Savings and Investing Precedence

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Savings and Investing Precedence

Postby umfundi » Thu Jun 27, 2013 8:50 pm

Assuming one is young and has no debt and a good job (some marginal fraction of the population?) the usual savings precedence is:

1. 401k up to the employer match
2. Roth IRA
3. 401 k up to the allowed max.
4. Taxable savings

I am interested why, if one cannot reach the level of taxable savings in item 4., why is Item 2. not a deductible Regular IRA rather than a Roth?

Aside from speculation on future tax rates, why would you not maximize a deductible IRA rather than a Roth?

Question 2, how about adding item 3a., non-deductible 401k contributions?

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Re: Savings and Investing Precedence

Postby livesoft » Thu Jun 27, 2013 8:57 pm

The "usual" precedence is something not validated on this site, but something politely argued over. Indeed, because quite a lot of high income folks are on the forum, they may not be able to contribute to Roth IRAs anyways.

I will say that non-deductible 401(k) contributions are bad unless they can be immediately converted to Roth. Can you figure out why?
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Savings and Investing Precedence

Postby Grt2bOutdoors » Thu Jun 27, 2013 9:08 pm

I'm a rule breaker - I've always put in 15% of salary in the 401k first, if extra cash - then Roth, if extra cash - then taxable accounts. It worked for me, even when I was not even close to a high income.
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Re: Savings and Investing Precedence

Postby umfundi » Thu Jun 27, 2013 9:11 pm

livesoft wrote:The "usual" precedence is something not validated on this site, but something politely argued over. Indeed, because quite a lot of high income folks are on the forum, they may not be able to contribute to Roth IRAs anyways.

I will say that non-deductible 401(k) contributions are bad unless they can be immediately converted to Roth. Can you figure out why?

The "usual" precedence is in the Bogleheads' Wiki. Which is, why I ask the question.

I am not sure what you mean:
I will say that non-deductible 401(k) contributions are bad unless they can be immediately converted to Roth.


If possible, I would move 401k contributions to a self-administered IRA asap, because of the likely inferior investment options in a company 401k.

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Re: Savings and Investing Precedence

Postby Kevin M » Thu Jun 27, 2013 9:19 pm

#2 should simply be "IRA". Traditional or Roth depends on individual circumstances. I know folks who blindly contributed to a Roth because they just heard "tax free", when it's probable that they'll get tax-free or very-low tax withdrawals from a traditional IRA in addition to the tax break on contributions. Also, even if paying no taxes, traditional IRAs can make more sense to increase refundable tax credits; I discovered that in working on my neices taxes.

Contributing to a 401k/403b beyond the employer match also depends on individual circumstances. If the 401k only has really expensive, actively-managed funds and you plan on staying at the employer for a long time, it might make more sense to put a higher priority on a taxable account.

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Re: Savings and Investing Precedence

Postby Kevin M » Thu Jun 27, 2013 9:26 pm

umfundi wrote:The "usual" precedence is in the Bogleheads' Wiki. Which is, why I ask the question.

One of many things in the wiki which are opinions, and not based on impartial references. Unfortunate IMO. I pointed this out in a post quite some time ago about the bias here toward Roth IRAs, and as I recall, even Taylor acknowledged that this may be an error in the Wiki, but nothing was done about it, and I'm not into arguing about opinion-based Wiki entries--I discovered it's a losing battle. The Boglehead's Wiki is a valuable resource, but it generally doesn't follow the Wikipedia guidelines about basing entries on reliable references.

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Re: Savings and Investing Precedence

Postby livesoft » Thu Jun 27, 2013 9:36 pm

livesoft wrote:I will say that non-deductible [traditional] 401(k) contributions are bad unless they can be immediately converted to Roth. Can you figure out why?

When one withdraws from a traditional IRA, the untaxed money is taxed at one's marginal income tax rate which is always higher than the long-term capital gains tax rate. So if one makes non-deductible contributions, not only does one have to keep track of a basis in the 401(k) for the future, one will also have to pay a higher tax rate on the gains when the money is withdraw.

In contrast, if the same contribution is just invested tax-efficiently in a taxable account, one will be able to tax-loss harvest capital losses and pay taxes on the gains at the long-term cap gains tax rate which can be as low as 0%. Plus there is no penalty for early withdrawal nor any contribution limits.

