Fresh off of a record-setting December in terms of dividend income, I’m ready to hit the ground running in 2018 and make some serious moves. Now that we are comfortably moved into our house and our cash outflows to make repairs and upgrades are shrinking drastically, we should have a lot of additional cash flow available for use in 2018. After brainstorming what the most efficient use of the capital would be, I realized there is an easy change that I need to make with my finances. Like Lanny over the past few years, my wife and I are finally taking the steps necessary to maximize our 401k contributions during the year!
Why Am I making the change?
This isn’t a new topic on this website. In fact, Lanny did the heavy lifting for me during his intense three-part series where he wrote about how he was planning on reducing his tax expense going forward. In this article, he laid out the case for maximizing your Traditional 401k contributions. However, due to the cash requirements of purchasing a house, I decided not to maximize my contributions during 2017. Instead, I opted to have more cash on hand in case a surprise popped up. I contributed approximately $7,500 of my own capital to my traditional 401k plan, which was ~$10,500 less than the limit. Ultimately, I was fine with this approach based on my circumstances in the year. Plus, since I love investing, I invested every extra dollar I could in my brokerage account anyway. So just because I fell $10,500 below the threshold, it doesn’t mean I didn’t invest the extra cash!
But that is all changing in 2018. Finally, I am kicking myself in the butt and making the changes necessary to maximize our Traditional 401k adjustments. Two things hit me in December that really influenced this decision. First, I thought to myself, why the heck not? Why shouldn’t I just go for it? If I am looking to minimize my tax footprint and grow my investment portfolio as fast as possible, this is a GREAT opportunity to do so. I re-read Lanny’s article where he discussed this strategy, along with the eventual Roth Conversion Ladder, and it just made too much sense to me. Here is MadFeintist’s article about the Conversion Ladder if you are looking for an excellent summary about the strategy. Finally, after Lanny telling me about this for over two years, I am all in on this strategy!
Second, as Lanny and I were fumbling to pre-pay our 2017 property taxes that were set to be paid in 2018 in order to maximize our 2017 itemized deductions (post tax reform signing), I had the realization that I need to maximize every tax benefit that is available to me when I can. Tax laws can change with a snap of the fingers. Tax breaks I was hoping to realize in the future can suddenly disappear. For example, we all know that prior to the tax law, owning a home had many tax benefits as you would instantly itemize based on interest paid, taxes, etc. However, after tax reform, itemizing in future years is going to be extremely difficult given the new increased standard deduction and the various caps on SALT taxes, interest (which I was under regardless since my property value is well below $750,000), and charitable contributions.
Tax benefits did not influence my home buying experience. My wife and I were planning on purchasing a home regardless. But man does it suck that I most likely will not be able to itemize after tax reform. This was the wake-up call I needed to realize that I need to maximize these tax benefits while I can. One of the ideas kicked around in tax reform, which thankfully didn’t pass, was lowering the traditional 401k contribution threshold to only $2,000 annually. Luckily this was not included in the bill, but it goes to show that this deduction is not untouchable. The time to start maximizing these contributions is NOW. Again, if there are savings to be had, why not take advantage of them? It is time to kick Uncle Sam’s figurative butt the way Lanny has.
The Plan and The Tax Savings
The decision has been made. My wife and I are maximizing our Traditional 401k contributions in 2018 effective January 1, 2018. Luckily, since we are starting in January, we are able to spread the impact over 12 months rather than making an adjustment in 2018. The contribution limit for each individual is $18,500 in 2018, so combined, we are contributing $37,000 in 2018. Wow, it just hit me that we are going to have a significant amount of money automatically invested every two weeks. 2018 is going to be a fun year. I’m “stealing” the table Lanny used to demonstrate the tax savings of his moves in 2016 because I loved how easily the table demonstrated the federal, state, and local taxes we will be saving each paycheck.
Woah, woah, woah. Are you kidding me? This move will help reduce our tax expense by nearly $10,500! My initial reaction is that I am kicking myself for not doing this sooner. The beauty of this is simple: I love investing and I am going to invest regardless. Now, I am finding a more tax-efficient way to invest. Sure these contributions will be invested into index funds rather than individual stocks; however, I am still investing into income producing assets that will help push me closer and closer to financial freedom.
Further, with my tax savings, I have a lot of additional options here of what I can do with the additional income. Here are some of the options I am going to mull over.
- Invest. Is this shocking that it is number 1 on my list? Instead of paying $10k to Uncle Sam I could instead use the capital o purchase even more income producing assets. Assuming a 3% yield, I could easily increase my dividend income $313 by investing all of the capital into dividend stocks.
- Pay-Down My Mortgage. Lanny has been asking himself whether he should invest or pay-down his mortgage for years. And there still isn’t a clear-cut answer to the equation. However, last year, I became so fed up with my debt levels that I committed myself to finding ways to reduce my overall debt burden in an effort to reduce my monthly cash outflows. Well, I could allocate all or a portion of the tax savings towards paying off our new mortgage. Now this is a pretty appetizing option, I must admit.
Summary
Why the heck not? Why not take a stand and try something different? To me, this is a no brainer decision and I would be a fool to not try to maximize my tax benefits. One other thing that hit me. If I don’t like the reduction in my cash flow, I can always change my deduction level to a level that is more comfortable for my wife and I. Nothing about your finances are permanent and any decision you make can easily be reversed. But two contributions into this, we don’t even realize a difference. Starting in 2018 you are going to see a new me. A me that is less complacent and more pro-active, in terms of finances and life. This is just the first step in a fun journey.
Do you maximize your traditional 401k contributions? What other tax savings measures do you take? Would you use the extra capital to invest or pay down debt? Or do you think a little bit of both options is the way to go?
Bert