2015 Plan B: Mega Backdoor Roth IRA

My plan has always been to pay off the mortgage after maxing out all tax-advantaged investment accounts available to me. When I first made the mortgage payoff plan, I only had access to an employee-contribution 401(k) of $18,000 and a Roth IRA of $5,500 in 2015 dollars. It is possible (I don’t know yet) that with my new employer, I’ll have access to the Mega Backdoor Roth IRA. This is where the employee contributes after-tax up to the total 401(k) annual maximum of $53,000 in 2015 and then you use in-service distribution to transfer the contributions to a Roth IRA and the earnings to a Traditional IRA (and then convert the small bit of earnings to the Roth IRA to keep things clean).

Since I don’t know whether or not I’ll have access to the Mega Backdoor Roth IRA at my new job, I made a plan for 2015 assuming I don’t and then this is my plan for if I do. I’ll go with whichever plan pans out.

The 401(k) maximum is $53,000 in 2015. The maximum employee contribution is $18,000, which I will contribute pre-tax, leaving $35,000 for my employer’s contributions and after-tax contributions. This will leave me approximately $31,425 to contribute after-tax, which is about $2,856/month averaged over 11 months or $2,618.75/month averaged over 12 months. This is clearly going to put a dent in my mortgage payoff plan, but I think it’s worthwhile.

I project my total net pay in 2015 to be $118,142.85. I also expect to have $24,000 extra in my savings account at the end of 2014, after the $5,500 for my 2015 Roth IRA.

The first $18,000 of this goes towards maxing out my 401(k). Then $34,611.43 for monthly spending plans (this includes the mortgage payment). My current plan is $550.00 to my Health Savings Account.

This leaves $88,981.42 of money to work with, including the extra savings account money. Some portion of this money will be funneled into the ESPP with a good discount, but I only see that as a cash flow annoyance since I plan to sell the ESPP funds once their holding period is up.

Next, I’ll fill up the after-tax 401(k), leaving me with another $57,556.42. I’ll throw all of that at the mortgage. I had planned on throwing $73,806.93 at it from savings in 2015, so that’s only $16,250.51 less than planned, which isn’t so bad. This would leave me with the following financial structure at the end of 2015:

  • $20,000 general savings
  • $2,800 Health Savings Account
  • $119,400 Traditional 401(k)s
  • $6,800 Roth 401(k)
  • $73,500 Roth IRA
  • $26,800 taxable investments
  • $75,500 mortgage balance
  • $659,000 net worth

I would then be able to pay about $25,746.63 extra on the mortgage in 2016 and in 2017, which should erase it save for $1,902.56, which I would take out of my $20,000 general savings account. Even if I don’t quite pay it off before the rate resets in January 2018, it will not reset high enough that I can’t afford the payment and I think that is worth it for taking advantage of the Mega Backdoor Roth IRA. I mean, an extra $30,000/year in a Roth IRA in my late twenties is too amazing of an opportunity to pass up. So then in 2018, once the mortgage is fully paid off, I’ll be able to save approximately $38,074.47 outside of tax-advantaged accounts. Note that all of these calculations also assume no raises, no appliances dying, and expenses in general not going up.

The only annoying thing about the Mega Backdoor Roth IRA is that it’ll make my checking account cash flow negative most months since gross pay – taxes – pre-tax 401(k) – ESPP – after-tax 401(k) is less than my monthly spending plan. That’s okay – I can use my signing bonus and savings account to smooth out my cash flow, plus the ESPP funds will be able to be cashed in at various intervals.

Readers, do you take advantage of a Mega Backdoor Roth IRA? How does it impact your cash flow? Would you if you had access to one?

Financial Plan for 2014

Simple goals, simple implementation, right?

