5 ms·

Tax Advantaged Accounts

42 points by auc 5y ago

nablags 5y ago
Interesting information, but I wish there was an easier way to keep track of this stuff
NAHWheatCracker 5y ago
I didn't realize my Roth IRA contributions limits are curtailed starting at ~$125k income. My income is around that, although I guess I wouldn't hit the limit due to maxing my 401K. What would happen if I contributed too much to an IRA one year? Would I have to pay a penalty during tax season? Would I get the difference back in cash?
- auc 5y ago
  https://www.investopedia.com/articles/retirement/04/042804.asp https://www.investopedia.com/articles/retirement/04/042804.a... "If you contributed to a Roth when you made too much to qualify—or if you contributed more than you’re allowed to either IRA—you’ve made an excess contribution. That contribution is subject to a 6% tax penalty"
  - dataflow 5y ago
    I feel like I read somewhere that you can withdraw the exceeds before the tax filing deadline without penalty, but don't quote me on this; verify it.
- auc 5y ago
  You can completely avoid this by doing a backdoor roth ira though.
  - senkora 5y ago
    Note that congress is interested in closing this however: https://www.fool.com/investing/2022/01/21/you-can-still-do-a-backdoor-roth-in-2022-but-hurry/ https://www.fool.com/investing/2022/01/21/you-can-still-do-a...
    - auc 5y ago
      Yes, the BBB plan would close the backdoor loophole, but that's if it passes and it would be closed 10 years from now.
      - senkora 5y ago
        I’d welcome that, but it’s new information to me and I can’t find confirmation of it. The sources I find all say it could potentially be banned retroactive to the start of this year.
        auc 5y ago
        Actually, it seem you are right. If BBB passed, they would close the loophole at end of year. The 10 year rule applies to a traditional -> roth conversion to high income earners.
      - Unklejoe 5y ago
        > it would be closed 10 years from now Is that confirmed? I was holding off on doing my backdoor Roth because it seemed like no one was really sure what was going to happen if BBB passes. Most people figure that it would at least take effect in 2023 instead of the original intent of 2022, but as far as I know, it wasn't actually changed.
- BigGreenTurtle 5y ago
  You can re-characterize the contribution until tax deadline day of the following year, you can contact your investment firm do to that and they'll handle everything. With Vanguard it's as easy as filling out a form and waiting for the process to complete.
senkora 5y ago
This is a really good article and I highly recommend reading through it. It collects a lot of great info in one place.
- PopAlongKid 5y ago
  But it has several errors/omissions. I understand it is meant to be a high-level overview, but that still means what is included should be accurate. I'll contact the author as he asks at the site, but want to mention the items here because I don't know how long site updates may take. Plus, I'm sure that here I'll get feedback on whether my input itself is flawed! Terminology: in the tax preparation industry, "pre-tax" and "post-tax" usually only refer to contributions (not account types) that are or are not (respectively) excluded from current income. Earnings in the account over time are either tax-free or tax-deferred (depends on account type and what the distributions of said earnings are eventually used for), and distributions are either taxable (possibly with penalty), or tax-free. HSA - these are indeed like a Traditional IRA "on steroids", but calling it "a pre-tax account that is only allowed to spend money on healthcare related items" is incorrect. Distributions from HSAs can be spent on anything, but they are taxed as ordinary income if not spent on medical expenses. Also, before age 65, distributions not spent on medical expenses receive a 20% penalty as well as regular tax. So, at age 65, it essentially turns into a regular Trad. IRA (distributions are taxable), except if you want, you can pay your Medicare premiums and other health expenses tax-free from the HSA. An HSA can either be through an employer or opened directly by the individual. If there are other tax-advantaged employer health expense arrangements (or Medicare coverage), contributions to HSAs maybe limited. I have known of the benefits of HSAs for years but always felt the employer subsidy for non-HDHP insurance coverage was a better deal; however if you don't have employer insurance coverage, HSAs are probably the best way to go. See IRS Publication 969 for more details. 401k - "No access until minimum age 55". But what's worse, there is essentially no access at all while you are still employed with that employer, in other words you can't take any money out unless the plan allows it (and most don't), even if you are willing to pay tax & penalty. (There may be a loan option, but that is a bad idea for several reasons). "For self-employed people, I would look into a SIMPLE 401K. " For self-employed people with no employees of their own, a solo 401k (401k with only the owner as a member) allow for much higher contribution levels than SEP-IRA, especially at lower profit levels. IRA - "with an income of $140k, one cannot make ANY contribution, at least directly. " False. With even a little earned income, any taxpayer can make a contribution to a Trad. IRA no matter their total income (AGI). What the income limit pertains to is the deductibility of contributions to Trad. IRA (pre-tax or post-tax). And there is also an income limit that prevents any contributions to a Roth IRA at all. Until recently there was an age 70.5 cut-off on making contributions. " IRAs do not allow access until minimum age 59.5" -- well they do, but with a 10% penalty (other than a few exceptions for special purposes). One feature not many understand is that at any age, you can convert money from Trad. IRA to Roth, pay the tax, and then after five years you can take that money out penalty-free from the Roth. So if you can afford to pay the tax now and wait five years, you can get some or all of your money out of your IRA at any age without penalty. Section 529 plans aka QTP - "One can switch beneficiaries tax free up to $70k (double for couples) by "front-loading" or "superfunding", although there are federal gift tax consequences". This is really mixing up several different things. First, it is extremely unlikely that anyone would end up paying any gift tax on contributions to a 529 plan, although there may a tax reporting requirement (Form 706). Also, switching beneficiaries does not have anything to do with a $70K limit. What is being referred to is that one can contribute up to five year's worth of gifts all at once, each under the annual reporting threshhold for gifts, instead of having to spread the contributions out over five years to avoid reporting (and again, even with reporting, it is extremely unlikely any gift tax would be owed).
