Balance between saving in taxable account and retirement account? (mega backdoor version)

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Topic Author
Rainy
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Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by Rainy »

At beginning of this year, we made a goal to maximize all tax-advantage account including after-tax 401k savings, which can be converted to roth ira. This means we need to put a total of 18000 (my pre-tax 401k) + 26000 (my after-tax 401k, my company matches 9000 for 401k) + 18000 (husband's pre-tax 401k) + 30500 (husband's after-tax 401k, his company matches 4500 for 401k) + 5500 (roth ira) + 5500 (roth ira) = 36000 pre-tax dollars + 67500 after-tax dollars.

Now, we are reviewing our finance for the first half of the year. We have set our paycheck deduction to 100% to 401k, so we have already accomplish the goal of maximizing all the retirement account. On the other hand, we were eating our taxable savings from previous years for the first half of the year because we did not take much income home. Actually, we spent 88k more than we take home for the first half of the year (including 2 big purchase of 38k total, which does not happen often). I hope we will be able to make up this 88k deficit, but I do not think we can save more in the taxable account.

The problem is that I'm 27. Even my mom is not old enough to access the retirement account without penalty. In fact, she did not save in a retirement account at all that all her money is within her reach in a taxable account, which makes her feel safe. So she is strongly against me putting all money into the retirement account at this age. She suggest I invest in RE, start my own business, or spend more money improving life quality, as retirement is too far away. I agree with her in the sense that I am enabled to do a lot of more things with money in taxable account, but I do want to take the tax advantage of retirement account. As I described above, it will be very hard for me to save more taxable money if I continue to maximize all my retirement account. I wonder how I should balance the savings between the retirement account and the taxable account? Any suggestion?

Some more information about our finance:
- We had a big one-time windfall last year, so we have about 200k liquid taxable asset. That's why we go ahead to put all money in retirement account at the first place.
- Our federal marginal tax rate is 33% and state marginal tax rate is 9.3%.
- We purchased a house this year, with about 900k mortgage
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investorguy1
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by investorguy1 »

You want to make sure you have enough money in non qualified accounts that you could access in case you need it. People often say around 3-6 months some like to ave more. Once you have that I think your other money could go into retirement accounts. When it comes to saving vs spending there is a balance there. It is very important to save for retirement. Some people go to the extreme saving every penny and not spending on things they need like their health, family etc. I'm not sure if that is your situation but you should feel good about what you are doing.
mhalley
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by mhalley »

I think diversification is a good idea, accross all tax catagories. Taxable, tax free and tax-deferred. How much you put in each will depend on a lot of things. First, when do you need to access the money? If you plan on being a very early retiree, then you will want to put more toward taxable than if you plan on retiring when you can gain access to the tax deferred accounts (55). Putting a huge chunk away now is a great idea, because of the power of compounding. I don't think I would have had the foresight to put 100% into retirement in order to front load the retirement account, so I salute you for that.
Other life events also determine this, ie saving for a new car or house downpayment, or for investing in real estate. Only you will be able to figure out what is best for you.
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Rainy
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by Rainy »

I have no idea when I need to spend a lot of money. I am happy with my current lifestyle, $200 per month on restaurant, $300 per month taking piano classes, $10k travel budget per year (never used up). I think it is a bit luxury than most of people in the world, so I definitely not save every penny in my life. And I definitely have more than enough on my taxable account to support my current lifestyle for years.

I think I'm too young so I need to take more advice. I do not know when there will be life changing event that I need more money than I current have on taxable account. I have not thought about when to retire yet. I think I have a huge amount of uncertainty in my life, so I'm a little bit concern about saving too much in retirement account. On the other hand, because there's a limit on how much money we can put into retirement account and I do not want to miss it.
letsgobobby
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by letsgobobby »

From what you've written I cannot gather the whole picture. For example you are in the 33% bracket suggesting a gross income of, say, $300,000, or $150,000 in the first half of the year. But you also say you don't need to spend much. How then did you spend $50,000 more than your $150,000 in only six months? And that excludes one time expenses of $38,000. I don't think spending $238,000 in six months is cheap or frugal by anyone's standards except Donald Trump's, or the Queen of England's. Also, $900k mortgage: not frugal.

