Saving Rule of THUMB

Leave a comment on Saving Rule of THUMB

One of my favorite things about the new year is the resetting of contribution limits to tax-advantaged accounts. Very heartwarming, I know. Just like how my favorite part of turning 18 was opening a bank account in my own name, but that’s a story for another day.

As I was trying to figure out how I would fund these accounts over the course of the year, it got me thinking about if there’s a logical order in which to save, just like how we use PEMDAS, the order of operations in math.

So given these assumptions:

  • Matching > No Matching
  • Tax-Advantaged Accounts > Regular Accounts
  • Time in the Market > Timing the Market or Dollar Cost Averaging
  • Income – Expenses > Sum of All Account Contribution Limits

This is the rule of THUMB that I came up with:

  • Traditional (pre-tax) accounts: 401k, 403b, 457
  • HSA
  • Unless no retirement plan at you or your spouse’s work: Traditional IRA
  • Mega Backdoor Roth IRA
  • Backdoor Roth IRA

Of course, any additional savings can go towards other savings goals like an emergency fund, a downpayment on a house, or post-tax accounts for retirement.

So why traditional accounts first? Any employer matching means free money that can further grow in the markets. After reading the argument that the Mad Fientist makes in favor of front loading with pre-tax money, I’m convinced that the potential for growth on top of guaranteed returns (through employer matching) beats almost every other argument. Of course if you’re in a situation where your work offers a match on your HSA, but not your 401k, then by all means max out the HSA first with its triple-tax advantage.

What about the unfortunate people that don’t have a retirement plan through work? That U is for you, because income restrictions for pre-tax contributions to Traditional IRAs don’t apply if you or your spouse (if married) don’t have a retirement plan through work. You can also ignore the other two letters since they won’t apply either.

And why the Mega Backdoor Roth IRA before the regular Backdoor Roth IRA? That’s because if it’s available to you at all, it’s only available through your employer. There’s always the chance that your employment situation might change in the middle of the year and that you lose access to this rare account. In addition, a Mega Backdoor Roth IRA can only be funded with deductions from your paycheck so the effective deadline for contributions is the end of the year, whereas a regular Backdoor Roth IRA can be funded until tax day of the following year. So don’t be sad that you didn’t strike the iron while it was hot!

This is not to say that you should feel bad if you don’t have access to some of these accounts or can’t max out the ones that you do have access to. I know that planning for and writing about this means that I’m privileged with both access to these accounts and the means to fund them. I know because I’ve had jobs without any tax-advantaged accounts or health insurance. I hope, regardless, that this information is useful in the future should you ever find yourself in the position to take advantage of these accounts.

That said, I’m curious to hear your thoughts on my personal rule of THUMB. Leave a comment and let me know what you think!

Leave a comment on Saving Rule of THUMB

Get Out of Town!

Leave a comment on Get Out of Town!

You’ll save on city taxes.

I hear this phrase in some form or another from every person I know that lives outside the five boroughs. I’ve always wondered though, is that just a coping strategy or is this the original geo arbitrage?

Let’s find out.

First, how much is there to actually save? New York City income taxes are graduated just like federal taxes, meaning that the first dollars you make are taxed at a lower rate than the last dollars you make. Here’s the chart for 2018:

BracketSingleMarriedHead of Household
2.907%$0 – $12,000$0 – $21,600$0 – $14,400
3.534%$12,001 – $25,000$21,601 – $45,000$14,401 – $30,000
3.591%$25,001 – $50,000$45,001 – $90,000$30,001 – $60,000
3.648%$50,001 – $500,000$90,001 – $500,000$60,001 – $500,000
3.876%$500,001+$500,001+$500,001+

*Brackets for Married Filing Separately are the same as Single

Keep in mind that these numbers are for taxable income, which is the income you have left after taking exemptions and deductions.

For these example after-tax incomes, this is how much you would pay in city taxes:

IncomeSingleMarriedHead of Household
$50,000$1,706$1,634$1,688
$100,000$3,530$3,436$3,506
$150,000$5,354$5,260$5,330
$200,000$7,178$7,084$7,154

Assuming that you need to work in Manhattan, here are the amounts you would need to be making just to offset the cost of commuting into one of the main transit hubs:

Monthly PassCostSingleMarriedHead of Household
PATH
$89$32,235$34,054$32,733
NJTransit Bus Zone 2$109$38,919$40,845$39,417
NJTransit Train Zone 2$152$53,238$55,281$53,786
Ferry$272$92,771$95,299$93,358
Metro North Zone 3$239$81,856$84,354$89,739
LIRR Zone 4$261$89,093$91,680$89,739
Metro North Greenwich$301$102,251$104,838$102,897

So if you’re making less than six figures a year and are still determined to save on income tax, the only neighborhoods that make sense are those along the PATH, just outside the Lincoln Tunnel, and the closest towns beyond Secaucus Junction. Any savings you’d get by moving to Westchester, Long Island, and Connecticut would be eaten up by train tickets.

If you’re fortunate to work within walking distance of the transit hubs and won’t need an unlimited 30-day MetroCard, then transit costs are essentially a wash or at least lowered by $121.

But what if you own property?

New Jersey, Long Island, and Westchester are famous for their eye-popping property tax bills. Let’s say that the average property tax bill is about $5,000 cheaper in the city (based on the figures presented here). Here are the amounts that you would have to make in order to break even on the higher property taxes:

SingleMarriedHead of Household
$140,299$142,886$140,946

So what’s the takeaway?

If you’re renting, make less than $40,000 after-tax income, and don’t work within walking distance of the PATH or Port Authority, stay put. If you’re renting and make over $40,000 after-tax income or work within walking distance of the PATH or Port Authority, take the PATH or bus from Port Authority across the river and don’t go any deeper in to New Jersey if you have to. If you’re buying, stick around the city until you’re making north of $140,000 taxable income and then some if your transit costs increase as well. Obviously there are many more factors that you need to consider about your own situation before making a decision, so do your own calculations.

Hopefully this provides a good starting point for thinking about what’s best for you. I’d love to hear what other factors you considered in your decision!

Leave a comment on Get Out of Town!