Therefore, if one does not get a benefit from a traditional 401(k) (tax-deferral on the contribution) or a Roth 401(k) (tax-free gains) or maybe an employer match, then don't bother with a 401(k) contribution.
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Re: Savings and Investing Precedence

Postby pteam » Thu Jun 27, 2013 9:50 pm

I would rather put $5k in a Roth IRA and let it grow for 30 years if your young and pay tax on the $5k then have to pay taxes on it thirty years later when its worth $30k
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Investing Priority: Suggested change

Postby Taylor Larimore » Fri Jun 28, 2013 8:16 pm

Our wiki has a wonderful link for Investment Planning. This is the part in question:
The general rule of thumb for investing priority is:
1. 401k/403b up to the company match
2. Max out Roth
3. Max out 401k/403b
4. Taxable Investing

In my opinion, item #2 might better read:

"2. Max out a self-directed IRA"

Edit

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Re: Savings and Investing Precedence

Postby LadyGeek » Fri Jun 28, 2013 8:59 pm

^^^ A google search for "self-administered IRA" (self-administered IRA - Google Search) only returned results for "self-directed IRA" :shock: I think it's best to leave #2 as-is.

Update: Here's the wiki article: Prioritizing investments
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Re: Savings and Investing Precedence

Postby Kevin M » Fri Jun 28, 2013 9:08 pm

LadyGeek wrote:^^^ A google search for "self-administered IRA" (self-administered IRA - Google Search) only returned results for "self-directed IRA"

I think Taylor just meant "IRA"; i.e., without specifying Roth or traditional.

LadyGeek wrote:I think it's best to leave #2 as-is.

And I think it should be changed. That's the trouble with basing Wiki articles on opinions and not on references.

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Re: Savings and Investing Precedence

Postby umfundi » Fri Jun 28, 2013 9:11 pm

livesoft wrote:
livesoft wrote:I will say that non-deductible [traditional] 401(k) contributions are bad unless they can be immediately converted to Roth. Can you figure out why?

When one withdraws from a traditional IRA, the untaxed money is taxed at one's marginal income tax rate which is always higher than the long-term capital gains tax rate. So if one makes non-deductible contributions, not only does one have to keep track of a basis in the 401(k) for the future, one will also have to pay a higher tax rate on the gains when the money is withdraw.

In contrast, if the same contribution is just invested tax-efficiently in a taxable account, one will be able to tax-loss harvest capital losses and pay taxes on the gains at the long-term cap gains tax rate which can be as low as 0%. Plus there is no penalty for early withdrawal nor any contribution limits.

Therefore, if one does not get a benefit from a traditional 401(k) (tax-deferral on the contribution) or a Roth 401(k) (tax-free gains) or maybe an employer match, then don't bother with a 401(k) contribution.

livesoft,

Thank you! You make a very good point, one that I had not realized.

I actually have a fair amount of non-Roth after-tax dollars stashed in both my old 401K and my IRA (now all rolled to an IRA). All I can say, in my own defense, is that the money was then off limits and I did not have to manage the taxes in the interim.

Not a whole lot of harm done, but not something I would repeat.

I think your point absolutely needs to be explained in the Wiki. It is a gem.

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Re: Savings and Investing Precedence

Postby Svensk Anga » Fri Jun 28, 2013 9:21 pm

I think item 2 ought to be "contribute to a Health Savings Account to the maximum". One gets the tax deduction up front and tax-free withdrawals later (at least to the extent of one's medical expenses). My employer gives a nice premium discount for selecting the HDHP instead of the conventional insurance and they kick in a few hundred to the HSA to sweeten the deal a bit more. That is, more free money, like a 401k match. I just wish I had this option sooner.

The question becomes, when does one have enough in their HSA to cut back or stop contributions? One has to predict one's future health spending and the policy environment. If a deductible IRA makes sense and the HDHP still makes sense, the HSA should have preference over the IRA.
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Re: Savings and Investing Precedence

Postby grabiner » Fri Jun 28, 2013 9:23 pm

livesoft wrote:I will say that non-deductible [traditional] 401(k) contributions are bad unless they can be immediately converted to Roth. Can you figure out why?


I don't think this should be emphasized in the wiki or our other standard advice, since few 401(k) plans even allow after-tax contributions. And one important plan which has allowed them, the TSP for military earning non-taxable combat pay, now has a better option, the Roth TSP.

