A few questions have come in more tailored to personal finance and one item that keeps coming up is 401K distributions and contributions. This blog does not advocate usual advice which is to “max out and wait” because this likely limits your mobility, your assets are tied up in taxable income and of course if you’re still worried about income at 60 you’ve chosen the wrong career. Here is a good guide for someone who is going to join the work force and wants to maximize his liquidity.
Year 1: The thing about jobs after college is this… You’re only working half of the year. This means you have minimal taxes because bonuses are generally not paid until January and even if they are paid in December you’re not getting a full year, it’s just a stub payment. So if you’re starting in June/July here’s a non-conventional move… Max out your 401K in the half year.
Why? The reason why is you’re forcing your income bracket down a peg. You make maybe 45K in total ($10K sign plus your 35K or so for the half year) which throws you into the 25% income bracket, which starts at $36.250K. That is a 10% increases from the 15% tax marker under this level. So in short, max out your 401K if possible in your first year or at minimum enough to remain at the 36.25K level.
The $10K Rule: This is the amount of money every single person should have in their 401K.
Why? There are many workarounds. You can draw down $10K for a home (which we advise you do not buy right now) and you can also use this as a water mark for high deductible health care. The last part is likely confusing, so what we are referring to is the idea that you should choose the cheapest healthcare at your firm that has a higher deductible closer to the $5K mark. By having $10K in your 401K account if you have a real accident, you can use the money for medical purposes.
For medical expenses exceeding 7.5% of your adjusted gross income you can use the money without penalty. Also you do not need to itemize the items in order to claim the medical exception.
Company Match: This level of investment is the water mark for how much you should absolutely contribute every year. If your company has a 5% match, you should always contribute 5%. This is free money. If you are making $100K a year, that’s is $5K on the table, 100% returns for simply delaying 5% of your spend. A no brainer transaction.
Rollover To Get Liquid: Assuming you’re good at your job, you’ll likely be jumping ship after 2-3 years unless you get promoted. Roll your 401K over to a Roth IRA on December 31.
Why would you do this? The answer again lies in liquidity and taxes. Ideally you’ll have somewhere around $30-40K in your 401K by the time you jump ship and you’ll make somewhere around $150K. So if you run the math correctly your rollover and tax payment will be just under the $183.25K tax bracket. If you hit the number on the head then you’re looking at paying the normal 28% tax on the rollover. Next year you’ll be closer and closer to the 33% bracket so do it as soon as you jump ship.
Why December 31? The reason is the way taxes currently work for the Roth. So now that you’ll be paying taxes on it you likely want it to be liquid as fast as possible. If you roll on December 31 this counts as January 1, 20XX. This means in 4 years and 1 day you can take out the entire principal tax and penalty free. Now you’ve got even more liquidity and mobility in your life. It is called the “5 year rule” but really it should be called the 4 years and 1 day rule if you play it smart.
Investing: Notably at the age of twenty five or so, you’re still unlikely versed in investing so you should stick to a 7% or so return profile. In another 5 years or so, you’ll be much better positioned for a more aggressive investment approach.
Wow thanks, on a roll with the finance posts. Never knew that it was only about 4 years that you have to wait out, now that I think about it, it makes no sense not to be more liquid with my cash.
I’m still in college and I am so afraid of when I get my first job what I am going to do with the contributions and rewards and shit!
It seems like there are so many tricks you have to be aware of and ready to take advantage of and I’m worried I’ll never figure out how to pool my retirement fund and make it into something amazing.
I’m scared of the market. I’m scared of the state of the economy. And the more stocks rise the more afraid I get, people lost so much on their retirement fund when the financial crash happened and it still hits too close to me. I don’t know a single safe place to put my money and I’m starting to think about going into zero coupon treasury strips or buying an index of the S&P or just buying blue chip dividend stocks and making a portfolio of thirty of them.
Those same people who lost so much money in 2008 would be richer now than they were before if they never sold in the first place.
Fear is how you lose money.
You need to control your emotions and have enough money so that you are unphased by 30%+ swings in your portfolio.
Playboys give me a straight up answer, what would you do with 5.8K in savings just sitting there in the bank if you were a poor college student? IRA? Scottrade? Fidelity? Vanguard? Help a baby out…
Go check out our post on college student finance no debt. Sounds perfect for you. If it doesn’t answer feel free to ask another question over there. Most of your concerns are addressed here:
http://wallstreetplayboys.com/personal-finance-college-student-no-debt/
With $6K liquid and a young person you’re far and away ahead of your peers. Your fear of fincancial distress is pure paranoia and baseless. You are fortunate.
Also if your working on a visa / not planning on living in the USA in several years, you can do a tax deferral by putting money in your 401k and withdraw at a much lower rate once you have left, even without the penalty.
For example, your taxed marginally at %40 right now. You can avoid those %40 taxes now and then withdraw later on at %10 federal + %10 penalty (%20) and save %20 on taxes over a span of several years depending how much you have in your IRA. Since they’ll be in an IRA style account, you can still invest the money too.
Good one. Savvy.
