Changed withholding... Am I doing it right? Also: How to prioritize tax shelters when your tax rate maybe nil?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
kjvmartin
Posts: 1366
Joined: Wed Jan 21, 2015 8:57 am

Changed withholding... Am I doing it right? Also: How to prioritize tax shelters when your tax rate maybe nil?

Post by kjvmartin » Sat Jan 12, 2019 8:12 pm

Reviewing my tax situation with three home age kids, a stay at home mom, and a recent promotion at work to $74k gross a year.

The IRS withholding form advised me to change my withholding to 14. The online calculator said 15. The form said to give 4 exemptions for each kid plus 1 for each adult. 12+2=14.... My salary and deductions are consistent. This caused me to have only $0-$4 withheld from my biweekly pay. I was a little concerned about this so I created a dummy TurboTax 2018 file. They are still forecasting a $1000 federal refund. Does this make sense??

If this seem realistic, I'm wondering how to best go forward.

I have an excellent governmental 401k and 457 with ultra low fee index funds. For example, my S&P index where I put 90% of my contributions has a total ER of 0.003%. I also have Roth options I have not used. Would this be more attractive or less based on my new tax situation? I currently elect my pre-tax contributions into the 457 and the employer puts a base 4% into the 401k as well as a 3% match. I do not yet have a Roth IRA.

Thanks for weighing in.

User avatar
willthrill81
Posts: 12780
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Changed withholding... Am I doing it right? Also: How to prioritize tax shelters when your tax rate maybe nil?

Post by willthrill81 » Sat Jan 12, 2019 9:17 pm

I just ran your numbers through H&R Block's online estimator, and they estimate a refund of $381 if you paid nothing. This is due to the tax credits for having three young children.

In this situation, socking away every dime you can in Roth IRAs should be priority #1. Money going in will not be federally taxed, and money pulled out will not be federally taxed either.

Beyond that, finding the right mix of tax-deferred and taxable accounts will be more difficult. I suspect that taxable accounts may come out ahead, depending on how much you'll be contributing and for how long. With the tax-deferred accounts, withdrawals will be taxed as earned income, whereas capital gains resulting from selling shares in a taxable account will be subject to long-term capital gains, which are lower. However, you won't have any tax drag in the tax-deferred accounts, while you will eventually have some with the taxable accounts (though not much for a while with the kids at home).

That being said, you need about $600k of tax-deferred assets just to produce enough retirement income to meet the $24k standard deduction for a married-filing jointly couple, assuming 4% withdrawals. So you definitely what to contribute enough to those accounts to have that much in today's dollars in your tax-deferred accounts at the time of your anticipated retirement.

How much are your anticipated total retirement contributions?
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Topic Author
kjvmartin
Posts: 1366
Joined: Wed Jan 21, 2015 8:57 am

Re: Changed withholding... Am I doing it right? Also: How to prioritize tax shelters when your tax rate maybe nil?

Post by kjvmartin » Sat Jan 12, 2019 9:46 pm

willthrill81 wrote:
Sat Jan 12, 2019 9:17 pm
In this situation, socking away every dime you can in Roth IRAs should be priority #1. Money going in will not be federally taxed, and money pulled out will not be federally taxed either.

Beyond that, finding the right mix of tax-deferred and taxable accounts will be more difficult. I suspect that taxable accounts may come out ahead, depending on how much you'll be contributing and for how long. With the tax-deferred accounts, withdrawals will be taxed as earned income, whereas capital gains resulting from selling shares in a taxable account will be subject to long-term capital gains, which are lower. However, you won't have any tax drag in the tax-deferred accounts, while you will eventually have some with the taxable accounts (though not much for a while with the kids at home).

That being said, you need about $600k of tax-deferred assets just to produce enough retirement income to meet the $24k standard deduction for a married-filing jointly couple, assuming 4% withdrawals. So you definitely what to contribute enough to those accounts to have that much in today's dollars in your tax-deferred accounts at the time of your anticipated retirement.

