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Hello - I have a question I am hopeful you can answer for me. My wife and I are 40 and just paid off our mortgage. We carry no debt (credit card, auto, etc). We both have 401ks at work and contribute the company-match maximum (6%). I have about $80,000 and my wife's is about $60,000. We also both have an IRA - mine is a Roth and my wife's is a Rollover. Mine is about $5000 and my wife's is about $12,000. We have about $60,000 in savings, CDs and Savings Bonds too. Now that we paid off our mortgage we are planning on maxing both IRAs out every year. Our biggest concern though now is what is the best thing we can do with our money to cut our tax bill as well as save for the future. We both make about $80,000 and do not have any children nor do we plan to have kids. Any help would be greatly appreciated. Thank you!
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greggor36: "Hello - I have a question I am hopeful you can answer for me. My wife and I are 40 and just paid off our mortgage. We carry no debt (credit card, auto, etc). We both have 401ks at work and contribute the company-match maximum (6%). I have about $80,000 and my wife's is about $60,000. We also both have an IRA - mine is a Roth and my wife's is a Rollover. Mine is about $5000 and my wife's is about $12,000. We have about $60,000 in savings, CDs and Savings Bonds too. Now that we paid off our mortgage we are planning on maxing both IRAs out every year. Our biggest concern though now is what is the best thing we can do with our money to cut our tax bill as well as save for the future. We both make about $80,000 and do not have any children nor do we plan to have kids. Any help would be greatly appreciated. Thank you!"

First, congratulations.

Second, you already get the standard deduction without having to incur any expenses; hard to find a better deal in the tax world.

Last, yoru focus is starting to slide. Cutting your tax bill should not be the real goal; IMNSHO, your focus should be on having ghe most dollars available after paying taxes that are due. The two goals are not the same. I am in a good mood today, so I will omit my standard offer to borrow and not pay whenever you want a bad debt write-off.

Regards, JAFO
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Thank you for your insight! I'll do my best! Thank you!

Greg
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Look at it this way - if you're in the 25% tax bracket, in order to save a dollar in taxes, you have to spend $4 on something. If that's your idea of a good deal, I'll be glad to take $100 of yours and give you $25 back ;)

Unless its something thats 'paying yourself', i.e. 401K, IRA, etc, you're best off letting taxes be a consideration, but not the driving factor.
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I see. Thanks for the input! Greg
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Our biggest concern though now is what is the best thing we can do with our money to cut our tax bill as well as save for the future.

By now I think we've pretty well covered the "don't throw money after deductions; it's dumb" part of tax avoidance. So let's look at some things that you can do to both fatten your pockets and keep taxes at a minimum, always remembering that if you're paying more taxes you're making more money. Borrowing from Martha Stewart, "That's a good thing."

You can hold investments for the future in retirement accounts and regular taxable investment accounts. Where you keep which investments can help reduce your current tax bill. Coupled with this you need to think about your plans. For example, maybe you want to take a special trip to celebrate a special anniversary, or one (or both) of you would like to retire early. As a reformed spendaholic I'm death on nonmortgage debt, so if you anticipate some major spending before you're 59 1/2 you want that money in nonretirement accounts where you can get your hands on it without penalty.

So, back to taxes. Current tax law favors long-term capital gains and qualified dividends. In addition with respect to individual stocks, you don't have any taxable income except dividends until you sell. On the flip side, all distributions from retirement accounts are ordinary income, even if the source of earnings was LTCG. So, a taxable investment account is a good place to hold LTBH securities and tax-efficient (e.g., index) mutual funds. Retirement accounts are a better place to hold investments that yield a lot of ordinary income, such as bonds and REITs.

Phil
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We both have 401ks at work and contribute the company-match maximum (6%).

Unless your 401(k)s have really bad investment choices, a lot of fees, or you are maxed out because of being highly compensated employees, you should each be putting the maximum of $15,500 into your 401(k)s. Assuming you are in the 25% bracket, every dollar you contribute to a traditional 401(k) will drop your taxes by 25¢.

