Re-balancing my investments: 2013 Roth IRA contribution edition

My investments have been mostly plodding along this year. Occasionally, I have adjusted how much of my 401(k) contribution went to what (S&P 500 index, total international index, and stable value fund) and then left it alone again. For example, my September and October contributions went about 50/50 to the stable value fund and the total international index because the US stock markets had been doing so well.

But now that it is time to make my 2013 Roth IRA contribution, I am going to re-balance by exchanging some funds around. Back in May, I wrote a post on Tax-Efficient Investment Placement Over Time, which I have referenced so many times that I should really bookmark it.

First, what are the balances in my various accounts?

  • $23,600 Roth IRA (with $5,500 new contribution)
  • $8,200 Old tax-deferred CDs
  • $10,100 Series I Savings Bonds
  • $15,700 Taxable account
  • $74,500 401(k)
  • $132,000 Total investments

What is my asset allocation?

% Category Amount
26% Fixed income $34,320
37% International stocks $48,840
37% US stocks $48,840

If we follow my ordering from my post on tax-efficient investment placement, what does that ideal portfolio look like?

Steps

  1. My employer match to the company stock
  2. Series I Savings Bonds that already exist in taxable
  3. CDs that are already in my Roth IRA
  4. The remaining portion of my fixed income allocation to the stable value fund in my 401(k).
  5. (not necessary) As much of my remaining fixed income allocation to Total Bond Market in my Roth IRA as possible
  6. (not necessary) If my tax-advantaged balances weren’t enough for all the fixed income necessary, added $10,000 in Series I Savings Bonds (possibly early for future-proofing)
  7. (not necessary) Any other fixed income went to a tax-exempt bond fund in taxable.
  8. As much of my international allocation in taxable as it allowed (in the first few years, my entire taxable balance; in later years, the entire international allocation)
  9. Next, I added any of the remaining international allocation into my 401(k).
  10. The remaining 401(k) funds went to the S&P 500 index fund. Call this amount X.
  11. (X/0.8)-X is how much I put into the Extended Market index fund in my Roth IRA (minimum of $3,000).
  12. The remaining Roth IRA funds went to Total Stock Market.
  13. (not necessary) The remaining taxable funds went to Total Stock Market.

Ideal portfolio

Account Fund Current Ideal Difference
401(k) Stable value $14,300 $16,000 +$1,700
Taxable Total international stock index (admiral shares!) $15,700 $15,700 (same)
401(k) Total international stock index $22,100 $33,200 +$11,100
401(k) S&P 500 index + employer stock $38,000 $25,300 -$12,700
Roth IRA Extended Market index fund $8,400 $6,300 -$2,100
Roth IRA Total international stock index $9,700 $0 -$9,700
Roth IRA Total Stock Market index fund (admiral shares -soon!) $5,500 $17,300 +$11,800

Note that these numbers are all rounded, so they may be slightly off if you try to make calculations with them, but they should still illustrate my example sufficiently.

The main thing here is that I’m moving my Roth IRA from being mostly Total International Stock Market index (TISM) with a bit of Extended Market index to being mostly Total Stock Market Index (TSM) with a smaller amount of Extended Market. I’m also going to exchange all of my company stock into the S&P 500 index fund to diversify better. (So many people don’t know you can do this!)

I’ll perform a few transactions to accomplish this:

  1. Contribute $5,500 to the money market account in my Traditional IRA. – done!
  2. Convert the $5,500 from my Traditional IRA into the total stock market index fund in my Roth IRA once the funds settle. – done!
  3. In my 401(k), exchange all of the company stock money to the S&P 500 index fund.
  4. Next in my 401(k), exchange ($11,100 – company stock money = $12,700) from the S&P 500 index fund to $1,700 in the stable value fund and $11,000 in the total international stock index fund.
  5. In my Roth IRA, exchange $2,000 from the extended market index fund and the entirety of the total international stock index fund into the total stock market index fund.

And that’ll be the last re-balance I make by exchanging until early 2015 when I make my Roth IRA contribution for 2015 – all other rebalancing will be done by adjusting which funds in my 401(k) get how much of my contribution each month.

Happy Friday, all!

