Late starters trying to reduce skew between taxable & tax deferred

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industrialauk
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Late starters trying to reduce skew between taxable & tax deferred

Post by industrialauk » Sun Sep 10, 2017 5:30 pm

Emergency funds: Six months in Ally Bank
Debt: 30 year fixed jumbo mortgage in HCOL area at 3.625%
Tax Filing Status: Married Filing Jointly
Marginal Tax Rate: 39.6% Federal, 11.30% State (for this year, last year it was different)
State of Residence: CA
Age: 34 (His), 35 (Her), 6 months (Daughter)
Desired asset allocation: 75% stocks / 25% bonds
Desired International allocation: 20% of stocks
Current portfolio size: Mid six figures
Taxable portfolio size: 81% of total
Tax deferred portfolio size: 19% of total


Taxable investments breakup:

Code: Select all

|-----------+-------+--------------------------------------------------------------------------------------------------------------------------|
| Desc      | Split | Investments                                                                                                              |
|-----------+-------+--------------------------------------------------------------------------------------------------------------------------|
| Vanguard  | 92%   | Total Stock Market Index, Total International Stock Index, Intermediate-Term Tax-Exempt, CA Intermediate-Term Tax-Exempt
| Robinhood | 8%    | Facebook                                                                                                                 |
|-----------+-------+--------------------------------------------------------------------------------------------------------------------------|
Tax deferred breakup:

Code: Select all

|-------------------------------+-------+--------------------------------------------------------------------------------------------|
| Desc                          | Split | Investments                                                                                |
|-------------------------------+-------+--------------------------------------------------------------------------------------------|
| His roll over TIRA (Vanguard) | 51%   | Total Bond Market Index                                                                    |
| Her 401k (Vanguard)           | 22%   | Institutional Index Fund, Mid-Cap Index Fund, Small-Cap Index Fund, Target Retirement 2045 |
| His 401k (Fidelity)           | 22%   | Fidelity® 500 Index Fund, Fidelity® U.S. Bond Index Fund Premium                           |
| Her TIRA (Vanguard)           | 5%    | Total Bond Market Index                                                                    |
|-------------------------------+-------+--------------------------------------------------------------------------------------------|
Both me & my wife max out 401k. No other contributions to tax deferred account.


Question:

We started tax deferred contributions really late in our careers, so there is a skew between taxable & tax deferred. How do I reduce this skew & increase the weight of tax deferred? In recent times a sizable income is via RSU vesting (every quarter) which I have been putting in taxable (vanguard) between VTSAX, VTIAX, VWITX, VCAIX. This increases the skew further. Looking forward to suggestions!

Edit: Fixed formatting and replaced symbols wit fund names.
Last edited by industrialauk on Sun Sep 10, 2017 11:39 pm, edited 1 time in total.

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Watty
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by Watty » Sun Sep 10, 2017 7:00 pm

It would help if you edited your post to include the names of the funds since most people will not know all the ticker symbols
industrialauk wrote:
Sun Sep 10, 2017 5:30 pm
We started tax deferred contributions really late in our careers, so there is a skew between taxable & tax deferred. How do I reduce this skew & increase the weight of tax deferred? In recent times a sizable income is via RSU vesting (every quarter) which I have been putting in taxable (vanguard) between VTSAX, VTIAX, VWITX, VCAIX. This increases the skew further. Looking forward to suggestions!
If you are maxing out all your retirement accounts, HSAs, and college savings plans there is not much else you can do on that side. One option though would be to do back door Roths but that might not work with your large IRA unless you could roll that into your 401k.
https://www.bogleheads.org/wiki/Backdoor_Roth_IRA

If you used a lot of your taxable money to pay down your mortgage then you could reduce the amount of money in the taxable amounts.

The federal capital gains tax rate are normally 0, 15 or 25% which is lower than you are paying now so investing in a taxable account really isn't all that bad. You can control when you take capital gains and you might retire in a state with lower state capital gain taxes too.

https://www.bogleheads.org/wiki/Tax-eff ... _placement

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FiveK
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by FiveK » Sun Sep 10, 2017 9:21 pm

industrialauk wrote:
Sun Sep 10, 2017 5:30 pm
We started tax deferred contributions really late in our careers, so there is a skew between taxable & tax deferred. How do I reduce this skew & increase the weight of tax deferred?
As Watty noted there is a relatively low limit on what a W-2 income can put into tax deferred.

