2 in Daycare -Sell Taxable to Max 401k?

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TurtleTurtle14
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Joined: Tue Mar 21, 2017 7:52 pm

2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Sat Oct 21, 2017 10:24 pm

Hi,

Long time lurker - first time poster. Hopefully quick question:

We max out IRAs (11k) every year and for last several years have maxed out work 401k contributions (36k) annually. Luckily, when we were both younger we inherited a large $ stock in taxable account that we have not had to sell. However in January we will have 2 kids in daycare costing $2200-$2700 per month (They will be 2.5 and 6 months in January meaning they'll be there for a couple of years but costs should decrease as they get out of diapers etc.) In planning for next year we have 2 options and wanted to get input on best one:

1. (My choice as of now) Sell ~1k a month from taxable account and pay capital gains tax to continue maxing out retirement accounts and pay for increased daycare costs

2. Decrease 401k contribution by a little more than 1k to pay for daycare costs but be unable to max out 401k accounts

Emergency funds: Check
Debt: 13 years left on 15 year mortgage owe 200k, no other debt
Tax Filing Status: Married Filing Jointly
Tax Rate: 25% Federal, 5.75% State
State of Residence: VA
Age: 28 (Wife 32)

Her 401 ~120k
His 401 ~ 90k
His IRA ~70k
Her IRA ~60k
Joint Brokerage ~372k (all with capital gains) - contributing $0

(Likely free undergrad tuition if stay with current employer) - contributing $100 month to each account
Kid 1 529 8k
Kid 2 529 1 k

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ruralavalon
Posts: 14100
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Location: Illinois

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by ruralavalon » Sun Oct 22, 2017 12:00 pm

Welcome to the forum :) .

It's good to see that you are debt free, other than the mortgage note, and have been making max contributions to your 401ks and IRAs.

It looks like you are doing well.

TurtleTurtle14 wrote:
Sat Oct 21, 2017 10:24 pm
Hi,

Long time lurker - first time poster. Hopefully quick question:

We max out IRAs (11k) every year and for last several years have maxed out work 401k contributions (36k) annually. Luckily, when we were both younger we inherited a large $ stock in taxable account that we have not had to sell. However in January we will have 2 kids in daycare costing $2200-$2700 per month (They will be 2.5 and 6 months in January meaning they'll be there for a couple of years but costs should decrease as they get out of diapers etc.) In planning for next year we have 2 options and wanted to get input on best one:

1. (My choice as of now) Sell ~1k a month from taxable account and pay capital gains tax to continue maxing out retirement accounts and pay for increased daycare costs

2. Decrease 401k contribution by a little more than 1k to pay for daycare costs but be unable to max out 401k accounts

Emergency funds: Check
Debt: 13 years left on 15 year mortgage owe 200k, no other debt
Tax Filing Status: Married Filing Jointly
Tax Rate: 25% Federal, 5.75% State
State of Residence: VA
Age: 28 (Wife 32)

Her 401 ~120k
His 401 ~ 90k
His IRA ~70k
Her IRA ~60k
Joint Brokerage ~372k (all with capital gains) - contributing $0

(Likely free undergrad tuition if stay with current employer) - contributing $100 month to each account
Kid 1 529 8k
Kid 2 529 1 k
In general I think the better choice is probably # 1, drawing from the taxable account to enable continued maximum contributions to the 401ks and IRAs. My opinion on that would be reinforced if your 401ks offer good broadly diversified index funds, with low expense ratios.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Sun Oct 22, 2017 1:23 pm

ruralavalon wrote:
Sun Oct 22, 2017 12:00 pm
Welcome to the forum :) .

It's good to see that you are debt free, other than the mortgage note, and have been making max contributions to your 401ks and IRAs.

It looks like you are doing well.

TurtleTurtle14 wrote:
Sat Oct 21, 2017 10:24 pm
Hi,

Long time lurker - first time poster. Hopefully quick question:

We max out IRAs (11k) every year and for last several years have maxed out work 401k contributions (36k) annually. Luckily, when we were both younger we inherited a large $ stock in taxable account that we have not had to sell. However in January we will have 2 kids in daycare costing $2200-$2700 per month (They will be 2.5 and 6 months in January meaning they'll be there for a couple of years but costs should decrease as they get out of diapers etc.) In planning for next year we have 2 options and wanted to get input on best one:

1. (My choice as of now) Sell ~1k a month from taxable account and pay capital gains tax to continue maxing out retirement accounts and pay for increased daycare costs

2. Decrease 401k contribution by a little more than 1k to pay for daycare costs but be unable to max out 401k accounts

Emergency funds: Check
Debt: 13 years left on 15 year mortgage owe 200k, no other debt
Tax Filing Status: Married Filing Jointly
Tax Rate: 25% Federal, 5.75% State
State of Residence: VA
Age: 28 (Wife 32)

Her 401 ~120k
His 401 ~ 90k
His IRA ~70k
Her IRA ~60k
Joint Brokerage ~372k (all with capital gains) - contributing $0

(Likely free undergrad tuition if stay with current employer) - contributing $100 month to each account
Kid 1 529 8k
Kid 2 529 1 k
In general I think the better choice is probably # 1, drawing from the taxable account to enable continued maximum contributions to the 401ks and IRAs. My opinion on that would be reinforced if your 401ks offer good broadly diversified index funds, with low expense ratios.
Thanks for the reply - much appreciated. Sorry I didn't include that in my post - yes both of the 401ks have Vanguard Index funds to make up the 3 fund portfolio with very low expense ratios.

