401k + pension

[minnie1928]

Ok, I've just had a thought...

My husband works for a major corporation that still offers pension benefits at retirement. He's definitely vested based on his years of service. We've also been contributing heavily to his 401k. My question is at what point do we just invest...not retirement investments, but normal, taxable investing.

I guess what I'm wondering is are we tying up too many assets into retirement by putting that much in his 401k considering that he will also get a pension. We are both under 40 and have a fully funded 6 month EF.

Thanks!

[jIM_Ohio]

I would not do this unless you have a very specific retirement date in mind, or unless you had a very specific tax reason to not invest in the 401k.

I would try to divert some of the 401k money to a Roth IRA. This is because the 401k will have RMDs at age 70.5, where as the Roth would not have an RMD. Lets you control taxes in retirement more than if all money in retirement is taxed.

[minnie1928]

I'm pretty sure that we don't qualify for ROTH. Assuming that's correct...what would you suggest?

[swanson719]

Bottom line up front: It's probably better to first max out 401(K) contributions and then buy stocks and bonds through a broker if your combined income makes you ineligible to contribute to a Roth. The reasons follow.

A married couple has to have a gross income in excess of $169,000 to not be able to contribute to a Roth.

Contributing to the 401(K) only makes sense if you can contribute the $16,500 to it and have it lower your tax bracket. If that amount doesn't lower your tax bracket and save you a substantial amount of money, cut straight to stocks and bonds as long term investments.

If you work outside the home and make significantly less income than your husband and are inside the Roth contribution limits ($110,000 each) then it may make sense to file your taxes separately. This will certainly raise your tax liability, though to what degree is income based. If the uptick in your taxes is less than the amount you can invest in the Roth, then it would seem worth it, simply because later on you won't have taxes on the Roth.

Short of filing separately, the alternative is either a traditional IRA or general stocks and funds held in a taxable account. Both have pro's and con's.

The traditional IRA isn't usually great for high income earners. Traditional IRA withdrawals are taxed at your income tax rate at time of withdrawal - so if you are still making a great deal of income during "retirement" then it wouldn't make sense. Being taxable income in themselves, if you plan on living large during retirement, a simple distribution could potentially put you into a 35% tax bracket - a quick way to crack and scramble your nest egg.

The one caveat to this is if you both make less than $100,000 but have a combined income over $160,000. If that is the case, then you can file separately and convert a traditional IRA to a Roth, which eliminates the taxes on the back end. The IRA will be taxed at your current tax bracket at the time of conversion, but all gains would grow tax free. A traditional IRA has an annual contribution limit of $5,000 before age 50, and $6,000 if you turn 50 during that tax year. The same applies to a Roth, though not for roll-over purposes.

You're alternative, if you don't qualify for a 403(b) or 457 via working for a school, tax exempt organization, or the government, or qualifying for an SEP, SIMPLE IRA, Solo 401(K), etc. via self-employment is to invest directly into stocks and bonds placed into a taxable account.

The major benefit to stocks and bonds for high income earners is the tax implications. They are taxed at the 15% long term capital gains rate at time of sale, so long as they are Long Term and you are in the 25% tax rate or higher. If you are in the 15% tax rate or lower, they are taxed at 5%. To qualify as long term each stock or bond has to be held a minimum of 366 days.

Disbursed dividends are taxed. No if's, and's, or but's about it. So ensure you have either a) stock options to reinvest your dividends or b) stocks that do this for you. Unless you want to have dividends and pay taxes on them.

[minnie1928]

Unfortunately, we can't go up to the $16,500 limit because of the "highly compensated" rule. However, we have been able to contribute as much as possible without triggering that rule.

At the moment, I am a SAHM so I have no earned income. I plan on returning to work within a year or so, and at that point I'll start contributing to my 401k again.

So, I guess I'll just keep doing what we've been doing. I just was unsure with regard to the pension.

Thanks everyone!

[jIM_Ohio]

I'm pretty sure that we don't qualify for ROTH. Assuming that's correct...what would you suggest?

Can you list specifically which qualification? Is it because you do not file a joint return, or because you make too much money?