treebog 5y ago
One important note for residents of California and New Jersey: if you live in one of these states you must pay state tax on HSA contributions and gains, the same as if it were a regular taxable account. Your HSA is still tax-advantaged at the federal level though
andrewmcwatters 5y ago
This isn't terribly interesting or useful, though. A casual reading of these accounts even in your early 20s immediately makes this information clear. What pisses me off is no one talks about organizing your accounts around early retirement. There seems to be no benefit in using any tax advantaged accounts if, say for instance, you wanted to retire at 35. Further still, if you did use tax advantaged accounts and wanted to retire early, you've screwed yourself because you pay a penalty for pulling those funds out.
- auc 5y ago
  I think your comment is pretty mean spirited. The usefulness is in the summary - I do not think you can find a high level overview of these accounts in one place elsewhere. If you do, let me know. You say "What pisses me off is no one talks about organizing your accounts around early retirement" but I allude to this in my post about Traditional 401k* -> Traditional IRA -> Roth IRA conversion. There is a huge benefit to this if you have an early retirement.
  - andrewmcwatters 5y ago
    I'm sorry it came off as mean spirited, but I don't know what to say. Vanguard themselves provide layman explanations for this stuff on their site. Fidelity, too. Everyone does. I don't know what you "allude" to, but no one who retires early uses a Roth IRA. You incur the same penalties and have to follow rules on withdrawals, so I don't know what you're talking about. Yes, there are articles out there on using an HSA brokerage account, but I don't know a single person who thinks its a good idea to commingle your investments with your healthcare. An overwhelming amount of people have a PPO over anything else. If you were planning on exotic types of investment strategies, you're better off doing that in your actual investment choices versus the vehicles you plan on using to do so. Tax advantaged accounts are for people who plan on retiring at traditional retirement ages. Brokerage accounts for everything else. Most people who purchase healthcare do it for healthcare purposes, not investing. Turns out most people don't like high deductibles. Who actually says to themselves, "Yeah, I'm going to set up a backdoor or mega-backdoor tax advantaged account," but also wants to retire at 67? It just sounds insane to me that you'd put in all of this effort to screw yourself.
dataflow 5y ago
The biggest thing I see unmentioned is the ERISA protections. Do not turn your 401(k) into an IRA before understanding the implications of losing that protection. It's a safety mechanism for your future self.
- auc 5y ago
  Hey, thanks for the note! Would you mind linking me to a resource that would go into ERISA and it's effects on a 401K (or perhaps an example of what I would be protected from)? The IRS website is pretty vague on what the implications are besides providing "protections".
  - dataflow 5y ago
    Here are a couple of links [1] [2] that explain some of the details; I don't really know much about it myself beyond these (and obviously can't vouch for their correctness). It's admittedly not mentioned in many webpages that discuss IRAs and 401(k), so I think a lot of people don't hear about it, which is unfortunate. I wish I had good advice on how to dig up information like this without a priori knowledge, but I don't have great advice there—in my case, all I had was a nagging feeling of skepticism ("that can't be the only difference between IRAs and 401(k)s, can it? it doesn't seem compelling enough...") that kept me Googling until I found out about ERISA. [1] https://www.irahelp.com/slottreport/how-safe-creditors-your-401k-money-if-you-roll-it-ira https://www.irahelp.com/slottreport/how-safe-creditors-your-... [2] https://www.investopedia.com/articles/personal-finance/040716/which-retirement-funds-are-protected-creditors.asp https://www.investopedia.com/articles/personal-finance/04071...
ctchocula 5y ago
Thank you for the write-up! One correction I would make is that per [1] VTSAX does have a $3,000 investment minimum. Before, VTSMX used to have the $3,000 minimum and VTSAX $10,000. However, it looks like recently they've gotten rid of the VTSMX share class entirely and dropped the investment minimum of the VTSAX share class to $3,000. [1] https://investor.vanguard.com/mutual-funds/profile/VTSAX https://investor.vanguard.com/mutual-funds/profile/VTSAX
Kon-Peki 5y ago
1. HSAs also have a weird "feature" - you have an unlimited reimbursement time limit. If I have $100 in an HSA account and spend $100 on an HSA-eligible medical procedure, I don't have to submit the receipt right away and get my $100 back. I can invest the $100 and then submit my $100 reimbursement sometime in retirement. It should only take 15-20 years for the investment to grow beyond the marginal tax + inflation for waiting, and then all capital gains beyond that point are free money (from the government?). 2. People compare Trad. IRA and Roth IRA a lot, but I've never seen any that consider the effects of the avoided current tax payments of a Trad. IRA. Ceteris paribus, if you are putting $6000 in an IRA this year, you have an extra ~$1500 in your pocket if you choose the Trad. IRA (because you avoided paying taxes right now). What do you do with that money? I'd argue that a proper comparison requires that you put that money in a non-tax-advantage account. That makes a difference, especially if you think you will have an early retirement situation! 3. In addition to the various states that have no income tax at all, there are a good number that do not tax retirement distributions at all. While the Feds may consider it as earned income, depending on where you live, your effective tax rate in retirement may be significantly reduced - also something that should be considered when comparing Trad. IRA with Roth IRA.