If I'm reading things correctly the difference would be 25% tax rate on income that I don't contribute to 401K vs 15% capital gains tax on stock I sell out of taxable account plus the benefit of maxing out tax advantaged space.

Any reason not to do option 1?

If I do sell out of taxable account, any benefit to doing it in 2017 vs 2018?

downshiftme
Posts: 1049
Joined: Sun Mar 11, 2007 6:11 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by downshiftme » Sun Oct 22, 2017 1:25 pm

Consider the two alternatives. You are certainly incurring daycare costs, so if you reduce 401k to pay for it, you end up with slightly less in 401k and slightly more in taxable. Alternatively, if you spend some taxable (incurring some selling costs) you end up with slightly more in 401k and slightly less in taxable, plus you keep the maximum 401k deduction.

Of these two, I would choose to sell some taxable if I were in a similar situation.

Another way to consider this is to imagine you have enough cash flow to pay for daycare, fully fund 401k and also add to your taxable account. If daycare costs rise, do you reduce 401k contributions or reduce your additions to taxable. Most everyone would keep 401k in this situation, but reduce taxable investing until daycare costs decline.

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Sun Oct 22, 2017 1:33 pm

downshiftme wrote:
Sun Oct 22, 2017 1:25 pm
Consider the two alternatives. You are certainly incurring daycare costs, so if you reduce 401k to pay for it, you end up with slightly less in 401k and slightly more in taxable. Alternatively, if you spend some taxable (incurring some selling costs) you end up with slightly more in 401k and slightly less in taxable, plus you keep the maximum 401k deduction.

Of these two, I would choose to sell some taxable if I were in a similar situation.

Another way to consider this is to imagine you have enough cash flow to pay for daycare, fully fund 401k and also add to your taxable account. If daycare costs rise, do you reduce 401k contributions or reduce your additions to taxable. Most everyone would keep 401k in this situation, but reduce taxable investing until daycare costs decline.
Great way to think about it - thanks for your insight. Any benefit to doing this in 2017 vs 2018?

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Majormajor78
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Location: Chicagoish

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by Majormajor78 » Sun Oct 22, 2017 2:25 pm

TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:33 pm
Great way to think about it - thanks for your insight. Any benefit to doing this in 2017 vs 2018?
I don't see any tax benefit to doing one year or the other but who knows what taxes will shake out as in the near future. With stocks at a current high now is arguably a good time to sell if you are planning to sell anyway. We talk all the time about dollar cost averaging when making new stock purchases. This is the first time I've ever thought about a DCA approach on the selling side that wasn't part of a retirement plan but it looks sound to me.
"Oh, M. le Comte, it is only a loss of money which I have sustained... nothing worth mentioning, I assure you."

KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by KlangFool » Sun Oct 22, 2017 2:52 pm

https://www.fsafeds.com/explore/dcfsa

OP,

I assume that you may use Dependent Care FSA to pay for the daycare. If you have not done this, you may want to set one up.

KlangFool

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ruralavalon
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Location: Illinois

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by ruralavalon » Sun Oct 22, 2017 3:35 pm

TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:23 pm
ruralavalon wrote:
Sun Oct 22, 2017 12:00 pm
In general I think the better choice is probably # 1, drawing from the taxable account to enable continued maximum contributions to the 401ks and IRAs. My opinion on that would be reinforced if your 401ks offer good broadly diversified index funds, with low expense ratios.
Thanks for the reply - much appreciated. Sorry I didn't include that in my post - yes both of the 401ks have Vanguard Index funds to make up the 3 fund portfolio with very low expense ratios.

If I'm reading things correctly the difference would be 25% tax rate on income that I don't contribute to 401K vs 15% capital gains tax on stock I sell out of taxable account plus the benefit of maxing out tax advantaged space.

Any reason not to do option 1?
No reason that I can see.

TurtleTurtle14 wrote:If I do sell out of taxable account, any benefit to doing it in 2017 vs 2018?
The only benefit I can see is if selling in 2018 gives you a long-term capital gains rate, but selling in 2017 will not.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Sun Oct 22, 2017 6:47 pm

Majormajor78 wrote:
Sun Oct 22, 2017 2:25 pm
TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:33 pm
Great way to think about it - thanks for your insight. Any benefit to doing this in 2017 vs 2018?
I don't see any tax benefit to doing one year or the other but who knows what taxes will shake out as in the near future. With stocks at a current high now is arguably a good time to sell if you are planning to sell anyway. We talk all the time about dollar cost averaging when making new stock purchases. This is the first time I've ever thought about a DCA approach on the selling side that wasn't part of a retirement plan but it looks sound to me.
Thanks for the reply

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Sun Oct 22, 2017 6:47 pm

KlangFool wrote:
Sun Oct 22, 2017 2:52 pm
https://www.fsafeds.com/explore/dcfsa

OP,

I assume that you may use Dependent Care FSA to pay for the daycare. If you have not done this, you may want to set one up.