Likewise, the reason that our advice recommends maxing out a Roth IRA is that most investors who are considering the precedence issue are ineligible for a deductible traditional IRA, and a Roth (through the backdoor if necessary) is always better than a non-deductible IRA. A non-deductible IRA which is not converted to a Roth is bad for the same reason as a non-deductible 401(k) contribution.
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Re: Savings and Investing Precedence

Postby umfundi » Fri Jun 28, 2013 9:24 pm

Kevin M wrote:
LadyGeek wrote:^^^ A google search for "self-administered IRA" (self-administered IRA - Google Search) only returned results for "self-directed IRA"

I think Taylor just meant "IRA"; i.e., without specifying Roth or traditional.

LadyGeek wrote:I think it's best to leave #2 as-is.

And I think it should be changed. That's the trouble with basing Wiki articles on opinions and not on references.

Kevin

Kevin,

I am not sure that "opinions" is the right qualifier.

The point is there are three (?) types of IRA and 401k contributions:

1. Traditional, tax deductible contributions on the way in. Earnings and contributions taxable on the way out.

2. Roth, taxable on the way in, earnings and contributions not taxable on the way out.

3. Excess, contributions taxable on the way in. Contributions not taxable, earnings taxable on the way out.

livesoft points out that 3. is not a good idea, since 401k/IRA withdrawals are taxed as ordinary income. The same amount in a taxable account can be tax-loss harvested, and will almost certainly be taxed at more favorable capital gains rates when withdrawn.

So much wisdom on this board!

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Re: Savings and Investing Precedence

Postby grabiner » Fri Jun 28, 2013 9:25 pm

Svensk Anga wrote:I think item 2 ought to be "contribute to a Health Savings Account to the maximum".


This isn't an option for most investors; it is certainly the correct advice if you have a HDHP.

The question becomes, when does one have enough in their HSA to cut back or stop contributions? One has to predict one's future health spending and the policy environment. If a deductible IRA makes sense and the HDHP still makes sense, the HSA should have preference over the IRA.


Agreed. An HSA is always at least as good as a deductible IRA, even if you need to spend the money on non-medical expenses in retirement, and it is much better if you have medical expenses. Therefore, you might as well contribute the max to the HSA as long as you can do it.
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Re: Savings and Investing Precedence

Postby joe8d » Fri Jun 28, 2013 9:26 pm

Kevin M wrote:
LadyGeek wrote:^^^ A google search for "self-administered IRA" (self-administered IRA - Google Search) only returned results for "self-directed IRA"

I think Taylor just meant "IRA"; i.e., without specifying Roth or traditional.

LadyGeek wrote:I think it's best to leave #2 as-is.

And I think it should be changed. That's the trouble with basing Wiki articles on opinions and not on references.

Kevin


Agree. The type of IRA ( Traditional or Roth ) would depend on an individual's personal circumstances.
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Re: Savings and Investing Precedence

Postby umfundi » Fri Jun 28, 2013 9:30 pm

Svensk Anga wrote:I think item 2 ought to be "contribute to a Health Savings Account to the maximum". One gets the tax deduction up front and tax-free withdrawals later (at least to the extent of one's medical expenses). My employer gives a nice premium discount for selecting the HDHP instead of the conventional insurance and they kick in a few hundred to the HSA to sweeten the deal a bit more. That is, more free money, like a 401k match. I just wish I had this option sooner.

The question becomes, when does one have enough in their HSA to cut back or stop contributions? One has to predict one's future health spending and the policy environment. If a deductible IRA makes sense and the HDHP still makes sense, the HSA should have preference over the IRA.


Svensk,

I absolutely agree. But, relatively few people have access to this option.

I have not succeeded in explaining to my wife and family why they should not use their HSA debit card at the dentist, etc.

By the way, at the April Detroit Bogleheads meeting, we had a great discussion on savings precedence. If you add in debt like student loans and mortgages, it becomes a very interesting and complex discussion.