Calculating total federal income tax due for 2012

We’re far enough along in the year that I’m reasonably confident in my total income for the year, so I’ve calculated how much federal income tax I should pay overall for the year.

Excel Calculations

To follow along, open up a new Excel spreadsheet.

In cell A1, enter the sum of your federal taxable earnings for the year. This isn’t your total gross earnings because you could have pre-tax deductions. My paychecks each month actually show what my federal taxable wages are.

In cell A2, enter your standard deduction (or the sum of your itemized deductions, if you plan on using those when filing instead). Personally, I prefer to do this calculation as it relates to the amount of federal income tax deducted from my paycheck using both the standard deduction and the sum of my itemized deductions to have a better margin of error. For 2012, this is [1]:

  • $5,950 for singles and married individuals filing separately
  • $11,900 for married couples filing a joint return
  • $8,700 for heads of household

In cell A3, enter the number of personal and dependent exemptions you can use. If you’re single, this is only 1.

In cell A4, enter:

=A3*3800

where $3,800 is the value of each personal and dependent exemption [1].

In cell A5, enter the sum of your interest and ordinary dividends.

In cell A6, enter:

=A1+A5-A2-A4

This is an approximation of your total taxable income. Disclaimer: I’m excluding more complex cases that don’t apply to me. You should do your own figuring if you have further income that I haven’t covered here.

In cell A7, enter:

=MIN(8700,A6)*0.1+IF(A6>8700,(MIN(35550,A6)-8700)*0.15,0)+IF(A6>35550,(MIN(85650,A6)-35550)*0.25,0)+IF(A6>85650,(MIN(178650,A6)-85650)*0.28,0)

This formula will calculate your total tax due if the amount in cell A6 was less than $178,650.

My situation

I ran this calculation with both the standard deduction and an estimated sum of my itemized deductions. I estimate the sum of my itemized deductions to be higher than the standard deduction, so I should owe a bit less tax (< $1,000 less) if I itemize.

I will have paid more federal income tax than the amount in A7 assuming the standard deduction with my November paycheck, which means that, mathematically, I don’t need to pay any income tax on my December paycheck to cover all of my tax owing for the year.

I did a similar calculation last year and didn’t really believe that I didn’t need to pay as much income tax with my December paycheck as my employer had been taking off each month. I ended up with the refund that I expected. But this year I’ve calculated that I even if I skip paying federal income taxes with December’s paycheck, I will still overpay by about $400, assuming that I take the standard deduction, which makes my margin of error in skipping paying federal income taxes with December’s paycheck about $1,000.

A resource that has helped me quite a bit in estimating my federal income taxes due is the IRS Withholding Calculator. Running the calculator this past Sunday, it seemed to think that I had already received my November paycheck, so I had to include the taxes I expect to be withheld from November’s paycheck in the field labelled “Enter the total Federal income tax withheld to date in 2012 (including amounts withheld from bonuses or which you expect to have withheld for bonuses):”. You can double check where it thinks you are in the pay year by looking at the amount under “Projected withholding for rest of year:” on the concluding page. If that is equal to “Total tax withheld from last check:” and you’re paid monthly, then it thinks you’ve already seen your November paycheck.

This year, I’m going to trust the math. I’m going to take the IRS Withholding Calculator’s suggestion of setting my W-4 allowances to 23 in early December so that my employer doesn’t withhold any federal income tax from my last paycheck of the year. That means that I’ll have a huge paycheck in December, since I’m also done with paying Social Security taxes and my 401(k) contribution will be less than other months.

Next year? I’m going to set my W-4 allowances to 2 instead of the 1 that I had been using this year and I’m going to adjust my RSU vests to have only 28% withheld instead of the 35% I had set it to to offset only 25% being withheld from them earlier in the year. I’ll continue to take a look at these calculations several times a year. I’ll need to evaluate whether I want to have less federal income tax withheld from each of my paychecks to take into account my itemized deductions now that I own a place, but for the first part of the year, I’m going to assume just the standard deduction on my paychecks. I would, after all, rather have too much withheld than end up paying penalties because I didn’t pay enough federal income tax throughout the year.

[1] http://www.irs.gov/uac/In-2012,-Many-Tax-Benefits-Increase-Due-to-Inflation-Adjustments

Would I take a job I hated for double my salary? Triple?

