Investment Options and Roth vs. Traditional

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Topic Author
Sftblldad
Posts: 6
Joined: Thu Jan 10, 2019 7:41 pm

Investment Options and Roth vs. Traditional

Post by Sftblldad »

I am in the middle of changing jobs and will see a substantial reduction in compensation. I recently had a huge health scare and it's changed my perspective towards my career. My new job will be much less demanding, but there's obviously a financial cost. Household income will drop from approximately $420-$450k to $305k. I have a few questions regarding the investment options with my new company's 403b as well as tax deferred vs. after tax investments. We currently have about $750k in retirement/taxable investments and a fully funded emergency fund. My wife will also get a pension that has numerous distribution options. Lump sum would be $350k at age 55 or $1400/month. I will not be eligible for the pension but will get 3% in a 401(a) account from the company. We currently are paying for private school and saving in 529s for both children. Once the youngest is in college when I turn 52, we plan to use private school tuition and 529 monthly savings to invest either in taxable or the company's non governmental 457's for both of us ($4500/month).

Emergency funds: Yes

Debt: $88K Student Loans at 3% and $580k on our mortgage. Current home value is $900-$950k

Tax Filing Status: Married Filing Jointly with 2 children (contributing to 529s but not included below)

Tax Rate: Was 32-35% Federal, 5.8% State. I believe we will be 24%/5.8% with the new job

State of Residence: Virginia

Age: 43/39

Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 33% of stocks



Taxable:
5.3% VTI (0.03%)


His 401k:
39% VFIAX S&P Fund (.04%)
8.8% VGTSX International (0.07%)
3.4% VSMAX Small Cap (0.06%)
5.4% VBMFX Bond fund (0.04%)


His Roth IRA at Vanguard:
4.1% VTSAX



Her 403b:
15% FXAIX S&P Fund (0.015%)
5.8% FSMAX Midcap (0.036%)
4.1%FSGGX International (0.055%)
4% FXNAX Bond (0.025%)
Yes, 3% of Salary


Her Roth IRA at Vanguard:
4.1% VTSAX
_______________________________________________________________


Contributions
Both DW and I max out our pre tax retirement accounts ($19.5k each) as well as do a back door Roth ($6k each)


Available funds

I will be working for the same company DW currently works for so my investment options will be the same as hers. The only funds available besides what's listed in her 403b that don't have very high expense ratios are:

VTWIX Total World (0.08%)
FRGXX Gov Treasuries (0.18%)



Questions:
1. With my new job, neither of us will have a total US stock index option. We will have either an S&P fund or Total world. With the difference in expense ratios, are we better off with the S&P 500 fund and an International fund or are we better off with the Total world fund? My concern with first choice is that we have no Small Cap or Midcap exposure. Our taxable and Roth accounts are all VTI/VTSAX so we do have total US there.

2. At our previous income level, pre tax was a no brainer. Now, I'm not as sure. Whether we contribute pre tax now or not, we are in the 24% federal income tax bracket. Before, we were right on the border line of the 35% bracket.

3. Are we on track for retirement at ages 59/55? We would like somewhere in the neighborhood of $120-$150k per year in today's dollars during our retirement.


Thank you
lakpr
Posts: 7411
Joined: Fri Mar 18, 2011 9:59 am

Re: Investment Options and Roth vs. Traditional

Post by lakpr »

Couple of comments.

1. At your salary levels (whether the 32% or 24% tax brackets), the student loan interest is not tax deductible. So that 3% you are paying, is after-tax. At 24% marginal tax bracket that's equivalent of approximately 4% before tax, and at 32% marginal tax bracket that's equivalent of 4.4% before tax. The figures rise to 4.3% to 4.75% if you were to take state taxes into consideration.

If you get an offer for a 4% CD from a bank, with terms that the max you can invest is only $88k, would you take it or no?

I do think that in this low rate environment getting a 4% CD is an excellent offer. That said, it is also a low enough bar that you can comfortably clear it with investment in the stock market, *but over long term*. Nothing is guaranteed in the short term. If I were you, I would take it ... in other words, I would pay off the student loans.

2. Total US Stock Market = 80% S&P 500 Index + 20% Small Cap Index (or Russell 2000 Index). See if there is a small cap index fund available in the line up of the new 401k plan. Then divide the amount you wanted to direct to a Total US Stock Market Index fund into 5 parts; direct 4 parts to the S&P 500 Index fund and the 1 part to the Small Cap Index fund.

Source: Approximating Total Stock Market

3. At 24% marginal tax bracket, pre-tax still makes sense. You will save at the bare minimum the state tax rate of 5.8%, if you were to move to a no-tax state in retirement (surely that is in the future plans if you do early retire?). Even if you would NOT move out of Virginia, all that would happen is that you would pay the equivalent of the tax you would pay now, and that's the worst case. Since taxes cannot be unpaid, going Roth 401k would mean giving up an in-the-money option. What do you anticipate you will be getting in return, when you surrender that option? If nothing, then why ?

