Evolution of Wealth » Taxes

Max Out Your 401k Math

Evolution Of Wealth — Wed, 23 Sep 2009 21:15:08 +0000

If your goal is to put as much money as possible into your 401k then you best bet is to fully fund your Roth 401k. The IRS set the contribution limit for your 401k in 2009 to $16,500 and a $5,500 catch-up contribution if you are over age 50. The funny thing is that the IRS doesn’t differentiate between Traditional and Roth contributions. They are not equal.

With a Traditional 401k contributions are pre-tax which means that you don’t pay taxes today. So if you were to max out your Traditional 401k then you could contribute $16,500 or $22,000 if you are over age 50. Simple enough right?

Now is the fun part. If you were to contribute to a Roth 401k the limits are the same. Remember though, that this is post-tax contributions which means you pay taxes today before the money goes in. So if you were to contribute the maximum of $16,500 you would really be putting aside even more income depending on your tax bracket. Let’s say you are in a 25% federal tax bracket. That would mean you would essentially be putting aside $22,000 of your income for retirement. If you were over age 55 that number would be about $29,333. My point is that it’s not apples to apples so make sure you are realizing how much you are contributing.

To take this one step further. You max out your 401k. Either way $16,500 goes into the account correct? It grows at about 7% for 30 years. Using the Rule of 72 we know that it will double every 10 years. So it doubles once to $33,000, twice to $66,000 and a third time to $132,000. Are you with me so far? Good. Here’s the key. If you have $132,000 in a Traditional 401k you still owe taxes on it, at 25% worst case scenario you really only have $99,000. Where as if you have $132,000 in a Roth 401k you really have $132,000.

If you goal is to put away as much money as possible for retirement then you should be taking advantage of the Roth 401k. If it’s not an option for you go to your HR or the owner of your company and ask them to make it an option. In most cases it can be added at no cost. If there are any questions please direct them to me.

One more side not, whether you contribute to the Traditional or Roth portion of your 401k, any employer match will be pre-tax so it will show up in the Traditional portion.

Tax Savings, The Finale

Evolution Of Wealth — Sun, 20 Sep 2009 23:57:35 +0000

Have you been following along? In our attempt to dispel myths surrounding retirement savings and how it affects your taxes, I think we’ve learned a lot. Have you learned some new things? What has been your favorite so far?

Let’s look more closely. We have learned how the Traditional 401k and Roth 401k work. We have also taken a look at what it says in your enrollment booklet. A lot of those booklets mention tax savings that we have been looking for all along. We just can’t seem to find it yet.

In episode I: Tax Savings, Where’s That?, we saw that even if we save the money we don’t have to pay in taxes it probably won’t be enough to offset the taxes we will have to pay later.

Then in episode II: Tax Savings, It’s In The Paycheck?, we saw that saving money pre-tax versus after-tax doesn’t mean you have more spendable income.

In the last reading, episode III: Tax Savings, Advantage Over The Roth?, we saw that, all things being equal, the Traditional 401k equals the Roth 401k in the long run.

With all these things what questions are left? One question you might have is that in episode I we demonstrated what happens if you save the supposed tax savings. Well where is that accounted for in episode III? You might even argue that your better off with the scenario in episode I because you’d have the extra $17,000. The problem is that all things aren’t equal between the two. See in episode II we established equal spendable incomes. Between I and III we have two different spendable incomes so these aren’t apples to apples.

What we are left with is that everything being equal, apples to apples, all things are the same. So it’s the almighty question, if you change the variables how does it affect the scenarios? Let’s look at it.

Taxes are probably the easiest one. If you think that taxes will go up in the future then it is more beneficial to contribute to a Roth. It’s taxed at today’s rates. Does anyone believe that taxes will be more favorable in the future?

The other main thing to look at is distribution regulations. The Roth has the definite advantage here. The biggest thing is not having to take withdrawals after the age of 70½. This allows your money to continue to benefit from tax-deferred growth. There can also be more flexibility with early access of a Roth account, definitely an IRA and depending on plan documents, a Roth 401k, as you may have access to the contributions at anytime.

Now that we’ve looked at some fallacies surrounding your Traditional 401k, has it changed your opinions at all? Is it going to change your behavior? You need to ask yourself where do you want to be in retirement. Is your goal to live off less money? Chances are you will have a lot less tax deductions, if any. There seems to be a trend of taking those away from taxpayers, don’t you think? Maybe you’ll have less expenses, pay off the mortgage? Or maybe you’ll have higher expenses trying to keep up with health care or your hobbies? I mean you need something to pass the time that you previously spent working and if it’s not making money then it just might be spending it, right?

Tax Savings, Advantage Over The Roth?

Evolution Of Wealth — Fri, 18 Sep 2009 22:09:54 +0000

We couldn’t find a tax savings in pre-tax contributions in Episode I: Tax Savings, What’s That?

We couldn’t find the tax savings in our income in Episode II: Tax Savings, It’s In the Paycheck?