KlangFool
Thanks KlangFool - yes we have one for both kids - you're an awesome poster - learned a lot by reading your posts

cherijoh
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Joined: Tue Feb 20, 2007 4:49 pm
Location: Charlotte NC

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by cherijoh » Sun Oct 22, 2017 7:41 pm

TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:23 pm
ruralavalon wrote:
Sun Oct 22, 2017 12:00 pm
Welcome to the forum :) .

It's good to see that you are debt free, other than the mortgage note, and have been making max contributions to your 401ks and IRAs.

It looks like you are doing well.

In general I think the better choice is probably # 1, drawing from the taxable account to enable continued maximum contributions to the 401ks and IRAs. My opinion on that would be reinforced if your 401ks offer good broadly diversified index funds, with low expense ratios.
Thanks for the reply - much appreciated. Sorry I didn't include that in my post - yes both of the 401ks have Vanguard Index funds to make up the 3 fund portfolio with very low expense ratios.

If I'm reading things correctly the difference would be 25% tax rate on income that I don't contribute to 401K vs 15% capital gains tax on stock I sell out of taxable account plus the benefit of maxing out tax advantaged space.

Any reason not to do option 1?

If I do sell out of taxable account, any benefit to doing it in 2017 vs 2018?
Actually you would only pay 15% on the capital gains from the sale of assets in the brokerage account (i.e., $ realized upon sale of asset - cost basis).

You mentioned an inheritance and not having sold any of the stock or fund (not sure which you inherited). I just wanted to make sure that you realized that inherited stocks/bonds/funds in a taxable account are subject to a step up in value when you inherit them. That means instead of using the cost basis of the original owner, you use their value at the time of the inheritance as your cost basis. This means you may owe a lot less tax than you thought you would when you sell the assets.

One reason to consider selling in 2017 vs. 2018 is if you were concerned that the value of the asset might decline due to a stock market jitters. I would be more tempted to do this if it were individual stocks vs. diversified funds. Another potential reason to sell this year is if you wanted to front load the 401k early next year so that you didn't need to keep moving money around to cover your expenses while still maxing out the 401k plan. Just make sure to plan your purchases so that you get maximum matching - some plans require you contribute enough each pay period, while other plans do a "true up" match and will make up for lumpy contributions.

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Sun Oct 22, 2017 8:06 pm

cherijoh wrote:
Sun Oct 22, 2017 7:41 pm
TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:23 pm
ruralavalon wrote:
Sun Oct 22, 2017 12:00 pm
Welcome to the forum :) .

It's good to see that you are debt free, other than the mortgage note, and have been making max contributions to your 401ks and IRAs.

It looks like you are doing well.

In general I think the better choice is probably # 1, drawing from the taxable account to enable continued maximum contributions to the 401ks and IRAs. My opinion on that would be reinforced if your 401ks offer good broadly diversified index funds, with low expense ratios.
Thanks for the reply - much appreciated. Sorry I didn't include that in my post - yes both of the 401ks have Vanguard Index funds to make up the 3 fund portfolio with very low expense ratios.

If I'm reading things correctly the difference would be 25% tax rate on income that I don't contribute to 401K vs 15% capital gains tax on stock I sell out of taxable account plus the benefit of maxing out tax advantaged space.

Any reason not to do option 1?

If I do sell out of taxable account, any benefit to doing it in 2017 vs 2018?
Actually you would only pay 15% on the capital gains from the sale of assets in the brokerage account (i.e., $ realized upon sale of asset - cost basis).

You mentioned an inheritance and not having sold any of the stock or fund (not sure which you inherited). I just wanted to make sure that you realized that inherited stocks/bonds/funds in a taxable account are subject to a step up in value when you inherit them. That means instead of using the cost basis of the original owner, you use their value at the time of the inheritance as your cost basis. This means you may owe a lot less tax than you thought you would when you sell the assets.

One reason to consider selling in 2017 vs. 2018 is if you were concerned that the value of the asset might decline due to a stock market jitters. I would be more tempted to do this if it were individual stocks vs. diversified funds. Another potential reason to sell this year is if you wanted to front load the 401k early next year so that you didn't need to keep moving money around to cover your expenses while still maxing out the 401k plan. Just make sure to plan your purchases so that you get maximum matching - some plans require you contribute enough each pay period, while other plans do a "true up" match and will make up for lumpy contributions.
Great advice. I'll check with my parents about the stepped up cost basis so I have that in hand.

It actually is in individual stocks (another advantage to selling is to change assets from individual stocks to mutual funds)

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CyclingDuo
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by CyclingDuo » Sun Oct 22, 2017 8:45 pm

TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:23 pm
Any reason not to do option 1?
Isn't there a reason not to to do option 1? :?:

If you do option 1, you will be paying tax twice, right? First on the capital gains in taxable from the sale of the assets to cover the day care so you can contribute the full 401K amount. Next, you will pay taxes on that "substitute" money that you were able to boost your contributions in the 401K RMD's during retirement.

