Max out 401k just prior to ER?

[teejayevans]

o really? how bout this.

You can play games with numbers, but mathjak's basic premise is correct.
For Roth:
(B*Tr)*Int where B is beginning balance, Tr is tax rate (ie 0.75 if in 25%
tax bracket), and Int is the interest rate return.
for IRA:
(B*Int)*Tr ....which is exactly the same as Roth.

The Roth allows you to invest more because you pay the taxes up front
before you deposit the money. Advantage Roth. So if in 20% tax bracket,
your $5k in the Roth costs $6K, so your total investment cost is more than
if you put the money into a regular IRA. So you have to remember this when comparing IRA vs Roth comparison.
Then it becomes a question of tax rates now or later.
TJ

 

[kaneohe]

MJ107...........the model is only as good as the assumptions
(sometimes it is easy to forget the basic assumptions). jdw's is the "maxed out" model with "unlimited cash" so able to max out Roth (+taxes) and 401K. If not "unlimited", then your model has validity. No right or wrong here, just assumptions.

 

[mathjak107]

assumptions and sore hair ha ha ha

 

[mathjak107]

You can play games with numbers, but mathjak's basic premise is correct.
For Roth:
(B*Tr)*Int where B is beginning balance, Tr is tax rate (ie 0.75 if in 25%
tax bracket), and Int is the interest rate return.
for IRA:
(B*Int)*Tr ....which is exactly the same as Roth.

The Roth allows you to invest more because you pay the taxes up front
before you deposit the money. Advantage Roth. So if in 20% tax bracket,
your $5k in the Roth costs $6K, so your total investment cost is more than
if you put the money into a regular IRA. So you have to remember this when comparing IRA vs Roth comparison.
Then it becomes a question of tax rates now or later.
TJ

a better comparison would be roth to 401k so you dont bump the 4k limit.

then you can do the 4000 into the roth and 1000 into prepayment of taxes vs the 5,000 in the 401k ..

you bump the max trying to compare roth to deductable ira and so part of the deductable ira investment would have to be made in a taxable account outside the ira.... in that case roth would fair slightly better
depending again on whether tax rates are higher or lower later on

so far it looks like ill pass on any conversions.... ill just keep funding the 401k

 

[jdw_fire]

a better comparison would be roth to 401k so you dont bump the 4k limit.

then you can do the 4000 into the roth and 1000 into prepayment of taxes vs the 5,000 in the 401k ..

you bump the max trying to compare roth to deductable ira and so part of the deductable ira investment would have to be made in a taxable account outside the ira.... in that case roth would fair slightly better
depending again on whether tax rates are higher or lower later on

so far it looks like ill pass on any conversions.... ill just keep funding the 401k

math, before i start to address what you are now saying let me ask you a question. are you only investing in tax advantaged ways? if not then my argument holds. in other words if you are doing any saving/investing in after tax accounts my argument holds.

in reviewing what you wrote since my post i see that you are changing alot of conditions of YOUR original example, changing tax rates, in essence changing returns (by changing the investment products), even you making a move. NONE of these things invalidate what i said since i stated the conditions up front.

and now in the post i quoted above you even change the TIRA to a 401k. well this is bogus. the reason to compare the TIRA to a roth is that if you contribute to 1 you are giving up the option of contributing to the other. this is not so when comparing the roth to a 401k and therefore your suggestion is not a "better comparison".

now getting back to that question i asked above, i submit that my handling of the example is more relevant to people saving for ER than your original 1 because people who are saving for ER will be saving more than what they can contribute to their ira (traditional or roth) and therefore they can max out their contribution to said ira, which ever 1 they choose to contribute to. and my example remains relevant when, after you have maxed out your 401k, you are still saving more money or in other words you are doing some non tax advantaged saving/investing.

i am sorry you dont seem to like the result that my example shows but my example is still correct. (it also works for ira conversions, meaning if tax rates and investment returns are the same it pays to convert a TIRA to a roth provided you pay the taxes with non ira money.) i addressed a very simple statement you made with an equally simple example. this is not to say that all of the things you brought up since shouldnt be considered but what you brought up since doesnt disprove my example.