I think we might have found it in the classic debate of Traditional 401k versus Roth 401k. You’ll remember in Episode I that our $10,000 grows to $80,000 at 7% over 30 years. When taxes come into play at our 25% tax bracket the $80,000 quickly becomes $60,000.

Roth 401k

The key difference of the Roth 401k is that money goes in after-tax so that growth is tax-deferred and the withdrawals are tax-free. We start with our $10,000 then pay our taxes before we can contribute to the Roth 401k. This puts $7,500 into our retirement account. Using the Rule of 72, again, we know that it will double every 10 years. It doubles once to $15,000, twice to $30,000 and third times a charm, to $60,000.

$60,000, either way we look at it we end up with the same amount. Where’s the tax savings there? Oh your remember that we a good boys and there’s some extra money not accounted for from Episode I. I guess you’ll have to wait for the season finale to get that explained.

To Be Continued…

Tax Savings, It's In The Paycheck?

Evolution Of Wealth — Fri, 18 Sep 2009 14:41:40 +0000

This is a continuation from: Tax Savings, Where’s That?

Well we couldn’t find the tax savings in the first post. However, you remember those enrollment books we mentioned in the last post. They mention having more money in your paycheck. So the tax savings must be there, right? Let’s look at it…

We have our $4,000 paycheck here. We’re going to have our $400 Traditional 401k contribution come out pre-tax. Then we only have to pay taxes on $3,600. Great. In a 25% tax bracket that means we only pay $900 in taxes. That leaves us with a spendable income of $2,700 (4000-400-900). With the Roth 401k the taxes come out first. So we get our $4,000 paycheck and first take out $1,000 for taxes. Then our $300 Roth 401k contribution, that’s $400 minus 25% taxes. This leaves us with a spendable income of $2,700 (4000-1000-300). Wait, that’s the same amount. That isn’t right is it?

We paid less taxes, $900 vs $1,000. Plus we have $400 in our 401k instead of $300. Yeah, we have the same spendable income but this must be the advantages we are looking for. So the advantage is in the Traditional 401k?

To Be Continued…

Suze Orman is Right!?!

Evolution Of Wealth — Sun, 16 Aug 2009 16:23:42 +0000

I can’t believe I just said that. Well if you asked me a month ago if I thought it would be 90, sunny and no rain in Massachusetts for two days in a row I would have said no there as well. It’s not that I don’t agree with some things she says it’s more about the way she makes blanket recommendations to people after them talking for two minutes. I also don’t really like that her recommendations always support her advertisers but I understand that. I just hope other people do as well.

The article I read was in the Sunday MetroWest Daily Newspaper. Anyone out there still read the newspaper? Suze Orman was on the cover of USA Weekend and her article was titled “Suze’s top 6 tips“. Go read the article.

So from her article I am going to give you three things to do to find money.

1. Save a couple thousand dollars a year on property taxes The rules vary from town to town. So visit the assessor’s office and ask for your property record card. Also ask for the process to get your house reassessed due to declining market value. There is usually an application that is due by December 31st and decisions are made in January. Now that you have the property card review it to make sure the information on your house is correct. Then go on zillow.com and see how the assessed value compares. If you feel the two are different, the next step would to be to hire a real estate broker to do a sales comparison or a licensed appraisor. The simply follow the process of your town.

2. Save a few hundred dollars a year on your insurance Dig out your homeowners and auto insurance policies. Call up your insurance broker and make an appointment. If you don’t like or trust your own agent, ask your friends and family for the name of a good broker and schedule an appointment with them. Don’t waste your time by meeting with someone you don’t think will help. Now you want to ask about how much you can save by having both policies with the same company. Then look into raising your deductibles to $1,000. (side note: if you get in a lot of accidents or dents and dings on your car this might not be good for you) Have the broker review your policies and shop them around for you.

3. Stop giving the IRS an interest free loanDo you get a large tax refund? If so, contact your human resources or payroll department at work and ask to increase your exemptions. Instead of getting a lump sum back next April you will see an increase in your paychecks that will allow you to save this money and earn interest on it rather than letting the IRS do it. This is also a great way to help pay down some outstading debt you might have. Don’t spend this money though, save or pay down debt.

There are three easy ways for your to find money. This could easily result in you having a $2-3000 extra each year to keep and enjoy. I also want to commend Suze Orman for telling people to not max out their 401(k). I think this is great advice and couldn’t agree more. What do you think?

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Compounding Interest, Compounding Burden

Evolution Of Wealth — Wed, 05 Aug 2009 14:17:25 +0000

As I read “Savings Account Beckons Investors with Better Rates” from the Wall Street Journal it made me wonder two things. First, do people really think they are getting good rates on savings accounts and second, do they know what they are in for.

