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June 28, 2012


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My advice would be to invest in a normal taxable brokerage account. If all of your money is in retirement accounts and you need some of it before retirement you are going to have to pay penalties to get it out in most cases.

Beware of exceeding your 401k annual allowance, you may be taxed twice on those overages. Save the money in private investment accounts of your choosing and have the freedom to use that money whenever and however you please, regardless of age.

A good problem to have indeed! The current tax law has a loophole for high-income earners that allows them to contribute to a Roth IRA no matter their income. All you do is contribute to a normal IRA (which will not be deductible) and then convert it over into a Roth IRA. Prior to a year or two ago there was an income limit on converting normal IRAs into Roth IRAs.

Once you use up the extra $10k of savings that will give you, just put the money into stock index funds or index ETFs. Having the investments in taxable accounts is not a big deal as long as you are invested in low-turnover index funds.

(Disclaimer: I'm no accountant or tax lawyer)

backdoor roth:

then, just a regular, taxable, brokerage account with index funds.

Pay off your house.

Think about early retirement.

I would definitely utilize the full $34k in the 401k accounts and take advantage of the traditional IRA, as well, because tax advantaged is tax advantaged. After that, keep it in a taxable account so you can use it for early retirement or a sweet yacht:)

Maximize pretax 401k money, save the rest in a taxable brokerage account. You can't contribute anything else to a Roth 401(k). The 17k contribution limit applies to the combination of the two accounts.

I'd suggest you get a high deductible health plan and fully fund an HSA. I believe that's $6200 for a couple. The HSA is funded with pretax money and withdrawals are tax free for health expenses or at 65+ they have no withdrawal penalty for any purpose just income tax. So if you save it until retirement it works like a 401(k)+Roth if you spend the money on heath care or just a normal 401(k) if you don't. Plus you can withdraw it at anytime before that for health expenses. Most employers offer an additional contribution too. For most high earners the tax breaks make it a great investment option, fully fund it and just pay out of pocket for medical expenses, it makes even more sense for a young couple.

Aside from that welcome to the world of paying US income taxes as a high wage earner. You can do many things to try to reduce your total tax rate but that's usually tinkering with the marginal rates you are paying. Once you fully fund and HSA and 401(k) you're essentially out of options to completely avoid taxes.

I would max the 401k and IRA first. Then for any other money you can save I'd consider alternative non-retirement accounts.

I don't see a particular benefit in investing non-deductible 401k/IRA. You lose the tax dodge but that money is still locked into the retirement accounts.

You could buy stocks or funds in a brokerage account. You could buy real estate or bonds individually. These would generally be taxable. But if you look for investments with long term capital gains more then you can at least defer taxes and might get a cheap rate (unless capital gains goes up).

You could also switch to an HSA for health insurance at work if available like Bill mentioned. Thats an opportunity to save ~$6000 more tax sheletered. If you don't use it for medical care you can withdrawal it after retirement age.
You have kids or plan on it? You might start putting some money into 529 plan to save for college? If you don't have kids yet you can put the 529 in your own name then switch the beneficiary to your child later.

I don't know why you would like to put money in the 401k, if you are not getting a tax break. Put the $17000 each in your 401k and then put the rest in a taxable fund.

soners-thanks so much for the link, I'd not heard of a nondeductible IRA and converting that. That will help us!

To elaborate on Bill's "the HSA is funded with pretax money"... this means outside payroll taxes such as Social Security and Medicare.

If you have a range of investments, try to ensure that the taxable account holds the ones least subject to tax. (e.g. non-dividend paying stocks, low turnover mutual funds or ETFs, etc.)

Regarding converting your traditional IRA to a Roth, be aware that if you have past Traditional IRA contributions that have gained in value, your conversion will trigger taxes on some of those. For example, if you have an acount worth $45K, then you add $5K this year, when you convert the $5K to a Roth, the IRS will force you to assume that you converted $500 from this year and $4500 from your past account balances, i.e., porportionally. Even if you open a separate account, you cnnot declare that you have converted only the new account and avoid the tax on profits on the old balance. Also - that tax is at your marginal income tax rate, which for you will probably be 35%, not at capital gains rates.

Most employers won't allow you to put in more than 17K. Most also won't match in pay periods where you don't put anything in so you need to spread this 17K out over the whole year to get your full match. Be careful with this or you lose free money.

If your employer lets you put in over 17K that's generally very bad for you. You pay tax on excess over 17K when it goes in, you pay tax on it again when it comes out and you pay tax on all the earnings on it when they come out. This is what could accurately be called a tax DISadvantaged vehicle. It would be hard to come up with a scenario where this was a good idea.

Here is what I recommend you do.

1. Max the 34K 401k over the entire year so you are sure to get the full match.
2. Put 5K for each of you in a non-deductible IRA each year and the convert to a ROTH.
3. Put the rest in non-tax advantaged investments.