42 points by auc 5y ago

Interesting information, but I wish there was an easier way to keep track of this stuff

I didn't realize my Roth IRA contributions limits are curtailed starting at ~$125k income. My income is around that, although I guess I wouldn't hit the limit due to maxing my 401K. What would happen if I contributed too much to an IRA one year? Would I have to pay a penalty during tax season? Would I get the difference back in cash?

auc 5y ago
https://www.investopedia.com/articles/retirement/04/042804.asp https://www.investopedia.com/articles/retirement/04/042804.a... "If you contributed to a Roth when you made too much to qualify—or if you contributed more than you’re allowed to either IRA—you’ve made an excess contribution. That contribution is subject to a 6% tax penalty"
- dataflow 5y ago
  I feel like I read somewhere that you can withdraw the exceeds before the tax filing deadline without penalty, but don't quote me on this; verify it.
auc 5y ago
You can completely avoid this by doing a backdoor roth ira though.
- senkora 5y ago
  Note that congress is interested in closing this however: https://www.fool.com/investing/2022/01/21/you-can-still-do-a-backdoor-roth-in-2022-but-hurry/ https://www.fool.com/investing/2022/01/21/you-can-still-do-a...
  - auc 5y ago
    Yes, the BBB plan would close the backdoor loophole, but that's if it passes and it would be closed 10 years from now.
    - senkora 5y ago
      I’d welcome that, but it’s new information to me and I can’t find confirmation of it. The sources I find all say it could potentially be banned retroactive to the start of this year.
      - auc 5y ago
        Actually, it seem you are right. If BBB passed, they would close the loophole at end of year. The 10 year rule applies to a traditional -> roth conversion to high income earners.
    - Unklejoe 5y ago
      > it would be closed 10 years from now Is that confirmed? I was holding off on doing my backdoor Roth because it seemed like no one was really sure what was going to happen if BBB passes. Most people figure that it would at least take effect in 2023 instead of the original intent of 2022, but as far as I know, it wasn't actually changed.
BigGreenTurtle 5y ago
You can re-characterize the contribution until tax deadline day of the following year, you can contact your investment firm do to that and they'll handle everything. With Vanguard it's as easy as filling out a form and waiting for the process to complete.

senkora 5y ago

This is a really good article and I highly recommend reading through it. It collects a lot of great info in one place.