Income plan

The vast majority of my income comes from my W-2 day job. This is separated into regular salary, which is paid out monthly, and stock of which I will see two comparably sized vests this year. I am expecting my overall W-2 income (before deductions) to be somewhere between $160,000 and $200,000 for the 2014 year. This assumes a modest 2% increase and the 52 week low and 52 week high +20% stock prices for the RSUs. I anticipate my income surpassing the Social Security tax maximum ($117,000 in 2014) with my September or October paycheck.

My RSUs see a flat 25% of federal income tax deducted from them, which isn’t quite enough tax because my base pay alone takes me into the 28% federal income tax bracket these days, so I need to compensate for that with my W-4 allowances. My spreadsheet suggests that at this point in time, I should set zero (0) allowances on my W-4 for 2014. I will re-evaluate this after each RSU vest and raise.

Investment contributions

I plan to:

1) Contribute the 2014 maximum of $17,500 to my 401(k) for the year, spread out throughout the year:

  • H3 = annual base pay (gross)
  • J2 = Yearly max to the 401(k) – $17,500 for 2014
  • I2 = ROUNDUP(J2/H3,2) = the % that I should contribute monthly from my paycheck to max out the 401(k) over the course of the year, e.g. if it is XX.3%, I will set it to XX+1%. I will most likely reduce this by one percentage point for my April and subsequent paychecks.

2) Make my 2014 Roth IRA contribution of $5,500 through the backdoor on January 2nd, taking the funds from my savings account.

3) Continue contributing the maximum to my Health Savings Account until the plan year ends partway through 2014. I will then re-evaluate health insurance plans and whether I will contribute to the Health Savings Account again (depends on which plan works out the best).

4) Set aside my 2015 Roth IRA contribution from my final RSU vest for the 2014 year in a savings account. This will probably either be $5,500 or $6,000.

Mortgage plan

All funds that are not set aside for spending, my 401(k), my Health Savings Account, or my Roth IRA will be thrown at the mortgage. My estimate is that this should be around $2,500/month on average, plus RSU vests.

Investment allocations

This exercise is similar to what I did for 2013. As of 12/12/2013, my investments portfolio is worth ~$130,700. I estimate adding about $25,000 to the portfolio this year, including my 401(k) contributions, my employer match, and my Roth IRA contribution, putting an estimated year end balance at $156,000.

(Note: when I wrote this post last year, I estimated that my end of year balance would be $98,100. It is $34,600 higher than that as of November 30th. Crazy!)

My target asset allocation at the end of 2014 will be:

  • 27% Fixed income
  • 36.5% US stocks
  • 36.5% International stocks

Based on this, let’s calculate my ideal portfolio at the end of 2014 and compare it to where my portfolio is now:

Current Ideal EOY Difference
US stocks $48,500 $56,945 $8,422
International Stocks $47,900 $56,945 $9,073
Fixed Income $34,400 $42,124 $7,773
total $130,700 $156,000 $25,268

I will add my $5,500 Roth IRA contribution to the Vanguard Total Stock Market Index Fund Admiral Shares, which means I only need to add another $2,922 to US stocks for the year. Subtracting out my 401(k) match from there leaves my 401(k) contributions as follows for the year:

  • 4% or $654 to add to US stocks (S&P 500 index fund)
  • 52% or $9,073 to add to international stocks (total international index fund)
  • 44% or $7,773 to add to fixed income (stable value fund)

There, we can set and forget for the rest of the year!

I will re-balance the Extended Market index fund vs S&P 500 index fund amounts in January 2015 when I make my Roth IRA contribution for that year – for now, I just care about US vs international vs fixed income.

Banking plan

I’m going to have my entire pay direct deposited to my credit union checking account and then pay the mortgage from there with the leftovers each month. My credit cards are all on auto-pay from here and all of my bills are on auto-pay to a credit card.

I will continue to withdraw any health expenses from my HSA after putting them on a rewards credit card through the end of this plan year. I will re-evaluate my HSA plans during open enrollment.