In essence, you would be performing a sort of substitute "shell game" by selling taxable as it would allow you to cover the day care now, and the "replacement money" for that sum used to finance the day care would be going into the pre-tax deduction that goes into your 401K so you can max it out. You will pay ordinary income (most likely a higher rate) on that once you start RMD's in retirement.

Are we off in our thinking here? Wouldn't the most cost-effective tax treatment be in this scenario to finance the day care costs with your after tax salary, and live with the lower annual contribution into your 401K? Is there a way to only pay tax one time, as opposed to twice?

Sleepy and not thinking clearly after a long weekend...
"Everywhere is within walking distance if you have the time." ~ Steven Wright

ERISA Stone
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by ERISA Stone » Sun Oct 22, 2017 8:59 pm

KlangFool wrote:
Sun Oct 22, 2017 2:52 pm
https://www.fsafeds.com/explore/dcfsa

OP,

I assume that you may use Dependent Care FSA to pay for the daycare. If you have not done this, you may want to set one up.

KlangFool
One has to be a federal EE to do this, correct?

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Sun Oct 22, 2017 9:28 pm

CyclingDuo wrote:
Sun Oct 22, 2017 8:45 pm
TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:23 pm
Any reason not to do option 1?
Isn't there a reason not to to do option 1? :?:

If you do option 1, you will be paying tax twice, right? First on the capital gains in taxable from the sale of the assets to cover the day care so you can contribute the full 401K amount. Next, you will pay taxes on that "substitute" money that you were able to boost your contributions in the 401K RMD's during retirement.

In essence, you would be performing a sort of substitute "shell game" by selling taxable as it would allow you to cover the day care now, and the "replacement money" for that sum used to finance the day care would be going into the pre-tax deduction that goes into your 401K so you can max it out. You will pay ordinary income (most likely a higher rate) on that once you start RMD's in retirement.

Are we off in our thinking here? Wouldn't the most cost-effective tax treatment be in this scenario to finance the day care costs with your after tax salary, and live with the lower annual contribution into your 401K? Is there a way to only pay tax one time, as opposed to twice?

Sleepy and not thinking clearly after a long weekend...
Thanks for the reply - interested to hear other's thoughts

John Laurens
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by John Laurens » Sun Oct 22, 2017 9:53 pm

I would pay off the mortgage with the taxable account and I would not pay for daycare. I would use the free cash from no mortgage and daycare costs to max a 401k and 2 Roth’s.

Regards,
John

KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by KlangFool » Sun Oct 22, 2017 10:15 pm

ERISA Stone wrote:
Sun Oct 22, 2017 8:59 pm
KlangFool wrote:
Sun Oct 22, 2017 2:52 pm
https://www.fsafeds.com/explore/dcfsa

OP,

I assume that you may use Dependent Care FSA to pay for the daycare. If you have not done this, you may want to set one up.

KlangFool
One has to be a federal EE to do this, correct?
[/quite]

No. Private employer can offer this option too.

KlangFool

gostars
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by gostars » Sun Oct 22, 2017 11:17 pm

CyclingDuo wrote:
Sun Oct 22, 2017 8:45 pm
TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:23 pm
Any reason not to do option 1?
Isn't there a reason not to to do option 1? :?:

If you do option 1, you will be paying tax twice, right? First on the capital gains in taxable from the sale of the assets to cover the day care so you can contribute the full 401K amount. Next, you will pay taxes on that "substitute" money that you were able to boost your contributions in the 401K RMD's during retirement.

In essence, you would be performing a sort of substitute "shell game" by selling taxable as it would allow you to cover the day care now, and the "replacement money" for that sum used to finance the day care would be going into the pre-tax deduction that goes into your 401K so you can max it out. You will pay ordinary income (most likely a higher rate) on that once you start RMD's in retirement.

Are we off in our thinking here? Wouldn't the most cost-effective tax treatment be in this scenario to finance the day care costs with your after tax salary, and live with the lower annual contribution into your 401K? Is there a way to only pay tax one time, as opposed to twice?

Sleepy and not thinking clearly after a long weekend...
For easy numbers, if you take $36000 income at 25% then you pay $9000 in income tax and end up with $27000 in cash. From the taxable account, picking an easy number of 50% of the value being capital gains, you would withdraw 29189.19, pay 2189.19 in capital gains tax, and end up at the same $27000. Eventually all that money in the market grows and you end up with most of the taxable value being capital gains and due 15% on withdrawal. That $36000 in the 401(k) grows over the years, and you work distributions so that you end up in the 15% bracket after retirement, since you have all that Roth money that can also be used without bumping up your taxable income. You're paying 15% either way, but having it in the 401(k) gave you another $6810.81 in the market which adds up over 30 or 40 years. Even if you end up in the 25% bracket in retirement, it's marginal and you probably wouldn't have all that much at 25%.

MotoTrojan
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by MotoTrojan » Sun Oct 22, 2017 11:41 pm

Sell your lowest cost basis shares, ideally shares at s loss. Then buy similar but different (if any were at a loss) in 401k.

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FiveK
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by FiveK » Mon Oct 23, 2017 12:21 am

MotoTrojan wrote:
Sun Oct 22, 2017 11:41 pm
Sell your lowest cost basis shares, ideally shares at s loss.
Good idea, assuming "highest cost basis relative to current price" is what is meant.

