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Started By
Message
Future Tax/Investment Question
Posted on 4/1/14 at 3:00 pm
Posted on 4/1/14 at 3:00 pm
Scenario:
Let's say you are substantially certain you will have a big tax bill 20 years from now(Age of of person (51/52ish in 20 years).
The prevailing investment wisdom is:
1) 401k to match
2) ROTH IRA or whatever/HSA
3) 401k to max contribution
4) Taxable account
Would you continue these steps as is, OR
Would you skip step 3, and open a taxable account, so when this tax hit comes in 20 years, you pull out at 15% cap gains (or whatever the hopefully low rate is then), instead of pulling out of your 401k? It has been enjoying tax deferred status BUT you'll have to pay the early withdrawal penalty on the 401k unless you get around it.
Any ideas here?
Let's say you are substantially certain you will have a big tax bill 20 years from now(Age of of person (51/52ish in 20 years).
The prevailing investment wisdom is:
1) 401k to match
2) ROTH IRA or whatever/HSA
3) 401k to max contribution
4) Taxable account
Would you continue these steps as is, OR
Would you skip step 3, and open a taxable account, so when this tax hit comes in 20 years, you pull out at 15% cap gains (or whatever the hopefully low rate is then), instead of pulling out of your 401k? It has been enjoying tax deferred status BUT you'll have to pay the early withdrawal penalty on the 401k unless you get around it.
Any ideas here?
This post was edited on 4/1/14 at 3:04 pm
1
Posted on 4/1/14 at 3:09 pm to Teddy Ruxpin
What is the "big tax bill" going to be? Is it a single event that will create ordinary income? A big sale of a capital asset? Huge withdrawal from tax-deferred investment?
Put another way... are you trying to save money now for the tax bill later on? The last sentence you wrote - about having to pull the money out of the 401K before you hit 59.5 is what is confusing me. You should not put money in a 401K that you know you will need before age 59.5.
Generally speaking, skipping step 3 might make sense if all of the money you would have put in step 3, you instead put into single growth stocks that have large appreciations and never pay out dividends. If a stock pays out dividends, you have to pay the tax each year. If it's a fund, surely it will pay out dividends and capital gains, both of which will be taxed each year.
You could also put that step 3 money into hard assets such as precious metals and land. Of course, this is just looking at the tax aspects... you have to consider if those types of investments make sense for you. Don't let the tax tail wag the investment dog.
Put another way... are you trying to save money now for the tax bill later on? The last sentence you wrote - about having to pull the money out of the 401K before you hit 59.5 is what is confusing me. You should not put money in a 401K that you know you will need before age 59.5.
Generally speaking, skipping step 3 might make sense if all of the money you would have put in step 3, you instead put into single growth stocks that have large appreciations and never pay out dividends. If a stock pays out dividends, you have to pay the tax each year. If it's a fund, surely it will pay out dividends and capital gains, both of which will be taxed each year.
You could also put that step 3 money into hard assets such as precious metals and land. Of course, this is just looking at the tax aspects... you have to consider if those types of investments make sense for you. Don't let the tax tail wag the investment dog.
This post was edited on 4/1/14 at 3:11 pm
Posted on 4/1/14 at 3:22 pm to LSUFanHouston
quote:
What is the "big tax bill" going to be? Is it a single event that will create ordinary income? A big sale of a capital asset? Huge withdrawal from tax-deferred investment?
Loan forgiveness which at this point in time would be treated as income. (I know the obvious opposite of that is to pay the loan before forgiveness, but I already know how to do that
) Hence, the question is, does taking advantage of the advantages of the 401k going to the max contribution outweigh the withdrawal penalties when that tax bill comes due OR should I open the taxable, and use stock index fund/ETFs to keep them tax efficient and use their proceeds 20 years down the line to pay off the tax bill.
And yes, the idea is to prepare for this tax bill, I just want to have the money in the most efficient place to pay it off when the time comes.
This post was edited on 4/1/14 at 3:24 pm
Posted on 4/1/14 at 3:39 pm to Teddy Ruxpin
Part of the problem is, who knows what the tax law will be in 20 years. From time to time, there has been talk of making certain types of loan forgiveness not includeable in income (such as certain medical and teaching loans, if you work in certain areas). But who knows if that will actually happen or not.
Another thing to consider - will your ordinary tax rate be more in 20 years than it is today? If you think the tax rate in 20 years will be much higher than it is for your today, it might make sense to do some sort of tax-efficient investment.
There are calculators out there that you can use to model different growth rates, tax rates, etc. Take some time and play around with them.
