Retirement savings options for high-income earner

[jpg7n16]

I currently live in Washington, which has no state income tax. I don't know where I'll be living when I retire. Part of the reason I was doing a Roth 401K now is to avoid a state income tax on the money. Would this change your opinion at all?

No not really. You are just as likely to move to a state with state tax, as the OP is to be in a state with it. He could be saving on state taxes today also. So like Jim says, it's hit or miss.


But the main reason is the old 'a bird in the hand is worth two in the bush'.

Why pass up a guaranteed 33% tax savings because of what you may or may not do in the future, which is an unknown, and even if you move to another state isn't guaranteed to have state tax?

Those are a lot of conditions to be met for a maybe. I mean what if you retire in Florida or Texas, or Washington? Then you will have passed up a great opportunity to save on taxes for nothing.

You could always save up, and then if you decide to retire in NYC or Cali, convert at that time before you move.

[slackbox]

Thanks for your helpful replies so far.

The Roth vs Traditional 401k calculators that I'ved used online so far show the Roth coming out ahead in retirement income. For example, this one from Schwab scrs.schwab.com/tools/schwab_roth_401k_calc.htm

What important piece of information are these calculators leaving out or am I overlooking?

Thanks.

[jIM_Ohio]

Thanks for your helpful replies so far.

The Roth vs Traditional 401k calculators that I'ved used online so far show the Roth coming out ahead in retirement income. For example, this one from Schwab scrs.schwab.com/tools/schwab_roth_401k_calc.htm

What important piece of information are these calculators leaving out or am I overlooking?

Thanks.

The Roth will win out if you do not take the tax savings of the traditional 401k and invest it similar to the 401k.

Meaning if you invest $16,500 in a Roth, the equivalent investment for a traditional 401k is $16,500 into 401k PLUS a tax savings of $5400 (33% of $16,500- please check tax bracket because you might only be in 28% bracket, I do not have my tables in front of me).

If you invested the $5400 tax savings the same as the 401k, both options should be equal.

I like tax deferral, so I would do the Roth, just being mindful of focusing on after tax return of the investment.

[slackbox]

I like tax deferral, so I would do the Roth, just being mindful of focusing on after tax return of the investment.

I'm sorry, but you would or would not do the Roth? The Roth is not tax deferred because it is after-tax dollars that are invested.

BUT -- Shifting gears back to the original question...

My original question was that I have an extra (after maxing a 401k) $20K each year to invest and I'm wondering what to put it in. 30 minutes ago I discovered that my employer offers an "after-tax 401k" (different from the Roth 401k). I don't think the same 401k ($16,500) limits apply to this after-tax 401k.

So, should I simply max out a regular 401k, then put the extra $20k into the after-tax 401k and forgo messing with the IRAs? (disclaimer: I'm having trouble finding good info online about "after-tax 401ks").

Thanks.

[KTP]

There is an income limit on conversions- many years ago I tried converting, and with an Agi ABOVE 100K, that prevented me from converting. That limit changes yearly.

I hope Roth IRA questions are not on your exam Jim

the income limit on IRA -> Roth conversions does not change yearly, it disappeared as of 2010 and is still gone. It will not come back until/unless Congress changes the law.

The income limit on direct contributions to a Roth DOES change yearly, but in 2011 I think it will be the same as 2010 because there was zero inflation adjustment.

So you can fund a IRA with $5000 tommorow and then immediately convert it to a Roth IRA with no tax due IF and only IF you don't have any other non-Roth IRAs hanging around. If you do, then you may owe some amount of tax on the conversion. You can do all of this if you make $5000 a year or $5,000,000,000,000 a year.

[jIM_Ohio]

I hope Roth IRA questions are not on your exam Jim

the income limit on IRA -> Roth conversions does not change yearly, it disappeared as of 2010 and is still gone. It will not come back until/unless Congress changes the law.

The income limit on direct contributions to a Roth DOES change yearly, but in 2011 I think it will be the same as 2010 because there was zero inflation adjustment.

