Should I maximize the 12% tax bracket?

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Topic Author
sam1838
Posts: 68
Joined: Fri Nov 08, 2019 10:28 am

Should I maximize the 12% tax bracket?

Post by sam1838 »

I am maximizing my Roth IRA and HSA, and getting my employer match in my 401(k). I also have paid off my student loans and saved up the amount of cash I want to hold. I am now at a juncture where I can either a) contribute excess income to my 401(k) b) dump the excess each month into taxable investments or c) some mixture of the two. I plan to retire when I'm 50, so getting at my money early is a consideration.

I am wondering if it makes sense to contribute to my 401(k) until I get my taxable income just above the 12% tax bracket in order to maximize the amount of income I pay only 12% tax on, then dump the rest into taxable. I could contribute more, but then I'd be leaving some of that 12% tax bracket unused. Income withdrawn early from the 401(k) would have a 10% penalty plus tax. I could do conversions or SEPP, but even then I'm not sure if the average tax paid in future years would be under 12%.

What do people think? Any advice is appreciated, thanks.

Additional Information added:
Age: 32
Tax Filing: Single
Income: $70,000
Housing: Renting and intending to rent indefinitely
State: Wisconsin
State Tax: 6.27%, though it's more complicated to calculate

401(k)
100% VTWAX (Global equities) equivalent $40,000

Roth IRA
100% VTWAX $22,000

HYSA
$30,000 (12 months expenses)

HSA
Deductible in cash
100% VTWAX equivalent for excess, currently $2,000

No debt

Desired allocation: 10% cash or 12 months expenses, whichever is greater. 90% VTWAX or remainder.

I can save about 50% of my after tax income (calculated assuming no tax advantaged savings). Employer match is 6%, which I've been doing for some time.
Last edited by sam1838 on Sat May 08, 2021 8:20 am, edited 2 times in total.
mbasherp
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Re: Should I maximize the 12% tax bracket?

Post by mbasherp »

You should absolutely get as far into the 12% bracket as you can if you already have a taxable account. It makes dividends and distributions tax free and you can tax gain harvest back up to the top of the 12% bracket (roughly) each year. This is too good to pass up if you are in that zone. We typically get $2k in tax free dividend distributions plus book another $10k in capital gains tax free each year (because of maximizing pre-tax contributions).

You indicate that you’re aware of the possibilities to access the money earlier. That’s right; don’t get scared off because most access after 59.5. It is highly, highly unlikely that your “average” tax rate would be anywhere near 12% in the future if that’s where you are now. A lot of that 401k money can come out at a 0% rate with minimal planning.

So get down into that 12% bracket- don’t maximize what you’re paying 12% on, maximize what you’re paying 0% on!
Last edited by mbasherp on Sat May 08, 2021 8:12 am, edited 1 time in total.
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Watty
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Re: Should I maximize the 12% tax bracket?

Post by Watty »

What to do could also depend on the rest of your situation and we do no know that. For example we do not know if your are single or what your state taxes are. We also do not know if you are 25 and hoping to retire at 50 or if you are 47 and you are pretty sure that you going to retire in a few years.

Your housing situation is also real important. For some people renting for life makes sense but for me having a paid off house when I retired was one of the key to making my retirement numbers work better.

There is a suggested format for asking portfolio questions and if you post your information using that as a guideline you will likely get better responses.

viewtopic.php?f=1&t=6212
Topic Author
sam1838
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Joined: Fri Nov 08, 2019 10:28 am

Re: Should I maximize the 12% tax bracket?

Post by sam1838 »

Watty wrote: Sat May 08, 2021 7:37 am There is a suggested format for asking portfolio questions and if you post your information using that as a guideline you will likely get better responses.

viewtopic.php?f=1&t=6212
I have added additional information to the post, thank you.
Topic Author
sam1838
Posts: 68
Joined: Fri Nov 08, 2019 10:28 am

Re: Should I maximize the 12% tax bracket?

Post by sam1838 »

mbasherp wrote: Sat May 08, 2021 7:29 am So get down into that 12% bracket- don’t maximize what you’re paying 12% on, maximize what you’re paying 0% on!
Thank you for your response. It probably makes sense to just increase my 401(k) contribution then. 12% just seems like a low amount to pay to not have to worry about an unpredictable tax bill later in life, but I may just be a little paranoid and like the idea of taxable account flexibility.
MrJedi
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Re: Should I maximize the 12% tax bracket?

Post by MrJedi »

Do you have a Roth 401(k)? If so you can start using that when you're in the 12% bracket (or 0% LTCG tax bracket which is slightly lower). This is assuming you believe this 12% bracket is favorable for you. I would prefer Roth over taxable. Roth vs traditional is a bit trickier.
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Svensk Anga
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Re: Should I maximize the 12% tax bracket?

