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It was about 6 months ago when I realized I was missing out o a great opportunity on our path to financial independence. For as long as I can remember filing our taxes … my wife and I have always gotten back a nice return. I always used these refunds to help invest in our kids 529 plans or into regular dividend stocks.
Getting a large refund seemed great. But what I didn’t realize is that we were not fully optimizing our tax situation … specifically our federal taxes.
It wasn’t until I started reading a few posts from other bloggers that I realized we needed to optimize our tax situation. You see … these bloggers are killing it on their federal taxes. Most of them are earning good incomes and not paying any federal taxes … or at least very little.
So I started investigating our tax situation and quickly realized we too could owe $0 in federal taxes if we changed where our money was invested.
At the start of 2018, my wife and I set a goal to pay $0 in federal taxes on a 6-figure income. So we put together a strategy of where to invest our money.
How is our investment plan for 2018 doing after the first 3 months of the year?
1. Pension – 6% of Paycheck (Pre Tax) = $6,089.04
We previously projected our annual contribution to my pension at $6,000. But when I made the projection, I loosely based it on earning 6% of $100,000 … which isn’t accurate. My W-2 income is a bit higher than that, so we are now estimating $6,089.04 of contributions for the year. This is a mandatory contribution … so unless my income goes up (or down) … this should be the exact amount we contribute.
On top of my personal 6% contribution, my employer contributes a little over 8% match to the pension. I am eligible for a partial pension in about 12 years from my work … so this could provide a nice income stream in the future.
As long as I continue to work for my employer, this is the first deduction taken out of my paycheck. Therefore, it will always remain as bucket #1 on our investment plan.
For the first 3 months of the year, I contributed a total of $1,522.26 to my pension … which is exactly what I had expected.
2018 Projected Contribution = $6,089
2. Spousal Roth IRA (Post Tax) = $5,500
The spousal Roth IRA is second on our retirement bucket priority list … but we ended up contributing $0 the past 3 months!
One of our goals for the year is to pay $0 in federal taxes in 2018. We have optimized our income and tax situation enough for the year, that we likely won’t need additional IRA (traditional) deductions. So we want to take advantage of putting our money into Roth accounts so that our taxes are optimized in the future too.
Unfortunately, other contributions seemed to get in the way the past 3 months … so we didn’t contribute any money to the spousal Roth IRA. I actually didn’t even set up the account yet … which is now on my to do list this month.
Our goal is still to max out this retirement bucket for 2018 and we still have 9 months to do it.
2018 Projected Contribution = $5,500.00
3. Roth IRA (Post Tax) = $1,650
After reviewing our paycheck, taxes, and spending … we are modifying the projected contribution of this bucket to $1,650 from $5,300. However, if our income increases this year … we may choose to raise this higher again.
This is another Roth account (in my name) that follows the same logic as the spousal Roth IRA (priority #2). Since we are optimized to pay $0 federal taxes this year … we can take advantage of using Roth accounts.
We were able to contribute $300 to this account during the first quarter of the year. The account was already opened a few years back, so it was easy to setup an automated investment each month into this account. Pay yourself first – right?
My wife’s account will be the priority starting this month … since she doesn’t have many accounts really in her name.
2018 Projected Contribution = $1,650
4. 457b (Pre Tax) = $12,045
I have the fortunate option at my work to contribute pre tax dollars to a 457b account. The maximum contribution limit for 2018 is $18,500 … which gives us plenty of room to maneuver with our tax optimization.
We could make a choice and max out this bucket … but we don’t need to at this point. Instead, we want to leverage our Roth accounts for future tax optimization. So for now, we plan to contribute $12,045 to this account in 2018. This is up from $10,000 in our original plan.
After reviewing our tax withholding and raising the number of allowances on our paycheck, we were able to optimize our 457 contributions.
For the first 3 months of the year, we have contributed a total of $2,775 to our 457 account.
2018 Projected Contribution = $12,045
5. Brokerage Accounts (Post Tax) = up to $10,000
Even though these are taxable accounts, our brokerage investing is still a very important part of our investment strategy. We are slowly building a solid dividend income stream with these investments.
Our goal for this year is to invest $10,000 of our income into these accounts. We were fortunate to get back our federal tax return in March and sent off $5,000 to one of our brokerage accounts. In total, for the first 3 months of the year, we have invested $5,137.28 in these accounts.
2018 Projected Contribution = $10,000
I would like to point out that the dividend income we are earning is calculated into our tax optimization strategy. We expect to earn around $3,300 in dividend income this year from our taxable accounts. This is included in our overall income earned for our taxes.
The good news is most of the income we are earning are from qualified dividends … and thus not taxed. The remaining portion is not currently enough to push our income levels to a point where it would be taxed.
6. Rollover IRA (Pre Tax) = $100
The combined contribution limit for an individual is $5,500 for 2018. That means I can contribute up to a total of that amount for the sum of my Roth IRA and traditional rollover IRA.
Since our approach in 2018 is to maximize our Roth accounts because of current tax law, this traditional IRA bucket falls to the bottom of our priority list. At the beginning of the year, I actually contributed $100 to this account … which is why it is even included in the list at this point.
If our income levels ever rose high enough to max out all our other retirement accounts, then we would consider using this bucket to invest.
2018 Projected Contribution = $100
2018 1st Quarter Investments
For the first 3 months of 2018, we invested $9,834.54.
Of that amount, $4,397.26 went to tax deferred accounts including my pension, 457b plan, and my $100 IRA contribution. The combination of these investments will help to lower our taxable income for 2018. This is a key step that has been carefully planned out so we don’t pay any federal taxes this year.
Another $5,137.28 was invested in taxable brokerage accounts. Any capital gains or dividend income earned from these investments “could” be taxed. Since we are long term buy and hold investors, I am not so much worried about capital gains. Dividend income could be taxed but as I mentioned before … it isn’t that much of an impact at this point.
The final $300 of investments were made to Roth accounts. These investments won’t help to lower our taxable income this year … but there will be tax advantages when we take the money out. So as long as we our optimizing and keeping our taxable income below a certain threshold … we want to take advantage of these Roth investments while we can.
One final item … we have adjusted our projected 2018 investments to $35,384.04 after the end of the 1st quarter. If we hit this target, then we will have invested 35% of our income this year. We would like to push this up to 50% eventually, but this is still way better than our past 5 or 6 years.
How are your 2018 investments going? Are you on target still? What types of accounts are you investing in?