4. $150k in expenses in current dollars at retirement means you need to have $150k / 4% = $3.75 million by the time you retire, assuming a 4% safe withdrawal rate. Subtract the $350k lumpsum for your wife's pension, you need to have $3.4 million from your other assets.

$750k, at a hypothetical rate of 5% real return, in 20 years = $1.99 million
$51k periodic investment into retirement accounts (max 401k + max two Roth IRAs), at the same rate of 5% real return, in 20 years = $1.03 million.
Total at the end of 2 years = $3 million; lower than the $3.4 million projected above.

It's a bit of a tight squeeze. If the markets were to smile on you and generate more than 5% real CAGR over the next two decades, you may be able to retire early. I would try to either eliminate expenses (pay down that mortgage faster!) or work for a bit longer.
Topic Author
Sftblldad
Posts: 6
Joined: Thu Jan 10, 2019 7:41 pm

Re: Investment Options and Roth vs. Traditional

Post by Sftblldad »

lakpr wrote: Mon May 03, 2021 4:16 pm Couple of comments.

1. At your salary levels (whether the 32% or 24% tax brackets), the student loan interest is not tax deductible. So that 3% you are paying, is after-tax. At 24% marginal tax bracket that's equivalent of approximately 4% before tax, and at 32% marginal tax bracket that's equivalent of 4.4% before tax. The figures rise to 4.3% to 4.75% if you were to take state taxes into consideration.

If you get an offer for a 4% CD from a bank, with terms that the max you can invest is only $88k, would you take it or no?

I do think that in this low rate environment getting a 4% CD is an excellent offer. That said, it is also a low enough bar that you can comfortably clear it with investment in the stock market, *but over long term*. Nothing is guaranteed in the short term. If I were you, I would take it ... in other words, I would pay off the student loans.

2. Total US Stock Market = 80% S&P 500 Index + 20% Small Cap Index (or Russell 2000 Index). See if there is a small cap index fund available in the line up of the new 401k plan. Then divide the amount you wanted to direct to a Total US Stock Market Index fund into 5 parts; direct 4 parts to the S&P 500 Index fund and the 1 part to the Small Cap Index fund.

Unfortunatley there is no Small Cap option in my new plan. Previously, DW utilized a Mid cap fund and I utilized a Small cap fund to get the allocation we wanted. Now, our options are S&P fund, International, Total world, and Mid cap as far as low cost index funds go.

Source: Approximating Total Stock Market

3. At 24% marginal tax bracket, pre-tax still makes sense. You will save at the bare minimum the state tax rate of 5.8%, if you were to move to a no-tax state in retirement (surely that is in the future plans if you do early retire?). Even if you would NOT move out of Virginia, all that would happen is that you would pay the equivalent of the tax you would pay now, and that's the worst case. Since taxes cannot be unpaid, going Roth 401k would mean giving up an in-the-money option. What do you anticipate you will be getting in return, when you surrender that option? If nothing, then why ?

We do not intend to stay in Virginia once we retire but things could change depending on where the kids decided to settle

4. $150k in expenses in current dollars at retirement means you need to have $150k / 4% = $3.75 million by the time you retire, assuming a 4% safe withdrawal rate. Subtract the $350k lumpsum for your wife's pension, you need to have $3.4 million from your other assets.

$750k, at a hypothetical rate of 5% real return, in 20 years = $1.99 million
$51k periodic investment into retirement accounts (max 401k + max two Roth IRAs), at the same rate of 5% real return, in 20 years = $1.03 million.
Total at the end of 2 years = $3 million; lower than the $3.4 million projected above.

This is where the planned increase once the youngest graduates comes in. We should have 7 years of another $40-50k going into a 457 or taxable. There are also some distribution options on her pension such as $44k per year until social security kicks in. We both expect to receive about $36k per year in social security if we wait till full retirement age. About $24k per year if we take it at 62. Do you think this would make a difference?

It's a bit of a tight squeeze. If the markets were to smile on you and generate more than 5% real CAGR over the next two decades, you may be able to retire early. I would try to either eliminate expenses (pay down that mortgage faster!) or work for a bit longer.
Thank you for your feedback.
lakpr
Posts: 7411
Joined: Fri Mar 18, 2011 9:59 am

Re: Investment Options and Roth vs. Traditional

Post by lakpr »

Sftblldad wrote: Mon May 03, 2021 5:03 pm This is where the planned increase once the youngest graduates comes in. We should have 7 years of another $40-50k going into a 457 or taxable. There are also some distribution options on her pension such as $44k per year until social security kicks in. We both expect to receive about $36k per year in social security if we wait till full retirement age. About $24k per year if we take it at 62. Do you think this would make a difference?

Thank you for your feedback.
$50k additional contributions for 7 years = $350k, pretty much covering the entire shortfall I had calculated. Not even including any growth.

I had also discounted the Social Security for both of you, since neither would be able to claim at least until age 62, which is more than 20 years out from now (based on the ages you provided).

I did not put any money value on the distribution options from her pension, I assumed they are all actuarially equivalent, so lump sum = 5 year distribution option = 10 year distribution option etc. I could be wrong, but then I was only doing a back-of-the-envelope calculations anyway.