My plan for expenses is as follows:

  1. If purchase is in person and < $15, use debit card until I reach N transactions. This should earn me just under $200 in interest for the year, i.e. meets my $100 gain for the year rule.
  2. All Amazon.com purchases go on that credit card (this is mostly automatic, so no big deal), as well as restaurants and in-person places that don’t take American Express.
  3. All non-foreign purchases that take American Express go on the Fidelity Amex card
  4. All other purchases (including possibly foreign ones) go on the credit union cashback visa (I love this one because it does automatic redemption every month, no matter the amount!)

This algorithm should net me about $400-550 in cashback rewards for the year, based on 2013 spending levels.

Based on my spending patterns and my rule that I will only add a credit card if it will gain me at least an additional $100/year in cashback rewards and I think I could use the card effectively for at least two years, I can’t really optimize any further than this. I could add the US Bank Cash+ Visa Signature card for 5% cashback on restaurants, but with my spending levels, that may or may not actually make any sense. My credit history is still new enough at this point that I don’t want to churn yet (under 4 years), but I will re-evaluate that in 2015.

I’m really enjoying how simple this plan is and I can’t wait to let it be implemented! Here’s to an awesome 2014!

No Bad Choice

I am already maxing out my 401(k), Roth IRA, and HSA on autopilot. I feel like beyond that, there are a lot of good options, each with their own risk and reward and it’s really difficult to choose between them.

For example, with my RSUs I could:

  1. Pay cash for the taxes and keep all of the shares. (High risk, high reward as this is $30,000 to $80,000 per year of shares in my employer. It also requires me to save up the cash to pay the taxes of up to $10,000 on a vest.)
  2. Sell shares for taxes, keeping about 2/3 of them. (High risk, high reward as this is $20,000 to $55,000 per year of shares in my employer.)
  3. Sell all shares for cash and diversify.

I’ve chosen option 3. It doesn’t seem to be working out that badly so far as I still see the efforts of my employer’s stock doing well with future RSU vests.

With my extra cash flow after maxing out tax-advantaged accounts, I could:

  1. Pay down the mortgage.
  2. Set the money aside in cash.
  3. Invest in index funds in a taxable account.

For the last year, I’ve been doing option 1 exclusively with an occasional dip into option 2. I’m starting to realize that life could change a lot in the next 4 years before my mortgage payoff goal and maybe it would be nice to have some more easily accessible funds. As with my psychological want to have a nice round number in my online savings account ($20,000), I have a feeling that once my mortgage balance reaches some number, I will feel less of a need to pay down the mortgage so aggressively and that’s when I’ll switch to investing in index funds instead or doing a mix. I’m already starting to feel less antsy about the mortgage balance, so I have a feeling that I will hit this number in the next six months or so.

Some numbers at which I think I’ll feel better about the mortgage balance:
a) $228,800: 20% of original loan balance paid down ($14,200 to go – will probably hit June 1st)
b) $214,800: 40% in equity (could hit by end of July)
c) $200,000: a round number (could hit November 1st)
d) $XXX,XXX: my expected gross income for this year including RSUs (could hit by end of November)
e) $179,000: 50% in equity (could hit by end of year, if I make the January 1st payment in December)
f) $150,000: a round number
g) $XXX,XXX: my base salary and what I would probably get somewhere else
h) $100,000: a round number
i) $50,000: a round number
j) $20,000: the balance of my savings account
k) $0: no more mortgage!

My guess is that somewhere between a) and e), I will feel better enough about the mortgage balance that I will start either splitting funds between investments and mortgage or just to investments. My investments have been going up so much lately that that seems like a bit of a scary idea though.

Why do I want to do this? Another 3-4 years is a long time to keep paying down the mortgage aggressively and not build up much of any savings/investments outside of a paid off condo and well-stocked retirement accounts. If I want to go work at a startup and lose my job stability or quit my job and travel the world, I’d like to have some more liquid funds aka a bit of a diversified nest egg rather than the gazelle intensity that I have right now on the mortgage. I can also always cash out the investments and pay off the mortgage, assuming that they haven’t lost value.

