Advice for young high-income earner?

[Smoothtones47]

This year, my wife and I expect to earn about $130,000 plus a $200,000 bonus (before taxes) and we're trying to find the appropriate investment vehicles for us since a lot of the tax-preferred investment options seem to no longer be available to us. This is our first time in this income bracket and we want to avoid the pitfalls that seem to abound from a tax standpoint.

We're young (under 30) and can no longer contribute to our Roth. I had considered a Traditional IRA-to-Roth conversion, but I'm not sure that helps us from an income tax standpoint since we're probably going to end up in a higher bracket now than we will when we retire.

I will max out my company's 401k at the $17,000 limit for 2012. We have no kids, a 15-year fixed mortgage of about $240,000 and no other debt. Our goal is financial independence by our 50s.

We'd appreciate any guidance and advice you can offer and look forward to reading your replies.

Thank you!

[bjl584]

Your only option may be a taxable brokerage account. But, within it you can invest in several tax advantage vehicles. Tax advantage funds and muni bonds come to mind if taxes are a concern. However, taxes shouldn't be your only concern when investing. The amount of money that you are conceivably talking about is going to most likely require a talk with a professional. Have you sat down with a financial planner and gotten any insight?

[jpg7n16]

You said you guys earned that amount as a household, did she do any of the earning? Is there a plan available through her work? Any of that income from self-employed earnings?

What do you expect to be your income going forward?

As far as accounts that allow for a tax break today, if you're both maxing work plans, at that income you're pretty much tapped out. However, you can both still make Traditional IRA contributions (non-deductible), use tax efficient investments in taxable accounts, and/or consider a low cost deferred annuity for additional tax shelter. Each of those options reduce the tax on gains going forward.


Agreed on the advice to see a planner.

Find a Certified Financial Planner Professional

[Jwilliamson22]

Great advice in here, but am I the only one wondering what you do? I'm always interested to here about careers etc, I'm young and have time to reconsider if I want! Sounds like a great paying job!

[BuckyBadger]

Great advice in here, but am I the only one wondering what you do? I'm always interested to here about careers etc, I'm young and have time to reconsider if I want! Sounds like a great paying job!

I'm curious simply because I've never seen a job where the bonus is more than the salary!

You have so very little tax advantaged space that and IRA is an absolute no brainer. Since you have no Roth space anywhere I'd I would absolutely max out a Roth for both you and your wife (backdoor Roth, of course, due to your income). Absolutely. Immediately. It'll be 11,000 a year starting next year (max contribution is going from $5,000 to $5,500) but you can put $10,000 in right now. Like today.

Do you have access to an HSA?

Any kids?

Looks like you're going to have to break out some taxable investing. Make sure that your bonds are in your tax advantaged space and keep Total US and Total International in your taxable space.

[Smoothtones47]

A little more information ...

Thank you for the thoughtful advice thus far. Here is some additional information that was requested ...

jpg7n16: Yes, my wife earned part of our household income (about $40,000) and we take all of her company match, which is 6 percent. Conceivably, we could take that up to 20 percent and reduce tax exposure there. Does that sound right?

I expect that, next year, our total income (bonus included) will be more like $180,000 or so since my business is cyclical. That will still leave us out of reach of the Roth. What is your view of the Traditional IRA-to-Roth conversion?

I've typically avoided annuities, but my sense is that you may be right, from a tax standpoint, that's becoming a more attractive option.

bjl584: I have a non-qualified taxable brokerage account, but I had not yet considered tax-advantage funds like municipal bonds, etc. We're young, so I'd characterize our investment strategy, on balance, as reasonably aggressive. That's why we had not spent much time looking into bonds. I'll learn more about those options.

Yes, we have a financial planner through our bank. However, her expertise appears to me to be oriented around investment rather than tax efficiency, so I find myself shuttling back between the financial planner and an accountant and needing to serve as my own "general contractor" in this sense. Is that normal? Or should I be searching for a planner who brings the tax equation into the picture?

artwest: Good question. Yes, we have about $90,000 in savings which we consider an emergency fund of sorts. I boosted it considerably over the last few years since the economy is weak, my job is cyclical and my income fluctuates significantly.