If you make too much money, you are probably in 28% tax bracket, and the 401k is a really good choice for the immediate tax relief it gives you.

Example- say you tell me you put ~$800/mo (or $10,000 per year) into investments.

If this is in a taxable account, you pay $2800 in taxes and have $7200 left to invest
If this is a 401k, you put in $10,000 now, and hope to pay only $1500 or $2500 in taxes when you withdraw. You hope to withdraw in a lower tax bracket than you are now.

If you give more information into financial picture, I could make examples more to your situation.

What are annual expenses?
How much are retirement accounts worth now?
Can you guess at value of pension (like 50% of pay, 80% of pay...)
Does the pension give a cost of living adjustment each year?
How much can you invest in retirement accounts each year?

Do you have any debts? Include mortgage.
What are balance and interest rates of the debts?

[jIM_Ohio]

If you work outside the home and make significantly less income than your husband and are inside the Roth contribution limits ($110,000 each) then it may make sense to file your taxes separately. This will certainly raise your tax liability, though to what degree is income based. If the uptick in your taxes is less than the amount you can invest in the Roth, then it would seem worth it, simply because later on you won't have taxes on the Roth.

Last I checked, married filing separately makes someone ineligible to contribute to a Roth.

Short of filing separately, the alternative is either a traditional IRA or general stocks and funds held in a taxable account. Both have pro's and con's.

The traditional IRA isn't usually great for high income earners. Traditional IRA withdrawals are taxed at your income tax rate at time of withdrawal - so if you are still making a great deal of income during "retirement" then it wouldn't make sense. Being taxable income in themselves, if you plan on living large during retirement, a simple distribution could potentially put you into a 35% tax bracket - a quick way to crack and scramble your nest egg.

The one caveat to this is if you both make less than $100,000 but have a combined income over $160,000. If that is the case, then you can file separately and convert a traditional IRA to a Roth, which eliminates the taxes on the back end. The IRA will be taxed at your current tax bracket at the time of conversion, but all gains would grow tax free. A traditional IRA has an annual contribution limit of $5,000 before age 50, and $6,000 if you turn 50 during that tax year. The same applies to a Roth, though not for roll-over purposes.

You're alternative, if you don't qualify for a 403(b) or 457 via working for a school, tax exempt organization, or the government, or qualifying for an SEP, SIMPLE IRA, Solo 401(K), etc. via self-employment is to invest directly into stocks and bonds placed into a taxable account.

The major benefit to stocks and bonds for high income earners is the tax implications. They are taxed at the 15% long term capital gains rate at time of sale, so long as they are Long Term and you are in the 25% tax rate or higher. If you are in the 15% tax rate or lower, they are taxed at 5%. To qualify as long term each stock or bond has to be held a minimum of 366 days.

Disbursed dividends are taxed. No if's, and's, or but's about it. So ensure you have either a) stock options to reinvest your dividends or b) stocks that do this for you. Unless you want to have dividends and pay taxes on them.

Assuming I am correct on married filing separate eliminates Roth eligibility, you will want to do a general, multi pronged approach to your retirement planning. Some of which is above- I would verify the info listed because if the Roth comment is incorrect, other numbers might not apply either...



For example-
Put $5k into traditional IRA for each spouse (10k total)
Put as much into a taxable account as you feel comfortable with

Overall goal is 20% contributions to retirement plans (401k, Traditional IRAs, taxable accounts).

Next issue is taxes. Your high income and pension in retirement are a tax problem. Tax problems are better than income problems (you only have tax problems if you have income).

I am assuming you are in 28% tax bracket. This bracket is based on income of the family. Have you analyzed what tax bracket your expenses are in?

I am pulling information from this table
Reference Room

Two examples:

Example 1: Say your husband's income is 200k per year. Maybe all your expenses add up to 80k.
The 200k gross income (married filing jointly) is in 28% tax bracket (and just below 33% bracket with another $8000 in raises). The 80k of expenses is in 25% tax bracket. If you have a mortgage included in that 80k which is $2000/mo ($24k per year), the 56k of expenses without a mortgage are in 15% tax bracket.

