401k and savings questions for non-conventional job

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Topic Author
Armonaut
Posts: 8
Joined: Fri Jan 08, 2021 10:51 pm

401k and savings questions for non-conventional job

Post by Armonaut »

Hi everyone,

It's my first post! Thanks for reading. Been lurking for a bit on here, reading as much as I can, read the Three Fund Portfolio, excited to learn more.

Growing up I've always been a saver, and that's turned out to be the most tremendous help to my career path and lifestyle.

I am in my mid-30's and have my own solo business, in a sense I think of myself as financially independent, since I love what I do and I stopped working what I viewed as 'jobs' about 10 years ago. I have a large emergency savings fund that keeps growing.

Over the last 5 years I've consistently made about $50-70k annually pre-tax, and I imagine that will be the case for at least the next 5-10 years give or take. That to me feels as much as I'm able to predict realistically in terms of income.

I have no debts, and currently have about $90k in savings. It's given me peace of mind to slowly increase that number, sometimes by a lot, depending on the year and any lifestyle/job expenses.

I'd consider that whole thing my "emergency fund", although I could get by for the next 6 months on $10k if I needed to, but for the sake of safety let's consider the "emergency" part of this to be $30k total, which would mean I have $60k in a bank account that I'd like to do more with starting in 2021.

I have a fairly new Roth IRA that I'll max out again for 2021, leaving me with $53k left over to potentially invest this year.

I've been reading up extensively on the pros and cons of Solo 401k vs Solo Roth 401k on this board, but it's hard for me to feel like I've found much specific advice for a lifestyle like mine––not a steady job, unsure if my income will increase or decrease over time, etc.

Since it's hard to predict the future (which seems to be the general reasoning used to pick the traditional solo 401k over the Roth in most cases), I have a simple question for what I should do this year, a year in which I am almost certain I will have a lower income due to Covid.

Let's just say I make $30k in 2021 which would cover my cost of living and then some, and I still have that $53k in savings to invest.

1) Do I open up both an Individual Solo 401k and Roth 401k and contribute $19.5k to the Roth 401k this year? Since that would conceivably give me a greater tax advantage later than writing off $19.5k on 30k income...

2) Would my plan be to do this year-to-year moving forward? Alternating between both accounts? Say in 2022 I make $75k, well then I'd presume I want to max out my Traditional Individual 401k that year and take the tax write-off up front.

3) Is this the best possible plan for me to maximize the benefits across the two 401k accounts? And lastly:

4) Would this be the best way to slowly year-after-year decrease my bloated savings account by $19.5 (401k) +$6k (Roth), or would it make any sense to also begin to invest this year into a non-tax-advantaged account with that additional $33k?

If you've made it this far and have any insight, thank you!
lakpr
Posts: 6760
Joined: Fri Mar 18, 2011 9:59 am

Re: 401k and savings questions for non-conventional job

Post by lakpr »

I am assuming that, based on your post, you are single and not married.

GENERALLY, if you are in the 12% tax bracket, I would suggest to pay the taxes now and make the Roth contributions, all future growth will be tax free. One reason is that the 12% tax bracket is scheduled to expire at the end of 2025, and I do not believe we will see that bracket in our lifetimes again. Better take advantage of it now.

GENERALLY, again, if you are in the 22% tax bracket, I would encourage making Traditional 401k contributions until the pre-tax assets (including contributions and growth) grow to about 20 times the 12% bracket threshold. For 2021, the top of 12% bracket is approximately $53k, so it means keep making Traditional 401k contributions until your balances reach $1.15 million. If you are lucky enough to amass that amount of money, feel free to switch to Roth 401k contributions whenever you reach that threshold.

GENERALLY again, if you are in the 24% tax bracket or higher, it's almost a given that you will be in a lower tax bracket in retirement (as the top of 22% tax bracket is $98k income for single, and 20 times that is almost $2 million), so continue to make the Traditional 401k contributions to capture the tax break now, and pay a lower tax during retirement.

GENERALLY, if you have cash on hand to live on -- defer your paycheck as much as possible to the retirement plan and draw your living expenses from the cash stash. Indirectly you will have converted your money from tax-exposed to tax-shielded.