You're in a high tax bracket so I would max out every opportunity I had. You may want to read about 72t and SEPP withdrawals from retirement accounts to understand why your mom probably made a mathematical mistake when she declined to contribute to hers.

I do not think $200,000 will last many years of your current expenses. It sounds like it may only last two. Again, something is not adding up here so I hope you will clarify.

The after tax accounts are even better than taxable accounts if you can avoid needing the money for five years. Saving $100,000 per year on a gross of $300,000 sounds very nice but may not be strictly necessary; it depends on your goals. By buying a million dollar plus home, it seems unlikely you'll be able to continue to save $100,000+ on a $300,000 income.
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Epsilon Delta
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by Epsilon Delta »

First decide the balance between spending and savings. You should not let the government's arbitrary limits on various accounts determine what you do with your money.

Once you've decided how much to save put the money in the best places, until all your savings are accounted for. You need to look at what the savings are for. Generally deductible (pre-tax) and Roth accounts should usually be used first, but you need to consider that you may need to access the money before age 59.5. Roths quite flexible so this limits pre-tax accounts more than Roths. In any case your savings are much larger than available Roth and deductible this should not be an issue for you, max them out.

It is less clear that non-deductible accounts are good. Unless you will be able to convert them to a Roth (called a mega backdoor Roth by some bogleheads) in the next few years or decade, an investment in a total stock market index is likely to be better in taxable accounts than a non-deductible 401(k) so I'd pass on some and possibly all the post-tax 401(k) -- exactly how much depends on many things, including asset allocation (bonds in a non-deductible 401(k) are better than bonds in taxable.)
rai
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by rai »

I'd say, for myself. There is never enough allowable room in my tax shelter, meaning if I could put more money in I would. So the excess money is put into taxable account by default. I have been able to save more in quasi tax shelter that is 529 plan for kids. But I don't want to over save in the 529 plan.

Some of the benefits of a tax shelter are:
- immediate tax savings in the area of 40-50% tax savings (for high earners)
- yearly tax savings on dividends and cap gains (in the tax shelter)
------the above two benifits allow you to save more and have more yearly to grow.
- the ability to invest in high tax or tax inefficient areas such as REITS and Bonds
- the ability to rebalance without taxable consequences
- the benefit of having money deducted before you can spend it (forced savings)
- the difficulty of spending it is actually a good thing forces you to live within your means
- the ability to work is never a sure thing, so saving early is hardly ever a mistake
- there are exceptions to the age rule for penalty free withdrawal if needed such as retirement after 55 or SEPP rule: http://www.investopedia.com/articles/re ... 112602.asp

The downside of tax shelters is they are more heavily taxed on withdrawal but give you decades of tax savings which are priceless IMO.
"Life is what happens to you while you're busy making other plans" - John Lennon. | | "You say that money, isn't everything | But I'd like to see you live without it." - Silverchair
icefr
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by icefr »

It sounds like you and your husband had some unexpected expenses this year and it is probably a good time to re-evaluate your spending for the year and see if you can re-build your taxable accounts. What level would you like your taxable/liquid accounts to be at? If you look at your spending and net income expectations for this year and next, how much can you save? Does maxing out all of your retirement accounts mean that you will save negative money over the course of the year? If so, you have to determine if you are okay with that.

I've found that I generally don't take my parents' financial advice. They think I should spend more money, that I'm not enjoying life enough. I am enjoying life perfectly well. I just don't need to spend all of my income to be happy. My mom thinks I'm putting too much money in retirement accounts too, so eventually I told her how much money I make and then she didn't think that anymore.