Post by Svensk Anga »

You want to get your income to just below the 12% bracket top at the time your taxable account is paying dividends. There is a sneaky marginal rate there where extra ordinary income is taxed at 12% and it pushes qualified dividends into the 15% tax zone, so you effectively pay 27% on the marginal income.

Actually, the top of the 0% qualified dividends and long term capital gains bracket is a few hundred dollars of AGI below the top of the 12% bracket.

You are wise to be looking ahead with your plan. I blindly maximized tax deferred. Turns out, a couple years I deferred in the 15% bracket and now in retirement, I am using up the 22% bracket to try to stay out of the 24% or maybe 25-28% if the current rates sunset.
mbasherp
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Re: Should I maximize the 12% tax bracket?

Post by mbasherp »

sam1838 wrote: Sat May 08, 2021 8:25 am
mbasherp wrote: Sat May 08, 2021 7:29 am So get down into that 12% bracket- don’t maximize what you’re paying 12% on, maximize what you’re paying 0% on!
Thank you for your response. It probably makes sense to just increase my 401(k) contribution then. 12% just seems like a low amount to pay to not have to worry about an unpredictable tax bill later in life, but I may just be a little paranoid and like the idea of taxable account flexibility.
I see now, with what you added, that you don’t yet have a taxable account other than that big emergency fund. But yeah, volunteering to pay more in taxes now usually doesn’t work out to leave the most money in your pocket.

If you did something like invest 6 months of that 12 month emergency fund, you could start taking advantage of that strategy I mentioned.
MishkaWorries
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Re: Should I maximize the 12% tax bracket?

Post by MishkaWorries »

sam1838 wrote: Sat May 08, 2021 6:26 am I could contribute more, but then I'd be leaving some of that 12% tax bracket unused. Income withdrawn early from the 401(k) would have a 10% penalty plus tax.
Anyone who wishes to retire early needs to research Rule 72t. That can allow you to access your 401K prior to 59 1/2 without a 10% penalty.
We plan. G-d laughs.
mffl
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Re: Should I maximize the 12% tax bracket?

Post by mffl »

Svensk Anga wrote: Sat May 08, 2021 9:14 am You want to get your income to just below the 12% bracket top at the time your taxable account is paying dividends. There is a sneaky marginal rate there where extra ordinary income is taxed at 12% and it pushes qualified dividends into the 15% tax zone, so you effectively pay 27% on the marginal income.
I don't know the intricacies of this particular tax bracket threshold. Is it really 27%? Or just 12% if it's ordinary income OR 15% if it's cap gains -- one or the other?
HomeStretch
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Re: Should I maximize the 12% tax bracket?

Post by HomeStretch »

If you have any excess funds after you use Traditional 401k employee deferrals to get down into the 12% bracket, prioritize making retirement contributions to whatever Roth options are still available to you over contributing to a Taxable account. Roth accounts grow tax free. This could include making employee deferrals to Roth 401k, if available, up to the $19.5k 2021 limit. After that, if your 401k plan offers a ‘mega backdoor Roth’, you can contribute (assuming eligible compensation) up to the 2021 limit of $58k (limit is for all 401k employEE/employER contributions combined). BH wiki page on mega backdoor Roth:
https://www.bogleheads.org/wiki/After-tax_401(k)
Topic Author
sam1838
Posts: 68
Joined: Fri Nov 08, 2019 10:28 am

Re: Should I maximize the 12% tax bracket?

Post by sam1838 »

HomeStretch wrote: Sat May 08, 2021 9:47 am If you have any excess funds after you use Traditional 401k employee deferrals to get down into the 12% bracket, prioritize making retirement contributions to whatever Roth options are still available to you over contributing to a Taxable account. Roth accounts grow tax free. This could include making employee deferrals to Roth 401k, if available, up to the $19.5k 2021 limit. After that, if your 401k plan offers a ‘mega backdoor Roth’, you can contribute (assuming eligible compensation) up to the 2021 limit of $58k (limit is for all 401k employEE/employER contributions combined). BH wiki page on mega backdoor Roth:
https://www.bogleheads.org/wiki/After-tax_401(k)
It didn't occur to me that I could do both, but it looks like I can set a rate for before tax and after tax simultaneously in the UI for my 401(k). It does seem like that could be the best option then. Thank you.
HomeStretch
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Re: Should I maximize the 12% tax bracket?

