tax 401K vs paying down mortgage

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fiddlefaddle
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tax 401K vs paying down mortgage

Post by fiddlefaddle »

Hello Bogleheads,

This is my first time posting. But I've enjoyed the Bogleheads' Guide to Investing book and this forum and wiki. My Q is where should we be putting our contributions after we've maxed out roth IRA's and pre-tax 401K's? We still have 20K per year of capital we could allocate to investments. Should we consider:

1) After tax 401K? With this my question is can I only roll over the 20K each year into a Roth IRA (my employer allows in-service distributions). Or must I roll over my entire 401K, including the pre-tax?
2) pay down mortgage 3.375% 450K principal
3) contribute to 529?
4) contribute to after-tax unsheltered locations

Thanks!
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LAlearning
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Re: tax 401K vs paying down mortgage

Post by LAlearning »

You only roll over the after tax. If it's for retirement, that's my vote. Otherwise taxable vs mortgage debate.
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DVMResident
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Re: tax 401K vs paying down mortgage

Post by DVMResident »

+1 for the vote for a backdoor ROTH via 401(k) after tax assuming an adequate emergency fund is in place.

Taxable investing is a second option if you need more liquidity.
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Watty
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Re: tax 401K vs paying down mortgage

Post by Watty »

There is a wiki on thing choice.

https://www.bogleheads.org/wiki/Paying_ ... _investing

One option would be to invest it for the short term then decide in a year or two what to do with the money. If you saved up $45K then decided to pay down the mortgage you could then ask the lender if they would "recast your mortgage" (Google this). They are not required to do this but they often will for a small processing fee but so that if you pay the mortgage down by 10% then your mortgage payment would also go down by 10%.
ralph124cf
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Re: tax 401K vs paying down mortgage

Post by ralph124cf »

If your mortgage is a thirty year fixed, I would be tempted to leave it alone, because historically at a low rate, but if it is an adjustable rate mortgage I wold start paying it down. In any case, you are getting an after tax benefit of 3.75% from paying down the mortgage which is equivalent to approximately 5% pretax. Also, in the case of an adjustable mortgage, the payment is automatically recast every year when the adjustment happens, so the liquidity concerns of paying down a fixed mortgage are lessened.

Ralph
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fiddlefaddle
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Re: tax 401K vs paying down mortgage

Post by fiddlefaddle »

Thank you all for your advice. It looks like after-tax 401K gets multiple votes. Just to clarify: If I am maxing the 18K of pretax 401K and in addition contributing 20K of aftertax into the same 401K and I request a 20K distribution into a Roth IRA at the end of the year, the 20K can be purely counted as after tax 401K not a mixture of 52% (20K/38K) aftertax such that I would need to pay taxes on 48% of the 20K that I request distribution? Hope Q is clear.

Thanks!
CppCoder
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Re: tax 401K vs paying down mortgage

Post by CppCoder »

fiddlefaddle wrote:Thank you all for your advice. It looks like after-tax 401K gets multiple votes. Just to clarify: If I am maxing the 18K of pretax 401K and in addition contributing 20K of aftertax into the same 401K and I request a 20K distribution into a Roth IRA at the end of the year, the 20K can be purely counted as after tax 401K not a mixture of 52% (20K/38K) aftertax such that I would need to pay taxes on 48% of the 20K that I request distribution? Hope Q is clear.

Thanks!
Correct. You will only pay taxes derived from the after-tax subaccount; it is not commingled with the pretax. Keep in mind that you will pay taxes on the difference in your after-tax basis and the amount in the after-tax at the time of conversion. That is, if you have a basis of $20k, but it grows to $22k, you will pay tax on the $2k if you convert it all to Roth. The alternative is to send $20k to Roth and $2k to traditional. To not mess up the "regular" backdoor Roth IRA, you'll want to roll the $2k back to your pre-tax 401k. Personally, I prefer the simplicity of paying the taxes on the gain.
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Earl Lemongrab
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Re: tax 401K vs paying down mortgage

Post by Earl Lemongrab »

If you aren't at least age 59-1/2 it wouldn't even be legal to roll over pretax contributions.