Ways I could diversify:

  1. Invest with my monthly savings and pay down the mortgage with the RSUs since those are bonuses. (7 year amortization)
  2. Invest 50% and pay down the mortgage with 50% of my monthly savings and RSU vests. (9 year amortization ignoring RSU vests)
  3. Pay down the mortgage with a specific amount each month to make the amortization over say 10 years (~$2,500 from today) or 15 years (~$1,700 from today) and invest the rest.
  4. Pay down the mortgage with the original payment each month (~$1,200) and invest the rest. (~20 year amortization)

I’m leaning towards diversifying by paying down the mortgage with a specific payment each month and investing the rest once I reach either $200,000 or my expected gross income including RSUs for the year.

Readers, do you find that you get attached to magic/round numbers emotionally when evaluating options? How do you deal with that?

July savings plan

I’m maxing out my 401(k). My income is high enough that that is really my only tax-advantaged savings vehicle available to me: 1) I’m past the deduction for the traditional IRA and 2) I’m past the Roth IRA income eligibility for single filers or pretty close to it.

I’m not the sort of person who would *not* take out a loan to invest. I’m the sort of person who would have more job security if I lowered my yearly fixed expenses by $14,469.48 than by having a larger amount of money in the bank.

This would be a somewhat different decision if I, like nicoleandmaggie, I had a ton of tax-advantaged savings room that I would give up if I didn’t use in a particular year.

I also have this strange goal to have an Admiral Shares index fund. So since I can’t get it in my Roth IRA (my account has dipped below the $10,000 that I have contributed to it) and I don’t plan on leaving my employer anytime soon and rolling over my 401(k), the only place I could do that is in a taxable account. I need about $3,600 to accomplish that goal.

I have some more things that I want to do/buy for my condo:

  1. Re-paint the second bathroom and the hallways – $500?
  2. Fix the closets in the master bedroom – $500?
  3. Buy a bed to put in the second bedroom for guests – $500?
  4. Buy a small table to put in the front entryway – $500?

(I realize that some of these estimates are probably way off, but the total could likely add up to $2,000.)

  • Money in my condo savings account right now less the projects listed above: $6,400
  • Savings planned for this month: $12,000

I’m going to take the money necessary to reach the Admiral Shares index fund goal out of my condo savings account, leaving it with $4,800. I’ll leave $2,000 in the condo savings account for those projects, so I’ll take $2,800 and pre-pay the mortgage principal. I’m also going to take the money from my bonus this month and the savings from my paycheck at the end of the month and pre-pay the mortgage. Anything that is leftover in the condo savings account will end up going there too, as well as whatever I get as a refund of the deposit on my apartment (I’m guessing about $100).

Between those two, the mortgage balance could be down to $271,100 by the end of the month, before my first payment is even due! Right now, I see about another $10,000 in savings funds for the year (August through September), which projects an EOY balance of $261,000 (plus a bit lower from the principal in regular payments, maybe just under $260,000), which is below where I need to be to be on track to pay off the mortgage in five years.

It is actually super easy to make a principal only payment on my mortgage. It’s at the credit union I use for my daily banking. I just go to the transfer screen, select the from account (checking or savings), set the to account as the mortgage, enter the amount, and then it confirms whether it is an early payment or a PRINCIPAL ONLY (their emphasis, not mine) payment. It seemed too easy to be true, but the balance was updated correctly based on my payment!

So, in summary: I’m going to use the tax-advantaged savings vehicles that I have, which is only my 401(k), and pay off the mortgage ASAP with the rest since I have a comfortable cash reserve of $24,200, ignoring my goals of investing 20% of my gross income or investing in taxable (other than having an Admiral Shares index fund) or generating $1,000 in passive income for the year.

Maybe I’ll re-evaluate this plan each month, but this is what I’m going to do this month. Mortgage balance after my first (!) pre-payment is now sitting at $283,200!