Month: April 2018

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What is a ROTH IRA and does it make sense?

Hi EnLifers! So, we paid off the student loan!! Woo-hoo! Now on to other things. At this point, the only debt we have right now is one more student loan which is currently being paid by our employer and our house. So now our attention has turned to what to do next. One of the things we’ve discussed and I’ve heard a lot about via podcasts over the years are ROTH IRAs. What is a ROTH IRA? First, IRA is short for Individual Retirement Account, so basically it is a way/tool to save for retirement instead of or in addition to whatever plans your employer may have with some income restrictions (see this link at irs.gov for additional details).  IRAs are generally tax-advantaged in that you can deduct your contributions to the IRA on your income tax return and the IRS does not consider it income. However, when you withdraw money in retirement, you will pay taxes on those withdrawals. Now, the difference in a regular IRA and a ROTH IRA is that you pay taxes on your contributions in the present. That way, when you retire you can withdraw your money (including the growth) tax-free. There are some income restrictions with ROTHs too, basically you can’t make over a certain amount in order to take advantage of it.

So for the longest time, I’d heard that ROTHs were the way to go and now circumstances actually allow for me to contribute. The thing is, I’m not sure if it’s the best deal. Hear me out. So, I actually changed to the ROTH option at my job for a couple of years once our income situation changed. I was doing a 10% split, so 5% in the regular account to get the match and 5% in the ROTH option. This option significantly reduced my take-home pay, but ROTHs are very much encouraged by most personal finance experts and I really like the idea of not paying taxes later. However, this year, I’ve been thinking if that’s the best thing for me and my family. Right now, with young kids and lower income, we could use all of the help we can get AND I’m not so sure our income in retirement years will be more than what it is now. So for instance, if we are in a 28% tax bracket now, there’s a chance it will be lower in the future because we just earn less and are in a lower bracket or the government may actually reduce it which ACTUALLY just happened. The only thing is, plain ‘ole economics tells us that tax breaks just aren’t sustainable in the long term, so they WILL increase at some point. The question is will we be a part of the group that pays more. These are all things to consider and probably a lot more depending on your situation as there are so many nuances with both plans that I haven’t delved into.

Ultimately, I’ve decided to go back to the traditional retirement route where we contribute essentially tax free for now AND I decided to contribute the max in 2018, which actually puts me at a 14.5% savings rate which is better than the 10% I was doing with both the ROTH and traditional option. Even with increasing the savings rate, I’m still able to bring home more take home pay which helps our young family right now as we navigate pre-school and extra-curricular expenses. However, I do take some solace in having contributed to a ROTH for a couple of years which ultimately just helps to diversify our portfolio in case we need funds earlier than we can pull from our traditional accounts AND if it just so happens we’re balling out in our retirement age! LOL

What are your thoughts? What would you do?  Please share your thoughts below!

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It’s Tax Time! Choices, Choices, Choices!!

Hi EnLifers!! It’s tax season!! Exactly 9 days left to get those taxes in! I have had one heck of an experience myself as I pretty much had to handle payroll taxes for the nanny we had in 2017. That included having to develop and submit my first W-2 (exciting) and filing end of year employer state tax reports! I feel very accomplished having completed such a feat without a professional! On the other end, we did actually use a tax professional to actually prepare our personal taxes this year and they are now complete and I’m happy to report that we received an unexpected hefty refund-$10K to be exact. Now the question is what to do?, what to do?, what to do?  We could go on a luxurious vacation, replace the deteriorated deck at our house (or any other number of needed house projects), save it for emergency funds, pay off a debt, or invest it. How does one make decisions like these? Ultimately, I think it is a personal preference, but here’s how I’m making the choice.  My main financial goal is financial independence so that I can explore and pursue various life interests and decrease stress. As I think about what might get me closer to that goal sooner than later, the two options that make the most sense to me are either paying off debt or investing as both have the potential to produce cash flow or income. Technically, saving it for emergencies could produce a minimal amount if saved in a low yield accessible savings account, but right now, we’ve got an adequate emergency fund for now though I’m always happy to add to it when we can.

So now, what about investing or paying off debt?  Investing it could provide income in the future especially when you consider the compounding effect. According to smartasset.com, if we invested $10K for 10 years, assuming an average 5% growth, it would grow to $16,289 and double in 15 years to $20,789. Not too shabby! So what about the debt option?  At this point, thankfully we don’t have any credit card debt that we don’t pay off each month-basically we only use our credit card for the points. However, we have a fairly small mortgage and two student loans, one $14K and the other $25K for a total of $39K. Fortunately, the $25K one is being worked down via an employer-sponsored student loan repayment program beginning this year that won’t be complete for a few years provided continued employment, so it makes more sense to focus on the $14K one. Even if the repayment wasn’t on the table, I’d choose the $14K one also because 1) it has the highest interest rate of the two and 2) it’s the closest to $10K and would make the biggest dent. Right now, we pay ~$50 in interest per month which means it was more in previous years AND in previous years, we couldn’t even deduct the interest via taxes due to higher income levels. So that means we’re paying roughly $600 a year to have a $14K loan at this point. It’d be awesome if we could reduce that amount or better yet, completely eliminate it and do something else with it! That would free up some monthly cash flow AND we could even invest the interest that we would otherwise pay! According to the same calculator, if we started off investing the $50 monthly for May-December at a rate of 5%, we’d have $13,576 in 15 years! AND we wouldn’t have to worry about debt either and could maybe use the student loan payments to pay off our mortgage or even do some of the work around the house that we need like the new deck. It gets even better if we invest the actual student loan payments themselves, in 15 years, those monthly payments would grow to $48,492!! That’s crazy!! Ok-I’m getting giddy with all the possibilities!

So what to do? With all of the number crunching, it makes the most sense for us to pay off the debt-mainly because we’ve realized we just don’t like being in debt, but it also makes the most financial sense especially depending on what we decide to do with the cash flow it creates once the debt is paid off. It’ll take us a little while to pay off the additional $4K, but we’re leaning toward just taking it out of our emergency fund and just knocking it out as we can pay our emergency fund back more quickly than we could pay off the loan using the same monthly allotment. On another note, getting deep into these numbers today really has me thinking about debt and the true cost of it. A lot of times, we get into debt to attain something we want now instead of waiting until we can actually afford to pay for it. I know for some, it makes sense-say for education or a home, but this all has me wondering what IF we did things differently? Just food for thought. Anyhow, so yeah-that’s it! I’m not excited that we overpaid taxes in 2017 as I’d prefer my $ in pocket throughout the year, but I’m glad for the tax windfall as it will allow us to do something we’ve been wanting to do for a while! Time to pay off some debt! I can’t wait!! What will you do with your tax refund if you get one? Would you do the same if you were in my shoes? Please share in the comments below!