PopAlongKid 5y ago
But it has several errors/omissions. I understand it is meant to be a high-level overview, but that still means what is included should be accurate. I'll contact the author as he asks at the site, but want to mention the items here because I don't know how long site updates may take. Plus, I'm sure that here I'll get feedback on whether my input itself is flawed! Terminology: in the tax preparation industry, "pre-tax" and "post-tax" usually only refer to contributions (not account types) that are or are not (respectively) excluded from current income. Earnings in the account over time are either tax-free or tax-deferred (depends on account type and what the distributions of said earnings are eventually used for), and distributions are either taxable (possibly with penalty), or tax-free. HSA - these are indeed like a Traditional IRA "on steroids", but calling it "a pre-tax account that is only allowed to spend money on healthcare related items" is incorrect. Distributions from HSAs can be spent on anything, but they are taxed as ordinary income if not spent on medical expenses. Also, before age 65, distributions not spent on medical expenses receive a 20% penalty as well as regular tax. So, at age 65, it essentially turns into a regular Trad. IRA (distributions are taxable), except if you want, you can pay your Medicare premiums and other health expenses tax-free from the HSA. An HSA can either be through an employer or opened directly by the individual. If there are other tax-advantaged employer health expense arrangements (or Medicare coverage), contributions to HSAs maybe limited. I have known of the benefits of HSAs for years but always felt the employer subsidy for non-HDHP insurance coverage was a better deal; however if you don't have employer insurance coverage, HSAs are probably the best way to go. See IRS Publication 969 for more details. 401k - "No access until minimum age 55". But what's worse, there is essentially no access at all while you are still employed with that employer, in other words you can't take any money out unless the plan allows it (and most don't), even if you are willing to pay tax & penalty. (There may be a loan option, but that is a bad idea for several reasons). "For self-employed people, I would look into a SIMPLE 401K. " For self-employed people with no employees of their own, a solo 401k (401k with only the owner as a member) allow for much higher contribution levels than SEP-IRA, especially at lower profit levels. IRA - "with an income of $140k, one cannot make ANY contribution, at least directly. " False. With even a little earned income, any taxpayer can make a contribution to a Trad. IRA no matter their total income (AGI). What the income limit pertains to is the deductibility of contributions to Trad. IRA (pre-tax or post-tax). And there is also an income limit that prevents any contributions to a Roth IRA at all. Until recently there was an age 70.5 cut-off on making contributions. " IRAs do not allow access until minimum age 59.5" -- well they do, but with a 10% penalty (other than a few exceptions for special purposes). One feature not many understand is that at any age, you can convert money from Trad. IRA to Roth, pay the tax, and then after five years you can take that money out penalty-free from the Roth. So if you can afford to pay the tax now and wait five years, you can get some or all of your money out of your IRA at any age without penalty. Section 529 plans aka QTP - "One can switch beneficiaries tax free up to $70k (double for couples) by "front-loading" or "superfunding", although there are federal gift tax consequences". This is really mixing up several different things. First, it is extremely unlikely that anyone would end up paying any gift tax on contributions to a 529 plan, although there may a tax reporting requirement (Form 706). Also, switching beneficiaries does not have anything to do with a $70K limit. What is being referred to is that one can contribute up to five year's worth of gifts all at once, each under the annual reporting threshhold for gifts, instead of having to spread the contributions out over five years to avoid reporting (and again, even with reporting, it is extremely unlikely any gift tax would be owed).

treebog 5y ago

One important note for residents of California and New Jersey: if you live in one of these states you must pay state tax on HSA contributions and gains, the same as if it were a regular taxable account. Your HSA is still tax-advantaged at the federal level though

andrewmcwatters 5y ago

This isn't terribly interesting or useful, though. A casual reading of these accounts even in your early 20s immediately makes this information clear. What pisses me off is no one talks about organizing your accounts around early retirement. There seems to be no benefit in using any tax advantaged accounts if, say for instance, you wanted to retire at 35. Further still, if you did use tax advantaged accounts and wanted to retire early, you've screwed yourself because you pay a penalty for pulling those funds out.