It sounds like you guys live in the Bay Area and both work at large tech companies. My boyfriend and I are around the same age as you and both work in tech (but live somewhere else) and spend somewhere around $70k/year combined and save the rest, which results in each of us saving somewhere around $100k/year. I think our place is much smaller than yours though as my mortgage is around $140k at this point.

Why do you think that you need to save more money in the taxable account? You can withdraw from Roth accounts before 59.5 relatively easily, which makes the after-tax 401(k) more beneficial than a taxable account.

It sounds like you're doing mostly fine to me :)
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retiredjg
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by retiredjg »

Rainy wrote: On the other hand, because there's a limit on how much money we can put into retirement account and I do not want to miss it.
There is absolutely no need to put over $100k into retirement accounts each year. Saving half that would be more than enough for most people.

You set an unnecessary and unreasonable goal. Listen to your mother and tone it down a bit.
Topic Author
Rainy
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by Rainy »

letsgobobby wrote:From what you've written I cannot gather the whole picture. For example you are in the 33% bracket suggesting a gross income of, say, $300,000, or $150,000 in the first half of the year. But you also say you don't need to spend much. How then did you spend $50,000 more than your $150,000 in only six months? And that excludes one time expenses of $38,000. I don't think spending $238,000 in six months is cheap or frugal by anyone's standards except Donald Trump's, or the Queen of England's. Also, $900k mortgage: not frugal.

You're in a high tax bracket so I would max out every opportunity I had. You may want to read about 72t and SEPP withdrawals from retirement accounts to understand why your mom probably made a mathematical mistake when she declined to contribute to hers.

I do not think $200,000 will last many years of your current expenses. It sounds like it may only last two. Again, something is not adding up here so I hope you will clarify.

The after tax accounts are even better than taxable accounts if you can avoid needing the money for five years. Saving $100,000 per year on a gross of $300,000 sounds very nice but may not be strictly necessary; it depends on your goals. By buying a million dollar plus home, it seems unlikely you'll be able to continue to save $100,000+ on a $300,000 income.
Sorry about the confusion. I front load all my retirement account. As a result, the the first half of the year I put more than 100k into retirement account. The money take home for the first half of year is about 50k. For the second half, I'll definitely have much more income because I do not need to contribute to retirement account.

I agree with you 900k mortgage is not frugal at all, but I spent more than 10 hours everyday at home, so I want to live in a nice one. Actually I do not think the house expensive. The current rent for a 2b apartment in our area is about $3000 - $3500. This house is much better than a 2b apartment, and 900k mortgage at 2.375% rate is only $3600 monthly payment. The house has an additional master room on the lot, which can be rent out for $1000 per month.

Some break down on how I spent on my first half of year:
Housing: 17k
Utility (including cellphone, internet): 2k
Restaurant: 1.2K
Grocery: 1.2k
Piano class: 2k
Car (insurance, gas and one car loan): 4k
Charitable donation: 42k (Donate a lot of long term capital gain stocks, I think this year I'm going to donate 5k more in the second half.)
Home improvement: 8k (termite treatment, furniture for new house, etc)
travel 1.2K
Piano: 38k (A used steinway M...both my husband and I really love piano...)
Other purchase: 3k (computer, clothes, makeup, house warming party, etc)
Additional tax payment for last year 28k (Last year has a windfall, and we two high income people got married...)
Topic Author
Rainy
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by Rainy »

icefr wrote:It sounds like you and your husband had some unexpected expenses this year and it is probably a good time to re-evaluate your spending for the year and see if you can re-build your taxable accounts. What level would you like your taxable/liquid accounts to be at? If you look at your spending and net income expectations for this year and next, how much can you save? Does maxing out all of your retirement accounts mean that you will save negative money over the course of the year? If so, you have to determine if you are okay with that.

