My goal is to purchase my first rental property (non-local) in 2017. I have just reached my emergency savings goal, now I want to save as much as I can for a down payment. Except for my emergency fund, all of my savings has been going to my 401K since that is the only tax-break that I receive (contributing 18% of my pre-tax salary). Now I am considering only saving the max that my company will match for my 401K (4%) but I am worried about how much less my take-home pay will be and the tax hit. What is the best way to maximize saving for a down payment and protect myself from such a big tax-hit?
Interesting question because the pre-tax 401k contributions reduce your annual taxable income.
I've wrestled with this question quite a bit myself. Here's what I have done:
I reduced the amount of my 401k contributions to the maximum required to get the employer match. While there are great tax benefits from contributing more, your investment options are likely pretty limited and are going to be locked in there unless you switch employers.
Next, I opened up a Vanguard Traditional IRA account. This gave me the ability to contribute up to $5,500 pre-tax at my own discretion to limit my tax liability come tax season.
Then, I also opened up a Vanguard Roth IRA account. This allows for you to contribute after-tax dollars to retirement up to $5,500 as well. The combination of your contributions to the Traditional and Roth IRA's cannot exceed $5,500 though. This offers the maximum flexibility and tax benefits for contributing to a retirement account.
Now, you've got 3 options for contributing to retirement (401k, Roth IRA, Traditional IRA).
Once I did this, I determined exactly how much money I would need to save in order to save up my down payment. I essentially reverse-engineered all of this and came back to the amounts I should then be contributing to my retirement accounts and the down payment savings account each pay period.
Unfortunately you're going to have a bite the bullet and pay some taxes here but your investment returns should be adequate enough (hopefully) to offset your increased tax burden.
One more that I did was add another $5500 as IRA contribution to my mom working spouse and a 529 plan for my daughter. However some of these Roth IRA and 529 are after tax money but you still get the benefit while withdrawing tax free. For 529 it's withdrawing tax free for educational expenses. If you have a primary residence you can get more tax deductions through interest and mortgage payment. If you have rental income you can offset income against depreciation etc. And still get the other home ownership benefits. If you have a HSA plan you can contribute before tax money and have the HSA money invested in different tax vehicles. You could also donate charitable deductions. If you take public transit to work you can deduct parking and commuter tickets to a certain limit before tax. use all of these strategies except rental of course which is why I am on bigger pockets. Good luck.
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