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« Giving 101: A Crash Course on Biblical Giving, Part 3 | Main | Develop a Broad Network »

January 23, 2012

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Have you thought about doing property management? If so, you could use the savings to buy a rental property. That will keep you busy in retirement, diversity your investment in ways that whatever happens to the economy you'll be covered, give you more tax advantages, and possible gift options to your kids in the future.

In addition to Luis' advice, I'd take the CDs and a chunk of the brokerage cash and make a point of paying down / off the mortgage. You could probably do it in a year or two, with bonuses.

We bought in cash a few years ago (@33 and 32), and the peace of mind is outstanding. It basically eliminated all my career stress.

Like yourself, I am sitting on cash in CD's and money markets that I wish I could get a better return. As I have 4 kids (one in college and another one soon to be in college) I have left e cash alone.

One thing to think about is paying off the mortgage early. If you take the 2500 a month and put it towards the loan, you will pay off the house in 6 years. Any bonus payments applied, will make that even shorter.

Could you refinance? I think a 15 year term would be better as you would have a paid for house much sooner. Maybe you could even get a better rate.

Like you, I'm not too much of an investor in the markets outside of my retirement accounts. I have all of my non-retirement savings in Ally bank 5 year CDs earning 2.4%. Not as good as the 8% that you could possibly make in the stock market, but better than the 1.2% you're getting now.

The thing I like about the Ally Bank 5 year CD is that the early withdrawal penalty is only 2 months of interest. If you calculate it out, as long as you don't touch the money for about 120 days after you open it, you will make more money than you would in a 1.2% savings account, even if you withdraw early and take the penalty.

If you don't have it already, I'd recommend having a very strong CPA to help with the tax planning. Not just the paperwork, you need a professional to regularly discuss the various options and implications/risks. You can of course increase your witholding to not get a large bill at tax time. It also sounds like you need some write offs. Something with lots of deductions, but doesn't take a lot of time, which I'm assuming is very short with both of you working and soon two children. I love rental properties, but you would likely want to have professional management. But there are many other options, a side business, charities, etc...

You guys are doing quite well - I want to be in your position when I'm your age :)

You say that you are no longer eligible to contribute to the Roth IRA. It looks like you don't have any Traditional IRAs, so you should be able to do so using the backdoor: http://www.bogleheads.org/wiki/Backdoor_Roth_IRA I like this idea because the alternative (for me at least) is investing in taxable accounts and at least this way, I know I'll never pay tax again later. Plus, who knows how long this loophole will be around for?

I am totally with you on not assuming the bonuses will happen! I certainly wouldn't be saving much beyond my 401(k) if they didn't happen, but I set my monthly budget completely assuming they won't and it's played out quite nicely so far.

Are your CDs earmarked for something? $100,000 is quite a bit to have in cash savings/CDs on top of the $90,000 that you indicated was your emergency reserves. I would either throw this at the mortgage or invest it. Once you have the mortgage gone, that would really help with the high cost of childcare each month and then you would have more room to save for college.

Get a rental -- mortgage interest (if applicable) + cost of upkeep + depreciation = great tax shelter!

One comment in response to texashaze - If they OP gets a rental, they need to be sure the property has positive cash flow (including upkeep and depreciation). At their income level, they can't write off rental losses.

KJ,
Given your high income and thus high tax bracket Tax efficiency is really important for you. You stated that AMT is costing you $14K/year- consulting with a CPA that specializes in AMT should pay for itself if they can to give you strategies to avoid AMT.
If you can’t totally avoid AMT completely - then perhaps you can avoid it every other year by changing the timing of AMT triggers. For example if exercising stock options every dec triggered AMT for you, instead of exercising every options every year in Dec one year exercise nothing then exercise twice the next calendar year- say Jan 1st and in Dec. In the years you don’t have AMT you maximize the disallowed deductions.
CDs are NOT tax efficient, I understand wanting to have a real cash emergency fund, but not only do you earn almost no interest but you will lose a lot of that to taxes. I’m sure that $100K is losing a few %/year due to inflation and taxes. Another good reason to consult with a CPA- they should be able to steer you to more tax efficient investments.
Roth IRA- you can no longer directly contribute but you could do a conversion to a Roth IRA. Note: You should be careful here- your income is very high so converting to a Roth only makes sense if you are really sure your income will be high enough in retirement that you would be in as high a tax bracket. To get a $260K income with a 4% withdrawal rate you would need a balance of $10.4 million dollars. If you would stop working long before reaching that amount I wouldn’t bother with the Roth IRA.
-Rick Francis

You state:
"Between the cash savings and CDs- we have about $191K sitting there earning, at the most, 1.2%."

I am also a father-in-law and a father that has trading authorization over his family's investments because of my track record over the last 20 years since I retired.

Right now the best low volatility mutual funds, if you are interested in income rather than capital gains, are municipal bond funds.
My first choice is: Wells Fargo Municipal Bond Inv CL(SXFIX)
It's yield for 2011 was 4.52%, free of federal taxes, and its volatility and 'max drawdown' is easy to live with. I even have some of it in our IRA accounts because I find that corporate taxable bond funds have volatilities that far exceed my comfort levels.