My net worth estimation as of July 31st is as follows:

  • Checking accounts: $8,400
  • Savings: $26,100
  • Taxable investments: $10,400
  • Tax-advantaged investments: $52,200
  • Condo equity: $86,700
  • Total: $183,800

A friend threw out the question “Would you take a job you hated for a few years if the base salary was $200,000? What if it was $300,000?” These numbers seem super unrealistic to me (or maybe I just underestimate how much companies will pay), but I thought it was an interesting exercise.

So, I made a spreadsheet! I took into account the increased taxes, hitting the social security tax earlier, and still maxing out my 401(k). For the sake of this exercise, I used 2012 income tax rates since I don’t have any future tax tables available.

$200,000 base salary: Throwing everything at the mortgage, it would be paid off by May 2015. After that, building up my taxable investment account such that 4% of the value would provide me with $30,000 per year would take until December 2021.

$300,000 base salary: Throwing everything at the mortgage, it would be paid off by April 2014. My taxable investment account would be sufficiently large in December 2018.

Estimation with my current salary including bonuses: Mortgage would be paid off by June 2017. Taxable investment account would be sufficiently large by 2025.

Would being financially independent, not needing a salary anymore, 4-7 years earlier than at my current income level, be worth giving up the reasonable work/life balance that I have now? I’m not sure that it is, considering how young I would still be in 2025.

Maybe it would be worth it to do that now, put in a few years at that level of commitment. But honestly? That’s what I did in college. I took a heavy course load, working 70 hours/week on school for 4 years. I’m not sure that I have that level of commitment in me anymore. I know that I burn out quickly and need time to re-group before I can go back at it again.

So I feel like now is the time to take a slight step back (only slight really since dating happens mostly outside of normal work hours) in my career and put more of an effort on dating. Since graduating from college, I haven’t made a huge effort towards dating or finding a relationship. I feel like my social life has dwindled mostly down to my coworkers and I’ve been going on pairs of dates endlessly. I’ve finally gone on more than two dates with the same person and I’m dating someone :) That’s why I’ve been a bit less active around the blog and commenting elsewhere.

Investing with Moving Targets: Complicated Case Study

Now what if things are more complicated and I don’t know exactly how much money I’m going to invest at the beginning of the year? I can instead set an algorithm and then follow that throughout the year.

Let’s say that my investments look like this and it is early May:

Roth IRA

  • $3,000 Vanguard Extended Stock Market Index Fund
  • $6,400 Vanguard Total International Stock Market Index Fund
  • $7,700 five-year CDs that I opened while in college

401(k)

  • $14,400 Vanguard 500 Index Fund
  • $5,600 Vanguard Retirement Savings Trust
  • $10,200 Vanguard Total International Stock Market Index Fund
Total investments: $47,400

Then my asset allocation looks like this:

  • 28% Cash
  • 30% US Large-cap stocks
  • 6% US Small/mid-cap stocks
  • 35% International stocks

Target is 23% Cash / 39% US stocks / 38% International stocks, so that isn’t too far off base.

I plan on maxing out my 401(k) and obtaining the full match from my employer, which would put an additional $12,600 into my 401(k) in 2012. My goal though is to invest 20% of my gross income, which isn’t covered by maxing out my 401(k) and receiving the employer match, so I will invest further in a taxable account. With the stock price that I’m using in my income forecasting, I should put $7,300 into my taxable account in addition to investing the $5,500 which is currently sitting in a money market fund at Vanguard.

Let’s plan this out like we did with the simpler case above.

First of all, with the amount that I plan on investing in taxable this year, I want to simplify my portfolio a bit so that it looks like this:

Roth IRA

  • $9,400 Vanguard Total Stock Market Index Fund
  • $7,700 five-year CDs that I opened while in college – these are staying

401(k)

  • $9,100 Vanguard 500 Index Fund
  • $3,000 Vanguard Retirement Savings Trust
  • $18,100 Vanguard Total International Stock Market Index Fund

I’m going to pretend that Vanguard 500 Index Fund = Vanguard Total Stock Market Index Fund since it makes rebalancing easier, the return graphs are similar, and I only have the former available in my 401(k).

