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My incredible shrinking paycheck

January 16th, 2015 at 10:32 pm

Last year I was funding a traditional 401k from my paycheck. Today I got my first paycheck after having switched from funding the (pre-tax) traditional 401k to an (after tax) Roth 401k.

My net bi-weekly paycheck has remained almost exactly the same, at about $1204! I thought I would net much more because I reduced the overall contribution from 25% to 22.5%. Yet I'm paying an extra $350 in taxes each paycheck just because I'm having to pay taxes upfront on the Roth 401k contributions..

I was paying just $476 in taxes per paycheck with the traditional 401k contributions as opposed to $825 now!

Still, I'll be netting $2709 a month in pay and with my expenses sometimes as low as $2,000, I should have sufficient cushion.

I wanted to put more money into a Roth account as I am quite top-heavy now with much more $ in traditional IRAs, and after having read a number of articles about withdrawal strategies that minimize taxes, I know I need more money in Roth accounts to do that.

Say you know you'll need to withdrawal a certain amount a year for living expenses in retirement, like $40,000. By being aware of tax bracket cut-offs, you could make sure you stay completely in a lower tax bracket by simply withdrawing whatever excess you need over the lower tax bracket limit from your Roth account. (In this case, the 15% tax bracket peaks at $37,450, so you'd withdraw the overage of $40,000, or $2,550, from your Roth.) So by withdrawing a combination of both traditional and Roth IRA/401k monies, you can minimize your taxes; over the years, it could become a significant amount. Of course, it also depends on where your income needs fall in the bracket and how much you need to live on. I mean, the 25% tax bracket goes from $37,451 all the way to $90,750. For me, knowing my annual income needs are right around $40,000, perhaps up to $45,000 if I travel, I would want to have some Roth money to withdraw to avoid bumping myself into a higher tax bracket on anything over $37,450.

Now I suppose MonkeyMama or Dido will tell you you'd be taxed at the 15% bracket up to $37,450 and only the $2,550 would be taxed at the higher 25% bracket. But if my income needs were higher, say $45,000, then we're talking paying 15% taxes instead of 25% on $7,550. A little extra attention to details would be worth it to me.

Around the holidays I bought myself a very nice mug from Stash Tea. I'm a big tea drinker so my mugs are important to me. Smile This one had a rabbit in a woodland on the outside, and the image was repeated in miniature on the inside.

Well, I just don't know what happened to this mug. I've looked absolutely everywhere for it. At one point I had brought this mug in to the office and kept it there as my office mug. Now it's possible I left it on the desk before I locked up my drawer at the end of the work day; it's where I usually store personal possessions. So while I think it's unlikely it was stolen (becus I've left out so many other more valuable things) it's the only conclusion I can come up with, simply becus i can't find this mug anywhere.

I spent more time thinking about it than probably was worth it, but since i got out of work at 3 today, I had to scoot over to a gift shop in town where I had seen the same mug. I was hoping they might be having an after-Xmas sale and I could just buy it again. Turns out the mug wasn't on sale, but i bought it anywhere, plus the matching mug with a fox on it. (I like woodland animals I see in my own backyard.)

Although they weren't cheap, they cost about the same as they would have cost on the Stash Tea website, after you factor in shipping. So I got 2 mugs I really like. Murphy's Law being what it is, I will probably find the original bunny mug, but maybe not. Maybe someone took a liking to it and made off with it. I hope that's not the case and i sure would like to know one way or the other. I need closure. Smile

I was delighted to fill up my oil tank today to the tune of $2.15 a gallon for 166 gallons. I haven't paid less than that since March 2009. I charged it on my new AARP card, easily hitting the $500 spend target (I only had $200 more to go), thereby earning the $100 credit.

Happy Friday!!!!!!

16 Responses to “My incredible shrinking paycheck”

  1. ThriftoRama Says:

    I think the Roth is a wise move. We've been meaning to stash more in ours. It's always a good idea to diversify not just in investments, but in tax status.

  2. Petunia 100 Says:

    Looks like you have forgotten about your standard deduction and personal exemption. If your income is 45k, your taxable income is at most 35k. Smile

  3. Petunia 100 Says:

    Here's another strategy to consider. You have 48k in taxable. In your first full year of retirement, you could take 45k from taxable to live on, then convert 45k of traditional to Roth. If you don't want to wipe out taxable in one fell swoop, you could choose a smaller amount to both withdraw from taxable and convert from traditional to Roth.

  4. PatientSaver Says:

    I have thought about conversions, but didn't like the idea of the big tax bill. However, whenever I do start withdrawing money from retirement, there will be a definite pecking order of which monies I withdraw from first, and taxable should always be used up before tax-deferred.

  5. PatientSaver Says:

    If I have enough accumulated in Roth accounts, I could plan on withdrawing from taxable and Roth (staying in the 15% bracket) those 7 years between the time I cut back my hours to p/t at age 60 and when I want to start collecting Social Security, at age 67. Depending on what kind of p/t income I have, i may not have to withdraw that much from other accounts.