auc 5y ago
I think your comment is pretty mean spirited. The usefulness is in the summary - I do not think you can find a high level overview of these accounts in one place elsewhere. If you do, let me know. You say "What pisses me off is no one talks about organizing your accounts around early retirement" but I allude to this in my post about Traditional 401k* -> Traditional IRA -> Roth IRA conversion. There is a huge benefit to this if you have an early retirement.
- andrewmcwatters 5y ago
  I'm sorry it came off as mean spirited, but I don't know what to say. Vanguard themselves provide layman explanations for this stuff on their site. Fidelity, too. Everyone does. I don't know what you "allude" to, but no one who retires early uses a Roth IRA. You incur the same penalties and have to follow rules on withdrawals, so I don't know what you're talking about. Yes, there are articles out there on using an HSA brokerage account, but I don't know a single person who thinks its a good idea to commingle your investments with your healthcare. An overwhelming amount of people have a PPO over anything else. If you were planning on exotic types of investment strategies, you're better off doing that in your actual investment choices versus the vehicles you plan on using to do so. Tax advantaged accounts are for people who plan on retiring at traditional retirement ages. Brokerage accounts for everything else. Most people who purchase healthcare do it for healthcare purposes, not investing. Turns out most people don't like high deductibles. Who actually says to themselves, "Yeah, I'm going to set up a backdoor or mega-backdoor tax advantaged account," but also wants to retire at 67? It just sounds insane to me that you'd put in all of this effort to screw yourself.

dataflow 5y ago

The biggest thing I see unmentioned is the ERISA protections. Do not turn your 401(k) into an IRA before understanding the implications of losing that protection. It's a safety mechanism for your future self.

auc 5y ago
Hey, thanks for the note! Would you mind linking me to a resource that would go into ERISA and it's effects on a 401K (or perhaps an example of what I would be protected from)? The IRS website is pretty vague on what the implications are besides providing "protections".
- dataflow 5y ago
  Here are a couple of links [1] [2] that explain some of the details; I don't really know much about it myself beyond these (and obviously can't vouch for their correctness). It's admittedly not mentioned in many webpages that discuss IRAs and 401(k), so I think a lot of people don't hear about it, which is unfortunate. I wish I had good advice on how to dig up information like this without a priori knowledge, but I don't have great advice there—in my case, all I had was a nagging feeling of skepticism ("that can't be the only difference between IRAs and 401(k)s, can it? it doesn't seem compelling enough...") that kept me Googling until I found out about ERISA. [1] https://www.irahelp.com/slottreport/how-safe-creditors-your-401k-money-if-you-roll-it-ira https://www.irahelp.com/slottreport/how-safe-creditors-your-... [2] https://www.investopedia.com/articles/personal-finance/040716/which-retirement-funds-are-protected-creditors.asp https://www.investopedia.com/articles/personal-finance/04071...

ctchocula 5y ago

Thank you for the write-up! One correction I would make is that per [1] VTSAX does have a $3,000 investment minimum. Before, VTSMX used to have the $3,000 minimum and VTSAX $10,000. However, it looks like recently they've gotten rid of the VTSMX share class entirely and dropped the investment minimum of the VTSAX share class to $3,000. [1] https://investor.vanguard.com/mutual-funds/profile/VTSAX https://investor.vanguard.com/mutual-funds/profile/VTSAX

Kon-Peki 5y ago

1. HSAs also have a weird "feature" - you have an unlimited reimbursement time limit. If I have $100 in an HSA account and spend $100 on an HSA-eligible medical procedure, I don't have to submit the receipt right away and get my $100 back. I can invest the $100 and then submit my $100 reimbursement sometime in retirement. It should only take 15-20 years for the investment to grow beyond the marginal tax + inflation for waiting, and then all capital gains beyond that point are free money (from the government?). 2. People compare Trad. IRA and Roth IRA a lot, but I've never seen any that consider the effects of the avoided current tax payments of a Trad. IRA. Ceteris paribus, if you are putting $6000 in an IRA this year, you have an extra ~$1500 in your pocket if you choose the Trad. IRA (because you avoided paying taxes right now). What do you do with that money? I'd argue that a proper comparison requires that you put that money in a non-tax-advantage account. That makes a difference, especially if you think you will have an early retirement situation! 3. In addition to the various states that have no income tax at all, there are a good number that do not tax retirement distributions at all. While the Feds may consider it as earned income, depending on where you live, your effective tax rate in retirement may be significantly reduced - also something that should be considered when comparing Trad. IRA with Roth IRA.