Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Old 05-27-2007, 08:42 AM   #21
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jul 2005
Posts: 5,414
Quote:
Originally Posted by ferco View Post
Just an abstract thought.....do we all REALLY believe the gov-ment, is going to keep its word and let all that Roth money be taking out tax free. Since the US will still have huge ongoing debt from the war and future obligations for medicare and SS. As the social program needs expand for the boomers that money will have to come from somewhere. Overall will any of this make a difference....we are still all guaranteed to get screwed (ie., the middle class).

already roths get screwed as tax brackets increase by 3% a year letting more and more income fall under a lower rate that you should maybe have taken a current tax deduction fot instead.
__________________

__________________
mathjak107 is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 05-27-2007, 11:57 PM   #22
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: May 2005
Posts: 13,294
Quote:
Originally Posted by ferco View Post
Just an abstract thought.....do we all REALLY believe the gov-ment, is going to keep its word and let all that Roth money be taking out tax free. Since the US will still have huge ongoing debt from the war and future obligations for medicare and SS. As the social program needs expand for the boomers that money will have to come from somewhere. Overall will any of this make a difference....we are still all guaranteed to get screwed (ie., the middle class).
Ahhh.... yes, I do think that they will not tax all that money...


Now... there is a possibility that there will be a VAT tax, but I don't think that they would get rid of the income tax even if they went that way... so that does not count unless they get rid of the income tax system.... but then you have to ask.... do you think they will allow all that UNTAXED 401 and IRA money not get taxed if they don't spend it
__________________

__________________
Texas Proud is online now   Reply With Quote
Old 05-28-2007, 10:36 AM   #23
Thinks s/he gets paid by the post
 
Join Date: Oct 2006
Posts: 3,820
Quote:
Originally Posted by bots2019 View Post
Currently I'm trying to determine whether to participate in a Roth 401 or 401k with my wife's employer. From what I understand conventional wisdom is that you should consider whether your future tax rate will be higher or lower than your present tax rate (if they're equal then the two options are equivalent).

However, I ran a few figures and it appears that the Roth option may be preferable (even if the current and future tax rates are equal)... Here's the scenario:

Current federal rate: 33%
Assumed future rate: 33%
Assumed investment return: 8%
timeframe - 20 years
Investment amount for both options = $1,000 (to keep it simple)
Gross required income = $1,493 ($1,493 x .67 = $1,000)

Option 1 - pay tax on $1,493 and invest remaining $1,000 in Roth

Option 2 - contribute $1,000 to 401k, pay tax on remaining $493 and invest after tax amount of $330 in after-tax accounts

After 20 years at 8% return:

Option 1 - Roth balance of $4,661 = tax free

Option 2 - 401k balance of $4,661, pay 33% tax=$3,123, after tax investment of $330 is now worth $1,296, pay gains taxes of 20% on $966 gain => total after tax value of $4,419

So... it appears that if my tax rate remains the same then the Roth may be a better option. I've ignored any dividends in the after-tax account, but those would have a pretty minor impact...

Am I missing something here? This seems to defy conventional wisdom
I would do the analysis a little differently -- I see three options.

Assume that you have $1,493 of before-tax income that you are willing to commit to retirement savings this year. You have three ways of using it: Roth, Traditional tax deferred, Taxable.

Option 1: I agree with your math for the Roth. You use $493 to pay taxes, save the rest in the Roth, and end up with $4,661 of spendable, after-tax money.

Option 2: Put the whole $1,493 into a traditional 401k. You pay no taxes today. The $1,493 grows to $6,959 in 20 years. Pay taxes at 33% and end up with $4,661 in spendable, after-tax money.

Option 3: Use $493 to pay taxes on the $1,493. Put all the remaining $1,000 into a taxable account. If you can get it to grow at 8% without paying any taxes along the way (e.g. no dividends), you will have $4,662 in 20 years. The 20% cap gains tax on the $3,662 of gains is $834, so you end up with $3,828.

My Option 1 and Option 2 end up with the same spendable money. This is a general result - if the tax rates, investment returns, and beginning before-tax dollars are the same, the Roth and Traditional will always give the same value.

My Option 3 is worse. I think this is also a general result. It seems that Option 3 has to be worse than Option 2 if the capital gains rate is any numbers bigger than 0%.