If you have the option to contribute to a Roth 401(k), that won't drop your taxes now, but it will give you more tax flexibility in the future. Part of this decision would depend on exactly where you are in your tax bracket. For instance, if, between the two of you, $20k in traditional 401(k) contributions is enough to drop you to the next lower tax bracket, you may each want to contribute $10k to the traditional 401(k) and $5.5k to the Roth 401(k). With the same $20k scenario, but only one of you has the option to contribute to a Roth 401(k), then the other one could max out their 401(k), and the one with the Roth option could contribute $4.5k to the traditional 401(k) and $11k to the Roth 401(k).

AJ
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Unless your 401(k)s have really bad investment choices, a lot of fees, or you are maxed out because of being highly compensated employees, you should each be putting the maximum of $15,500 into your 401(k)s. Assuming you are in the 25% bracket, every dollar you contribute to a traditional 401(k) will drop your taxes by 25¢.

"Should" seems like a pretty strong word. We have often weighed a taxable investment account against more than the match in the 401K. A taxable account gives different choices in use and investment and at higher incomes, the lower capital gains and qualified dividend rates can be attractive. Contributing to a 401K over the match is something to consider but it's only one tool in the tool box and should be considered in terms of the big picture.

JMHO
rad
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you should each be putting the maximum of $15,500 into your 401(k)s

I wish I could, but my employer's 401k plan doesn't allow employees to contribute more than 16% of their salary, for some reason. (My last employer didn't allow contributions of over 15% to the 401k.) I have no idea why this is.
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The main benefits of a 401K are:
1) Employer match of the 1st x%. For me it was as 50% match of the first 6% of my contribution.
2) Locking it away from you getting your grubby hands on it to buy a boat, SUV, bigscreen TV, etc.
3) Tax deferred growth.

You should always put in enough to get the full employer match----that's free money.

After that, PROVIDED you have discipline to keep your hands off of it, you should stop at the match and put the balance into a taxable LTBH account, such as an S&P500 index fund. Since it's LTBH the ongoing tax is minuscule, so you get the benefit of tax-deferred growth same as the 401K. BUT when you take the money out you'll pay only LTCG tax rather than ordinary income tax. Regardless of that future tax rates are or your future tax bracket, LTCG tax will never be more than ordinary income tax.
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If you max out your 401k contributions you will lower your taxable income and therefore lower the amount of tax you owe. Otherwise, spending money to get a deduction is sort of a win/lose deal. One option is to donate to charity in the amount you used to pay in mortgage interest. That way the money goes to good use for a cause you believe in and you still get to deduct $25 for every $100 you donate. This is more of an emotional rather than financial decision, since you still are out more out of pocket than if you just paid your taxes. However, Uncle Sam is known to be inefficient in getting funds to good causes, where a direct donation may be a better use of funds. You have to research the charities carefully, because some of them are as wasteful as the equivalent government program.
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Regardless of that future tax rates are or your future tax bracket, LTCG tax will never be more than ordinary income tax.

While that is true under the current tax code, it's dangerous to make a blanket statement. Congress in its infinite wisdom could decide to discourage capital investment by taxing long term capital gains at a higher tax rate than other income.

Ira
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Regardless of that future tax rates are or your future tax bracket, LTCG tax will never be more than ordinary income tax.

While that is true under the current tax code, it's dangerous to make a blanket statement.


IIRC there was a brief time, before they got serious about simplifying the Code, after TRA '86 that LTCG were treated as ordinary income.

Phil
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By now I think we've pretty well covered the "don't throw money after deductions; it's dumb" part of tax avoidance.

I'll be a contrarian. Sure, it would be dumb to buy a bigger home than you need just to get a deduction. But I don't think the deduction overall is a dumb thing to use in financial planning. Interest rates are getting very low again. All that equity in a paid-for home just earns whatever the appreciation in value that is occurring for where the house is located. A more aggressive approach would be to refinance the house at low rates and invest the proceeds into something that will earn you a higher rate of return. The deduction would be icing on the cake.