How much are your anticipated total retirement contributions?
1. Indeed, the tax credit for the kids is a huge financial help! Thanks for taking the time to crunch numbers and reply. My main concern is at least a small refund instead of owing, and that helps me feel more secure in that.

2. So, if a Roth IRA is priority #1, is there any reason to not use the Roth 401k instead of the standard 401k in my work retirement plan? Also, are Roth IRA and Roth 401k funds basically the same? Any advantage either way?

3. I really don't know what will shake out long term. I'm only 34. I'll be getting a few nice step increases up to about $85,000 and annual cost of living bumps. In several years I think we may return to dual income but we have one child with special needs that makes things tough for scheduling for the foreseeable future. I am currently at 10% plus employer contributions totaling 17%. That's $12,580 per year. $7,400 of those dollars are mine. I think, based on what I've learned from you, that I will possibly redirect all of that into a Roth 401k until my situation changes. I will still have the match and defined benefit going into the pre-tax 401k. Would this make sense?

clemrick
Posts: 153
Joined: Wed Sep 09, 2009 8:46 pm

Re: Changed withholding... Am I doing it right? Also: How to prioritize tax shelters when your tax rate maybe nil?

Post by clemrick » Sat Jan 12, 2019 10:12 pm

willthrill81 wrote:
Sat Jan 12, 2019 9:17 pm

In this situation, socking away every dime you can in Roth IRAs should be priority #1. Money going in will not be federally taxed, and money pulled out will not be federally taxed either.
Typo here, I believe. Contributions to Roth IRAs are made with after-tax money. Traditional IRA contributions are pre-tax. Distributions from ROTH IRAs (if all the rules are followed) are not federally taxed.

User avatar
willthrill81
Posts: 12780
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Changed withholding... Am I doing it right? Also: How to prioritize tax shelters when your tax rate maybe nil?

Post by willthrill81 » Sat Jan 12, 2019 10:26 pm

kjvmartin wrote:
Sat Jan 12, 2019 9:46 pm
willthrill81 wrote:
Sat Jan 12, 2019 9:17 pm
In this situation, socking away every dime you can in Roth IRAs should be priority #1. Money going in will not be federally taxed, and money pulled out will not be federally taxed either.

Beyond that, finding the right mix of tax-deferred and taxable accounts will be more difficult. I suspect that taxable accounts may come out ahead, depending on how much you'll be contributing and for how long. With the tax-deferred accounts, withdrawals will be taxed as earned income, whereas capital gains resulting from selling shares in a taxable account will be subject to long-term capital gains, which are lower. However, you won't have any tax drag in the tax-deferred accounts, while you will eventually have some with the taxable accounts (though not much for a while with the kids at home).

That being said, you need about $600k of tax-deferred assets just to produce enough retirement income to meet the $24k standard deduction for a married-filing jointly couple, assuming 4% withdrawals. So you definitely what to contribute enough to those accounts to have that much in today's dollars in your tax-deferred accounts at the time of your anticipated retirement.

How much are your anticipated total retirement contributions?
1. Indeed, the tax credit for the kids is a huge financial help! Thanks for taking the time to crunch numbers and reply. My main concern is at least a small refund instead of owing, and that helps me feel more secure in that.

2. So, if a Roth IRA is priority #1, is there any reason to not use the Roth 401k instead of the standard 401k in my work retirement plan? Also, are Roth IRA and Roth 401k funds basically the same? Any advantage either way?

3. I really don't know what will shake out long term. I'm only 34. I'll be getting a few nice step increases up to about $85,000 and annual cost of living bumps. In several years I think we may return to dual income but we have one child with special needs that makes things tough for scheduling for the foreseeable future. I am currently at 10% plus employer contributions totaling 17%. That's $12,580 per year. $7,400 of those dollars are mine. I think, based on what I've learned from you, that I will possibly redirect all of that into a Roth 401k until my situation changes. I will still have the match and defined benefit going into the pre-tax 401k. Would this make sense?
It's very likely that you should first max out your Roth IRAs ($6k for you and another $6k for your wife), then switch over to the Roth 401k with remaining contributions. Since you're not paying enough federal income tax right now, you want to stuff every dollar you can into Roth accounts. And no, Roth IRAs and Roth 401k plans are not equivalent. The wiki explains them here.