I have, as you may have noticed, only general guidelines. You need to make the decision yourself.
an_asker
Posts: 3024
Joined: Thu Jun 27, 2013 2:15 pm

Re: 401k and savings questions for non-conventional job

Post by an_asker »

lakpr wrote: Wed Jan 13, 2021 6:02 pm [...]
GENERALLY again, if you are in the 24% tax bracket or higher, it's almost a given that you will be in a lower tax bracket in retirement (as the top of 22% tax bracket is $98k income for single, and 20 times that is almost $2 million), so continue to make the Traditional 401k contributions to capture the tax break now, and pay a lower tax during retirement.
[...]
I am curious why you used the "20 times" multiplier. Does that signify anything? Or a 5% annual withdrawal from $2 million at retirement?
lakpr
Posts: 6760
Joined: Fri Mar 18, 2011 9:59 am

Re: 401k and savings questions for non-conventional job

Post by lakpr »

an_asker wrote: Wed Jan 13, 2021 6:18 pm
lakpr wrote: Wed Jan 13, 2021 6:02 pm [...]
GENERALLY again, if you are in the 24% tax bracket or higher, it's almost a given that you will be in a lower tax bracket in retirement (as the top of 22% tax bracket is $98k income for single, and 20 times that is almost $2 million), so continue to make the Traditional 401k contributions to capture the tax break now, and pay a lower tax during retirement.
[...]
I am curious why you used the "20 times" multiplier. Does that signify anything? Or a 5% annual withdrawal from $2 million at retirement?
Sure ... I used the 5% multiplier because it is the mid-point of the RMDs between age 72 and age 87. It is also a round number that is greater than the 4% used in various studies as "safe withdrawal rate", and an approximation of the ever-escalating RMD as a percentage of your portfolio as you age -- RMDs will not let you be limited to just 4% of the outstanding balance. It's also meant to be a not-so-safe-withdrawal-rate that would discourage accumulating too much money in the pre-tax accounts, and tilts the balance somewhat in favor of the Roth accounts.
Danny184
Posts: 1
Joined: Wed Jan 13, 2021 5:57 pm

Re: 401k and savings questions for non-conventional job

Post by Danny184 »

There is a lot to dig into here!

I'm relatively new to this forum as well, but I can at least shed some light on the Roth/Traditional debate as well as offer my opinion.

A good starting point is taking a look at the 2020 federal income tax brackets and tax rates. See below

Rate For Single Individuals For Married Individuals Filing Joint Returns
12% $9,876 to $40,125 $19,751 to $80,250
22% $40,126 to $85,525 $80,251 to $171,050

With the income numbers that you are describing, it's important to see what kind of actual benefit you would immediately see by contributing to a traditional tax-deferred account. Assuming you are single (I don't think I missed any indication that you gave that you are married), you can see that contributing to a traditional account at the income level you are at would save you roughly 22% (or roughly 4k on a maxed out 19,500 contribution). This is pretty significant, however it's really not possible to do a detailed Roth/Traditional calculation without having a pretty detailed understanding of future earnings. Also, regardless of how detailed of a calculation you may be able to do NOW, future tax rates are absolutely unknown and there is no reasonable way of knowing what they will be 20-30 years down the road.

With that being said, I (low 20s, married individual with household earnings around 100k) am opting to take advantage of as much Roth space as I can on a yearly basis with Roth IRAs, a Roth 401k as well as a Roth 403b. We are currently at historically low federal tax rates, and I'll sleep better at night knowing that I've already paid my tax. No matter whether my income significantly increases or tax rates increase (as they can't get much lower than 10-20%), I've already paid my tax and can take out everything tax free upon reaching 59 1/2.

Just my 2 cents. Good luck!
Last edited by Danny184 on Wed Jan 13, 2021 8:45 pm, edited 1 time in total.
User avatar
FelixTheCat
Posts: 1952
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Re: 401k and savings questions for non-conventional job

Post by FelixTheCat »

I have a Solo Traditional 401k and a Roth 401K. I max out my Roth with employee contributions first. Then I max out my Traditional 401K with employer contributions. In both accounts I invest in Total Stock Market index.

I use Vanguard as my 401K provider https://investor.vanguard.com/small-bus ... -solo-401k

To calculate how much you can contribute in employer contributions, I use this calculator https://obliviousinvestor.com/solo-401k ... alculator/
Felix is a wonderful, wonderful cat.
Topic Author
Armonaut
Posts: 8
Joined: Fri Jan 08, 2021 10:51 pm

Re: 401k and savings questions for non-conventional job

Post by Armonaut »

Thanks everyone.

I'm still a bit confused on exactly the decision I should make vs Roth 401k or regular, I'm a bit dense :oops: and I think there's a part of the retirement tax bracket concept I am still fundamentally trying to grasp as well.

