By: Revanche

Thinking Aloud: Cash versus Retirement Savings

April 4, 2008

This isn’t the first time I’ve pondered this and I’m sure it’s getting old. I’m mulling over the various adjustments I’d like to implement for Tax Year 2008. I know what my annual goal was fairly sensible, but in light of some mistakes made in Tax Year 2007, I need to make some post-Q1 adjustments.

Mistake Number 1: Underestimating the amount of “contractor” income I was going to make.

This led to Mistake Number 2: Adjusting my withholdings drastically to make up for what I thought had been excessive withholding, given my Head of Household status. For the last few months of the year, I was paying very little federal tax.

Had I not received so much untaxed income in Q4, too late to correct the withholding and increase my retirement contributions correspondingly, my estimate of my taxable income and corresponding tax bill would have been just about perfect.

Instead, the effects of the two mistakes above were:

1. I ended up owing the entire amount of taxes assessed on the untaxed income, and
2. My percentage of retirement contributions of total income was significantly lower than it should have been.
3. I think I’m being assessed a $32 federal penalty for not making quarterly payments on that income because I withheld too little. 🙁

Rather than making quarterly payments this year, I’m considering the following:
1. Increase my retirement contributions for the rest of the year to include the equivalent of 30% of the untaxed income.
2. Save 10% of the untaxed income for taxes, instead of the usual 30%.
3. Keep my withholding at 1 and add a small, additional amount per month so that I don’t have to waste time, money and brain capacity on sending in quarterly payments.

I like this plan because I really like watching the balances in my Vanguard account go up (despite the market volatility, it creeps up now and again). I really like the idea of committing to a bit more in the retirement accounts. I like reducing that feeling of false security when I’m holding a lot of cash in anticipation of a tax bill.

Cons of the plan: reducing my take-home pay even more will make budgeting even more difficult. I’ll have to be ultra-careful about juggling expenses because I’m no longer holding out until that next fat supplement check, what I gots is what I gots!

Any cons that I’m missing here?

4 Responses to “Thinking Aloud: Cash versus Retirement Savings”

  1. mOOm says:

    I think it is a bad idea to adjust retirement contributions for tax reasons alone. Yes in the US you can get the money out before 60 but you need to pay a penalty of 10% (unless you do a 72t or whatever and get a stream of income) though there are some exceptions for home buying. Hopefully, you’ve maxed the Roth IRA before adding any more to a 403b because you can get your contributions out again penalty free.

  2. ~moom~ It’s not solely for tax reasons, that’s just my excuse to re-evaluate, but you have a good point.

    I’d like to max out pre-tax contributions before I put more money into the Roth, but there IS that downside of not being able to touch that money in case of home-buying. I’ll think about it some more.

    Partly, it’s a bit of a laziness issue because my Roth money was put into a bond mutual fund and it constitutes nearly 25% of my entire portfolio. I don’t want to increase my bond exposure at this point for fear of being TOO conservative, but also lack the motivation to research what else my portfolio should have. *sigh* Now that I’ve admitted that, I feel like I really should get off my lazy duff and do it.
    Drat.

  3. mOOm says:

    There are some exceptions for homebuying on regular IRAs too but probably don’t apply to 403b/401k while you are still working at the employer. I’ve tried to balance thinsg so I have 50% of my net worth in retirement accounts and 50% outside. On the Roth – you can put the new money into anything you like and also sell the fund you already have. I have a list of some mutual funds I like on my “Summing up” post in my “Madame X” series.

  4. ~moom~ Dividing assets between retirement and non-retirement accounts is a sensible move in the near future, as I do want to expand my investing horizons.
    I’ll definitely take a look at your Madame X series, I’ve been meaning to examine that more closely and just haven’t had a chance.
    Thanks for the perspective!

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