 

[jdw_fire]

i think you figured wrong but im not sure.... first question is why did you not figure it with all 4,000 in the ira and 3,000 in the roth which is 4,000 less the 1,000 tax. which is typically how it works out for a 4,000 layout .?

btw the answer to this question is i have been retired so long that i dont know (and didnt look up) what the max contribution is to an ira. however that said if your tax rates and investment yields are the same it pays more if you max out your roth when compared to maxing out your TIRA.

 

[mathjak107]

the origional was just a general premise that a roth dosnt yield higher returns from the fact that the returns grow tax free... i was thinking in terms of a 4000.00 ira contibtuion vs a 4000 roth contribution where 3000 goes in the roth and 1000 to prepay taxes. that was my example... that way 4,000 came out in both cases. many folks have a limited amount of money they can contribute to their plan so what comes out of pocket is important.

in order to get 4000 into a roth they need to cough up about 5,000 of income.. to get 4,000 in a traditional ira growing they only need cough up about 3000.00 in income and 1,000 from their refund...

you introduced an example where the ira was maxed out , so in order to invest equal amounts you would have to invest 1000 bucks outside the ira.... in that case the taxes on the money outside the ira would be taxed only on the gains... yes the roth would fair better...

then we compared a roth to a 401k where you wouldnt bump the limit...

4,000 in the roth was the same out of pocket as 5000 in the 401k... again not 1 penny difference in net amounts at the end.

the only thing i saw as a flaw was i believe you took 250 bucks off the 1,0000 you were putting in the taxable investment in your example and i said that would be incorrect, you count all 1,000 as the investment as that was funded with your tax refund money.

we are both talking the same thing but your talking about what happens after you max an ira and i was talking putting in the same amounts out of pocket

 

[jdw_fire]

we are both talking the same thing but your talking about what happens after you max an ira and i was talking putting in the same amounts out of pocket

and which case is probably more relevant to someone trying to save enough to ER? i think that someone would likely be maxing out his/her ira. so i think it is important for that person to know that, in some cases, it does make a difference which type of ira they put their money in, dont you?

 

[mathjak107]

Absolutely

 

[rescueme]

My gut feeling is ill be in a lower bracket when i retire, as besides the decades of the brackets allowing more and more thru at lower rate and the fact that im moving from new york city to pa

Just an FYI, based upon my actual circumstances (resident of PA, retired in 2007).

Total taxes (e.g. federal, along with a slight reduction in state/local) did not get reduced on an overall basis (based upon my circumstances).

I planned on 100% on net income in retirement vs. my income when I was working (including taxes). That assumption has proved correct (in my circumstance - yours, of course may be different)....

 

[mathjak107]

just not having the nyc tax alone is a big savings for us....

 

[ikubak]

I read something in a magazine that made me think....it suggested that you may only want to contribute enough to the 401k to get your company match, and save the rest in a taxable account. The logic behind this was that tax rates are low now compared to what they will be.

I think whether you start raising cash and stop or limit your contributions to your tax deferred savings in the last few years before retirement really depends on how you have your nest egg allocated. DW and I sat down and decided we were close enough to jump in a year or two but we would prefer to have more $ outside of retirement before retiring so we wouldn't have to touch the retirement funds until after 59.5. So we decided to cut back on the defined contributions to raise cash or short term investments outside of retirement. That's what we are doing anyway.

 

[mathjak107]

a giant factor is whether you have enough money to leave just sitting in a roth for the kids .. its an incredible passer of wealth..

as long as the kids take their first witdrawl in the same year the owner dies they can get a lifetime of tax free withdrawls... imagine decades of growth compounding tax free . if they blow it and miss the first year then they have to disolve the roth within 5 years... that kills the entire purpose in my eyes. sooooo make sure your heirs know this ....

in fact if its still allowed and im not sure if they closed this whole but leave it to your grandchildren... can you imagine 100 years of compounded tax free growth.

to me thats the best part... whether ill be in a higher bracket, a lower bracket , thats small potatos compared to the wealth passing ability.