I've found that I generally don't take my parents' financial advice. They think I should spend more money, that I'm not enjoying life enough. I am enjoying life perfectly well. I just don't need to spend all of my income to be happy. My mom thinks I'm putting too much money in retirement accounts too, so eventually I told her how much money I make and then she didn't think that anymore.

It sounds like you guys live in the Bay Area and both work at large tech companies. My boyfriend and I are around the same age as you and both work in tech (but live somewhere else) and spend somewhere around $70k/year combined and save the rest, which results in each of us saving somewhere around $100k/year. I think our place is much smaller than yours though as my mortgage is around $140k at this point.

Why do you think that you need to save more money in the taxable account? You can withdraw from Roth accounts before 59.5 relatively easily, which makes the after-tax 401(k) more beneficial than a taxable account.

It sounds like you're doing mostly fine to me :)
WOW, 140k mortgage :)

You can see my previous post on our spending. I think I maybe able to rebuild our taxable account, but not be able to save any more. In other words, we can bring the taxable account back to the level at beginning of the year.

The 1.3M house we bought is actually not large, just a 1700sqft ranch built in 1950s, and not in a good school district (but not bad either). The biggest advantage is that we can commute to work within 30 minutes in rush hours (the bay area traffic is very very very bad these days...). I do have a dream to live in a better house (maybe not in the bay area) after maybe 10 years...For that dream I may need some money in a taxable account, but definitely the dream is at least 10 years far away, unless hit by another windfall soon....
icefr
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by icefr »

Rainy wrote: WOW, 140k mortgage :)
I bought a two bedroom condo for around 350k a few years ago and have aggressively paid down the mortgage with bonuses, which has helped me sleep a lot better at night knowing that I own most of the place. It definitely makes it hard to consider buying a house at some point as those would be around double what my place is worth...
Rainy wrote: You can see my previous post on our spending. I think I maybe able to rebuild our taxable account, but not be able to save any more. In other words, we can bring the taxable account back to the level at beginning of the year.
It sounds like you guys are mostly doing fine, but had a few one-off big expenses this year. I would say that if you can re-build your taxable account this year and then don't need to draw it down nearly as much next year, then you're probably fine with doing this. I also front load my retirement accounts and I keep a cash buffer to help smooth out cash flow while I'm doing that. Since you do that every year, maybe you guys need a larger emergency fund/cash buffer to help with this. I hope you have adjusted your W-4s so that you don't get with as much of a tax bill next year :)

If you take out the big expenses, you spent $40k in the first half of the year. $80k spending for the year isn't that bad for a couple in the 33% tax bracket. I somehow doubt you'll buy a piano every year or donate 42k to charity?
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Rainy
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by Rainy »

icefr wrote:
If you take out the big expenses, you spent $40k in the first half of the year. $80k spending for the year isn't that bad for a couple in the 33% tax bracket. I somehow doubt you'll buy a piano every year or donate 42k to charity?
I hope I'll keep the piano forever, so no piano purchase any more. But I do doubt whether I'll have other large purchase in future years....

For the charitable donation, We do tithe every year. This 42k is more than tithe of this year but some of that money is for the last year's windfall. Apart from that, we donate to my university a few thousand dollars since I graduate. I am very grateful that I was able to go to a very good private university with full financial aids. I want to contribute back to the university because now I have the money.

My goal was 100k expense including donation every year. Definitely this year spends much more than that, but I hope I can keep the budget in future years. If I can do 100k expense, I think I'll be safe front load retirement account.....I sometimes doubt my budget control ability...
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torius71
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Re: Balance between saving in taxable account and retirement account? (mega backdoor version)

Post by torius71 »

Rainy wrote:...For that dream I may need some money in a taxable account, but definitely the dream is at least 10 years far away, unless hit by another windfall soon....
Mega-Roth conversions (including earnings before the conversion) are accessible after 5 years. I don't think you need to think of this money as only "retirement money". Here's a great review by our own TFB:

http://thefinancebuff.com/rollover-afte ... 9-1-2.html
"A new truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it."-MP
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