Earl
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fiddlefaddle
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Re: tax 401K vs paying down mortgage

Post by fiddlefaddle »

Thank you all. CppCoder: When you say after-tax "subaccount" you don't literally mean that there is a subaccount per se, but just in my mind and in terms of delineation for tax purposes. That is, functionally say in 2017 and am contributing to my 401K and after I hit >18K I still make contributions to the same exact account, it's just that now I and the IRS delineate it as a after-tax "subaccount"? So when I distribute into a Roth, it's still coming from the same 401K account but I, in my mind call it a subaccount? Thanks! Total newbie.
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Earl Lemongrab
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Re: tax 401K vs paying down mortgage

Post by Earl Lemongrab »

fiddlefaddle wrote:Thank you all. CppCoder: When you say after-tax "subaccount" you don't literally mean that there is a subaccount per se, but just in my mind and in terms of delineation for tax purposes. That is, functionally say in 2017 and am contributing to my 401K and after I hit >18K I still make contributions to the same exact account, it's just that now I and the IRS delineate it as a after-tax "subaccount"? So when I distribute into a Roth, it's still coming from the same 401K account but I, in my mind call it a subaccount? Thanks! Total newbie.
No, there literally is a sub-account. It might not be evident to you, but the custodian has to track that pool of money separately. In my 401(k) that becomes evident when you do a withdrawal. You might want to take it all out of say the stable-value fund, and seemingly have plenty in that fund to cover the withdrawal, but then find out that the sub-account investments don't have enough in that and you have to withdraw from other investments as well.

Earl
Dottie57
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Re: tax 401K vs paying down mortgage

Post by Dottie57 »

fiddlefaddle wrote:Thank you all. CppCoder: When you say after-tax "subaccount" you don't literally mean that there is a subaccount per se, but just in my mind and in terms of delineation for tax purposes. That is, functionally say in 2017 and am contributing to my 401K and after I hit >18K I still make contributions to the same exact account, it's just that now I and the IRS delineate it as a after-tax "subaccount"? So when I distribute into a Roth, it's still coming from the same 401K account but I, in my mind call it a subaccount? Thanks! Total newbie.

Are you sure your 401k plan allows for after tax monies in 401k and they allow rollover to roth ira? I was surprised to find that mine plan does not allow this.
avalpert
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Re: tax 401K vs paying down mortgage

Post by avalpert »

ralph124cf wrote: In any case, you are getting an after tax benefit of 3.75% from paying down the mortgage which is equivalent to approximately 5% pretax.
Not if he itemizes and deducts mortgage interest - then the 3.75% is the pretax return.
Topic Author
fiddlefaddle
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Re: tax 401K vs paying down mortgage

Post by fiddlefaddle »

Dottie57 wrote:
fiddlefaddle wrote:Thank you all. CppCoder: When you say after-tax "subaccount" you don't literally mean that there is a subaccount per se, but just in my mind and in terms of delineation for tax purposes. That is, functionally say in 2017 and am contributing to my 401K and after I hit >18K I still make contributions to the same exact account, it's just that now I and the IRS delineate it as a after-tax "subaccount"? So when I distribute into a Roth, it's still coming from the same 401K account but I, in my mind call it a subaccount? Thanks! Total newbie.

Are you sure your 401k plan allows for after tax monies in 401k and they allow rollover to roth ira? I was surprised to find that mine plan does not allow this.

I think so, I am not super sure, I need to verify with HR. However, I do know that different employers handle this differently.
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grabiner
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Re: tax 401K vs paying down mortgage

Post by grabiner »

fiddlefaddle wrote:1) After tax 401K? With this my question is can I only roll over the 20K each year into a Roth IRA (my employer allows in-service distributions). Or must I roll over my entire 401K, including the pre-tax?
2) pay down mortgage 3.375% 450K principal
3) contribute to 529?
4) contribute to after-tax unsheltered locations
Saving for tax-deferred growth (via the after-tax 401(k) if allowed, or in a 529 if you have children and save for their college) is likely to be a better deal than paying down a mortgage with that low a rate.

And in a high tax bracket, if that is a 30-year loan and you intend to stay in your home a long time, it may even be better to invest in a taxable account than to pay down that mortgage.
Wiki David Grabiner
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