Here's a hypothetical question: say that in addition to having a Solo/Roth 401k, I also had a non-tax advantaged account of stocks, that by the time I was 60, it had $500k in it. Let's say it was making an average return of 6% a year on it and I could withdraw $30k a year from it. I would pay 15% capital gains tax on that and be left with about $25k a year of income.

If that were the case, but I still wanted to pull another $20k as income from a 401k account, would that change whether or not I choose to invest in a regular Solo 401k or a Roth now? If I am understanding it correctly, I would want to invest in the Roth 401k now, so that the hypothetical $20k was tax free, and I didn't bump up to the next tax bracket... But I might be wrong.

But someone tell me I'm right! Thank you for entertaining this weird example, and for helping me get it together.
Nate7out
Posts: 152
Joined: Wed Jan 16, 2008 2:06 pm

Re: 401k and savings questions for non-conventional job

Post by Nate7out »

Re: your scenario

Of the $20k you pulled out of traditional 401k - $12k would be the standard deduction and only $8k would be taxable income (10% bracket). For the $30k you get from taxable, a portion of it, perhaps half, would be return of invested capital and the other half (gains) would be taxed at 0%, given your low income put you in the 0% cg bracket. You would pay very low taxes in that scenario, hence the traditional recommendation for now.

NOTE: If the $30k was from dividends, you would probably pay more in taxes than if you had a tax efficient fund paying < 2% dividends and you sold shares to get additional money.
Topic Author
Armonaut
Posts: 8
Joined: Fri Jan 08, 2021 10:51 pm

Re: 401k and savings questions for non-conventional job

Post by Armonaut »

Nate7out wrote: Wed Jan 13, 2021 11:00 pm Re: your scenario

Of the $20k you pulled out of traditional 401k - $12k would be the standard deduction and only $8k would be taxable income (10% bracket). For the $30k you get from taxable, a portion of it, perhaps half, would be return of invested capital and the other half (gains) would be taxed at 0%, given your low income put you in the 0% cg bracket. You would pay very low taxes in that scenario, hence the traditional recommendation for now.

NOTE: If the $30k was from dividends, you would probably pay more in taxes than if you had a tax efficient fund paying < 2% dividends and you sold shares to get additional money.
This is very helpful, thank you! The only thing I don't understand is your Note, but your explanation of my scenario helped me understand a few things I wasn't getting.
Nate7out
Posts: 152
Joined: Wed Jan 16, 2008 2:06 pm

Re: 401k and savings questions for non-conventional job

Post by Nate7out »

My note isn't that helpful, probably should have left it off. There are non-qualified dividends that are taxed at your income tax rate vs. qualified dividends that are taxed at the LTCG rate. For some reason I read your post as if you expected 6% dividends on your $500k. That could result in higher taxes than a general assumption of 6% growth split between some appreciation in price as well as some dividends.
lakpr
Posts: 6760
Joined: Fri Mar 18, 2011 9:59 am

Re: 401k and savings questions for non-conventional job

Post by lakpr »

Danny184 wrote: Wed Jan 13, 2021 6:29 pm A good starting point is taking a look at the 2020 federal income tax brackets and tax rates. See below

Rate For Single Individuals For Married Individuals Filing Joint Returns
12% $9,876 to $40,125 $19,751 to $80,250
22% $40,126 to $85,525 $80,251 to $171,050

<<Snip>>

With that being said, I (low 20s, married individual with household earnings around 100k) am opting to take advantage of as much Roth space as I can on a yearly basis with Roth IRAs, a Roth 401k as well as a Roth 403b. We are currently at historically low federal tax rates, and I'll sleep better at night knowing that I've already paid my tax. No matter whether my income significantly increases or tax rates increase (as they can't get much lower than 10-20%), I've already paid my tax and can take out everything tax free upon reaching 59 1/2.
Note that those amounts are TAXABLE income, so you must add the standard deduction amounts of $12,400 for single and $24,800 for couples to determine the AGI. Thus the thresholds for 12% tax bracket are $52,525 and $105,050 for singles and Married Filing Jointly, respectively.

With a $100k income for MFJ status, @Danny184, you are below the 12% threshold, so Roth contributions to your IRA and 401k and 403b all, is the right choice and falls within the guidelines I posted above. I do suggest, if your income increases above $105k, to start making some Traditional contributions to your 401k and/or 403b to pull back the AGI to $105k.
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