Keith
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Re: Savings and Investing Precedence

Postby LadyGeek » Fri Jun 28, 2013 9:30 pm

This is posted in Laura's Investment Planning sticky:

Investing Priority

The general rule of thumb for investing priority is:
1. 401k/403b up to the company match
2. Max out Roth
3. Max out 401k/403b
4. Taxable Investing

which should be consistent with the wiki. Currently, they do not match. Prioritizing investments has:

wiki wrote:1. Company plan (401k, 403b, etc.) up to the company match
2. Roth IRA or deductible Traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
3. Company plan up to maximum contribution limit
4. Taxable Investing
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Re: Investing Priority: Suggested change

Postby grabiner » Fri Jun 28, 2013 9:33 pm

Taylor Larimore wrote:Our wiki has a wonderful link for Investment Planning. This is the part in question:
The general rule of thumb for investing priority is:
1. 401k/403b up to the company match
2. Max out Roth
3. Max out 401k/403b
4. Taxable Investing

In my opinion, item #2 might better read:

"2. Max out a self-directed IRA"


The term won't be familiar; it could be "Max out Roth (or traditional IRA if deductible)", which matches what we have in Prioritizing Investments.

However, "Max out Roth IRA" is right for most investors who aren't eligible for a deductible IRA (since the options are usually better than in a 401(k)), and also for most who are eligible for a deductible IRA (since investors who qualify for a deductible IRA and have a 401(k) are usually in a low tax bracket and should prefer a Roth IRA).
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Re: Savings and Investing Precedence

Postby Ketawa » Fri Jun 28, 2013 9:43 pm

pteam wrote:I would rather put $5k in a Roth IRA and let it grow for 30 years if your young and pay tax on the $5k then have to pay taxes on it thirty years later when its worth $30k


It is a question of marginal tax rates, not how old you are. However, when you're young, you typically are earning less than you will later in life and may be in the 10% or 15% marginal tax brackets. Roth contributions typically make sense if this is true.
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Re: Investing Priority: Suggested change

Postby joe8d » Fri Jun 28, 2013 9:51 pm

grabiner wrote:
Taylor Larimore wrote:Our wiki has a wonderful link for Investment Planning. This is the part in question:
The general rule of thumb for investing priority is:
1. 401k/403b up to the company match
2. Max out Roth
3. Max out 401k/403b
4. Taxable Investing

In my opinion, item #2 might better read:

"2. Max out a self-directed IRA"


The term won't be familiar; it could be "Max out Roth (or traditional IRA if deductible)", which matches what we have in Prioritizing Investments.

However, "Max out Roth IRA" is right for most investors who aren't eligible for a deductible IRA (since the options are usually better than in a 401(k)), and also for most who are eligible for a deductible IRA (since investors who qualify for a deductible IRA and have a 401(k) are usually in a low tax bracket and should prefer a Roth IRA).


When I was working I maxed out my 401K which drove down my marginal tax bracket.I then did the Roth at that lower tax bracket and which was funded from the tax deferal saving from doing the max 401k.I think a lot people are in similar circumstances and would find that approach beneficial.
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Re: Savings and Investing Precedence

Postby grabiner » Fri Jun 28, 2013 10:15 pm

pteam wrote:I would rather put $5k in a Roth IRA and let it grow for 30 years if your young and pay tax on the $5k then have to pay taxes on it thirty years later when its worth $30k


It isn't this simple. If you put $5000 in a Traditional IRA in a 15% tax bracket, you get $750 back in taxes, and you can use this $750 to contribute another $882 to your 401(k). So, would you rather have $5000 in tax-free accounts or $5882 in traditional accounts? If you retire at a 15% marginal tax rate, it's a wash, as you can have $30,000 in a Roth, or $35,294 in a tax-deferred account on which you will pay $5294 in taxes. (And if your 401(k) options aren't as good as your IRA options, the Roth IRA is better because the extra $882 in the 401(k) will lose some of its value.)
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Re: Savings and Investing Precedence

Postby Kevin M » Fri Jun 28, 2013 11:59 pm

Of course I think the version in Prioritizing Investments is better.

Too many assumptions being stated here about investors not qualifying for deductible IRA contributions. I personally have friends and relatives who do qualify, and misleading statements, with no references, in the Wiki make me hesitant to refer them to the Wiki.

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Re: Savings and Investing Precedence

Postby EmergDoc » Sat Jun 29, 2013 3:52 am

umfundi wrote:
livesoft wrote:The "usual" precedence is something not validated on this site, but something politely argued over. Indeed, because quite a lot of high income folks are on the forum, they may not be able to contribute to Roth IRAs anyways.

I will say that non-deductible 401(k) contributions are bad unless they can be immediately converted to Roth. Can you figure out why?

The "usual" precedence is in the Bogleheads' Wiki. Which is, why I ask the question.

I am not sure what you mean:
I will say that non-deductible 401(k) contributions are bad unless they can be immediately converted to Roth.


