From January to September 2017, we have saved $248,820.66. In today’s post we’re going to look at the kinds of accounts we put that money into and how as high income earners we save as much on taxes as we can by maximizing our tax-advantaged accounts.
Tax advantaged accounts typically have government mandated limits to how much you can stash away in a year, and in today’s post I’m also going to talk about the new limits for these accounts in 2018 (Spoilers: we get to save more tax advantaged money in 2018, wheeeee!).
Taxable Vs. Tax Advantaged
So far in 2017 42.6% of the money we’ve saved made its way into tax advantaged accounts and the rest resides in taxable accounts.
The rest of this article is going to focus on the kinds of accounts we use to give 42.6% of our savings some kind of tax advantage.
Various Flavours of Tax Advantage
We partake in a variety of tax advantaged accounts. Each account type has a different kind of tax advantage.
|Account Type||Money going in||Growth||Money coming out|
|401k||Pre-tax||Tax-free||Taxed at income tax rates|
|HSA||Pre-tax (including no FICA taxes)||Tax-free||Tax-free for qualified medical expenses|
Let’s take a look at how our $105,889.25 of tax-advantaged savings in 2017 have been distributed amongst these three kinds of tax advantaged accounts.
The Limitations of Our Tax Advantaged Accounts
Tax advantages are fantastic, so there is obviously a reason that only 42.6% of our savings have found a home in tax advantaged accounts. The reason is that each of these account types has a max cap on how much you can contribute to the account in a year.
|401k employee contribution||$18,000||$18,500|
|HSA||$6,750 for a family, $3,400 single||$6,900 for a family, $3,450 single|
For those of you who like going to the source here is a link to the IRS announcement for 2018 limits for pension plans and the IRS publication for new HSA limits.
The observant reader would have noticed that the numbers in the table above don’t add up to the amount we’ve managed to put away in tax advantaged accounts this year. $18,000 * 2 + $5,500 * 2 + $6,750 does not give us $105,889.25, so what gives Mrs. BITA, they ask in voices tinged with suspicion, hands reaching for pitchforks.
The discrepancy is explained by the following factors:
- Our 401k is made fatter via both employee and employer contributions. Mr. BITA and I both maxed out our 401ks this year and our employers added in another $15,000 (put together, not each).
- This year we did both our 2016 and our 2017 Roth IRA contributions (you can fund your Roth IRA up until tax day), so $11,000 of our savings should actually be attributed to the tax advantaged space of 2016.
- We have access to a mega-backdoor Roth. More on that in a second.
Of Baby Roths and Mega Ones
Roth IRAs have, in addition to contribution limits, income limits associated with them. For a couple with a tax filing status of married filing jointly, the income phase out range for contributions to a Roth IRA is $186,000 to $196,000 (for 2018 this is increasing to $189,000-$199,000). So if your household income is more than these limits, you can’t contribute the $5,500 described above.
Our household does have a modified adjust gross income (MAGI) of more than $196,000, so how do we contribute to Roth IRAs? We use the the backdoor roth.
The short version is: you contribute $5,500 to a traditional IRA (tIRA). You don’t deduct this on your taxes, so essentially you put $5,500 of after-tax income into a tIRA. Then you ‘convert’ this into a Roth IRA. Ta-da! Mr. BITA and I both do backdoor Roths.
We lovingly refer to our backdoor Roths as our baby Roths. Because we also have access to the awesome (and somewhat dirty sounding) megabackdoor Roth.
In 2017 the megabackdoor Roth allowed us to put another $27,000 into a Roth IRA.
Where does the number $27,000 come from?
In 2017 the IRS limit for a defined contribution pension plan (which is the category a 401k falls under) is $54,000. I’ve noted above that as an employee you can only put in $18,000 in 2017. Mr. BITA’s employer gives him a $9,000 match, so that leaves $27,000 of ‘unused’ space in his 401k. His employer’s 401k plan supports the megabackdoor option, which is essentially a way of making after-tax contributions via paycheck deductions to fill up the ‘unused’ space and to treat the money thus contributed as a separate Roth ‘sub-account’ within the 401k account.
In 2018 the IRS is increasing the limit for a defined contribution plan to $55,000. $500 of this $1000 increase will be taken up by the new 401k limit ($18,500), so we will get to contribute an extra $500 to our Roth balances next year via the megabackdoor.
That’s All Folks!
So there you have it – a list of all the accounts we are utilizing to take advantage of $95,750 in tax advantaged space in 2017:
- $18,000 * 2 in our 401ks plus
- $5500 * 2 in our Roth IRAs plus
- $6750 in our HSA plus
- $15,000 via employer contributions to our 401ks plus
- $27,000 into a Roth IRA via the megabackdoor
In $2018, thanks to the increased limits, we will be able to sock away $96,900 in these various tax advantaged accounts.