With regard to the house, we have seriously considered starting to pay off that debt at this point. My fears are two-fold: One, we recently refinanced the house as a 15-year fixed with a 3.125 percent rate. I generally look at debt the same way I look at yield on investments -- can I make better than 3.125 percent in the market or though another instrument rather than investing more in my home. My second fear is the instability of the market and putting equity into my home with housing weak. I may have the wrong outlook on this and would welcome the views of others.

Jwilliamson22: I work in public affairs and love my job. It's up and down and depends entirely on initiative, and that makes income planning difficult but the most important thing for me is that I love this line of work.

Again, thank you for your patience and guidance. We're somewhat new to this and we don't come from families with well-established money management habits so we're eager to learn.

[BuckyBadger]

Wait -- I'm confused. Are you not maxing out your tax advantaged space? Your wife has a 401k?

You shouldn't do any taxable investing OR pre pay on your house until you've maxed out all of that space.

Order of operations:

1) Contribute enough to both 401ks get maximum employer match
2) Max out Roth (backdoor, or what you're calling "traditional IRA to Roth conversion") for both of you
3) Finish maxing out both 401k
4) optional: HSA/429 plans
5) Taxable investing
5) mortgage

Or am I misunderstanding something here?

[bjl584]

Yes, we have a financial planner through our bank. However, her expertise appears to me to be oriented around investment rather than tax efficiency, so I find myself shuttling back between the financial planner and an accountant and needing to serve as my own "general contractor" in this sense. Is that normal? Or should I be searching for a planner who brings the tax equation into the picture?

I wouldn't say that it's odd that she is focusing on investing first, then taxation. A CPA will focus on taxation. A Financial Planner will focus on investing. I'd say that a good financial planner will pay attention to both. You should seek out someone that you are comfortable with. I wouldn't give someone my hard earned money if they weren't working toward my goals and interests.

[Smoothtones47]

BuckyBadger: Yes, my wife and I both receive the maximum employer match. Her employer matches up to 6 percent. However, she does not max out her contributions to her 401k beyond the 6 percent (I believe 20 percent is the 401k max). Your "order of operations" is very helpful. Thank you.

bjl584: Thanks for your advice on a financial planner. Makes sense.

We do not have an HSA. I may have access through my employer. Is it basically like an IRA for health care expenses?

We do not have any kids.

[BuckyBadger]

Okay -- thanks for clarifying.

You said in your original post "since a lot of the tax-preferred investment options seem to no longer be available to us," so I was surprised to then see that you weren't taking advantage of the tax advantaged options that ARE available to you.

With the lack of an income limit on Roth conversions, there is no traditional tax advantaged space not available to you. You just have to actually use it.

I am a fan of the backdoor Roth (contribution to a traditional IRA and then immediately transferring to Roth). I do it every January for my husband and myself. If you don't have other traditional IRAs, it's simple. It gets complex if you've got pre-tax money in traditional or roll over IRAs, though.

So (unless you need the money to live on, in which case we should start a budgeting thread for you! ;-)) I think that you should absolutely max out your tax advantaged space. Ideally that'll be $17k for each of your 401ks (up to $17.5k next year) and $5k for each Roth (up to $5.5k next year).

Investing gets a lot more complicated once you pull it out into taxable space, so keeping as much as you can in tax advantaged space is a HUGE benefit.

[jpg7n16]

Thank you for the thoughtful advice thus far. Here is some additional information that was requested ...

jpg7n16: Yes, my wife earned part of our household income (about $40,000) and we take all of her company match, which is 6 percent. Conceivably, we could take that up to 20 percent and reduce tax exposure there. Does that sound right?

For a 401k in general, she should be able to defer up to $17k as well, which gives you a pretty big tax deduction this year (which you said you wanted). But based on her specific plan, there may be limits on what her company will allow her to contribute.