Tax deferred vehicles are nice but they have restrictions on use. You are only 29. Do you really want to turn 45 and have 2 million dollars in tax vehicles that you can't access for another 15 years? By the time you turn 45, doing what I suggest will have 750K in contributions into tax deferred vehicles. With returns you should have over 1 million in those accounts. In my opinion that is more than enough locked up in those kinds of accounts.

By 45 you might have different ambitions, different goals, different ideas about what to do with your life and your money. If you found a way to lock up most of your money in tax deferred accounts, your options would be very limited.

Not only that but if you have that much money in tax deferred accounts you will have large taxable withdrawals in retirement. You may find your tax rate higher then than now if you do that. Your retirement is too far away to attempt to put too much money into these accounts.

Do not worship at the alter of tax deferred vehicles. They make a poor god.

What Apex said.

Also, another type of "tax advantaged" asset that I don't see mentioned above is real estate - right now obviously there are some screaming deals in real estate, and as property appreciates you can sell it and do a 1030 exchange into another more valuable property (as a down payment or otherwise), and continue trading up indefinitely. You'll earn income on the property forever, and if you so choose, years down the road you can donate the property and never be taxed on the appreciation from your initial investment made today. You are taxed on the rental income of course, but no sense getting rid of income to avoid being taxed on that income.

I am in similar situation in terms of assets and tax issues. Although this year I bought an apt. so I'm hoping that will help w/ the tax bill a little. I know I might lose some of the deduction due to AMT, which I'm guessing you would be subject to as well.

1. Look into a backdoor Roth IRA and leverage that to invest into two Roth IRAs (one for you and one for your wife).
2. Consider I-bonds and/or TIPS.
3. Open a taxable brokerage account and look into tax efficient fund placement to maximize gains across different types of account.

You can read up on all of that on the Bogleheads wiki.

There are may factors that you have left out in this post.

Housing debt, other debt, goals of kids or not, etc.

Keep up your max of everything but eliminate all other debt.Go ahead and pay off your house. be contrarian to the common belief. It is liberating. Save for the rainy day and then save more. If you want kids then save for that. They are not cheap.

But also have some enjoyment in your blessing.

There are some attractive municipal bond mutual funds that invest in bonds of a particular state, thereby making them double tax free.
My database shows funds for MN, MD, GA, MI, and OH with annual returns for the last 12 months ranging between 7.42% - 9.97%.

Since I live in CA, my favorite is BCHYX yielding 12.99%.
However you failed to disclose the state in which you live.

Pay off all your debt, including your house.

As others mentioned, an HSA is a fantastic tool for retirement planning and sheltering income from taxes.

Beyond that, pay off the house and any other debt.

I second the other suggestions to max out the 401(k)s and backdoor into Roth IRAs. If you feel you're playing catchup with the IRA contributions, see if either your 401(k)s allow in-service withdrawals. If so, you can make after-tax contributions (not the same as Roth 401k) then rollover into your Roth IRAs.

Of course, this assumes you have a 6-12 month emergency fund and no non-mortgage debt. If not, those should come first.

I like all the advice given so nothing to add there. Make sure you don't decide that a whole life policy or some other kind of rip off insurance product is your key to tax avoidance. Don't even talk to your insurance people about it as their pitch will sound so go you'll be back here with another post about their great deal.

I invest my taxable savings in real estate and it has worked out well. Eventually all the properties will be paid off and they will generate a nice retirement income stream.

Invest $17,000 each into your 401k. The match and profit-sharing contributions you are receiving goes against that $50,000/year limit. After that, I'd invest $5,000 each in a non-deductible Traditional IRA, then convert it to Roth IRAs. Keep at least 3-6 months of your after-tax savings in liquid accounts for your emergency fund. Look at paying off your home early and put the rest of your savings in a taxable account in tax-effificent, low-cost index funds.

Make sure you have a solid insurance portfolio. You want to protect that strong income stream (disability insurance & liability) and all the hard work you have done to build your netowrth! Also have adequate life insurance. For disability insurance, make sure to get own occupation or modified (avoid any-occ!) with benefits indexed for inflation and up to retirement age. If you don't have a personal liability umbrealla policy (PLUP), get one for $2MM or potentientally more depending on your net worth (these are pretty cheap but might require increasing your liability coverage on your auto and homeowners).

You are in a great position and have obviously worked hard at both your jobs and not submitting to lifestyle creep. Keep it up!

I would look into starting your own business.. either real estate, consulting, anything! that can really make you money. That way you can REALLY contribute to any retirement you wish. (the real estate can work to your advantage with depreciation on the property helping to lower your taxable income.)

For self employment retirement, look up "SEP-IRA" and "Solo 401k", which allows contributions up to $49,000 per year.

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