 

[free4now]

My take is the numbers work out the same for roth and trad, so when all is said and done you end up with the same amount of distributions. But the roth has fewer limitations so it's more flexible. Many people don't know that you can withdraw the principal (not interest) at any time from the Roth with no penalties at all. Not something I would want to do, but if my back was up against a wall it's a nice option to have.

And comparing the Roth versus non-retirement accounts, consider that retirement accounts are protected income; i.e. if god forbid someone successfully sues you for your life savings you might be able to hold onto the retirement money. Again, not something I would plan on, but a good reason to prefer having the money in the Roth where I can get at it any time but few others can.

 

[mathjak107]

yes and no , we discussed this above... the roth lets you put the full limit inside the roth to compound tax free. its actually allowing you to put more in because the money your prepaying the taxes with is also part of the mix. 5000 in a roth plus 1000 to go for taxes is actually like 6,000 in a traditional but since you cant put 6,000 in a traditional you have to put the extra in a taxable account where the gains will be taxed,.... if your not maxing out your contributions and can add more to the traditional then the gains will be the same. but if your maxing them out the roth wins most of the time.

to me the above is the small potatoes part to it... personaly i think ill be in a lower bracket when i retire in 1-1/2 years. the real meat is the wealth passing ability . the ability to compound and grow tax free for my entire lifetime. . it can pass enourmous amounts of wealth to your kids and give them a lifetime of tax free, still compounding tax free, income

on the tradional the compounding on the full amount stops at 70-1/2 and you have to start killing your goose thats laying the golden egg by breaking it up. each year less and less is compounding .... the roth goes on compounding tax free forever and that is where it really shines and comes thru.
its like the traditional bumps the house limit and if you were playing double or nothing at the casino eventually if you loose the house limit keeps you from making it back. thats 70-1/2, the house limit for the traditional.

you can leave some serious dough to your kids or better yet , if its still allowed your grandchildren.... when your roth is spread out over their lifetime too now thats like 100 years of compounding tax free. its amazing amounts of money...

for me its not about the slight difference in gains if im going to hit the money anyway to live on. for me its for money i know ill never get down to spending and just let that grow tax free for 100 years

 

[kaneohe]

as long as the kids take their first witdrawl in the same year the owner dies they can get a lifetime of tax free withdrawls... imagine decades of growth compounding tax free . if they blow it and miss the first year then they have to disolve the roth within 5 years... that kills the entire purpose in my eyes. sooooo make sure your heirs know this ....

mj107........agree w/ you about the great Roth advantage for heirs esp. young ones and the need to make sure they know the rules. Your rule would work but I believe the actual rule gives them an extra yr to take the first RMD
https://personal.vanguard.com/us/accounttypes/retirement/ATSIRAInheritDeadlinesNSContent.jsp

 

[nanannjen]

I think whether you start raising cash and stop or limit your contributions to your tax deferred savings in the last few years before retirement really depends on how you have your nest egg allocated. DW and I sat down and decided we were close enough to jump in a year or two but we would prefer to have more $ outside of retirement before retiring so we wouldn't have to touch the retirement funds until after 59.5. So we decided to cut back on the defined contributions to raise cash or short term investments outside of retirement. That's what we are doing anyway.

This is exactly what we decided in the end (thanks, everyone, for all of the thought-provoking discussion!) We will be 54/53 when we ER, so we need as much as possible outside the retirement funds at that point. I know that we will be able to do a 72t, but I'd rather defer that to later rather than sooner! So, we have switched our contribution to just the company match.

 

[mathjak107]

mj107........agree w/ you about the great Roth advantage for heirs esp. young ones and the need to make sure they know the rules. Your rule would work but I believe the actual rule gives them an extra yr to take the first RMD
https://personal.vanguard.com/us/accounttypes/retirement/ATSIRAInheritDeadlinesNSContent.jsp

you are correct , i didnt realize that it was changed.. i did notice one other thing i wasnt aware of, the roth must be in existance 5 years for the heirs not to be taxed on some of it as the same 5 year rule applys to them as to you. they can wait until the five year period and then take their 1st distribution if the roth they inheirited isnt mature yet.