So you can fund a IRA with $5000 tommorow and then immediately convert it to a Roth IRA with no tax due IF and only IF you don't have any other non-Roth IRAs hanging around. If you do, then you may owe some amount of tax on the conversion. You can do all of this if you make $5000 a year or $5,000,000,000,000 a year.

The limit was $100,000 AGI in 2008 when I last looked, and the only thing on my test re: Roths is that contributions are NOT tax deductible, earnings grow tax deferred, and there are NO minimum distribution requirements at age 70.5.

That limit can change yearly, but keeping up with tax code is tough to do if you do not use it every year (I don't do conversions every year, so no reason to keep up with that specific portion of the code right now unless someone pays me to know it for them...)

I'm sorry, but you would or would not do the Roth? The Roth is not tax deferred because it is after-tax dollars that are invested.

BUT -- Shifting gears back to the original question...

My original question was that I have an extra (after maxing a 401k) $20K each year to invest and I'm wondering what to put it in. 30 minutes ago I discovered that my employer offers an "after-tax 401k" (different from the Roth 401k). I don't think the same 401k ($16,500) limits apply to this after-tax 401k.

So, should I simply max out a regular 401k, then put the extra $20k into the after-tax 401k and forgo messing with the IRAs? (disclaimer: I'm having trouble finding good info online about "after-tax 401ks").

Thanks.

The tax deferral on earnings is what I was referring to.

I like tax deferral, so I would do the Roth, just being mindful of focusing on after tax return of the investment.

My initial impression was your situation was OK (do the Roth 401k and pay 28% or 33% federal tax now). Hoewever I could sell this both ways with more information and more research.

If you saved $5000 in taxes, would that money be spent or saved? This would be in addition to the 20k you were asking in the OP.

So if choices were the following, here would be my suggestions and issues with each choice:


1) Roth 401k to $16,500 (be sure to capture 100% of match) and $20k of after tax savings (any mortgage debt, how much do you invest in bonds?)

2) Traditional 401k to $16,500, increase after tax savings to $25,000 (capture all tax savings and invest it). Still need to know about bond holdings and mortgage debt for suggestions on the 25k.

Big differences between #1 and #2:

If spending is about 40k (single) or 60k (married), situation 2 comes out ahead tax wise (I think) because paying 33% taxes to spend at 15% bracket level is a bad idea (paying 2X as much in taxes). If your spending is between 75k-90k, that is clearly in 25% bracket and the Roth should really help you, so situation 1 has more flexibility.

If early retirement is a consideration, situation 1 is a big winner as well (distributions have more flexibility).

Because there is a considerable chance for higher taxes because of so much after tax savings (dividends and interest on the 25k invested after tax without tax deferral), this might give Roth 401k more weight... meaning that if you did #2, you are paying taxes (15% current rate on dividends and capital gains) on 1% of the 25k per year (assuming investments pay out 1% in dividends and capital gains). In situation #1 only 20k of money is subject to those same taxes (because 5k extra is taxed and inside Roth).

I said before this is hit or miss.
JPG agreed with me (I think- stop the presses LOL)

I could sell this either way. I would stick with Roth 401k and invest 20k post tax. The 20k post tax should be used to

1) pay down debt
2) invest in bonds which lowers tax burden. Even consider individual bonds and not bond funds (different risks, less risk IMO with individual bonds).
3) invest in commodities (gold does not pay a dividend) being mindful that some items carry a guarantee of 28% tax rate (and not 15% long term capital gains rate). If you do this, keep the position in commodities to no more than 10% of portfolio, and 10% might even be pushing it.

You did not state your goals (early retirement, live high on hog now, or something in between), and did not state risk tolerance either. Tough to build a full financial plan or make a recommendation if it is difficult to ascertain how you will be using money or when you will use it.