I can’t imagine there is a huge buzz because you can get a little over 2% in a savings account. I understand that the article is intended to help people get another percent or more on their savings. The best point it makes is to pay attention. You can’t seem to pay enough attention to banks nowadays. They seem to be increasing fees, dropping rates, or in credit card cases, rasing rates; doing anything they can do to make extra money. They are a business.

I can’t help but think the change isn’t a search for good rates as much as it is fear of what the market will do next.

To my second point. How closely do you look at the christmas present you bank sends you every year? Did anyone just ask what xmas present? I mean the one with the big 1099 in the corner. Well if you just moved all your money to fixed accounts in search of safety you can most likely expect a bigger present. In this case it might not be a good thing. As most people are in search of safety they are shifting to fixed accounts such as saving, money markets, CD and some forms of bonds. Most of these account will pay interest that is fully taxable, the biggest exception being municipal accounts. In the short term that might not be a big deal. A little extra taxable interest but if you either leave it there for a longer period of time or you have a decent amount of money, you might get a very unpleasant surprise at the end of the year.

If you are single and make between $33,950 and $82,250 or are married filing jointly with income between $67,900 and $137,050 you will be in a 25% federal tax bracket for 2009. Plus I live in Massachusetts so that would be an extra 5.3%. Let’s round off to 30%. That means for every $100 of interst you earn you owe $30 in taxes. So let’s say you have $10,000 in a 1-year CD that’s paying 2%. That means next year you’ll earn $200 interest and owe $60 in taxes. Where does this money come from?

Most people pay this money out of pocket. That means it reduces your spendable income. The only other way to do it would be to take a distribution from the CD interest to pay the taxes. I’m sure you’ve heard before that compounding is an investors best friend or something along those lines. If you are paying the taxes out of pocket not only are you enjoying compounding interest but also compounding liabilities. Did you realize you are letting your debt compound? What do you think of compounding debt?

Can you overcome procrastination?

Evolution Of Wealth — Tue, 23 Jun 2009 12:46:59 +0000

I was always told ‘not to put off until tomorrow what could be done today.’ How many times have you heard that saying? What does it mean to you?

What does the word procrastination mean to you? Psychology Today says “There are many ways to avoid success in life, but the most sure-fire way might be procrastination.” That is a pretty strong statement. Think about that. How does procrastination affect your life? Your job? We are all guilty of procrastinating at some time or another, whether it be a phone call, an errand or a project. Sometimes you say you are too busy, other times it’s just not as much of a priority. It all needs to get done.

How about in your financial world? What are you putting off that could get done today? Is it updating your finances? Is it reviewing your investments? Is it updating your wills and trusts? Making sure your insurance is adequate and accurate?

What about taxes? Are you procrastinating there? I know you are. The media, government and investment firms are telling you to max out your 401k. Isn’t tax deferral another form of procrastinating? Aren’t you just putting off until tomorrow what could be paid today? You will be paying the taxes no matter what. By putting money away tax deferred you have an IOU to the government on each dollar you save. What are you hoping for? That you will have less money when you retire? That taxes will go down? Maybe you just like the government controlling the access to your money.

I look around and don’t see much hope on taxes going down. I also know that my goal in retirement is to have more money than I have today not less. In my ideal world I will retire with money that I can live off of for 30+ years and still have some to pass on to my family. That’s what I’m working for. Is it time to stop procrastinating? Is it time to look beyond the misinformation that is crammed down your throat by the people who benefit from it? Or you can sit by and give the government and investment companies control. Let them tell you when and how you can access your own money. If you do a good enough job you just might be able to give well over 50% of your hard earned money to the government. Does that sound fair/right? Is that your goal or are you just procrastinating?

Who Controls Your Retirement Money?

Evolution Of Wealth — Wed, 20 May 2009 19:02:46 +0000

Here’s a Wall Street Journal article on changes in pension plans http://cli.gs/MUSXME.

This is what spurred me to write today. The American public is taught about the great tax savings that retirement plans offer them. Don’t forget the two certainties in life, death and taxes. I’ll save that for a different post.

The regulation around the retirement planning can and will change randomly. In the 1980s the IRS saw fit to add an extra tax on to retirment plan withdrawals. You save your money into a ‘tax-benefit’ account such as a 401k, 403b, IRA, pension, etc. In most cases it’s your money to invest how you see fit. Do you control that money then? In order to receive these so-called ‘tax-benefits” you give the IRS permission to make rules to limit your access to your money. The IRS limits the access to your money for the first 59 1/2 years of your life and then forces you to access your money from age 70 1/2 on. During these restricted times the rules can change without notice. Your money might not be able to change with them. Maybe these time frames will change. What if tax rates go up? Anyone think that can happen?

Did anyone have any big losses in a tax qualified (retirement) account in 2008? In a regular investment account you might choose to deduct some of those losses. You would have that option. Not inside your retirement account.

One final thought…you become the perfect taxpayer with each dollar you put into a qualified retirement plan. All the money in that plan is 100% taxable at the rate the IRS decides. Could it be more perfect for them? How about for you?