In this example, you could project your retirement expenses to be in the 15% tax bracket with a paid off mortgage. This means using the traditional IRAs now will help you because you can convert that money to a Roth IRA when you retire at half the tax you would be paying now.


Example 2 Say your husband's income is 160k per year and expenses add up to 120k. Same 2k per month mortgage. In this case your gross income is in 28% tax bracket, your expenses are in 25% tax bracket, and even paying off mortgage is not going to lower what tax bracket your expenses are in (94k of expenses is in 25% tax bracket).

Its possible Roth conversions do not fit in second example. With some work though (meaning planning work) you could fit the second example into a Roth conversion situation at a time when expenses are low in retirement.


Here are factors you want to consider:
1) Tax brackets now and in retirement based on expenses
2) What expenses you have now, and which ones go away when you retire (and will other expenses be added in).
3) Withdraw rules from pension, 401k and IRA. Know when you can access money.
4) What years will you project to have the highest income and what years will you project to have the lowest income. Low income means low taxes, and those are good years for Roth conversions.


If much of what is put above is beyond your scope of knowledge, ask questions. I have no idea how financial savvy you are with various terminology.

[minnie1928]

Can you list specifically which qualification? Is it because you do not file a joint return, or because you make too much money?

What are annual expenses?
How much are retirement accounts worth now?
Can you guess at value of pension (like 50% of pay, 80% of pay...)
Does the pension give a cost of living adjustment each year?
How much can you invest in retirement accounts each year?

Do you have any debts? Include mortgage.
What are balance and interest rates of the debts?

We hit the monetary limits, that's why.

My husband is a privacy freak, so I won't list specific details. But, if memory serves correct the pension is at least 50% of the average of the 5 previous years of work prior to retirement. I'm pretty sure it has a COLA. I haven't looked at the documents in a while, but I do recall thinking it was a very good pension at the time I read them. We also live fairly frugal, so our living expenses aren't outrageous.

We are probably in the $13-14,000/yr range for the 401k contributions. We've been contributing to 401k since we both started working 20 years ago.

The only debt we have is our mortgage and that is at 5%. We plan on remaining debt free (except the house). Cars are paid off and relatively newer (2005 & 2007 models).

[jIM_Ohio]

We hit the monetary limits, that's why.

My husband is a privacy freak, so I won't list specific details. But, if memory serves correct the pension is at least 50% of the average of the 5 previous years of work prior to retirement. I'm pretty sure it has a COLA. I haven't looked at the documents in a while, but I do recall thinking it was a very good pension at the time I read them. We also live fairly frugal, so our living expenses aren't outrageous.

We are probably in the $13-14,000/yr range for the 401k contributions. We've been contributing to 401k since we both started working 20 years ago.

The only debt we have is our mortgage and that is at 5%. We plan on remaining debt free (except the house). Cars are paid off and relatively newer (2005 & 2007 models).

Check this thread out

http://www.savingadvice.com/forums/investing-banking/50669-questionaire-people-starting-retirement-planning.html

The math I was going to do is listed there.

Take expenses (current household expenses) and multiply by 25.
That is your retirement target- when you have that amount in 401k, IRA and taxable accounts, you are financially independent and DH could tell employer CYA! Whether he does or not is up to him.

Then most planning falls into the following areas

1) taxes
2) expenses
3) withdraw techniques
4) investments and investment risks

Its possible you are really good with 1-2 of those, but have no idea on other 1-2. For example, post people on this board have a good handle on their expenses. This isn't the place to come for tax advice though.

For the pension, here is what you can do

List expenses
List pension value (50% of current salary for example)

Then subtract
that difference is what you want to multiply by 25 (lower number than above).

Because pension might go under, consider multiplying by 33 to be more conservative.

25 means you withdraw 4% of investments per year
33 means you withdraw 3% of investments per year
3% is more conservative.

[disneysteve]

My question is at what point do we just invest...not retirement investments, but normal, taxable investing.

I guess what I'm wondering is are we tying up too many assets into retirement by putting that much in his 401k considering that he will also get a pension.

Overall goal is 20% contributions to retirement plans (401k, Traditional IRAs, taxable accounts).

