$23,500 of New Debt!

I have a confession to make… I have not actually gotten myself into $23,500 of new debt. It’s actually quite the contrary as I’m pushing my savings efforts in 2015 to the limits! I decided at the end of 2014 that 2015 was going to be different, and I was going to max out my pre-tax 401k and Roth IRA. I decided to max them out for multiple reasons which I could not ignore.

Pre-tax 401k – The main reason I have decided to max out my pre-tax 401k is because of awful, ugly taxes! For those who have lived in NYC, or other areas in the US with high income taxes, know how bad we get hit here by the taxman! Living in NYC, you pay about 10% for state and local tax on your income if you’re in the 25%/28% federal marginal tax brackets. I have no plans on living anywhere in the US where the taxes are this high when I retire, and expect my income at that time to be lower. Therefore I will 100% take the tax savings now, and max this account out. The IRS contribution limit for a pre-tax 401k in 2015 is $18,000, and usually increases every few years to keep pace with inflation. Most people think you cannot tap this account until you leave your job and reach the age of 59.5 without incurring penalties, but this is untrue. There are two great methods to draw on this vehicle in early retirement which are the SEPP / 72(t) distributions and a traditional to Roth IRA pipeline strategy. I will not go into detail on these methods as madFIentist and LivingaFI have great posts on these topics which I would highly recommend to anyone trying to learn more about these strategies.

Roth IRA – Direct contributions to your Roth IRA can be withdrawn at any time tax and penalty free. This is a great vehicle to use for those who plan on retiring before 59.5 years old, and even though I have no plans to tap this account until my financial independence / early retirement, I have great peace of mind knowing I can withdraw my contributions tax and penalty free if an emergency situation arose (knock on wood). Also individuals have until April 15th of the following year to fund their Roth IRA, so there still is time in 2015 to fund your 2014 Roth IRAs! The IRS contribution limit for the Roth IRA in 2014 and 2015 is $5,500, and this also increases every few years to keep pace with inflation. There is an income phaseout for the Roth IRA, unlike a 401k, for Modified Adjusted Gross Incomes (MAGI) for single filers which begins at $116k for 2015.

I invest 100% of my contributions into these retirements savings accounts in passive index funds. No stock picking or actively managed funds for me when it comes to my 401k and Roth IRA. I’ll go into further detail on my choices for index funds in a later post, but for anyone doing there due diligence in investing knows that index funds that are not actively managed with low expense ratios are the way to go! I’m also contributing to an HSA in 2015 which is also a great vehicle to save pre-tax income in, but I’ll give this it’s own post in the future.

Now back to my title of this post “$23,500 of New Debt!” I’ve found that if I treat my retirement savings as debt, it is much easier to justify maxing out these accounts, rather then spending it on other discretionary items. I take the “set it and forget” approach with my deferral percentage for my 401k and set it at the beginning of the year to a percentage so that at the end of 2015, I’m sure it will be maxed out. I also have been taking any leftover money after I pay all my monthly bills and depositing them into my Roth IRA. Even if it’s $100 that I know I don’t need sitting in my checking account, it gets shipped over to my Roth IRA. If I treat this $5,500 as debt, I’m less likely to spend it elsewhere as I just think of it as a pesky student loan debt with a high interest rate I’m trying to get rid of! Saving for retirement is essential for financial independence, and a great way to lower your tax liability. Therefore I don’t mind maxing out these accounts as it feels like I’m killing two birds with one stone!

-FF

14 thoughts on “$23,500 of New Debt!

    1. Fervent Finance Post author

      Thanks for stopping by GYFG. I wish I could contribute to a traditional IRA to lower my tax liability even further, but Uncle Sam says I make too much (although I don’t agree). But yes contributing to a Roth IRA hedges my tax liability risk, and is a good alternative, so I can’t complain too much.

      Reply
      1. Gen Y Finance Guy

        Yes the rules around this are frustrating sometimes. One of the things that really frustrates me and makes absolute no sense to me is the fact that my wife doesn’t have a retirement plan at work. So that leaves us with a traditional IRA. But why is the limit on an IRA set at $5,500 vs. the $18,000 for a 401K? Regardless of whether the retirement account is through an employer or not, the contributor should not be penalized. Because if it were $18,000, you bet we would max that baby out like we do for mine.

        Also if you can contribute to a SEP IRA at 25% of your business income for a max of $55,000. Then why can’t employees have something similar? But just use 25% of their salary for a max of $55,000.

        At the end of the day the rules are the rules. So I won’t spend any more time complaining about them. Instead I will just try to play the best game I can and do the best I can within the rules of the game.

        Cheers!

        Reply
        1. Fervent Finance Post author

          Yes I bet that is frustrating, as your only benefit is that income limits are forgiven for the IRA in your scenario. If your wife is feeling real ambitious she could maybe recommend to her HR department that they look into instituting a 401k plan. In most scenarios anyways, the employers pass down the costs of the administration of the plan to the participants anyways so I wouldn’t think it would be too expensive to her employer. But I do know businesses run into problems if they have a concentration of highly compensated employees compared to the rest of the employee population, and run into a few problems if as a result they fail the discrimination test. So maybe the reason to not offer a 401k plan extends further than cost.

          Reply
          1. Gen Y Finance Guy

            She actually works for her mom in a family business. They are considering it, I am helping them look into options to get something set up. Its an office with only 4 employees.

          2. Fervent Finance Post author

            That’s great, much easier to guilt Mom into introducing a 401k plan, than another small business owner! 🙂

        1. Fervent Finance Post author

          Yes Brian I have an HSA as well which I take advantage of. Stinks that the contribution limit for a single guy in 2015 is only $3,350. I try to take full advantage of anything pre-tax due to the outrageous state and local income taxes here in NYC.

          Reply
        2. Gen Y Finance Guy

          Brian, I don’t currently have an HSA account. I currently spend about $425/month for insurance for my wife and I. But during open enrollment in April I plan to evaluate the HSA plan, will probably lead to a post 🙂

          If its not an HSA, I am also going to look for alternatives for covering my wife. Because it only costs $50/month to cover myself and an additional $375/month for my wife.

          Will see if it makes sense for us or not. I am all about saving more on taxes…as long as I don’t start overspending on medical bills 🙂
          Gen Y Finance Guy recently posted…Buy Into Weakness – Investment Rule #1My Profile

          Reply
          1. Fervent Finance Post author

            Just speaking from personal experience, I have yet run into a scenario where an HSA plan is not cheaper than a “normal” non-HSA plan. High deductible plans are so much cheaper to the employer and therefore they usually will incentive the HSA plans as well by contributing employer contributions to the HSA plan. I know not every plan is the same, but I’d be surprised if you didn’t lower your costs by switching.

  1. Financial Samurai

    FF, I responded to your question on hedge funds and asked you several questions. I’m kinda worried now. Have you not been maxing out your 401k already? If you can answer my questions in my comment that would be great, b/c I thought from your statement you’ve been investing for decades.

    Thanks!

    Sam

    Reply

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