The general advice is to put international stocks in taxable, but I would prefer to put the total US fund in taxable since I don’t have access to it in my 401(k), whereas I do have access to my the total international one in my 401(k). I’ll use the S&P 500 index fund to fill in the remaining US stock room in my portfolio.

  • Months 5 & 6 401(k) contribution allocation: 31% Vanguard 500 Index Fund / 26% Vanguard Retirement Savings Trust / 43% Vanguard Total International Stock Market Index Fund
  • Late in Month 7 taxable investment: $11,200 to Vanguard Total Stock Market Index Fund. In 401(k), move $6,800 from Vanguard 500 Index Fund split to: $2,600 to Vanguard Retirement Savings Trust / $4,200 Vanguard Total International Stock Market Index Fund.
  • Months 7-12 (regular) taxable investment: 100% to Vanguard Total Stock Market Index Fund
  • Month 7 401(k) contribution allocation: 23% Vanguard 500 Index Fund / 29% Vanguard Retirement Savings Trust / 48% Vanguard Total International Stock Market Index Fund
  • Month 8 401(k) contribution allocation: 24% Vanguard 500 Index Fund / 29% Vanguard Retirement Savings Trust / 47% Vanguard Total International Stock Market Index Fund
  • Month 9 401(k) contribution allocation: 24% Vanguard 500 Index Fund / 28% Vanguard Retirement Savings Trust / 48% Vanguard Total International Stock Market Index Fund
  • Month 10 401(k) contribution allocation: 24% Vanguard 500 Index Fund / 29% Vanguard Retirement Savings Trust / 47% Vanguard Total International Stock Market Index Fund
  • Late in Month 11 taxable investment: $400 to Vanguard Total Stock Market Index Fund
  • Month 11 401(k) contribution allocation: 9% Vanguard 500 Index Fund / 34% Vanguard Retirement Savings Trust / 57% Vanguard Total International Stock Market Index Fund
  • Month 12 401(k) contribution allocation: 8% Vanguard 500 Index Fund / 35% Vanguard Retirement Savings Trust / 57% Vanguard Total International Stock Market Index Fund

With all of that, at the end of 2012, my accounts would look like this:

Taxable

  • $12,800 Vanguard Total Stock Market Index Fund

Roth IRA

  • $9,400 Vanguard Total Stock Market Index Fund
  • $7,700 five-year CDs that I opened while in college – these are staying

401(k)

  • $1,400 Company stock
  • $4,800 Vanguard 500 Index Fund
  • $8,800 Vanguard Retirement Savings Trust
  • $27,700 Vanguard Total International Stock Market Index Fund

Based on the above data, I only need to adjust the allocations to my 401(k) in the months where I make a larger than regular taxable investment. In months 8-10 and 11-12 of what I’ve shown above, the suggested percentages are so close to the same, that it’s not worth fidgeting over. So that does prove my hypothesis that I should adjust my 401(k) future allocations after I make a larger-than-regular taxable investment in the month since that throws the asset allocation off a bit. This will be even more true next year (2013), when there will be several months where I invest $2,200 or so in my taxable account (or more, depending on what 20% of my gross turns out to be).

Algorithm

  • Buy only shares of Vanguard Total Stock Market Index Fund in my taxable account.
  • If a large contribution offsets the balance in my portfolio, then make adjustments as necessary to the existing shares I hold in tax-deferred accounts only if it represents a significant shift. Otherwise, just re-balance with new contributions.
  • Only adjust the contribution allocations to my 401(k) in the months where I make a larger than regular taxable investment, e.g. in the RSU vest months of January, May, July, and November.

Investing with Moving Targets: Simple Case Study

If I knew exactly how much money I was going to put where for the year, making an investing plan and sticking to it would be pretty simple.

Let’s say that my accounts looked like this at the end of 2011:

Roth IRA

  • $10,000 Vanguard Total International Stock Market Index Fund

401(k)

  • $1,000 Company stock
  • $5,000 Vanguard Retirement Savings Trust
  • $6,000 Vanguard 500 Index Fund
  • $10,000 Vanguard Total Stock Market Index Fund

Total value: $32,000

Then my asset allocation looks like this:

  • International stocks: $10,000 + $10,000 = $17,000 / $32,000 = 63%
  • Cash: $5,000 / $32,000 = 16%
  • Large-cap/market US stocks: $1,000 + $6,000 = $7,000 / $32,000 = 22%

That puts the split of Cash/US/International at 16/63/22, which I think is a bit overweighted to international. My target was 13/43/44.