Regarding Social Security, the default best case is for the lower earner to claim at 62 and the higher earner to claim at 70. This would definitely also add to the safety margin, but then again ... the feature that this stream of income kicks in after you attain a certain age, means you do need to be comfortable drawing down the existing assets at a higher than 4% withdrawal rate prior to SS. Say you had only $2.5 million at age 60, with full SS at least 7 years away. Are you comfortable withdrawing at 6% rate (to satisfy your $150k expenses) from this pot? I know I would not be ... (and perhaps projected that implicit bias on to your particular case).
Topic Author
Sftblldad
Posts: 6
Joined: Thu Jan 10, 2019 7:41 pm

Re: Investment Options and Roth vs. Traditional

Post by Sftblldad »

lakpr wrote: Mon May 03, 2021 5:23 pm
Sftblldad wrote: Mon May 03, 2021 5:03 pm This is where the planned increase once the youngest graduates comes in. We should have 7 years of another $40-50k going into a 457 or taxable. There are also some distribution options on her pension such as $44k per year until social security kicks in. We both expect to receive about $36k per year in social security if we wait till full retirement age. About $24k per year if we take it at 62. Do you think this would make a difference?

Thank you for your feedback.
$50k additional contributions for 7 years = $350k, pretty much covering the entire shortfall I had calculated. Not even including any growth.

I had also discounted the Social Security for both of you, since neither would be able to claim at least until age 62, which is more than 20 years out from now (based on the ages you provided).

I did not put any money value on the distribution options from her pension, I assumed they are all actuarially equivalent, so lump sum = 5 year distribution option = 10 year distribution option etc. I could be wrong, but then I was only doing a back-of-the-envelope calculations anyway.

Regarding Social Security, the default best case is for the lower earner to claim at 62 and the higher earner to claim at 70. This would definitely also add to the safety margin, but then again ... the feature that this stream of income kicks in after you attain a certain age, means you do need to be comfortable drawing down the existing assets at a higher than 4% withdrawal rate prior to SS. Say you had only $2.5 million at age 60, with full SS at least 7 years away. Are you comfortable withdrawing at 6% rate (to satisfy your $150k expenses) from this pot? I know I would not be ... (and perhaps projected that implicit bias on to your particular case).
Social security should be pretty close for both of us so I'm not sure having her claim later would make any significant difference. Actual expenses would be far lower than $150k (lots of discretionary built in). Again, thanks for your insight and perspective.
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ruralavalon
Posts: 21087
Joined: Sat Feb 02, 2008 10:29 am
Location: Illinois

Re: Investment Options and Roth vs. Traditional

Post by ruralavalon »

Sftblldad wrote: Mon May 03, 2021 3:31 pmI will be working for the same company DW currently works for so my investment options will be the same as hers.
. . . . .
Questions:
1. With my new job, neither of us will have a total US stock index option. We will have either an S&P fund or Total world. With the difference in expense ratios, are we better off with the S&P 500 fund and an International fund or are we better off with the Total world fund? My concern with first choice is that we have no Small Cap or Midcap exposure. Our taxable and Roth accounts are all VTI/VTSAX so we do have total US there.
The fund choices in your employer's 403b plan are excellent, both of you can use the funds she is currently using:
Fidelity® 500 Index Fund (FXAIX) ER 0.015%;
Fidelity® Extended Market Index Fund (FSMAX) ER 0.036%;
Fidelity® Global ex U.S. Index Fund (FSGGX) ER 0.055%; and
Fidelity® US Bond Index (FXNAX) ER 0.025%.

In my opinion a S&P 500 index fund is good enough by itself for investing in U.S. stocks. It covers over 80% of the U.S. stock market investing in stocks of selected large-cap and mid-cap U.S. companies. In the 29 years since the creation of the first total stock market index fund the two types of funds have had almost identical performance. Portfolio Visualizer, 1993-2021.

If you wish to add some small-cap and more mid-cap stocks, then an 84/16 mix of S&P 500/extended market index funds will mimic the content of a total stock market index fund. Wiki article "Approximating total stock market", link. In my opinion this is not necessary, it is optional if you prefer to do this.



Sftblldad wrote: Mon May 03, 2021 3:31 pmMy wife will also get a pension that has numerous distribution options. Lump sum would be $350k at age 55 or $1400/month. I will not be eligible for the pension but will get 3% in a 401(a) account from the company.
. . . . .
2. At our previous income level, pre tax was a no brainer. Now, I'm not as sure. Whether we contribute pre tax now or not, we are in the 24% federal income tax bracket. Before, we were right on the border line of the 35% bracket.
In the 24% tax bracket, but with a pension expected for the one of you, a combination of traditional and Roth 403b contributions is probably a good idea. Wiki article, "Traditional vs. Roth", link.



Sftblldad wrote: Mon May 03, 2021 3:31 pm3. Are we on track for retirement at ages 59/55? We would like somewhere in the neighborhood of $120-$150k per year in today's dollars during our retirement.
Here are two calculators you could use to assess the range of possible outcomes:
1) www.firecalc.com; and
2) www.i-orp.com.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
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