs all the way are the best! Purchased with after tax dollars, but forever tax free after that. You want tax free money in your retirement to balance that 401K on which you will be paying taxes on. Tax rates are only going to go up --- take advantage and fund ROTHs!

Sisugal · November 2013

ROTHs all the way are the best! Purchased with after tax dollars, but forever tax free after that. You want tax free money in your retirement to balance that 401K on which you will be paying taxes on. Tax rates are only going to go up --- take advantage and fund ROTHs!

Newbie Budget Round 2

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