 

[kaneohe]

. i did notice one other thing i wasnt aware of, the roth must be in existance 5 years for the heirs not to be taxed on some of it as the same 5 year rule applys to them as to you. they can wait until the five year period and then take their 1st distribution if the roth they inheirited isnt mature yet.

mj107........I agree w/ your first sentence. Not sure I agree w/ your second one about delaying..........do you have a link on that? I thought the penalty for delaying was pretty fierce.......like 50%??

Here's a quote from that VG link: I think the key words are
PRE-tax contributions and EARNINGS
Since the Roth is POST-tax contributions, my impression is that (at least for the original owner), contributions come out first and are tax and penalty free at any time. Rollovers and EARNINGS are a different matter. Not sure if the rules are different for heirs. I would think that if the Roth was not 5 yrs old, since RMDs are only a small % of the Roth, that the original contribution would be large enough to cover the RMD w/o having to reach into earnings.

"Tax issues
Generally, distributions of pre-tax contributions and earnings from inherited IRAs are tax reportable distributions included in your ordinary income. However, distributions of earnings from a Roth IRA may generally be tax-free if the original account owner had held the account for at least five years. If you're over age 59½ when you withdraw from an inherited Roth IRA and the five-year condition is met, your withdrawals will be tax- and penalty-free."

 

[mathjak107]

It says if the inherited roth isnt at least 5 years hold you can hold off taking distributions until it is. i guess thats to cover death bed conversions


As a rule, you don't pay tax on money you inherit; but there are important exceptions, such as inheriting a traditional IRA.

 

[kaneohe]

It says if the inherited roth isnt at least 5 years hold you can hold off taking distributions until it is. i guess thats to cover death bed conversions


As a rule, you don't pay tax on money you inherit; but there are important exceptions, such as inheriting a traditional IRA.

Here's the quote from that article: I might be wrong but I think you might be mixing 2 concepts.....the lifetime RMD and the 5 yr rule. My impression is that if you want the RMD to last for the beneficiary's lifetime, the RMD has to be taken by the end of the yr following owner's death. If you don't, then you have to take all of the Roth out within 5 yrs. Either/or but not both. Generally, I would think lifetime RMDs would not create an issue of being taxable since withdrawal of contributions are always tax free, they are a small % of total value, and first withdrawals are considered contributions but I don't think you can wait 5 yrs to take them if you want the Roth to last for a long time.

"Inherited Roth IRA
The Roth IRA is funded with after-tax dollars, and those dollars are never taxed again, no matter when they're distributed. If you inherit a Roth IRA that is at least 5 years old, all distributions -- including income and capital appreciation -- go to you tax-free.

The bad news: The very first Roth IRA account was born in 1998, and will not meet the five-year holding period until Jan. 1, 2003.

The good news: You don't have to take the money the minute you inherit it. There's a "five-year rule" that says you don't have to take distributions from an inherited Roth IRA until Dec. 31 of the fifth year following the year of death. That's more than enough time to meet the five-year holding period, and take your distributions tax-free.

For other distribution possibilities, read IRS Publication 590, Individual Retirement Arrangements (IRAs)."

 

[mathjak107]

ill research later but i believe the exception to withdawing at the end of the following year after death for lifetime withdrawls is if the roth isnt at least 5 years old.

i know i read it somewhere, but im no expert on this stuff thats for sure

 

[mathjak107]

looks like the answere is if you inherit a roth that hasnt been in existance yet for 5 years then you have to stretch the withdrawls out so all you take is principal first . after 5 years earnings can be withdrawn...

the trap is you must find out by hook or by crook how old the roth is when you inherit it. unless you ask the custodian the issue probley wont come up and you may take distributions that end up being taxable unknowingly .

 

[kaneohe]

Sounded like you were going to advise your heirs to do the lifetime RMD
anyways so just add the 5 yr rule to the many other things you tell them
...........I suppose it will have to be in writing since, if they're anything like my DD, they won't be so interested now in gory details and probably won't remember either.

 

[mathjak107]

Same here, we are going to staple very specific roth instructions to the packet with our wills and other paperwork... no chance any of our kids will remember this stuff