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FiveK
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by FiveK » Mon Oct 23, 2017 12:32 am

TurtleTurtle14 wrote:
Sat Oct 21, 2017 10:24 pm
We max out IRAs (11k) every year and for last several years have maxed out work 401k contributions (36k) annually.
...
Tax Rate: 25% Federal, 5.75% State
Just checking: if you are maxing (and deducting) traditional IRAs then your MAGI must be less than $99K. Standard deduction and 4 exemptions would then put you in the 15% bracket...?

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 4:54 am

John Laurens wrote:
Sun Oct 22, 2017 9:53 pm
I would pay off the mortgage with the taxable account and I would not pay for daycare. I would use the free cash from no mortgage and daycare costs to max a 401k and 2 Roth’s.

Regards,
John
Thanks for the reply - curious what you mean by "not pay for daycare"

As far as paying of the mortgage early it's at 2.75% so as of now we'd prefer to keep $ invested in market hoping for a better return than that

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 4:55 am

gostars wrote:
Sun Oct 22, 2017 11:17 pm
CyclingDuo wrote:
Sun Oct 22, 2017 8:45 pm
TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:23 pm
Any reason not to do option 1?
Isn't there a reason not to to do option 1? :?:

If you do option 1, you will be paying tax twice, right? First on the capital gains in taxable from the sale of the assets to cover the day care so you can contribute the full 401K amount. Next, you will pay taxes on that "substitute" money that you were able to boost your contributions in the 401K RMD's during retirement.

In essence, you would be performing a sort of substitute "shell game" by selling taxable as it would allow you to cover the day care now, and the "replacement money" for that sum used to finance the day care would be going into the pre-tax deduction that goes into your 401K so you can max it out. You will pay ordinary income (most likely a higher rate) on that once you start RMD's in retirement.

Are we off in our thinking here? Wouldn't the most cost-effective tax treatment be in this scenario to finance the day care costs with your after tax salary, and live with the lower annual contribution into your 401K? Is there a way to only pay tax one time, as opposed to twice?

Sleepy and not thinking clearly after a long weekend...
For easy numbers, if you take $36000 income at 25% then you pay $9000 in income tax and end up with $27000 in cash. From the taxable account, picking an easy number of 50% of the value being capital gains, you would withdraw 29189.19, pay 2189.19 in capital gains tax, and end up at the same $27000. Eventually all that money in the market grows and you end up with most of the taxable value being capital gains and due 15% on withdrawal. That $36000 in the 401(k) grows over the years, and you work distributions so that you end up in the 15% bracket after retirement, since you have all that Roth money that can also be used without bumping up your taxable income. You're paying 15% either way, but having it in the 401(k) gave you another $6810.81 in the market which adds up over 30 or 40 years. Even if you end up in the 25% bracket in retirement, it's marginal and you probably wouldn't have all that much at 25%.
Thanks for that example that helps a lot

TurtleTurtle14
Posts: 26
Joined: Tue Mar 21, 2017 7:52 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 4:59 am

FiveK wrote:
Mon Oct 23, 2017 12:32 am
TurtleTurtle14 wrote:
Sat Oct 21, 2017 10:24 pm
We max out IRAs (11k) every year and for last several years have maxed out work 401k contributions (36k) annually.
...
Tax Rate: 25% Federal, 5.75% State
Just checking: if you are maxing (and deducting) traditional IRAs then your MAGI must be less than $99K. Standard deduction and 4 exemptions would then put you in the 15% bracket...?
last year with only 1 kid, dividends plus taxable salary for both of us (amount not going into 401K) was 112K and we maxed out 401K and both maxed out roth ira

So, do you mind explaining more the 99k limit?

We max our ira contribution in January each year and with the need for extra cashflow for the next several years for daycare have considered maxing traditional IRA not roth IRA this year - does that sound like a good bet?

John Laurens
Posts: 384
Joined: Mon Nov 14, 2016 7:31 pm

Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by John Laurens » Mon Oct 23, 2017 8:49 am

TurtleTurtle14 wrote:
Mon Oct 23, 2017 4:54 am
John Laurens wrote:
Sun Oct 22, 2017 9:53 pm
I would pay off the mortgage with the taxable account and I would not pay for daycare. I would use the free cash from no mortgage and daycare costs to max a 401k and 2 Roth’s.

Regards,
John
Thanks for the reply - curious what you mean by "not pay for daycare"

As far as paying of the mortgage early it's at 2.75% so as of now we'd prefer to keep $ invested in market hoping for a better return than that
I mean that even if my wife and I both enjoyed our careers, one of us would stay home to avoid 30k a year in daycare costs.

Regards,
John

Luke Duke
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by Luke Duke » Mon Oct 23, 2017 10:50 am

TurtleTurtle14 wrote:
Sun Oct 22, 2017 6:47 pm
KlangFool wrote:
Sun Oct 22, 2017 2:52 pm
https://www.fsafeds.com/explore/dcfsa

OP,

I assume that you may use Dependent Care FSA to pay for the daycare. If you have not done this, you may want to set one up.