A somewhat larger amount can go into tax-advantaged (in this case, no further taxes) via a Mega Backdoor Roth IRA if your employers' plans allow this.

aristotelian
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by aristotelian » Sun Sep 10, 2017 9:54 pm

You could use your taxable funds to pay off your mortgage. Otherwise there is not much you can do. On the bright side, taxable dollars are worth more than 401k dollars because you have already paid the taxes.l

industrialauk
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by industrialauk » Mon Sep 11, 2017 1:36 am

Watty wrote:
Sun Sep 10, 2017 7:00 pm
It would help if you edited your post to include the names of the funds since most people will not know all the ticker symbols

If you are maxing out all your retirement accounts, HSAs, and college savings plans there is not much else you can do on that side. One option though would be to do back door Roths but that might not work with your large IRA unless you could roll that into your 401k.
https://www.bogleheads.org/wiki/Backdoor_Roth_IRA

If you used a lot of your taxable money to pay down your mortgage then you could reduce the amount of money in the taxable amounts.
The only retirement account we have contributing to is 401K. Income limits have disqualified us for deductible traditional IRA and Roth IRA. I am considering HSA for next year. For current tax year, I am researching back door Roth. My employer doesn't after post tax 401K so mega backdoor roth is out of the picture.

Thanks for your tip around paying down mortgage, I am risk-averse & seeing mortgage prepayment as guaranteed 3.625% return (& more compounded) struck a chord with me.

industrialauk
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by industrialauk » Mon Sep 11, 2017 1:44 am

FiveK wrote:
Sun Sep 10, 2017 9:21 pm
A somewhat larger amount can go into tax-advantaged (in this case, no further taxes) via a Mega Backdoor Roth IRA if your employers' plans allow this.
Unfortunately, my employer doesn't allow after tax 401K contributions, so I think I mega backdoor roth isn't an option for me. I am considering backdoor roth though. But I can't decide if the current year is a good time to do so. There are two issues effect of which I am not able to comprehend in the context of backdoor roth:

a] I rolled over an ex-employer's 401k to traditional IRA in January 2017, to proceed with backdoor roth I will have to initiate another rollover, this time from the same traditional IRA to new employer's 401K. Back and forth of retirement money from 401k --> IRA --> 401K, does it complicate things?

b] I am in a very high tax bracket right now, backdoor roth conversion requires careful assessment of current and future tax brackets. For next few 2-4 years I dont see tax bracket changing. What does it mean for roth conversion?
Last edited by industrialauk on Mon Sep 11, 2017 1:47 am, edited 2 times in total.

industrialauk
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by industrialauk » Mon Sep 11, 2017 1:45 am

aristotelian wrote:
Sun Sep 10, 2017 9:54 pm
You could use your taxable funds to pay off your mortgage. Otherwise there is not much you can do. On the bright side, taxable dollars are worth more than 401k dollars because you have already paid the taxes.l
Could you elaborate more on "taxable dollars are worth more than 401k dollars because you have already paid the taxes" ?

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FiveK
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by FiveK » Mon Sep 11, 2017 2:00 am

industrialauk wrote:
Mon Sep 11, 2017 1:45 am
Could you elaborate more on "taxable dollars are worth more than 401k dollars because you have already paid the taxes" ?
If person A has $1000 in the bank, and person B has $1000 in a 401k, person A can take the $1000 and spend all if it. Person B has to allow for taxes on the 401k withdrawal, so (assuming a 25% tax bite) only $750 of the $1000 is spendable.

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FiveK
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by FiveK » Mon Sep 11, 2017 2:08 am

industrialauk wrote:
Mon Sep 11, 2017 1:44 am
a] I rolled over an ex-employer's 401k to traditional IRA in January 2017, to proceed with backdoor roth I will have to initiate another rollover, this time from the same traditional IRA to new employer's 401K. Back and forth of retirement money from 401k --> IRA --> 401K, does it complicate things?
Not for the backdoor Roth. For the backdoor pro-rata effect, what matters is the 31-Dec tIRA balance. See 2016 Form 8606 - f8606--2016.pdf.
b] I am in a very high tax bracket right now, backdoor roth conversion requires careful assessment of current and future tax brackets. For next few 2-4 years I dont see tax bracket changing. What does it mean for roth conversion?
A backdoor Roth is mostly unaffected by tax brackets, as the choice is "Roth vs. taxable". Not paying taxes (Roth) beats paying taxes (taxable).

A Roth conversion (in which money in a traditional account is moved to a Roth account) is affected by tax brackets. If you don't need the money now, and expect a lower tax rate 4+ years from now, waiting for the lower tax rate makes sense.

