Why We’re Finally Maximizing our 401k Contributions in 2018

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.

  1.  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.
  2. 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

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25 thoughts on “Why We’re Finally Maximizing our 401k Contributions in 2018

  1. Thank you for sharing your thoughts.

    Tax-advantaged accounts, especially the 401(k), are amazing investment vehicles. Who can really argue with pre-tax dollars AND a match going to work for you?

    I believe you’ve mentioned early on in your post that due to liquidity requirements of purchasing a home, you decided against maxing out your 401(k) in 2017. I am constantly going back and forth between investments being liquid vs. illiquid.

    Lots of data and calculations out there for and against maxing out, but I ultimately set a rule for myself that I would only ever contribute up to the company match. The remainder would go directly into taxable investments accounts with better investment options, lower fees and immediate liquidity.

    Thanks again!

    • Church,

      Thank you for sharing your thoughts here and you’re right, why not take advantage of the max? I’m interested about your situation, especially if the investment options are bad. I’m lucky that I have low cost Vanguard index funds, so I don’t have to put much thought into any of this. But if your investment options are bad, I would consider maximizing other pre-tax options like my HSA and trying other venues.

      Liquid versus illiquid is a hard debate and it depends on personal preference and the situation. I wanted it last year since I wanted extra cash on hand for the purchase and some of the expenses that would come with the move. But, I also know myself well enough where I would invest every extra dollar I could rather than spend it for the sake of spending. So it wasn’t getting invested automatically; however, I knew that I would try to make it up on the back end.

      Bert

  2. Great decision Bert and one that I wholly endorse. I’ve been maxing out my Roth 401k contributions for a couple of years now and I think it’s one of the best decisions I’ve made. So, here’s something to consider. Last year, the maximum contribution limit was $18000. Now this year, the maximum limit was raised to $18500. Because I was maxing it out last year, I only had to ‘worry’ about coming up with an extra $500 a year to maintain the maximum. The point is that once you’re able to reach the maximum contribution limit in one year, chances are, you should be able to maintain the levels of contribution to keep it to the maximum in future years. Hope that makes sense.

    Also, like you, I’ve been investing in index fund regarding my Roth 401k and my Roth IRA actually. It’s like a safety net. In case all the stocks in my dividend portfolio tanked, at least I’m more diversified with the index funds. So, like I said, I think you made a great choice by maxing out your 401k.

    • Dividend Portfolio,

      Thanks for your support here! I love your thought process and mentality. Don’t worry it makes perfect sense and you bring up a great point. Once you automate and adjust your lifestyle to the adjusted amount, the small increases such as $500 are a drop in the bucket (especially over a 24-26 paycheck period). Cheers to kicking butt in 2018!!

      Bert

    • Nick,

      Hey, whatever gets people to maximize their tax benefits is a great. It shouldn’t take tax reform to have these discussions, but it has served as a great event and if it helps others, who cares!! Welcome to the maxing out club as well haha

      Bert

  3. Not only is the initial tax benefit great but so is the tax-free growth! Everyone should max out their 401k if they’re able before investing in taxable accounts as the benefits are huge. They’re a bit less this year due to the lower tax rates but still fantastic.

    I also heartily recommend maxing out the HSA to anyone since it’s just like a 401k but you save on FICA which is even better.

    • TITM,

      I endorse maxing out your HSA account as well! I didn’t mention that, but we also increased our HSA contributions as well! You’re right, maximizing your tax benefits is a no brainer decision and everyone who has the means to should take advantage of the opportunity.

      Bert

    • Lady,

      You underestimate what I get excited about haha Kidding, but I cannot wait to see the decrease in my tax rate in 2018 compared to last year. Don’t worry, I’ll make sure to keep you all updated based on the results.

      Bert

  4. Good move Bert. The only down side is you are limited to what you can pick in a 401k. The upside is you can roll it over when you leave and then pick your stocks. I am taking extra cash and paying down my mortgage. I hate paying interest to banks and having a burden. No debt = more freedom. Best of luck.
    DFG

    • DFG,

      Thank you very much! Luckily my plan has some great low-cost index funds, so I caught a break. But you are absolutely right. If your fund portfolio sucks, it could put a damper on this strategy. I understand what you are saying about the no debt = extra freedom. Trust me, I hit that point last year and am gradually working my way there. Take care!

      Bert

  5. Nice job getting to this point! I had to play catch up after doing this midway through 2017, so I’m glad you recognize the benefit of doing it early in the year. If you’re like me, I recommend checking in on your 401k balance regularly, especially after each paycheck contribution. It helps keep me excited about the otherwise hands-off process.

    • Dozer,

      Thank you very much! Yes, doing it early in the year makes it a lot easier, that’s for sure. It can easily be done, and that’s what Lanny did. But I slowly increased it throughout the year in 2017 to ease with my transition. And I am just like you, because I LOVE seeing my investment balance increase after each paycheck contribution. I am a huge fan of automating my investments and turning it into that hands-off process!

      Bert

  6. Hi Bert. I’ve been maxing out my 401(k) for years. Between what I contribute and some additional matching from my employer, it’s amazing how it grows. Now that I’m an old man, I get to make catch-up contributions, too. It was work to come up with the additional $6K (a 30%+ step), but it will be worth it when I’m withdrawing in the future. I applaud you and your wife for taking the steps to max out those accounts… $37K… oh yeah. Wishing you terrific returns!

  7. Great article, Bert. Last year was the first year I maxed my 401K, but what I often tweak is the amount I put to traditional vs. Roth 401K. I have started doing more to Roth 401K because I like the peace of mind. We don’t know what tax rates will be during retirement, but it doesn’t matter with Roth 401K (as you know). While you don’t get the tax break on this year’s taxes like you would with traditional, you don’t have to pay any taxes on it when you withdraw during retirement. Thus, a spike in the tax rate will never affect this money. This is why I’ve started doing about half to traditional and half to Roth. I don’t mind paying more taxes now on the Roth contributions for the peace of mind that that money will never be taxed again.

    • DivShower,

      That’s an interesting debate. Do you take the tax break now or do you enjoy the tax free growth/distributions in retirement. I’m hoping to have a much lower tax rate in retirement, so I’ve started leveraging the tax breaks I can receive now. I don’t think there is a wrong answer and the important thing is that you put some money aside for retirement 🙂 But I like your strategy of a little bit of each!

      Bert

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