KlangFool
Thanks KlangFool - yes we have one for both kids - you're an awesome poster - learned a lot by reading your posts
You don't need a separate account for each child. You can pay for expenses for multiple kids from the same account. You are limited to contributing $5K/yr total regardless of the number of children or the number of accounts.

TurtleTurtle14
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 11:10 am

Luke Duke wrote:
Mon Oct 23, 2017 10:50 am
TurtleTurtle14 wrote:
Sun Oct 22, 2017 6:47 pm
KlangFool wrote:
Sun Oct 22, 2017 2:52 pm
https://www.fsafeds.com/explore/dcfsa

OP,

I assume that you may use Dependent Care FSA to pay for the daycare. If you have not done this, you may want to set one up.

KlangFool
Thanks KlangFool - yes we have one for both kids - you're an awesome poster - learned a lot by reading your posts
You don't need a separate account for each child. You can pay for expenses for multiple kids from the same account. You are limited to contributing $5K/yr total regardless of the number of children or the number of accounts.
Thanks for that - didn't realize there was a total 5k limit per family not per kid. We've had 1 for past couple years with older kid - will easily max it out with both of them quickly into 2018.

Thanks for everyone's input so far

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by aristotelian » Mon Oct 23, 2017 11:22 am

Could you turn off dividend reinvesting in the taxable account and use dividends to close the cash flow gap from maxing your 401k without having to sell?

Alternatively, we were in the exact same position earlier this year, and we paid off the mortgage. Of course, it was a big hit on the brokerage balance, but that freed up cash flow to max the 401k.

TurtleTurtle14
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 11:27 am

aristotelian wrote:
Mon Oct 23, 2017 11:22 am
Could you turn off dividend reinvesting in the taxable account and use dividends to close the cash flow gap from maxing your 401k without having to sell?

Alternatively, we were in the exact same position earlier this year, and we paid off the mortgage. Of course, it was a big hit on the brokerage balance, but that freed up cash flow to max the 401k.
Great points but we've been using dividends for cash flow already to help with kid #1

Haven't really considered paying off the mortgage since interest rate is so low and to do that it would be large capital gains since we've both owned our taxable stock for > 10 years so they all have significant capital gains - any other thoughts on pros and cons for this?

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by aristotelian » Mon Oct 23, 2017 11:38 am

Reasonable minds may differ on the mortgage vs investing. My thinking was:
1. I would not take a loan to leverage for investing.
2. Mortgage is a reverse bond. If you keep a mortgage, you are reverse arbitraging your bond allocation.
3. I only took the mortgage out as a necessity. Now that I can afford to lose it, the only reason would be to use as leverage for investing.
4. From a market timing perspective, it seems like a good time.

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FiveK
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by FiveK » Mon Oct 23, 2017 12:02 pm

TurtleTurtle14 wrote:
Mon Oct 23, 2017 4:59 am
FiveK wrote:
Mon Oct 23, 2017 12:32 am
TurtleTurtle14 wrote:
Sat Oct 21, 2017 10:24 pm
We max out IRAs (11k) every year and for last several years have maxed out work 401k contributions (36k) annually.
...
Tax Rate: 25% Federal, 5.75% State
Just checking: if you are maxing (and deducting) traditional IRAs then your MAGI must be less than $99K. Standard deduction and 4 exemptions would then put you in the 15% bracket...?
last year with only 1 kid, dividends plus taxable salary for both of us (amount not going into 401K) was 112K and we maxed out 401K and both maxed out roth ira

So, do you mind explaining more the 99k limit?

We max our ira contribution in January each year and with the need for extra cashflow for the next several years for daycare have considered maxing traditional IRA not roth IRA this year - does that sound like a good bet?
The $99K is the 2017 traditional IRA Full Deduction Limit if You Are Covered by a Retirement Plan at Work. The Roth IRA contribution limit is higher.

The deductibility phases out linearly from $99K to $119K. It's usually worth deducting traditional contributions if you can save 25% or more. If you get down a 15% marginal rate, or are above the MAGI for deductibility, then Roth is useful.

WhiteMaxima
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by WhiteMaxima » Mon Oct 23, 2017 12:05 pm

Sell Aft-tax, Super fund 529. Max 70k for 5 years.

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 12:09 pm

FiveK wrote:
Mon Oct 23, 2017 12:02 pm
TurtleTurtle14 wrote:
Mon Oct 23, 2017 4:59 am
FiveK wrote:
Mon Oct 23, 2017 12:32 am
TurtleTurtle14 wrote:
Sat Oct 21, 2017 10:24 pm
We max out IRAs (11k) every year and for last several years have maxed out work 401k contributions (36k) annually.
...
Tax Rate: 25% Federal, 5.75% State
Just checking: if you are maxing (and deducting) traditional IRAs then your MAGI must be less than $99K. Standard deduction and 4 exemptions would then put you in the 15% bracket...?
last year with only 1 kid, dividends plus taxable salary for both of us (amount not going into 401K) was 112K and we maxed out 401K and both maxed out roth ira

So, do you mind explaining more the 99k limit?