I think a lot of the discussion thus far didn't actually address your question but Jim summarized the bottom line here. You should shoot to invest 20% of income for retirement. If you are doing more than that, I'd look to put the rest into taxable accounts. Why? Because taxes aren't the only issue in life and retirement isn't the only investing goal.

You are both under 40 and obviously make good money, and will make even more when you return to work. At some points in your life, you will want money for other things: travel, home renovations, charitable donations, entertainment, gifts to the kids, etc. Who knows what? If virtually all of your savings except your EF is tied up in 401K and IRA accounts, how will you pay for that luxury cruise or your kid's wedding or the new addition to the house?

[jIM_Ohio]

I think a lot of the discussion thus far didn't actually address your question but Jim summarized the bottom line here. You should shoot to invest 20% of income for retirement. If you are doing more than that, I'd look to put the rest into taxable accounts. Why? Because taxes aren't the only issue in life and retirement isn't the only investing goal.

You are both under 40 and obviously make good money, and will make even more when you return to work. At some points in your life, you will want money for other things: travel, home renovations, charitable donations, entertainment, gifts to the kids, etc. Who knows what? If virtually all of your savings except your EF is tied up in 401K and IRA accounts, how will you pay for that luxury cruise or your kid's wedding or the new addition to the house?

Thanks for keeping me on topic.


Here is a good way to see if retirement accounts have enough


Pick a date (year) you want to retire and put an age on that
get that 25X expenses number

Might look like this

2026 age 55 $1.6 M


Then do some subtraction and dividing
subtract 8 from age and 25X number in half
keep repeating until the age listed is under what age you are now

age 47 $800k
age 39 $400k
age 31 $200k

**above is my chart... I am 37, and do not have 400k invested in retirement accounts yet, so I need to focus on retirement more than any other financial objective.

Once that scale "tips" to where I have 400k by age 39 or $800k by age 47, I would be investing in taxable accounts for other goals.

That chart has many assumptions built into it. As long as you have a handle on what your expenses are, it should be effective unless your retirement expenses will be really really different than expenses when you worked.

[disneysteve]

If you are doing more than that, I'd look to put the rest into taxable accounts.

I realized upon re-reading this that I didn't really state it properly. I should have said "non-retirement" accounts. They may or may not be taxable. In your income bracket, it might make sense to look into municipal bonds for part of your portfolio. Also, there are numerous non-retirement investments that are very tax-efficient and generally create very little tax liability. You should never choose your investments purely based on tax issues, but it should be one of the factors you consider.

[zetta]

Contributing to the 401(K) only makes sense if you can contribute the $16,500 to it and have it lower your tax bracket. If that amount doesn't lower your tax bracket and save you a substantial amount of money, cut straight to stocks and bonds as long term investments.

It doesn't have to lower your tax bracket to be worth it -- simply not paying taxes on that income and on the investment gains each year is beneficial. (You do pay income taxes in retirement on the money as you take money out.)

[minnie1928]

At some points in your life, you will want money for other things: travel, home renovations, charitable donations, entertainment, gifts to the kids, etc. Who knows what? If virtually all of your savings except your EF is tied up in 401K and IRA accounts, how will you pay for that luxury cruise or your kid's wedding or the new addition to the house?

That's what I was thinking...I mean right now we are doing the 401k up to what we think is about the limit and socking the rest in savings. But, I've got to start investing it elsewhere (the 1.5% just isn't cutting it in a savings account ). Then the question came up as to whether or not the investment should be for retirement or just as an investment.

Jim-Thanks so much for the references/formulas. I'll definitely be running some numbers and seeing how we shake out. Like I said, we live fairly frugal...our only real splurge is travel related and I expect that to continue. We don't plan on retiring for at least another 18 years, so we have that on our side as well. And, once I return to work I will contribute the max to my 401k to help compensate for the 2 years I've been home.

Thanks again!

[minnie1928]

If much of what is put above is beyond your scope of knowledge, ask questions. I have no idea how financial savvy you are with various terminology.

FWIW - I have an accounting degree, however my experience has been more in corporate accounting than personal. I understand the terminology & principles as you have laid them out...I just haven't spent much time studying this aspect of finance. I guess I just don't trust myself enough in this area to go completely unguided.