[scfr]

slackbox - You may want to consider a Series EE Savings Bond from Treasury Direct. Currently the fixed interest rate is only 0.6%, however "the US Treasury guarantees that an EE Bond's value will double after 20 years, its original maturity ... If a bond does not double in value as the result of applying the fixed rate for 20 years, the US Treasury will make a one-time adjustment at original maturity to make up the difference." (Quote pulled off of the Treasury Direct web site.) This means that if you hold the bond for 20 years you will actually earn the equivalent of 3.5% interest.

Other features I made note of when I bought my first Series EE Savings Bond last August, and re-confirmed when I bought my second one today:
Federal taxes on the interest income deferred until the bond is redeemed.
State & local tax free (doesn't affect you where you currently live).
You have to hold the bond for 1 year.
If you cash it out before you have held the bond for 5 years, you will pay a 3-month interest penalty.
After 5 years if you cash it out, there is no interest penalty. So, if bank savings interest rates have skyrocketed after 5 years, you could move it to a higher-yield savings vehicle.
The bond will earn interest for 30 years, but after the one-time value adjustment after 20 years you will only earn the guaranteed interest rate (currently 0.6%).
Unlike mutual funds or other investments, there are zero fees. Completely free.

You can only purchase a maximum of $5K per year. I do not know this for sure, but I would assume that if you and your wife had separate accounts with Treasury Direct the two of you could purchase $10K per year. You'd have to decide what to do with the other $10K.

It's definitely a "fix it and forget it" investment. You'd just look at it once a year when you did your taxes or did your year-end review. Guaranteed by the US government.

Don't know how old your kids are, but there are tax advantages to using Savings Bonds to pay for education, so that is something to look in to.

You can read more at TreasuryDirect

[krantcents]

Let's say I make about $200,000 annually (married w/ kids). I have a $600K house on which I owe about $350K, and I have no other debt. I'm very thankful that I'm in a pretty good position right now, and I want to make smart retirement plans.

I max out my employeer-sponsored Roth 401K each year, but I'd like to save another $20K each year. I have about 30 years until retirement. My question is: where should I save an extra $20K each year?

Some of my random thoughts on the topic:
- I want my investing to be simple and "automatic" (ala David Bach)
- I want the investment(s) to be simple; hopefully just check on it once/twice a year.
- I make too much for a Roth IRA; I could do a traditional IRA then convert to Roth, but not sure if I should
- I can have a traditional IRA, but I can't deduct the contributions and I'm not sure if I get any benefit from it
- Should I just put all $20K each year into a Target 2040 retirement fund? Will I owe taxes each year on this?
- Should I just pay off my house quicker?

Where should a "high-income earner" put their money?

Thanks in advance.

Maybe consider a brokerage account. Even though it would not be tax sheltered, at least currently you would only pay capital gains tax.

[krantcents]

Let's say I make about $200,000 annually (married w/ kids). I have a $600K house on which I owe about $350K, and I have no other debt. I'm very thankful that I'm in a pretty good position right now, and I want to make smart retirement plans.

I max out my employeer-sponsored Roth 401K each year, but I'd like to save another $20K each year. I have about 30 years until retirement. My question is: where should I save an extra $20K each year?

Some of my random thoughts on the topic:
- I want my investing to be simple and "automatic" (ala David Bach)
- I want the investment(s) to be simple; hopefully just check on it once/twice a year.
- I make too much for a Roth IRA; I could do a traditional IRA then convert to Roth, but not sure if I should
- I can have a traditional IRA, but I can't deduct the contributions and I'm not sure if I get any benefit from it
- Should I just put all $20K each year into a Target 2040 retirement fund? Will I owe taxes each year on this?
- Should I just pay off my house quicker?

Where should a "high-income earner" put their money?

Thanks in advance.

Maybe consider a brokerage account. Even though it would not be tax sheltered, at least currently you would only pay capital gains tax. You could participate in real estate where you would just receive a k-1, it is almost like owning shares. Own income property and have it managed for you. The benefit of income property, it offers tax shelter for the income.