If possible, I would move 401k contributions to a self-administered IRA asap, because of the likely inferior investment options in a company 401k.

Keith


I wish someone would take it out and replace it with:

Roth IRA or traditional IRA (with a link to the wiki page on roth vs traditional)

so we can quit rehashing this thread every month.

The usual is right for lots of people, but not everyone, and it's even more complicated now with Roth 401Ks. It should really be:

401K up to match (Roth or traditional)
IRA (Roth or traditional)
401K
Taxable

If you want to know what I do, I've got about 4 more steps in there including a defined benefit plan, HSA, spousal Roth , 529s etc. It's hard for me to get to taxable.
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Re: Savings and Investing Precedence

Postby red5 » Sat Jun 29, 2013 6:02 am

grabiner wrote:It isn't this simple. If you put $5000 in a Traditional IRA in a 15% tax bracket, you get $750 back in taxes, and you can use this $750 to contribute another $882 to your 401(k).

...

If you retire at a 15% marginal tax rate, it's a wash, as you can have $30,000 in a Roth, or $35,294 in a tax-deferred account on which you will pay $5294 in taxes.


I whole heartedly agree with this assumption. But I wonder how much of the general population consciously uses this extra money coming back from taxes and invests it in such a way you describe?

With standard deduction and personal exemptions is it possible to owe less than $5,294 in taxes, which would make the traditional option better than it seems?
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Re: Savings and Investing Precedence

Postby Bob's not my name » Sat Jun 29, 2013 6:57 am

EmergDoc wrote:The usual is right for lots of people, but not everyone, and it's even more complicated now with Roth 401Ks. It should really be:

401K up to match (Roth or traditional)
IRA (Roth or traditional)
401K
Taxable
And this doesn't make sense, either, for many people. We see posts every week from people who don't realize that traditional 401k contributions will make them eligible for direct Roth IRA contributions, or who don't know the income limits for a Roth IRA and deductible spousal TIRA are the same, or who are in a very high bracket and have decent 401k's and therefore should be maxing their 401k's before putting anything in Roth, or who don't realize one spouse may be able to make clean (no pro rata taxation) back door Roth contributions even if the other can't, or who don't know that their state taxes IRA contributions but not 401k contributions, etc. Generic advice tends to be bad advice for a substantial minority.

Also, I think about 80% of new posters have their marginal rate wrong, so even if we can teach readers the basic math for figuring out which tax-advantaged option is best, they'll still get it wrong because they'll plug in the wrong numbers.
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Re: Savings and Investing Precedence

Postby IlliniDave » Sat Jun 29, 2013 7:52 am

umfundi wrote:Assuming one is young and has no debt and a good job (some marginal fraction of the population?) the usual savings precedence is:

1. 401k up to the employer match
2. Roth IRA
3. 401 k up to the allowed max.
4. Taxable savings

Keith


Lot's of interesting stuff in the thread already. It's hard to come up with a recipe that objectively the best approach for everyone. If you close your eyes and do the above you'll probably wind up in the top 5% group when it comes to being efficient with your income. There are benefits on the margin by tweaking the recipe, but they start to get specific to individual situations.

My process is quite simple:

1. Max out 401(k)
1. Max out IRA (nondeductible, Roth via backdoor conversion, it's all I'm allowed)
1. Max out taxable investments (walk the line between frugal and austere)

I fully expect to retire at a lower relative income, so if the tax rates stay reasonably consistent I'm better off taking my tax break now. I happen to be odd in that my 401k appears to be outstanding, a solid selection of index funds with noticeably lower expenses than I would get as an individual investor at VG. It will be a tough call when I leave the company to decide whether to roll it over to a Vanguard IRA (so I can convert portions to Roth over time) or leave it alone and enjoy the even lower fees.

One thing I happen to like about Roth IRA's is the lack of RMDs and the current treatment when bequeathed. Monday is the due date for my second grandchild, and my focus increasingly encompasses time beyond my time. Therefore I'm willing accept some tax inefficiency when it comes to Roths. Just goes to show the effect individual goals have on capital deployment decisions.
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Re: Savings and Investing Precedence

Postby mike143 » Sat Jun 29, 2013 7:59 am

For me the Roth is functioning as my emergency fund so a Traditional IRA is not ideal in this scenario. I currently max 401k and Roth and started taxable investing.
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Re: Savings and Investing Precedence

Postby ruralavalon » Sat Jun 29, 2013 8:16 am

A general rule can only be a general rule, individual circumstanes vary greatly, and future tax brackets and rates are unknown. I think this is the best formulation offered so far, and cannot really be improved on as a general statement:
wiki wrote: . . . . . the general rule for investing priority is:
1.Company plan (401k, 403b, etc.) up to the company match
2.Roth IRA or deductible Traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
3.Company plan up to maximum contribution limit
4.Taxable Investing

If the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan before contributing to an IRA.

