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I recently had an increase in income and would like to know how it affects the way I should save for retirement.

To keep this question generally helpful, please assume an annual salary of approximately $100,000, company subsidized healthcare, and 401k matching up to 3% plus 3% "safe-harbor" contributions (not my exact situation, but pretty standard and close enough to be helpful). You can assume I am single and mid-life (around 35), but an answer that covers all filing types would be helpful as few stay single forever. This is in the United States, specifically Pennsylvania.

I always had a simplistic view of traditional IRAs that they contributions were 100% tax deductible, probably because my income was low enough that that was always the case. However, I found out today that beyond a certain annual income ($61,000) the contributions are only partially deductible and over a slightly higher threshold ($71,000) they are not deductible at all. This was shocking to me and I wondered what other things might change with my new, higher income.

It seems like as long as AGI stays below $117,000 I can still contribute the maximum amount to a Roth IRA. I also never knew about that limit until today. This wouldn't save me anything in terms of taxes as the contributions are after-tax income, but I assume it does still save me from paying capital gains taxes on the appreciation regardless of my high income?

A 401k is available and seems like a good option due both to matching, and tax-deductibility of the contributions. However, if I understand correctly any gains will be taxed as income when withdrawn, historically a much higher rate than the capital gains tax.

Am I correct in assuming then that the optimal strategy would be to:

  • [If AGI Under $117k]: Invest in my 401k to get the company match until I hit the matching limit, and then to switch to investing all remaining funds in a Roth IRA?

  • [If AGI Over $117k]: Invest in my 401k up to the contribution limit, and then invest any remaining money in a standard investment account?

The ultimate goal for determining our choice of strategy is, of course, to have the greatest amount of wealth possible in retirement.

  • Distributions from 'traditional' (non-Roth) 401k or IRA, including both contributions that were pre-tax or deductible and gains, are taxed as ordinary income. (If before 59.5 in most cases there is an additional 10% tax; conversely after 70.5 if you don't take a minimum essentially matching your life expectancy there is a penalty.) If you have post-tax/nondeductible contributions, a pro-rata portion of the distribution is tax-free. – dave_thompson_085 Dec 22 '16 at 0:40
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After determining your potential savings rate, it is important to spend some time considering your retirement goals. In particular, do you want to live on the same amount of money you live on today? Maybe more? Less?

Less: If you plan on living on less than today, I would maximize pre-tax contributions as a first priority (ie, 401k). In doing so, you opt to withdraw the money in the future at a lower marginal tax rate. If you have other pre-tax accounts available, such as an HSA, I think it makes sense to go this route:

  1. 401k up to company match
  2. Max HSA
  3. 401k up to the maximum
  4. Traditional IRA if tax deductible
  5. Taxable brokerage

The Same/More: If you plan on living on the same or more than today, then the Roth choice becomes a matter of personal preference if you believe taxes will be higher at retirement then today. For those in this camp, I've seen recommendations that say Roth should be approximately one-fifth to one-half of annual contributions (where possible). My suggestion would be to wager on the lower end as most pre-tax accounts can be converted to Roth in a year when you may be in a lower marginal tax bracket. Assuming your savings rate is 20% on 100k income, the one-fifth recommendation would be $4000 towards Roth and the other $16000 towards pre-tax accounts, such as 401k or HSA.

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  1. Max both 401k and Roth.
  2. Max spouse Roth.
  3. Look into Backdoor Roth.

Then: (do these in whatever order)

  • Max college savings plan for kids.
  • After tax investing for wealth building.
  • Enjoy some things that are luxuries, but watch for cashflow drains.

35 is not mid-life. You're on the tail end of the age to get started on retirement planning.

Being single, relatively young, and a great income level, you are ideally situated to consider FIRE'ing yourself. (Financial Independent, Retire Early). The basic idea is to invest a large chunk of your income and establish your comfort level balancing frugality and comfort. There's a table on one of the FIRE websites that shows a graph between % of income saved and the number of years it takes to save enough to be financially independent. If you can go over 50% savings, you can get down to about 10 years. In this case, financially independent is where you can live on a safe percentage of withdrawal from your savings without depleting the savings. At that point, you no longer need to work for a paycheck. You would only do so to extend the savings, increase the safe withdraw rate, or because you want to do something that makes you feel productive.

  • Good answer, though I still feel I'm late to the party; I was doing great on retirement savings until I had to liquidate it all at 28 to pay off my spouse's failed business, and subsequently had to start over :(. Anyway, if I cannot yet max out 401k and Roth, which is more advantageous? Or is it a simple numbers game between pre-tax contributions with standard income-tax withdrawals vs post-tax contributions with no taxation on investment appreciation? – Nicholas Dec 22 '16 at 3:03

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