So, the way I'm doing it, I would say that your "Option 2" is a combination of my "Option 2 and Option 3". In my mind, you are comparing a Roth to a combination of something that is equal to the Roth plus something that is worse than the Roth, hence your Option 2 gave the lower value.

One important assumption in my approach is that you can really "fit" the whole $1,493 into your 401k max contribution limit. Since you picked the $1,000 for convenience, it's possible that your real situation is different. When Roths first became available for IRA, I believe that the IRA contribution limit was $2,000. People who found that $2,000 limit too restrictive were better off with the Roth because they could put the whole (after-tax) $2,000 into the tax free account. That is, they might be willing to "commit $3,000 of before tax money to retirement savings". If they went the Roth route, they got $2,000 of after-tax dollars into the Roth. If they went the traditional route, they had to do the split that's in your Option 2.

It's possible that you are maxing out on your 401k, so you are in this type of a situation today. Maybe this is why you constructed the example as 100% Roth vs. a combination of traditional plus taxable.
__________________
Independent is offline   Reply With Quote
Old 05-28-2007, 10:57 AM   #24
Recycles dryer sheets
bots2019's Avatar
 
Join Date: May 2007
Posts: 128
Quote:
Originally Posted by Independent View Post
I would do the analysis a little differently -- I see three options.

Assume that you have $1,493 of before-tax income that you are willing to commit to retirement savings this year. You have three ways of using it: Roth, Traditional tax deferred, Taxable.

Option 1: I agree with your math for the Roth. You use $493 to pay taxes, save the rest in the Roth, and end up with $4,661 of spendable, after-tax money.

Option 2: Put the whole $1,493 into a traditional 401k. You pay no taxes today. The $1,493 grows to $6,959 in 20 years. Pay taxes at 33% and end up with $4,661 in spendable, after-tax money.

Option 3: Use $493 to pay taxes on the $1,493. Put all the remaining $1,000 into a taxable account. If you can get it to grow at 8% without paying any taxes along the way (e.g. no dividends), you will have $4,662 in 20 years. The 20% cap gains tax on the $3,662 of gains is $834, so you end up with $3,828.

My Option 1 and Option 2 end up with the same spendable money. This is a general result - if the tax rates, investment returns, and beginning before-tax dollars are the same, the Roth and Traditional will always give the same value.

My Option 3 is worse. I think this is also a general result. It seems that Option 3 has to be worse than Option 2 if the capital gains rate is any numbers bigger than 0%.

So, the way I'm doing it, I would say that your "Option 2" is a combination of my "Option 2 and Option 3". In my mind, you are comparing a Roth to a combination of something that is equal to the Roth plus something that is worse than the Roth, hence your Option 2 gave the lower value.

One important assumption in my approach is that you can really "fit" the whole $1,493 into your 401k max contribution limit. Since you picked the $1,000 for convenience, it's possible that your real situation is different. When Roths first became available for IRA, I believe that the IRA contribution limit was $2,000. People who found that $2,000 limit too restrictive were better off with the Roth because they could put the whole (after-tax) $2,000 into the tax free account. That is, they might be willing to "commit $3,000 of before tax money to retirement savings". If they went the Roth route, they got $2,000 of after-tax dollars into the Roth. If they went the traditional route, they had to do the split that's in your Option 2.

It's possible that you are maxing out on your 401k, so you are in this type of a situation today. Maybe this is why you constructed the example as 100% Roth vs. a combination of traditional plus taxable.
Good analysis... you're right I'm really comparing maxing out each account (thus the hybrid approach)... it seems to me that IF the taxes are equal now and later THEN the roth is best... however, in reality, it seems that I'll likely be in a lower bracket in the future and should probably go with the 401k. Thanks for the good thoughts!
__________________

__________________
bots2019 is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
White House: As Many As 5 Million E-mails Possibly Missing FinallyRetired Other topics 7 04-15-2007 09:42 PM
"10 easy steps to FSBO your house" Nords FIRE and Money 4 06-01-2006 01:36 PM
Covered calls made easy....too easy? laurence FIRE and Money 8 09-13-2005 10:13 AM
How Firecalc handles missing Treasury data dory36 FIRE and Money 7 12-06-2004 04:00 PM

 

 
All times are GMT -6. The time now is 10:56 AM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.