Ideally, you would do your $17k, she would do hers ($34k total), and you would both do $5k to IRAs ($44k total). The match is just a bonus. Based on your tax rate, the benefit of the 401k is in the tax deduction today, as well as the deferred growth over time. By keeping her at 6%, you miss out on a pretty good value there.

I expect that, next year, our total income (bonus included) will be more like $180,000 or so since my business is cyclical. That will still leave us out of reach of the Roth. What is your view of the Traditional IRA-to-Roth conversion?

My view is that the goal is to minimize the tax rate due on the assets.

What are your balances in non-401k IRAs? Do you have a basis in them from non-deductible contributions?

bjl584: I have a non-qualified taxable brokerage account, but I had not yet considered tax-advantage funds like municipal bonds, etc. We're young, so I'd characterize our investment strategy, on balance, as reasonably aggressive. That's why we had not spent much time looking into bonds. I'll learn more about those options.

Whoa hold up a bit. Your tax situation should not determine your investment allocation, but rather the location of your assets, and the type of stocks/bonds/funds you use to fill that allocation.

If you guys want to be more aggressive, 1st figure out what percent should be devoted to stocks vs bonds vs cash. Then of those pieces, find tax efficient ways to fill them.

Yes, we have a financial planner through our bank. However, her expertise appears to me to be oriented around investment rather than tax efficiency, so I find myself shuttling back between the financial planner and an accountant and needing to serve as my own "general contractor" in this sense. Is that normal? Or should I be searching for a planner who brings the tax equation into the picture?

What are her qualifications? Certifications? Areas of expertise? (Investments, taxation, retirement planning, estate planning, insurance planning, loans, etc.)

With regard to the house, we have seriously considered starting to pay off that debt at this point. My fears are two-fold: One, we recently refinanced the house as a 15-year fixed with a 3.125 percent rate. I generally look at debt the same way I look at yield on investments -- can I make better than 3.125 percent in the market or though another instrument rather than investing more in my home. My second fear is the instability of the market and putting equity into my home with housing weak. I may have the wrong outlook on this and would welcome the views of others.

At that rate, after tax deductions, your net cost of borrowing will be very low. I believe that there are better uses for your dollars than saving you 2.5% after tax.

In other words, I would not be in any hurry to pay off the mortgage. I would invest instead.

We do not have an HSA. I may have access through my employer. Is it basically like an IRA for health care expenses?

To an extent, yes. Except IRA w/d's are taxable upon w/d. HSA w/d's when used for qualified medical expenses are completely tax free. So you get a tax deduction on the way in, and if used for medical, no taxes on the way out. A pretty good deal for those who have them.

However, there are certain requirements for an HSA, and not everyone qualifies to set one up. Main criteria is that you have to be covered by a high deductible health care plan through work.

Health savings account - Wikipedia, the free encyclopedia
Health savings accounts: Is an HSA right for you? - MayoClinic.com

[Ramose]

artwest: Good question. Yes, we have about $90,000 in savings which we consider an emergency fund of sorts. I boosted it considerably over the last few years since the economy is weak, my job is cyclical and my income fluctuates significantly.

Is this the only money you currently have? Do you already have stocks or bonds etc..?

We're somewhat new to this and we don't come from families with well-established money management habits so we're eager to learn.

Are you just looking for tax advice, or do you need wealth management advice too?

[bullfrogcorner]

I frequently had a huge bumps in income due to a sales commissions. Here's what I wish I'd done - invest in a charitable gift annuity donation to the Goodwill. I'd look into it even though you're rather young (the annuity may be small because of your youth). I didn't and I paid big bucks in taxes that year. After maxing out all IRA's:

Make a chartiable gift annuity donation to the Goodwill:

Benefits

Receive dependable, fixed income for life in return for your gift.
In many cases, receive payments at a rate higher than the interest you are currently receiving from stocks, CDs, or savings accounts.
Receive an immediate income tax deduction for a portion of your gift.
A portion of your annuity payment will be tax-free.
Are you a younger donor? Consider a deferred gift annuity.

Check out their website.