Kevin,
Contribute to a tradition IRA. You'll need all the money you can for retirement. I'd keep the 30-year mortgage and pay extra per month; that's insurance in case something happens to your wife's or your job. It also gives you more wiggle room in the monthly budget. Keep a good cash cushion, just in case. Don't make the mistake of moving into a larger home unless you're really squeezed in your present home. Finally, keep up the good work!

KJ -

I would recommend putting together an asset allocation profile on the Bogleheads (bogleheads.org) investment forum. The community there will give you great recommendations for your taxable and tax-deferred/tax-free spaces.

You say AMT hits you every year and you pay "about $14K on top of our withholdings". First, if AMT is hitting you then I really do not think AMT alone is costing you $14,000. Your witholdings are probably too low. What you pay for witholding doesn't really have much to do with your actual tax bill. Your normal non-AMT tax bill could be very close to the AMT bill, so AMT may not be costing you much above the standard tax rate. There isn't enough info here to know whats going on but theres not much in the way of deductions.

Second, From the info given I'm not sure how AMT how you'd owe AMT tax. I don't see too much in the way of deductions. So there must be some deductions you're not mentioning? AMT is lower than the tax rate with standard deductions. Its often lower than the tax rate with some itemized deductions. So in order to have AMT tax bill you would have to have a lot of deductions. THis is my understanding at least... AMT is complex. :(

@jim: AMT can hit if he has high capital gains, exercises stock options, has high state or property taxes, etc. SOme deductions don't count and there is a phaseout of the AMT exemption which can make the effective rate on dividends and cap gains 22% instead of 15%.

Mark, Yeah one or more of those things might explain why they'd have AMT. But we're missing detail here. Still I question how AMT would cost them $14k more over standard taxes. He says AMT costs $14 above witholding. But that doesn't mean AMT is $14k more than the normal tax liability.

Wow, thanks everyone for all the great advice!

I have thought about a rental property, but need to educate myself more on this before I take the plunge. My personality also doesn't lend itself well to buying a place and letting someone live in it and possibly trash the place.

@Rick- I have an old 401(k) that I rolled into a Rollover IRA. From what I understand, if I contributed to a non-deductible IRA, then tried to convert, I'd be subjected to the 'pro-rata' rule that taxes all IRA funds?

@OldLimey- thanks for your advice. I'm a long-time fan of yours. Would you also recommend VFIIX for some of this extra money? I think I remember you mentioning GNMAs before.

@Carol- I agree that sticking with a 30 year mortgage makes sense from a security standpoint. We will throw some extra $$ at the principal when we can.

@Jim and Mark- you're right- AMT doesn't cost us $14K, rather AMT cost us $6315 last year. I think we may need to up the withholdings more. But I might rather just keep some of that money and try to get some return on it before I hand it over to Uncle Sam every quarter.

For deductions, we have the usual mortgage and property taxes, then charitable giving, etc. Stock options get us. We exercise those every spring instead of leaving them in company stock. That's a likely culprit.

Thanks everyone for your time. Greatly appreciated!

KJ - on the Rollover IRA, you are correct. That will get you on the pro-rata rules. Sadly I know from similar experience. However, if you have not added to it since rolling it over (i.e. made IRA contributions to it) then you may be able to roll it into your current employer's 401k plan, depending on the plan's rules. May be something to look into because it can get you out of that situation and back into a situation where you can do a backdoor Roth.

Also to note, your IRA account and your wife's are separate. This means that as long as your wife did not do a rollover IRA she could still do the backdoor Roth without worrying about the pro-rata rule.

As an aside, I have never seen this exact topic addressed in any financial magazine or website that I have read. Everyone urges you to do a Rollover but they never mention this consequence.

CPA- you're exactly right in my experience- I never saw this addressed at all when many publications discussed the ROTH conversions. Luckily, a financial planner that I happened to speak to told me to be careful with conversions. I have opened a non-deduct IRA for my wife and will convert. Thanks!

Ah, ok if you have ISO options then that would explain the AMT issue. Thats the detail I was missing. My understanding is that ISO options are NOT subject to normal witholding when exercised and you're allowed to hold them and potentially only pay capital gains. However the spread for ISO between grant and exercise IS counted when figuring AMT. So you would effectively have a large income source that isn't being taxed ordinarily but is caught by AMT. Seems that if you exercise an ISO for enough then you'll likely be hit with AMT. ISO spread is one of the things that AMT is actually meant to catch. ISO's could potentially be better for you cause they allow you to potentially only pay capital gains 15% tax rather than regular marginal income tax.

NSO options on the other hand are taxed as regular income when you exercise them, so no AMT cause you're just paying normal income tax on the profit. (I get NSO options at work)

I agree with Rick about talking to a CPA. You might want to see if you can find a CPA who is good with handling stock options and and see if they can help you structure it best to minimize the tax impact.


ref :
http://www.nceo.org/main/article.php/id/16

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