As time goes on and your tax situation changes, you'll need to reevaluate your plan. Remember that you need about $600k in tax-deferred (i.e. non-Roth) account balances in today's dollars just to produce enough income to cover the standard deduction for a married-filing jointly couple. This is important because withdrawals at that level will not be taxed.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

User avatar
willthrill81
Posts: 12780
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Changed withholding... Am I doing it right? Also: How to prioritize tax shelters when your tax rate maybe nil?

Post by willthrill81 » Sat Jan 12, 2019 10:27 pm

clemrick wrote:
Sat Jan 12, 2019 10:12 pm
willthrill81 wrote:
Sat Jan 12, 2019 9:17 pm

In this situation, socking away every dime you can in Roth IRAs should be priority #1. Money going in will not be federally taxed, and money pulled out will not be federally taxed either.
Typo here, I believe. Contributions to Roth IRAs are made with after-tax money. Traditional IRA contributions are pre-tax. Distributions from ROTH IRAs (if all the rules are followed) are not federally taxed.
No, it isn't, because he's not currently paying any federal income tax at all. Yes, the money going into Roth accounts is technically 'after-tax', but he's not currently paying any tax in the first place.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

trueblueky
Posts: 1563
Joined: Tue May 27, 2014 3:50 pm

Re: Changed withholding... Am I doing it right? Also: How to prioritize tax shelters when your tax rate maybe nil?

Post by trueblueky » Sat Jan 12, 2019 10:43 pm

kjvmartin wrote:
Sat Jan 12, 2019 9:46 pm
willthrill81 wrote:
Sat Jan 12, 2019 9:17 pm
In this situation, socking away every dime you can in Roth IRAs should be priority #1. Money going in will not be federally taxed, and money pulled out will not be federally taxed either.

Beyond that, finding the right mix of tax-deferred and taxable accounts will be more difficult. I suspect that taxable accounts may come out ahead, depending on how much you'll be contributing and for how long. With the tax-deferred accounts, withdrawals will be taxed as earned income, whereas capital gains resulting from selling shares in a taxable account will be subject to long-term capital gains, which are lower. However, you won't have any tax drag in the tax-deferred accounts, while you will eventually have some with the taxable accounts (though not much for a while with the kids at home).

That being said, you need about $600k of tax-deferred assets just to produce enough retirement income to meet the $24k standard deduction for a married-filing jointly couple, assuming 4% withdrawals. So you definitely what to contribute enough to those accounts to have that much in today's dollars in your tax-deferred accounts at the time of your anticipated retirement.

How much are your anticipated total retirement contributions?
1. Indeed, the tax credit for the kids is a huge financial help! Thanks for taking the time to crunch numbers and reply. My main concern is at least a small refund instead of owing, and that helps me feel more secure in that.

2. So, if a Roth IRA is priority #1, is there any reason to not use the Roth 401k instead of the standard 401k in my work retirement plan? Also, are Roth IRA and Roth 401k funds basically the same? Any advantage either way?

3. I really don't know what will shake out long term. I'm only 34. I'll be getting a few nice step increases up to about $85,000 and annual cost of living bumps. In several years I think we may return to dual income but we have one child with special needs that makes things tough for scheduling for the foreseeable future. I am currently at 10% plus employer contributions totaling 17%. That's $12,580 per year. $7,400 of those dollars are mine. I think, based on what I've learned from you, that I will possibly redirect all of that into a Roth 401k until my situation changes. I will still have the match and defined benefit going into the pre-tax 401k. Would this make sense?
In theory, annual cost of living bumps won't change your tax situation, because the brackets are adjusted for inflation each year too.

Post Reply