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Watty
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by Watty » Mon Sep 11, 2017 6:07 am

industrialauk wrote:
Mon Sep 11, 2017 1:36 am
Thanks for your tip around paying down mortgage, I am risk-averse & seeing mortgage prepayment as guaranteed 3.625% return (& more compounded) struck a chord with me.
In looking at the "Should I pay off my mortgage?" question people often just look at the interest rate and ignore the sequence of returns risk. Here is an example that I have posted before.
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.
If you do decide to pay it down then one thing to do is to call your lender to see if they will "recast your mortgage"(Google this). They are not required to but they usually will for a small processing fee. The way this works is that if you pay down your mortgage by 25%, or whatever works for you, then your mortgage payments will be reduced by the same percentage. The length of the loan and the interest rate stay the same. This is different than just sending them a large prepayment which only reduces the length of the loan. This difference can be important if something happens like you are laid off or interest rates go up.

retiredjg
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by retiredjg » Mon Sep 11, 2017 7:55 am

industrialauk wrote: I rolled over an ex-employer's 401k to traditional IRA in January 2017, to proceed with backdoor roth I will have to initiate another rollover, this time from the same traditional IRA to new employer's 401K. Back and forth of retirement money from 401k --> IRA --> 401K, does it complicate things?
If your new 401k will accept the rollover IRA and if the choices in your plan are good, there is no complication. Note that your spouse also has a tIRA so if she wants to do the back door, she will need to do the same thing.
I am in a very high tax bracket right now, backdoor roth conversion requires careful assessment of current and future tax brackets. For next few 2-4 years I dont see tax bracket changing. What does it mean for roth conversion?
No assessment is needed and this has nothing to do with future tax brackets.

The money you save for retirement has only a few choices of where to go. If it cannot go into a tax deferred location (your first choice), it can either go into taxable or into a non-deductible IRA to be converted to Roth. Either way the money will be taxed. Either way, the tax will be the same.

You should prefer Roth (via the back door) because earnings inside Roth are not taxed. If the money goes to a taxable account, the earnings will be taxed (if used by you instead of heirs).

If you are willing to go to the extra trouble and if you figure out how to do it right, getting money into Roth IRA via the back door is a no-brainer. That said, a lot of people mess it up. Be sure you can pencil through a Form 8606, front and back, before you try this. If you cannot figure out the paperwork, skip the back door and just put the money in taxable.

Don't depend on your tax-preparer to know how to do this. Many don't.

Steve723
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by Steve723 » Mon Sep 11, 2017 8:51 am

Doesn't seem like a bad problem to have. My wife and I (and I suspect many others) were on the opposite side of this imbalance a number of years ago. When you have a lot in taxed savings, it increases your options with things like early retirement, sabbaticals, career downshifting, etc. since you aren't restricted on when you pull out the funds.

desiderium
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by desiderium » Mon Sep 11, 2017 9:35 am

HSA is your best option if you are eligible.
There are a number of threads about saving receipts etc., and some controversy over this. However, future spending is going to include health care dollars, so utilizing this as a tax deferred savings vehicle would make sense for you.

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grabiner
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by grabiner » Mon Sep 11, 2017 5:11 pm

desiderium wrote:
Mon Sep 11, 2017 9:35 am
HSA is your best option if you are eligible.
There are a number of threads about saving receipts etc., and some controversy over this. However, future spending is going to include health care dollars, so utilizing this as a tax deferred savings vehicle would make sense for you.
CA doesn't recognize HSAs, but it's still a good deal, particularly given the OP's high federal tax rate. You could hold a Treasury or TIPS fund in your HSA to avoid state taxes.
David Grabiner

industrialauk
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by industrialauk » Tue Sep 12, 2017 2:07 am

Thanks for the great suggestions. I am going to try out the Form 8606 as suggested by retiredjg & if all looks well go ahead with backdoor roth. Paying down part of the mortgage is also under consideration, checking recasting with my lender. Sequence of returns risk was a fantastic concept to learn.

retiredjg
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by retiredjg » Tue Sep 12, 2017 6:58 am

Also check out this link for how to eventually use software to fill out the Form. This is not a substitute for doing it by hand because if you cannot do it by hand, you probably do not understand what you are doing.

https://thefinancebuff.com/the-backdoor ... ow-to.html

industrialauk
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by industrialauk » Tue Sep 12, 2017 7:10 pm

If you do decide to pay it down then one thing to do is to call your lender to see if they will "recast your mortgage"(Google this)
If cash flow isn't a problem, is there any other reason why would one go for a recast versus reducing the mortgage term? My lender allows recasting every 90 days as long as you pay 20K or more towards your principal balance. There is no cost associated with that process.

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Dale_G
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by Dale_G » Tue Sep 12, 2017 7:55 pm

You might look at a low cost variable annuity such as is available from Vanguard, especially if you believe you might be in a lower tax bracket and/or move to a lower tax state on retirement. Only bonds/REITs belong there and you need a long time horizon to overcome the slightly higher expenses. Skip the add-ons. I don't know about CA, but VAs also offer asset protection in many states.