An investor's tax bracket may influence the decision as well . . . . .
Wiki article link: Prioritizing investments .

And we should recall that average households probably don't have enough excess income to get beyond step 2, and won't be in the higher tax brackets on retirement anyway.
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Re: Savings and Investing Precedence

Postby livesoft » Sat Jun 29, 2013 8:45 am

For me, a general rule should apply to over half the folks the reading it. I don't think that is happening here.

Also one thing hinted at in this thread is that younger folks who just started out may be in a lower tax bracket than older folks. We have found that our tax rate has dropped as we got older and had more opportunities for exclusions and deductions such as kids, mortgages, charitable donations, college expenses, health care expenses.
Last edited by livesoft on Sat Jun 29, 2013 8:55 am, edited 1 time in total.
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Re: Savings and Investing Precedence

Postby Investing is boring » Sat Jun 29, 2013 8:50 am

Depends, depends, depends.

For me:
Table stakes:
- 401k to max
- both Roth's to max
- wife Solo-401k to compensation max
- iBonds for wife and I to max

Nice to have if variable income complies:
- Taxable
- EE Bonds
- After-Tax 401k
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Re: Savings and Investing Precedence

Postby Bob's not my name » Sat Jun 29, 2013 9:16 am

IlliniDave wrote:I fully expect to retire at a lower relative income, so if the tax rates stay reasonably consistent I'm better off taking my tax break now.
If you're in Illinois you get to have your cake and eat it too, since Illinois doesn't tax retirement plan withdrawals. So even if your federal rate doesn't change your state rate drops from 5% to 0%.
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Re: Savings and Investing Precedence

Postby Bob's not my name » Sat Jun 29, 2013 9:18 am

mike143 wrote:For me the Roth is functioning as my emergency fund so a Traditional IRA is not ideal in this scenario.
For real emergencies like a major medical setback, disability, premature death leaving dependents, or unemployment, a TIRA is a better emergency fund.
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Re: Savings and Investing Precedence

Postby Bob's not my name » Sat Jun 29, 2013 9:24 am

ruralavalon wrote:A general rule can only be a general rule, individual circumstanes vary greatly, and future tax brackets and rates are unknown. I think this is the best formulation offered so far, and cannot really be improved on as a general statement:
wiki wrote: . . . . . the general rule for investing priority is:
1.Company plan (401k, 403b, etc.) up to the company match
2.Roth IRA or deductible Traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
3.Company plan up to maximum contribution limit
4.Taxable Investing

If the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan before contributing to an IRA.

An investor's tax bracket may influence the decision as well . . . . .
Wiki article link: Prioritizing investments .

And we should recall that average households probably don't have enough excess income to get beyond step 2, and won't be in the higher tax brackets on retirement anyway.
Step 2 can still be bad advice. Many taxpayers who are not eligible for deductible traditional IRA contributions would be better off maxing their 401k before contributing after-tax to a Roth IRA. Even if they are eligible, the 401k will be better if their state taxes IRA contributions.

Also, sometimes future tax brackets and rate are known. It's astonishing how many young posters who plan to return full-time to school very soon are throwing away money by choosing a Roth IRA over their 401k.
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Re: Savings and Investing Precedence

Postby ruralavalon » Sat Jun 29, 2013 9:25 am

Bob's not my name wrote:
IlliniDave wrote:I fully expect to retire at a lower relative income, so if the tax rates stay reasonably consistent I'm better off taking my tax break now.
If you're in Illinois you get to have your cake and eat it too, since Illinois doesn't tax retirement plan withdrawals. So even if your federal rate doesn't change your state rate drops from 5% to 0%.