Another thing to consider - will your ordinary tax rate be more in 20 years than it is today? If you think the tax rate in 20 years will be much higher than it is for your today, it might make sense to do some sort of tax-efficient investment.
There are calculators out there that you can use to model different growth rates, tax rates, etc. Take some time and play around with them.
Posted on 4/1/14 at 3:43 pm to Teddy Ruxpin
I'm assuming large student loan debt currently being paid under Income Based schedule?
If so, I'm right there with you and curious how to manage this myself. For now, I am handling my 401k as I might do even without the upcoming tax hit. Paying as much as possible towards loans to get them down as best I can.
If so, I'm right there with you and curious how to manage this myself. For now, I am handling my 401k as I might do even without the upcoming tax hit. Paying as much as possible towards loans to get them down as best I can.
This post was edited on 4/1/14 at 3:46 pm
Posted on 4/1/14 at 3:49 pm to AnonymousTiger
quote:
I'm assuming large student loan debt currently being paid under Income Based schedule?
If so, I'm right there with you and curious how to manage this myself. For now, I am handling my 401k as I might do even without the upcoming tax hit. Paying as much as possible towards loans to get them down as best I ca
Ya, you'd be right. I'm trying to combat this issue as efficiently as possible to make up for the problem.
There's really only two routes, try to pay them off or IBR out to 25 years then pay the tax on the forgiven amount. At a certain point, the latter looks smarter than the former, but I'm trying to get all the info I can since its a unique scenario than what people were seeing 15 years ago when some of these rules became gospel.
Posted on 4/1/14 at 4:40 pm to Teddy Ruxpin
quote:
There's really only two routes, try to pay them off or IBR out to 25 years then pay the tax on the forgiven amount. At a certain point, the latter looks smarter than the former, but I'm trying to get all the info I can since its a unique scenario than what people were seeing 15 years ago when some of these rules became gospel.
Here is some food for thought.
1) If you are under an IBR, most of your monthly payment is going to interest. That interest may or may not be tax deductible currently and in the future depending upon your earnings.
2) Your tax rate on ordinary income at the time of forgiveness will probably be higher than the tax rate is now.
3) Inflation will cause the amount of loan forgiveness in 20 years to be less in real dollars than the debt is worth today.
4) You can pay $1 in today's dollars to go toward debt. Or, you can pay 45 cents maybe in future dollars if the debt is forgiven.
Posted on 4/1/14 at 4:49 pm to LSUFanHouston
quote:
2) Your tax rate on ordinary income at the time of forgiveness will probably be higher than the tax rate is now.
3) Inflation will cause the amount of loan forgiveness in 20 years to be less in real dollars than the debt is worth today.
4) You can pay $1 in today's dollars to go toward debt. Or, you can pay 45 cents maybe in future dollars if the debt is forgiven.
These are assumptions I have definitely already considered. That paying a percentage of the debt in future inflated dollars is better than paying a $1 today. With my tax rate most likely being higher, a withdrawal penalty from a 401k would be tough to swallow.
If you assume the above, considering the tax benefits from pre-tax contributions and withdrawal penalty vs the capital gain tax of a taxable account with tax efficient investments, What would you do? Of course, I'd continue 401k contributions to the company match, no brainer there.
This is literally the only part of the calculation/consideration that is proving difficult to me to wrap my head around. What's annoying is, I can't find one article which says what would be the best route if you KNOW in advance you'll need a big hunk of change in the future. They all talk about 401k withdrawals exclusively due to some emergency or whatever.
I suspect it is not an "easy" calculation due to tax rate uncertainty, but what is certain today is the 401k withdrawal penalty, but how likely will that be so bad that it wipes out the 401k advantages over the taxable account?
If the race is to have enough to pay the tax, which track do you put your horse on?
ETA: It seems like you'd use the same logic as some people do while investing House down payment (Which would be a one time future expense) money if that money isn't in a 401k or ROTH. Or perhaps the same logic as people who want to retire early would use, which would be a taxable account.
This post was edited on 4/1/14 at 5:06 pm
Posted on 4/1/14 at 10:29 pm to Teddy Ruxpin
Bump.
Intriguing questions. Curious to see more responses.
Intriguing questions. Curious to see more responses.
Posted on 4/1/14 at 10:58 pm to fratmonster
quote:You think these are intriguing questions. The OP has said he has no intention to repay money he borrowed. That is the same as announcing he stole the money from the lender. Rather than being ashamed of that fact, he is asking for advice to mitigate the income tax costs of his theft.
Intriguing questions.
quote:How about this response? The OP ought to be tried for grand theft the moment the loan becomes uncollectable by the lender.
Curious to see more responses.