If I knew that I would only add money to my 401(k) and max it out, with say a total employer match for the year of $2,400, I would know that I am adding $19,400 to my portfolio and be able to plan accordingly. (Employer match goes to company stock in full each month.)

  • Months 1-8: 100% Vanguard 500 Index Fund
  • Month 9: 25% Vanguard 500 Index Fund / 74% Vanguard Retirement Savings Trust / 1% Vanguard Total International Stock Market Index Fund
  • Month 10: 36% Vanguard 500 Index Fund / 15% Vanguard Retirement Savings Trust / 49% Vanguard Total International Stock Market Index Fund
  • Month 11: 50% Vanguard 500 Index Fund / 12% Vanguard Retirement Savings Trust / 38% Vanguard Total International Stock Market Index Fund
  • Month 12: 36% Vanguard 500 Index Fund / 14% Vanguard Retirement Savings Trust / 49% Vanguard Total International Stock Market Index Fund

And voila, after 12 months of that, my accounts would look like this:

Roth IRA

  • $10,000 Vanguard Total International Stock Market Index Fund

401(k)

  • $3,400 Company stock
  • $6,600 Vanguard Retirement Savings Trust
  • $19,100 Vanguard 500 Index Fund
  • $11,900 Vanguard Total International Stock Market Index Fund

Social Security “Recapture” Tax is dumb

Warning: This post is going to be full of math. This is not a political post – this is a math post.

For the first two months of 2012, Social Security Tax is 4.2% of your wages and for the remaining months, it will be 6.2%. The wage at which you stop paying Social Security Tax for 2012 is $110,100. [1]

I would thus expect that the maximum Social Security Tax that I will pay is as follows:

  • January/February: $110,100 / 12 * 4.2% = $385.35
  • March through December: $110,100 / 12 * 6.2% = $568.85
  • Overall total = $6,459.20

Since I will receive my first quarter bonus in one of (January, February), I will only pay 4.2% Social Security Tax on it, as will I on my January and February paychecks, despite these totaling almost $30,000 at my current calculations. Over the course of the year, I will still pay the $6,459.20 in Social Security Tax that I owe throughout the year, according to my calculations.

What exactly is the purpose of the new “recapture” provision of the tax law? It is suggesting that I will owe approximately another $176.41 at tax time come April 2013 simply because my first quarter bonus was paid out in one of (January, February).

Doesn’t this “recapture” provision defeat the whole purpose of phasing out the tax at the earnings level of $110,100? Those of us earning more than $110,100 in the year will not see Social Security in our old age past that earnings amount, so why I am being forced to pay more into Social Security than my math suggests? Is my math wrong?

[1] http://www.irs.gov/newsroom/article/0,,id=251650,00.html

Theory: Some Property Depreciation is Okay

I look at buying a place as buying a place to live, not as an investment. I’m trying to convince myself that some level of depreciation of a piece of property is acceptable to still break even on the property when it comes time to sell it.

Let’s say that you plan on staying in a property that you might purchase for about 7 years.

Let’s assume that your monthly fixed expenses, ignoring mortgage pre-payments, are the same whether you rent or buy a place.

Let’s also assume that you can and will pay off the mortgage in entirety in this time, costing you a total of $35,000 in interest.

If your rent goes up at a rate of 2% per year, then you would pay approximately $132,000 in rent payments during this 7 year period.

In order to break even on the value of this property versus what you would have spent in rent payments over the course of the 7 year period, the following must be satisfied:

Rent you would have paid >= Mortgage interest paid + Property Depreciation

Solving for property depreciation:

Property Depreciation <= Rent you would have paid – Mortgage interest paid

In our example, this gives:

Property Depreciation <= $132,000 – $35,000
Property Depreciation <= $97,000

Which means that for this particular property and the amount of rent that I am paying in my current apartment, the property could depreciate $97,000 or about 1/3 of its current value before renting for that 7 year period would have made more sense.