Love this :) .
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
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Re: Savings and Investing Precedence

Postby livesoft » Sat Jun 29, 2013 9:29 am

So the wiki should be edited to state: "There is no general rule-of-thumb for investing priority, but ...."
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Savings and Investing Precedence

Postby ruralavalon » Sat Jun 29, 2013 9:34 am

Bob's not my name wrote:
ruralavalon wrote: And we should recall that average households probably don't have enough excess income to get beyond step 2, and won't be in the higher tax brackets on retirement anyway.
Step 2 can still be bad advice. Many taxpayers who are not eligible for deductible traditional IRA contributions would be better off maxing their 401k before contributing after-tax to a Roth IRA. Even if they are eligible, the 401k will be better if their state taxes IRA contributions.

Also, sometimes future tax brackets and rate are known. It's astonishing how many young posters who plan to return full-time to school very soon are throwing away money by choosing a Roth IRA over their 401k.

Still, what is the better general statement? I don't think there is one that could apply to an average (median) household.

The only absolute I can think of is something like "contribute enough to the 401k/403b to get the full match each year; its free money, never pass up free money".
Last edited by ruralavalon on Sat Jun 29, 2013 9:37 am, edited 1 time in total.
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Re: Savings and Investing Precedence

Postby retiredjg » Sat Jun 29, 2013 9:36 am

Laura's investment planning sticky says:

    The general rule of thumb for investing priority is:
    1. 401k/403b up to the company match
    2. Max out Roth
    3. Max out 401k/403b
    4. Taxable Investing
This same question that umfundi is asking came up several years ago and this is what I recall of Laura's reply at that time. I can't guarantee it is correct, but I think it is.

    She had suggested Roth instead of traditional because most people at that crossroad would not be able to deduct contributions to traditional IRA. I think she also mentioned the benefits of tax-diversification.

    She had suggested only going to the match on 401k/403b because so many of them had horribly high fees.

    She agreed that the investing priority she posted was not the best one for every situation, but only a general rule of thumb.

    She had no problem with using traditional IRA instead of Roth IRA if the contributions could be deducted.

    She had no problem with maxing the 401k/403b before IRA if the 401k/403b had low cost options.
Again, I don't wish to speak for Laura, but I think this is what she said when her general rule of thumb was questioned back about 2009 or so.
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Re: Savings and Investing Precedence

Postby Bob's not my name » Sat Jun 29, 2013 9:37 am

I agree. There is no good general statement, except: tax-advantaged savings are generally more tax-advantaged than taxed savings.
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Re: Savings and Investing Precedence

Postby arthurdawg » Sat Jun 29, 2013 9:48 am

Personally... I just keep my cash invested in VHS tapes, those babies will be pure gold one day!


One perspective on this issue is that if most people follow the basic outline of the Wiki, they'll do pretty well for the long run. Beyond that, to really take advantage of every last drop of tax management for your money requires that you have a much more detailed knowledge of your 401k (the funds available, etc.) and a detailed knowledge of your current tax situation and possible future(s). Many will simply not be willing to take the time to understand and use this information.
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Re: Savings and Investing Precedence

Postby livesoft » Sat Jun 29, 2013 9:50 am

livesoft wrote:So the wiki should be edited to state: "There is no general rule-of-thumb for investing priority, but ...."

Or perhaps "A controversial rule-of-thumb for investing priority is: ...."
Last edited by livesoft on Sat Jun 29, 2013 9:50 am, edited 1 time in total.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Savings and Investing Precedence

Postby Call_Me_Op » Sat Jun 29, 2013 9:50 am

livesoft wrote:The "usual" precedence is something not validated on this site, but something politely argued over. Indeed, because quite a lot of high income folks are on the forum, they may not be able to contribute to Roth IRAs anyways.

I will say that non-deductible 401(k) contributions are bad unless they can be immediately converted to Roth. Can you figure out why?


I believe you are thinking of the tax issue - but that's only if you hold stocks in the IRA.
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Re: Savings and Investing Precedence

Postby YDNAL » Sat Jun 29, 2013 10:00 am

umfundi wrote:Assuming one is young and has no debt and a good job (some marginal fraction of the population?) the usual savings precedence is:

1. 401k up to the employer match
2. Roth IRA
3. 401 k up to the allowed max.
4. Taxable savings

I am interested why, if one cannot reach the level of taxable savings in item 4., why is Item 2. not a deductible Regular IRA rather than a Roth?

It is virtually impossible for any rule of thumb or guideline to apply to everyone.