Posted on 4/1/14 at 11:20 pm to Poodlebrain
Poodlebrain, I appreciate your advice that you routinely give on this board, but I do make monthly payments on my loan as agreed between myself and the lender. At the end of 25 years, the rest of the loan that remains unpaid (if any), is forgiven per the terms of the agreement. The forgiven amount becomes taxable income, which I would also pay if this were to happen.
None of this falls under the definition of "theft." You may not agree that this option should exist(which you can debate on the Political board), but it does, and it is a contract term, along with many others, that are possible for me to execute. I am only trying to research the issue and believe your post is uncalled for.
None of this falls under the definition of "theft." You may not agree that this option should exist(which you can debate on the Political board), but it does, and it is a contract term, along with many others, that are possible for me to execute. I am only trying to research the issue and believe your post is uncalled for.
This post was edited on 4/2/14 at 12:22 am
Posted on 4/2/14 at 11:31 am to Poodlebrain
quote:
The OP has said he has no intention to repay money he borrowed. That is the same as announcing he stole the money from the lender. Rather than being ashamed of that fact, he is asking for advice to mitigate the income tax costs of his theft.
Ouch.
You are a tax guy, right? We don't write the rules, we simply take the rules as they are written and try to apply them to our clients in the best possible way (the whole tax avoidance - which is completely legal vs tax evasion - which is against the law thing).
Whether or not someone should have the right to have their loans discharged after 25 years is worthy of debate. But the rule is what the rule is, and he might as well take advantage of it.
One thing I thought about last night is this: How do you know that in 20-25 years, your income won't increase to the point that the IBR won't result in much, if any, debt to be forgiven?
To the OP, you've written about the rules becoming gospel, and if there is one truth of personal finance, it is there is no such thing as gospel. Everyone has different things that will work for their different situation.
What I would do? I'd fill up my 401(K) and revisit the issue in 10 years. Why?
1) Your income may go up, making the issue moot. Your income may go up, and allow you to max out the 401(k) and also save money in taxable accounts to pay out the tax debt.
2) The law on student loan forgiveness may change. If the whole point of IBR is to reflect the fact that people can't pay their student loan amounts back in full, what gives the government the idea that the people will be able to pay the tax on the forgiven student loan debt? My guess is when this becomes a problem (in about 10 years) there will be pressure to change the rules.
3) With the annual limits for qualified plans in place, you can't make up for not making contributions later in life. (with the exception of the above age 50 thing, which helps some).
4) Depending on where the money is, and what type of situation you might be in, there could be other ways to pay the tax debt. You may be able to borrow directly against a 401(k). You may be able to borrow against home equity. You may be able to do what is called a 72(t) distribution, which is pretty complicated but essentially is a way around the penalty.
One more question, and I'm not trying to be rude here. How are you able to save money for a potential tax debt down the road, but are unable to make normal student loan payments and thus must be on IBR?
Posted on 4/2/14 at 11:53 am to LSUFanHouston
Thanks for your post, and that was how I read a lot of the situation myself when it comes to how the rules may change over time, and wasn't sure if the taxable account would be a nice hedge with that in mind. Thanks for your input.
Basically, full repayment could possibly make anything else impossible. No kids, no house, no vacations, no quality of life for 25 years or until my income rose enough to be able to absorb it. IBR gives me a breather to figure that all out, it wouldn't bother me to eventually get to full repayment as my income rose, but I would basically not be able to do anything at all, ever. I mean literally nothing, except food, water, shelter.
Now, I know how some people feel about this sort of thing as the poster above, but I only get to live life once, and then I'm fricking dead, and that's how I see it. I don't think that is being deceitful or a brat, but being a realist.
The government, as the lender, will receive a very handsome 6 figure sum over 25 years, another 6 figure lump sum at taxes due, plus, will get to tax my income in the 5 figure range for 25 years as well as per the terms of the contract they have with me.
I wonder if someone would call me a thief if I joined the military with my salary paid by the government, (less pay equal less monthly payments owed) for 10 years and had my loan AND income taxes forgiven under the PSLF program?
quote:
One more question, and I'm not trying to be rude here. How are you able to save money for a potential tax debt down the road, but are unable to make normal student loan payments and thus must be on IBR?
Basically, full repayment could possibly make anything else impossible. No kids, no house, no vacations, no quality of life for 25 years or until my income rose enough to be able to absorb it. IBR gives me a breather to figure that all out, it wouldn't bother me to eventually get to full repayment as my income rose, but I would basically not be able to do anything at all, ever. I mean literally nothing, except food, water, shelter.