Dale
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Watty
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by Watty » Tue Sep 12, 2017 8:16 pm

industrialauk wrote:
Tue Sep 12, 2017 7:10 pm
If you do decide to pay it down then one thing to do is to call your lender to see if they will "recast your mortgage"(Google this)
If cash flow isn't a problem, is there any other reason why would one go for a recast versus reducing the mortgage term? My lender allows recasting every 90 days as long as you pay 20K or more towards your principal balance. There is no cost associated with that process.
If interest rates or inflation go up a lot then you would would want the remaining mortgage to be paid off as slowly as possible. It is an extreme example but my parents had a 30 year mortgage that was at less than 4% interest during the double digit inflation years of the late 1970's and they did very well with that. It wasn't that long ago that you could get 5% on a money market account.

You could also run into unexpected cash flow problems in the future if something happens like you are laid off, disabled, divorced, or had to go down to one income for a while. You might also have some other need for the cash flow in the future like if you buy a second home.

btenny
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by btenny » Tue Sep 12, 2017 11:16 pm

Many high paid employees ask their boss or company to let them become to "contract workers ". This makes them independent and paid differently per the IRS rules. You lose some benefits but gain others. Plus you can make huge tax free retirement investments. So there are trade offs. See White Coat Investor web site and similar web sites for how many Doctors are paid.

https://www.nerdwallet.com/blog/investi ... ntractors/
http://www.kore1.com/should-you-be-a-co ... -employee/

Good Luck.

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celia
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by celia » Wed Sep 13, 2017 3:00 am

OP, I'm curious why you think it is a problem to have a lot more in taxable than in tax-deferred. Since taxable dollars are worth more than tax-deferred, it is a lot better than the other way around!


You and your spouse might as well learn about Backdoor Roth IRAs. Of course, you would have to first clear out all your non-Roth IRAs, most likely by moving them to a 401K. You'll have to start by asking your 401K administrator(s) if they will accept any of these that apply to you:
rollovers from traditional IRAs containing former 401K money (most plans do) and
tax-deferred contributions to traditional IRAs and their gains (many plans do).
No 401K is allowed to accept non-deductible contributions to a traditional IRA, but the gains on these contributions may or may not be accepted. Then after the money has been in the Roth for 5 years AND you turn 59.5, all the withdrawals will be tax-free. So you'll want to keep as much in there as long as you can and invest it in something that is likely to grow significantly.
industrialauk wrote:
Mon Sep 11, 2017 1:44 am
I am considering backdoor roth though. But I can't decide if the current year is a good time to do so. There are two issues effect of which I am not able to comprehend in the context of backdoor roth:

a] I rolled over an ex-employer's 401k to traditional IRA in January 2017, to proceed with backdoor roth I will have to initiate another rollover, this time from the same traditional IRA to new employer's 401K. Back and forth of retirement money from 401k --> IRA --> 401K, does it complicate things?
The primary thing you need to be cautious of, is the fairly recent rule that you can only do one rollover in a 12-month period if you took possession of it. If the former 401K wrote out a check addressed to Vanguard for your benefit that you forwarded to them or electronically sent the money, you are ok. But if the former 401K administrator sent you a check which you cashed, then you wrote a check to Vanguard for the same amount within 60 days, you will need to be very careful that the next rollover DOES NOT end up with a check being addressed to you. The penalty for doing this twice within 12 months is steep.
b] I am in a very high tax bracket right now, backdoor roth conversion requires careful assessment of current and future tax brackets. For next few 2-4 years I dont see tax bracket changing. What does it mean for roth conversion?
The Backdoor Roth will benefit you since you will be able to get money into a Roth IRA and pay the same taxes on it as if it had stayed in taxable. This is a no-brainer decision if you qualify (by not having anything in any non-Roth IRAs).
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

retiredjg
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Re: Late starters trying to reduce skew between taxable & tax deferred

Post by retiredjg » Wed Sep 13, 2017 6:20 am

celia wrote: The primary thing you need to be cautious of, is the fairly recent rule that you can only do one rollover in a 12-month period if you took possession of it. If the former 401K wrote out a check addressed to Vanguard for your benefit that you forwarded to them or electronically sent the money, you are ok. But if the former 401K administrator sent you a check which you cashed, then you wrote a check to Vanguard for the same amount within 60 days, you will need to be very careful that the next rollover DOES NOT end up with a check being addressed to you. The penalty for doing this twice within 12 months is steep.
True for IRA to IRA rollover, but this does not apply to IRA to retirement plan or retirement plan to IRA rollovers.

https://www.irs.gov/retirement-plans/pl ... tributions

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