We max our ira contribution in January each year and with the need for extra cashflow for the next several years for daycare have considered maxing traditional IRA not roth IRA this year - does that sound like a good bet?
The $99K is the 2017 traditional IRA Full Deduction Limit if You Are Covered by a Retirement Plan at Work. The Roth IRA contribution limit is higher.

The deductibility phases out linearly from $99K to $119K. It's usually worth deducting traditional contributions if you can save 25% or more. If you get down a 15% marginal rate, or are above the MAGI for deductibility, then Roth is useful.
Thanks sounds like we'll keep it at a Roth IRA contribution then since we'll be close to the 119 limit this year - thanks for your time in explaining that

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 12:11 pm

WhiteMaxima wrote:
Mon Oct 23, 2017 12:05 pm
Sell Aft-tax, Super fund 529. Max 70k for 5 years.
We're planning to increase 529 contributions once kids are out of daycare but are in no rush to do so since we likely will have undergrad tution paid for if we stay at our current jobs. Would rather not superfund it and kids not end up in college - prefer the flexibility from taxable account

randomguy
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by randomguy » Mon Oct 23, 2017 12:17 pm

aristotelian wrote:
Mon Oct 23, 2017 11:22 am
Could you turn off dividend reinvesting in the taxable account and use dividends to close the cash flow gap from maxing your 401k without having to sell?

Alternatively, we were in the exact same position earlier this year, and we paid off the mortgage. Of course, it was a big hit on the brokerage balance, but that freed up cash flow to max the 401k.
Dividends work and maybe TLH. Freeing up cash by locking up money seems like a wash at best:)


2017 versus 2018? Probably both.:) You want to make sure you don't cross any income limits that reduce tax credits. Based on your tax rate, I am guessing you are close.

At a high level, you are avoiding paying taxes on gains (compare 10k tax deferred to 7.5k taxable after the funds go up 4x and you pay 25% on the tax deferred and 15% capital gains) and the ~1% tax drag from dividends along the way. Comparing a ROTH to taxable makes it even easier to see the difference.

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 12:24 pm

randomguy wrote:
Mon Oct 23, 2017 12:17 pm
aristotelian wrote:
Mon Oct 23, 2017 11:22 am
Could you turn off dividend reinvesting in the taxable account and use dividends to close the cash flow gap from maxing your 401k without having to sell?

Alternatively, we were in the exact same position earlier this year, and we paid off the mortgage. Of course, it was a big hit on the brokerage balance, but that freed up cash flow to max the 401k.
Dividends work and maybe TLH. Freeing up cash by locking up money seems like a wash at best:)


2017 versus 2018? Probably both.:) You want to make sure you don't cross any income limits that reduce tax credits. Based on your tax rate, I am guessing you are close.

At a high level, you are avoiding paying taxes on gains (compare 10k tax deferred to 7.5k taxable after the funds go up 4x and you pay 25% on the tax deferred and 15% capital gains) and the ~1% tax drag from dividends along the way. Comparing a ROTH to taxable makes it even easier to see the difference.
Great food for thought. I'll take a look at income limits for 2017 and 2018 and tax credits - does anyone have a handy reference guide to look at for deciding how much taxable account stock to sell in 2017 vs 2018 to maintain all tax credits?

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FiveK
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by FiveK » Mon Oct 23, 2017 12:41 pm

TurtleTurtle14 wrote:
Mon Oct 23, 2017 12:24 pm
Great food for thought. I'll take a look at income limits for 2017 and 2018 and tax credits - does anyone have a handy reference guide to look at for deciding how much taxable account stock to sell in 2017 vs 2018 to maintain all tax credits?
You'll need to know how much of the sale is taxable gain but given that, the Personal finance toolbox spreadsheet can show your marginal rates for capital gains.

The "what if?" worksheets of TurboTax, TaxAct, etc. can be used to confirm the spreadsheet numbers if you are so inclined.

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by grabiner » Mon Oct 23, 2017 5:20 pm

CyclingDuo wrote:
Sun Oct 22, 2017 8:45 pm
TurtleTurtle14 wrote:
Sun Oct 22, 2017 1:23 pm
Any reason not to do option 1?
Isn't there a reason not to to do option 1? :?:

If you do option 1, you will be paying tax twice, right? First on the capital gains in taxable from the sale of the assets to cover the day care so you can contribute the full 401K amount. Next, you will pay taxes on that "substitute" money that you were able to boost your contributions in the 401K RMD's during retirement.
The second tax cancels out. You are in a 30% tax bracket, combined federal and state. Thus, if you contribute $10,000 to your 401(k), it only costs you $7000 out of pocket. If the $10,000 becomes $100,000 when you retire, and you are still in the same bracket, you will have $70,000 after tax, which is just as good as if the 401(k) was a tax-free account.