    1. That ↑ said, I don't see why anyone would have their shorts in a knot in reading the OP.

    2. Just as we diversify investments, we should diversify tax/RMD exposure. ← This is the reason why I don't take issue item #2, especially if you ONLY go through item #3 as you said in the OP.
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Re: Savings and Investing Precedence

Postby IlliniDave » Sat Jun 29, 2013 10:03 am

ruralavalon wrote:
Bob's not my name wrote:
IlliniDave wrote:I fully expect to retire at a lower relative income, so if the tax rates stay reasonably consistent I'm better off taking my tax break now.
If you're in Illinois you get to have your cake and eat it too, since Illinois doesn't tax retirement plan withdrawals. So even if your federal rate doesn't change your state rate drops from 5% to 0%.


Love this :) .

:thumbsup

Me too! I don't live there now but I plan on moving back at the commencement of semi-retirement (Heaven and markets willing) to be around to help my parents when the time comes. That's good to know. I'll take a 5% raise anytime I can get it.
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Re: Savings and Investing Precedence

Postby Bob's not my name » Sat Jun 29, 2013 10:12 am

If you're older (>65) many states are like this. Besides states with no tax, these states give breaks to folks under 65:

Exclude retirement plan withdrawals without age or dollar limit
Illinois
Kentucky
Oklahoma

$4,000/couple limit
North Carolina

$6,000/couple limit
South Carolina

No dollar limit for 55 or older
Colorado
Iowa

No dollar limit for 60ish or older
Arkansas
Delaware
Michigan
Mississippi
New York

No dollar limit for 62 or older
Georgia

When I did this survey "no dollar limit" meant the dollar limit was more than the IRA contribution limit, so it makes sense to deduct-and-convert every year. I'm aware that some of the states with "no dollar limit" do have limits above $13,000/couple.
Last edited by Bob's not my name on Mon Jul 01, 2013 12:20 pm, edited 2 times in total.
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Re: Savings and Investing Precedence

Postby boggler » Sat Jun 29, 2013 10:24 am

Why is #4 not a variable annuity?
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Re: Savings and Investing Precedence

Postby ruralavalon » Sat Jun 29, 2013 10:25 am

livesoft wrote:So the wiki should be edited to state: "There is no general rule-of-thumb for investing priority, but ...."


Bob's not my name wrote:I agree. There is no good general statement, except: tax-advantaged savings are generally more tax-advantaged than taxed savings.



Perhaps better to keep a general "rule of thumb" (otherwise why have a wiki article on this at all), and be more detailed about listing what factors influence the priority decision for particular households (some of which are already covered), such as:

1. always get the 401k/403b match no matter what;
2. pay off higher interest debt next after getting the match;
3. max the 401k/403b ahead of an IRA If the company plan offers very good, very low-cost funds (say investor class, even lower cost that Admiral);
4. tax-advantaged savings are generally more tax-advantaged than taxed savings.
5. investor's tax bracket may influence the decision as well: those in higher tax brackets should consider higher contributions to a tax-deferred plan;
6. maxing the trad 401k/403b can sometines qualiify you for a Roth IRA when you might not otherwise qualify;
7. "Max out Roth IRA" is right for most investors who aren't eligible for a deductible IRA (since the options are usually better than in a 401(k)), and also for most who are eligible for a deductible IRA (since investors who qualify for a deductible IRA and have a 401(k) are usually in a low tax bracket and should prefer a Roth IRA).
8. taxpayers who are not eligible for deductible traditional IRA contributions would be better off maxing their 401k before contributing after-tax to a Roth IRA.
9. Even if they are eligible, the 401k will be better if their state taxes IRA contributions.

"A rule of thumb is a principle with broad application that is not intended to be strictly accurate or reliable for every situation. It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination." Rule of thumb, from Wikipedia, the free encyclopedia

And of course the details should be drafted by someone like not Bob or Grabiner, certainly not by me.


Bob's not my name wrote:We're trying to explain something that's been created by legions of imbeciles over a period of decades. We are doomed to fail. :sharebeer

Amen to that.
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Re: Savings and Investing Precedence

Postby retiredjg » Sat Jun 29, 2013 10:46 am

Bob's not my name wrote:...tax-advantaged savings are generally more tax-advantaged than taxed savings.

Funny. :D
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Re: Savings and Investing Precedence

Postby Default User BR » Sat Jun 29, 2013 10:48 am

Investing is boring wrote:Nice to have if variable income complies:
- Taxable
- EE Bonds
- After-Tax 401k

If your plan allows in-service distribution of the after-tax contributions, then it should be much higher on the list.


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