Post by HomeStretch »

sam1838 wrote: Sat May 08, 2021 9:53 am
HomeStretch wrote: Sat May 08, 2021 9:47 am If you have any excess funds after you use Traditional 401k employee deferrals to get down into the 12% bracket, prioritize making retirement contributions to whatever Roth options are still available to you over contributing to a Taxable account. Roth accounts grow tax free. This could include making employee deferrals to Roth 401k, if available, up to the $19.5k 2021 limit. After that, if your 401k plan offers a ‘mega backdoor Roth’, you can contribute (assuming eligible compensation) up to the 2021 limit of $58k (limit is for all 401k employEE/employER contributions combined). BH wiki page on mega backdoor Roth:
https://www.bogleheads.org/wiki/After-tax_401(k)
It didn't occur to me that I could do both, but it looks like I can set a rate for before tax and after tax simultaneously in the UI for my 401(k). It does seem like that could be the best option then. Thank you.
Sounds like your 401k plan allows you to make after-tax (non Roth) employee contributions (step 1 of a mega backdoor).

Does your plan also allow you to do step 2, which is convert the after-tax contributions to Roth via an in-plan rollover to Roth 401k or in-service distribution to a Roth IRA?
Topic Author
sam1838
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Joined: Fri Nov 08, 2019 10:28 am

Re: Should I maximize the 12% tax bracket?

Post by sam1838 »

HomeStretch wrote: Sat May 08, 2021 9:59 am Sounds like your 401k plan allows you to make after-tax (non Roth) employee contributions (step 1 of a mega backdoor).

Does your plan also allow you to do step 2, which is convert the after-tax contributions to Roth via an in-plan rollover to Roth 401k or in-service distribution to a Roth IRA?
My mistake. The options are Before Tax Contribution and Roth Contribution, and I'm able to set both. I assume I would just want to set the Before Tax to maximize the 12% bracket, and the excess income I would sweep up in the Roth Contribution? I haven't looked into mega backdoor Roths as I assumed that was for higher income earners.
bsteiner
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Re: Should I maximize the 12% tax bracket?

Post by bsteiner »

sam1838 wrote: Sat May 08, 2021 8:25 am
mbasherp wrote: Sat May 08, 2021 7:29 am So get down into that 12% bracket- don’t maximize what you’re paying 12% on, maximize what you’re paying 0% on!
Thank you for your response. It probably makes sense to just increase my 401(k) contribution then. 12% just seems like a low amount to pay to not have to worry about an unpredictable tax bill later in life, but I may just be a little paranoid and like the idea of taxable account flexibility.
Especially since you're only 32, there's no way to know what your tax rate will be many years from now. But I agree that 12% is a low rate. If you think your future tax rate is more likely to be higher than 12% than lower than 12%, you may want to consider Roth contributions or conversions to fill up your 12% bracket. The risk is limited to 12%.
MishkaWorries wrote: Sat May 08, 2021 9:21 am
sam1838 wrote: Sat May 08, 2021 6:26 am I could contribute more, but then I'd be leaving some of that 12% tax bracket unused. Income withdrawn early from the 401(k) would have a 10% penalty plus tax.
Anyone who wishes to retire early needs to research Rule 72t. That can allow you to access your 401K prior to 59 1/2 without a 10% penalty.
You're thinking of one of the exceptions to Section 72(t). Section 72(t) imposes a 10% tax on distributions before 59 1/2, but contains several exceptions. https://www.law.cornell.edu/uscode/text/26/72. See my article on the exceptions in the January 2000 issue of Estate Planning: https://www.kkwc.com/wp-content/uploads ... 155030.pdf.
sandan
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Re: Should I maximize the 12% tax bracket?

Post by sandan »

It seems flexibility of funds is underappreciated in this thread. Tax laws and personal needs are ever changing in unpredictable ways. Unless there are clear cut savings, it is better to have funds in both taxable and 401k+roth accounts.
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FiveK
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Re: Should I maximize the 12% tax bracket?

Post by FiveK »

sam1838 wrote: Sat May 08, 2021 6:26 am I am wondering if it makes sense to contribute to my 401(k) until I get my taxable income just above the 12% tax bracket in order to maximize the amount of income I pay only 12% tax on, then dump the rest into [the Roth 401k].
Yes, as edited.

When you start having significant dividend income, that 27% marginal rate may suggest otherwise, but for now your wondering looks good. Unless you plan to move to an even higher tax state after retirement, saving 28.27% now on traditional 401k contributions is a reasonable strategy.
Topic Author
sam1838
Posts: 68
Joined: Fri Nov 08, 2019 10:28 am

Re: Should I maximize the 12% tax bracket?

Post by sam1838 »

Thanks everyone for your replies. I will think about it some more, but probably go with the max 12% bracket through traditional 401(k) contributions with the rest going into Roth 401(k) strategy, though as I approach retirement I will certainly review that strategy as tax laws and expectations change.
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