IF
in no rush to pay off his 4.5% mortgage
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Interest rates are getting very low again. All that equity in a paid-for home just earns whatever the appreciation in value that is occurring for where the house is located. A more aggressive approach would be to refinance the house at low rates and invest the proceeds into something that will earn you a higher rate of return.

An even more aggressive approach would be betting the farm on a sure thing in the sixth race at Aqueduct. Sorry, but no matter how much makeup you put on that pig, I still see it as gambling on borrowed money.

Note that I'm putting great emphasis on your use of the verb "will." If there's a guaranteed after-tax greater buck in the bank by borrowing here to invest there, sure, it's a great idea. I just don't see those opportunities.

Phil
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This doesn't make sense. They are restricting your deposits and effectively forcing your to not be able to fund the maximum. I don't get it. Somethings missing....

MZ4
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Note that I'm putting great emphasis on your use of the verb "will." If there's a guaranteed after-tax greater buck in the bank by borrowing here to invest there, sure, it's a great idea. I just don't see those opportunities.

Yes, I should have used the word "may" since I would with legal terms every day and should have recognized my use of words. Usually you have to take greater risk for greater return. I recognize that this is a higher risk way to go. As for guaranteed rate of return, I could do that last year when CDs and money market rates exceeded my mortgage interest rate.

IF
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They are restricting your deposits and effectively forcing your to not be able to fund the maximum. I don't get it. Somethings missing....

That's probably a left-over from some older tax laws.

Some time back, 401k contributions were limited in the tax code to something like 15% or 20% of your earnings. That was in addition to the overall dollar limitation.

A number of years ago, Congress removed the percentage limitation, leaving only the dollar limit. But companies had to amend their 401k plans to allow the contributions over the statutory percentage. (That percentage HAD to be written into the plan, or it would not be a qualified plan.) Not all companies have removed that old limitation completely. Some left it in place, and others increased the percentage.

So this is a bit of an historical artifact left in some 401k plans.

--Peter
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I want to thank everyone for their comments, insights and funny comments! I really appreciate it! I don't have the financial expertise some of you have so there were some things that went over my head but I was able to take away some valuable information from it all.

Right now we're thinking of contributing more to our 401ks - from 6% to 10%. Like I mentioned in my initial post, we both have IRA's. Mine is a Roth and my wife's is a Traditional Rollover. We're going to max them out every year as long as our income stays steady. What is the maximum now...is it $5000/year? Also, can my wife get a Roth IRA if she already has a Traditional IRA and I have a Roth IRA too? I thought I remembered hearing something about only one Roth IRA per married couple or only one IRA/person.

Thank you all again for your help! Any other insight or comments is much appreciated! Thanks!
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Like I mentioned in my initial post, we both have IRA's. Mine is a Roth and my wife's is a Traditional Rollover. We're going to max them out every year as long as our income stays steady. What is the maximum now...is it $5000/year? Also, can my wife get a Roth IRA if she already has a Traditional IRA and I have a Roth IRA too?

IIRC you're both under 50, so as of 2008 your annual IRA contribution limit is $5,000 each, until further notice or you turn 50, when it goes up $1,000. You can have as many different IRA accounts, Roth and traditional, as you like. The annual contribution limit is for combined traditional and Roth contributions.

Phil
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What is the maximum now [for IRA contributions] ...is it $5000/year? Also, can my wife get a Roth IRA if she already has a Traditional IRA and I have a Roth IRA too? I thought I remembered hearing something about only one Roth IRA per married couple or only one IRA/person.

Limit for 2008 is $5000 per individual under age 50, $6000 if 50 or older. You can have as many traditional or Roth IRA accounts as you want, however, the contribution limit applies to the total of all your contributions to all of your IRAs. So, the more you contribute to your traditional IRA, the less you can contribute to your Roth IRA and vice versa. IRA stands for Individual Retirement Arrangement. All IRA rules apply to an individual not to a couple.

Ira
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