Therefore, it makes sense to pay the capital-gains tax now to get what is effectively tax-free growth for forty years, as long as you don't need the money before retirement. (And given that huge account and the fact that you already own a house, you probably don't.)
Wiki David Grabiner

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TxAg » Mon Oct 23, 2017 5:38 pm

Tagged to read later

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by ruralavalon » Mon Oct 23, 2017 5:56 pm

TurtleTurtle14 wrote:
Mon Oct 23, 2017 12:11 pm
WhiteMaxima wrote:
Mon Oct 23, 2017 12:05 pm
Sell Aft-tax, Super fund 529. Max 70k for 5 years.
We're planning to increase 529 contributions once kids are out of daycare but are in no rush to do so since we likely will have undergrad tution paid for if we stay at our current jobs. Would rather not superfund it and kids not end up in college - prefer the flexibility from taxable account
That's an excellent approach for you in my option.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

victw
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by victw » Mon Oct 23, 2017 5:59 pm

John Laurens wrote:
Mon Oct 23, 2017 8:49 am
TurtleTurtle14 wrote:
Mon Oct 23, 2017 4:54 am
John Laurens wrote:
Sun Oct 22, 2017 9:53 pm
I would pay off the mortgage with the taxable account and I would not pay for daycare. I would use the free cash from no mortgage and daycare costs to max a 401k and 2 Roth’s.

Regards,
John
Thanks for the reply - curious what you mean by "not pay for daycare"

As far as paying of the mortgage early it's at 2.75% so as of now we'd prefer to keep $ invested in market hoping for a better return than that
I mean that even if my wife and I both enjoyed our careers, one of us would stay home to avoid 30k a year in daycare costs.

Regards,
John
I agree with John. I've been confused by this thread since the beginning. I wonder what the OP's saving/spending rates are? If you have to remove money from investment accts to cover expenses this implies to me you are saving more than is manageable and/or spending more than is manageable.

Vic

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camillus
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by camillus » Mon Oct 23, 2017 6:21 pm

Just dropping into this thread without reading much. Just thought I'd mention that the OP should check out if he or his wife's work offers a dependent care FSA. Some tax savings to be had here.

TurtleTurtle14
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 9:38 pm

camillus wrote:
Mon Oct 23, 2017 6:21 pm
Just dropping into this thread without reading much. Just thought I'd mention that the OP should check out if he or his wife's work offers a dependent care FSA. Some tax savings to be had here.
Thanks for suggestion. We have one and have been using it

TurtleTurtle14
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by TurtleTurtle14 » Mon Oct 23, 2017 9:50 pm

victw wrote:
Mon Oct 23, 2017 5:59 pm
John Laurens wrote:
Mon Oct 23, 2017 8:49 am
TurtleTurtle14 wrote:
Mon Oct 23, 2017 4:54 am
John Laurens wrote:
Sun Oct 22, 2017 9:53 pm
I would pay off the mortgage with the taxable account and I would not pay for daycare. I would use the free cash from no mortgage and daycare costs to max a 401k and 2 Roth’s.

Regards,
John
Thanks for the reply - curious what you mean by "not pay for daycare"

As far as paying of the mortgage early it's at 2.75% so as of now we'd prefer to keep $ invested in market hoping for a better return than that
I mean that even if my wife and I both enjoyed our careers, one of us would stay home to avoid 30k a year in daycare costs.

Regards,
John
I agree with John. I've been confused by this thread since the beginning. I wonder what the OP's saving/spending rates are? If you have to remove money from investment accts to cover expenses this implies to me you are saving more than is manageable and/or spending more than is manageable.

Vic
Thanks for the reply Vic and your input. The last 2 years we maxed both 401ks, Roth Iras, with no selling out of investment accounts with 1 kid in daycare. Gross salaries equal around 160 total so gross savings rate had been 47/160 or about 30%. We have only sold stock once before to help with a small amount of our downpayment 5 years ago.

This upcoming year I guess you could look at it as saving more than is manageable but since we have the taxable account available I look at it more as taking advantage of tax advantaged space. We do anticipate daycare costs dropping some both late next year and in upcoming years. I'm also planning on taking on some small extra teaching responsibilities to help increase take home pay to minimize the amount we have to sell which right now looks to be around 12k for next year.

Let me know if I can provide more information and thanks again for your input

victw
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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by victw » Mon Oct 23, 2017 11:04 pm

Ah. Tax deferred space - use it or lose it.

I get it now.

Vic

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by ruralavalon » Tue Oct 24, 2017 9:57 am

victw wrote:
Mon Oct 23, 2017 5:59 pm
I agree with John. I've been confused by this thread since the beginning. I wonder what the OP's saving/spending rates are? If you have to remove money from investment accts to cover expenses this implies to me you are saving more than is manageable and/or spending more than is manageable.
Life happens, and keeps changing.

Without children some people can have a very large savings rate, max their 401ks and IRAs and also do taxable investing.

Once children arrive the required living expenses greatly change, and the savings rate appropriately and necessarily changes. This is no indication that the earlier rates of saving or spending were not "manageable" before.

In both phases of life both the savings rate and spending might very well have been optimal for that time.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

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Re: 2 in Daycare -Sell Taxable to Max 401k?

Post by MotoTrojan » Tue Oct 24, 2017 10:11 am

FiveK wrote:
Mon Oct 23, 2017 12:21 am
MotoTrojan wrote:
Sun Oct 22, 2017 11:41 pm
Sell your lowest cost basis shares, ideally shares at s loss.
Good idea, assuming "highest cost basis relative to current price" is what is meant.
Good catch. Lowest delta is what I meant indeed.

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