WSP,
These personal finance posts are spot on for your readership- Personal finance is a discipline that has been discarded in generation Y and especially for the Millennials. Anyone who can master the art of money management and investing will exponentially rise above, financially speaking, the others in this age group. You’d be surprised at how many people my age (22) who still do not even have checking accounts. THIS is what young men need to be reading about, not some hocus-pocus alpha inflating method of looking away from people who are talking to you method of attracting women. *Shakes head and looks at the ground*
Anyways, for the quick and dirty for rollovers; you are essentially being taxed on all of the deferred income plus the interest that you have accumulated over the years in your 401(k) plan (403(b) and 457 plans included in this). It will come through on your tax return as if you were to withdraw that whole amount (treated as income!). As you know, this will increase your taxable base and your marginal tax rate. The trick to keeping your tax liability as low as possible is effective tax planning. That is to say, if you have an increase in income in one place (the rollover amount)- you must try your best to offset this will less income elsewhere via deductions.
Shoot us an email when you have free time.
Some ways to lower your taxable income:
-Max out 401(k), as discussed before. This will defer income and make it seem like you made less for the year. This can be up to $17,000, depending on income level.
-Max out Health Savings Account (HAS, MSA); max at $3,100 for self coverage, but still.
-If you have a small business, rental, or farm (loosely defined); take on any capital investments that you foresee future benefit from. Example: Purchase new assets as depreciate them using bonus depreciation or section 179. This would definitely be a good year to claim a loss. Plus, you’re buying shit you would be buying anyways. Don’t just purchase useless items for a write-off.
– If you do still have a gain on your small business, max out your SEP/SIMPLE; you can also include long-term care premiums in this amount. Not many people know this and will put it as an itemized deduction. It does a lot better for you in your schedule C (reduces self-employment tax).
– If you are currently investing or have a financial advisor, do not sell of any stocks at a gain. Instead, comb through your investments to find the dogs in which you see a capital loss. Sell off these stocks (which you’d probably want to sell anyway) up until the point you reach a $3,000 loss. This is the maximum amount of capital loss you can claim per annum. Down goes your taxable income by another $3k. Was it out of pocket? No, not necessarily-Just some shitty investments.
These are all above the line deductions. These will lower your AGI, which is an important figure for calculating items in your schedule A (Itemized deductions).
I would always advise young men to be lean financially and also be taking the standard deduction, but this situation would be applicable to maximize expenses (that are necessary btw).
-If you must, buy that new car this year instead of next. Itemize the sales tax on the purchase (could be a decent amount if you’re rollin’ mean)
-Get that dental work done that you’ve been putting off. Go to the doctor and get your physicals/bloodwork/etc. If your knee has been bothering you for quite some time, do the surgery this year instead of next. These are medical expenses (subject to 7% of AGI see the connection of a lower AGI now?)
-If there are transaction fees associated with the stock sale listed above, deduct those- same with management fees from your advisor. If you paid your accountant, this fee is deductible as well.
-Chances are, the reason you’re rolling over your 401(k) is because you got a new job, the rhino in the living room here is job search expenses. This includes mileage, employment agency fees, interview items, resume refining, etc. etc. Good accountants can get pretty creative here. Last year, we wrote off a custom suit for a woman to wear on her third interview that was in said company’s corporate colors. These expenses really added up. Also look into unreimbursed employee expenses (subject to 2%).
-If you own a house and property taxes are due around the end of the year (think October, November ish)- delay the previous year’s payment until January of the current year (even if there is a small fine). Then pay the current year’s property tax that November. This way you are double dipping and paying both in the same year (higher itemized deductions). Usually the late fees are not very substantial. Look at Florida for an example of this.
-In terms of charitable donations, some people will piss away their cash for an attempt to reduce their taxable income. This is a fool’s errand as most tax-exempt entities are corrupt (financially speaking). Why would you expend cash at 100% in order to receive a 25%/15%/10% deduction on that cash. Stupid. Instead, go through your closet and find clothing that you no longer wear. If it is nice and in good condition, you can have the lady at Salvation Army or Goodwill appraise them as such. Same with old golf clubs/couches/etc. Basically shit you don’t use anymore but you don’t have time to have a garage sale or deal with Craigslist weirdos for. Believe me, most people working the register there have no idea what things are worth nowadays. Come in looking sharp and name a price that you feel fit (be aggressive here) and they will issue a receipt near that amount. Also, charitable miles- Driving your nephew to a cub scout litter pick up in the next state? Record the miles and that $.14 per- these can add up.
Doing some or all of these tactics during the rollover year can significantly decrease your tax liability.
Those just getting out of college: Get a Roth IRA and a 401(k) – in your low income years, contribute to the Roth and grab the retirement savers credit on form 8880. It is essentially a 10% built in subsidy from the government (worth checking out). In your high income years, you do not want to pay the tax right away (roth)- deferral until later years is a better tactic. The thought process behind this is that you’re deferring income when you’re in the 30%+ bracket to when you retire and you fall back into the 10% or 15%- This is significant savings over time.
Yep. More announcements on personal finance to come.
Agree on bogus tricks to get girls. If you notice we rarely talk about crazy lines and feathers and focus in on choosing venues, reading body language, improving overall social skills.
So agree with the magic part, but every man needs social skills and women are half the audience. If you can’t get girls you sure wont be able to sell on Wall Street.
I’m getting ready to rollover about 200k into a Roth ira, but I can’t find how you can withdraw after 5 years without penalty. You have to be over 59 1/2 or a first time homebuyer to withdraw penalty free according to the documentation. Is there a piece I missed?
Yes… Simply Google 5 year rollover or call your tax specialist at the brokerage firm you have. They will confirm. You fill out a form 8606 if you withdraw the principal to avoid penalty.
After you roll it you will be fine.
If you do it today. You can take out the *principal* in 5 years.
Note, of course you do pay taxes on the actual rollover since the rollover was all pre-tax contributions.