  6. FrugalTexan75 Says:

    Why would you be withdrawing 40k if you are living on 24k now? Even if you took out an extra 8k for traveling, etc, you'd still be under the 25% bracket.

  7. PatientSaver Says:

    Well, frugaltexan, last year my total expenses were just $29,000, but I don't consider that my "normal" spending mode. In most of my previous years, when i was employed, my expenses were more in the $40 to $43,000 range due to some big capital improvements around here of which there never seems to be an end. A new roof, new car, new that, it all adds up.

    What I meant was that my minimum essential expenses are about $2,000 a month, but that's the bare minimum.

  8. Joe Says:

    Very savvy tax strategy Patient Saver. I've maximized my income in the 15% tax bracket the last few years by balancing my regular 401K and Roth 401K contributions. Once I estimate that my taxable income will hit the 25% tax cutoff (about 74K for married) I switch my contributions over to the Roth 401K.

  9. FrugalTexan75 Says:

    Ok, that makes sense.

  10. CB in the City Says:

    Well, it's a very cute mug! I'm glad you bought a copy and the fox one as well. Those little treats make the frugal live so much easier!

  11. Dido Says:

    Good points above. My thoughts: Putting more to Roth is a good idea. Favor tax-advantaged investments in taxable accounts. An in-state mini bond paying 3% is the equivalent of 4% in a taxable account if you are in the 25% bracket. It's worth more as your tax bracket goes up and less as your bracket goes down. Waiting to full retirement age (FRA) for Social Security is good. But rather than seeing that as a definite plan, you might want to consider doing "file and suspend" at FRA. If you wait until FRA and then file & suspend, you can then get a lump-sum payment for the amount that you *would* have gotten if taking it right at FRA. Kind of a nice insurance policy. Meanwhile your annual Social Security benefit grows at 8% per year up until age 70--a pretty decent, and relatively secure return on investment while you live off the money in your taxable accounts. The longer your life expectancy the more this is worth. A rough rule if thumb is that the break-even point for delaying SS until age 70 is a life expectancy of over 76. Living longer than that and you'll get more benefit. Since you still have both of your parents, I assume they are older than that (since you are 4 years older than me), so, something to think about.

  12. Dido Says:

    Note, if you opt for the lump sum, you'll lose the inflated benefit--no double-dipping on government benefits--but at least you'll have options.

  13. PatientSaver Says:

    Thanks for that analysis, Dido. I was familiar with the file and suspend technique from my days at Prudential, but I thought it pertained to married couples only.

    I see how it could create a lot more flexibility and allow me to not get too hung up on when I will file, although i have it in my mind that i won't want to wait til age 70 to begin collecting, because I'm afraid I'll be too old to really enjoy the extra money.

    I figured 66 and 10 months (almost age 67) was about as old as I'd want to get before getting the benefit of the higher monthly checks.

    To err on the side of conservatism, i usually use the age of 95 when i use various online calculators as to how long my money will last. My mom's 80 and dad's 81 so I figure I'll do at least as well. Neither of them are vegan, and I do believe that will keep me healthy even longer.

  14. Dido Says:

    Having a target to shoot for is great. Having flexibility is even better. Ideally, you'll have enough money at your targetted retirement age so that retiring won't be a problem. But if you are in good health and the market is crashing at the time you are planning to retire, you'll probably do better by waiting a couple of years until the market and your investments have recovered and then retiring. Rather than getting progressively safer and safer, current thinking amount financial planners is that the riskiest years are the five years before and after retirement and that is when investments should be most conservative. If you make it past the five year window, then some advise taking somewhat more risk again.

  15. PatientSaver Says:

    Yeah, that part about "if the market is crashing" when I plan to retire makes me nervous. I know the 5/5 window 5 years before and 5 years after is a critical time for one's investments. You might say I'm now in the "5 years before" window since my goal is to leave f/t work at 60. The uncertainty exists around whether, if I'm even still at the bank 5 years from now, and who really knows, whether they'd let me stay on a p/t basis. But if I could, then continuing to have some sort of p/t income would really help buffer whatever turbulence might come from the stock market. In fact, based on my current income of $80K, I should be able to cover all my day to day expenses if I stayed at the bank with my income cut in half. The main difference is that I would no longer be actively contributing to savings and retirement funds.

    My mother, who is 80, still is pretty well diversified in stock and bond mutual funds. I have tried to tell her she should minimize her risk more (given her age) but she doesn't want to.

    A good friend of mine, on the other hand, is 67 and has all his savings in CDs. But he has terminal prostate cancer and has been told he may have another 5 years at most, so he doesn't care about growing his money any more. He's given most of it away to his niece already.

  16. Dido Says:

    Well, hopefully she is diversified in her allocation. Remember that you can't minimize all risk, and focusing too much on minimizing volatility risk (beta) exposes you to other risks such as inflation risk and longevity risk. You can't eliminate all risk; you can balance between minimizing the multiple sources of risk.

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