Now, I know how some people feel about this sort of thing as the poster above, but I only get to live life once, and then I'm fricking dead, and that's how I see it. I don't think that is being deceitful or a brat, but being a realist.
The government, as the lender, will receive a very handsome 6 figure sum over 25 years, another 6 figure lump sum at taxes due, plus, will get to tax my income in the 5 figure range for 25 years as well as per the terms of the contract they have with me.
I wonder if someone would call me a thief if I joined the military with my salary paid by the government, (less pay equal less monthly payments owed) for 10 years and had my loan AND income taxes forgiven under the PSLF program?
This post was edited on 4/2/14 at 12:09 pm
Posted on 4/2/14 at 11:56 am to Poodlebrain
quote:
You think these are intriguing questions. The OP has said he has no intention to repay money he borrowed. That is the same as announcing he stole the money from the lender. Rather than being ashamed of that fact, he is asking for advice to mitigate the income tax costs of his theft.
LULLLLLZ. Or he is playing by the rules/law/terms of the contract established by the lender
This post was edited on 4/2/14 at 11:58 am
Posted on 4/2/14 at 12:00 pm to LSUFanHouston
quote:
Whether or not someone should have the right to have their loans discharged after 25 years is worthy of debate. But the rule is what the rule is, and he might as well take advantage of it.
:golfclap:
quote:
The law on student loan forgiveness may change. If the whole point of IBR is to reflect the fact that people can't pay their student loan amounts back in full, what gives the government the idea that the people will be able to pay the tax on the forgiven student loan debt? My guess is when this becomes a problem (in about 10 years) there will be pressure to change the rules.
I also believe this will change in the future. I see student loans being a huge problem in the next 5-10-15 years.
Posted on 4/3/14 at 8:36 am to Teddy Ruxpin
quote:
No kids, no house, no vacations, no quality of life for 25 years
I agree if someone establishes rules (like the government for loan forgiveness) and meet the criteria, it is fair. But no one is entitled to a certain quality of life just because they live. I guess in college I should have taken out more loans and not worked while in school to keep my debt low so I could have had a better quality of life in college. Then I could have let the government pay for them.
The bottom line is that when you do take out a loan, you're side of the loan paperwork is to pay it back; if you take out a college loan, you're expecting to get a job that provides you enough money to comfortably pay it back. If you don't finish the degree or don't make enough money to pay it back and have a certain quality of life you desire, that's the chance you take.
All the big banks and corporations the government bailed out should have been left to fail or sold at fire sale prices to willing buyers; the government shouldn't have been the backstop. They made their beds.
Posted on 4/3/14 at 12:21 pm to Teddy Ruxpin
quote:So repayment is possible, just inconvenient for you. Your expectations aren't being met, so let someone else eat the cost. You are going to take wealth from other people, but you are okay with that because you are playing by the rules, and you are going to pay tax on the amount you plan to take. Hooray for you.
Basically, full repayment could possibly make anything else impossible. No kids, no house, no vacations, no quality of life for 25 years or until my income rose enough to be able to absorb it.
Posted on 4/3/14 at 12:27 pm to Poodlebrain
quote:
So repayment is possible, just inconvenient for you. Your expectations aren't being met, so let someone else eat the cost. You are going to take wealth from other people, but you are okay with that because you are playing by the rules, and you are going to pay tax on the amount you plan to take. Hooray for you.
Posted on 4/3/14 at 12:33 pm to Teddy Ruxpin
Yeah I'd feel much more sympathy for your dire lot in life if you weren't on the OT posting pics of monkey dicks you took during your South Asian vacation.
Posted on 4/3/14 at 12:34 pm to Cold Cous Cous
quote:
Yeah I'd feel much more sympathy for your dire lot in life if you weren't on the OT posting pics of monkey dicks you took during your South Asian vacation
You're assuming I paid for that trip.
But in any event, the monkey dick pick was pretty good.
But for a serious answer. I took out the loan with the intention for full repayment. In fact, i did a few months of it. The other contracting party changed the terms. It would be stupid of me not take advantage of a change in contract terms. I also pay more taxes than 80% of the population, So I Am "The taxpayer"
Poodle does this every day as an accountant. If he doesn't he'd be a terrible accountant. No tax break or loophole is morally superior to any other. He'd rub his dick raw in excitement if the lender was named "Goldman Sachs" or "Chase Bank." Being a hypocrite without even knowing it.
And again, if people joined the military and took out PSLF in ten years, I'd wonder if he'd call them all thieves?
In any event, the government is probably going to get near 300,000 dollars from me at least. So Poodle can take out his aggression elsewhere.
This post was edited on 4/3/14 at 1:56 pm
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