New investors should look at Roth Ira

[pb4uski]

I just was hoping to reach out to younger people or maybe even those who never considered a Roth Ira before to take a look. ...

That is all fine and good, but at the same time it is important that they are getting a full understanding so they can make good decisions.

I love Roths and wish that they had been around more of my career. If you are in a relatively low tax bracket they are great... tax-free income for life. Great for DS... that is all he has now... no t-IRA needed.

 

[UnrealizedPotential]

UP--I disagreed with a couple of your strong comments, but I may know the reason... or at least have a guess. "Its hard to convert with no income or after you can't contribute to Roths. My guess is that you are looking at this with most of your assets are in TIRA/401ks/Annuities.

Try standing in my shoes... 56% after tax/39% TIRA/5% other. I'm below 59.5yo
If I invest the taxable in equity ETFs (low income) and I have after tax $ to pay taxes on Roth conversions.

If I had to pull everything from a TIRA, it would be expensive tax wise.

Sometimes when people disagree it is more that they see something different because they are looking at something different or a different set of conditions.

or I could be full of it.

I tend to have strong opinions. Sometimes that's good , sometimes it's not. But the thing is through all this, I learned a few things. I hope someone else has as well.

 

[pb4uski]

I tend to have strong opinions. ....

Me too. That personality trait could occasionally cause me problems when I was working but luckily my batting average was pretty good so my boss and our clients put up with me.

 

[TrvlBug]

I don't think it has been mentioned, but once the back door Roth became available, I started funding a non-deductible IRA each year (income too high for Roth IRA) then converted to ROTH the next day. All tax deferred monies were in a 401K therefore I was able to convert the non-deductible IRA's w/o tax impact. DH on the other hand had a large IRA, therefore, the back door Roth did not make sense for him. My Roth is in 100% equities and it has more than doubled. I only funded it for 4 years until I retired and moved my 401K to an IRA.

 

[ncbill]

Matching with my kid now while they're still in undergrad to max out their Roth.

If they get into med school and I'll do the same while they're still earning not much at all as a student, then resident.

 

[kgtest]

Me too. That personality trait could occasionally cause me problems when I was working but luckily my batting average was pretty good so my boss and our clients put up with me.

You don't need to like me, just my work That's what I say.

 

[dvalley]

Personally I've always followed this order:

1. 401k, HSA
2. T-IRA (though I haven't been able to contribute to T-IRA due to the AGI limits)
3. ROTH (many years I haven't qualified for this either due to the AGI limits)
4. Taxable accounts

 

[pb4uski]

^^^^ For those in a high tax bracket who expect to be in a lower tax bracket in retirement, the above makes perfect sense.

 

[younginvestor2013]

I am a big proponent of Roth IRA / 401k.

I am 28, and will be in the 25% tax bracket for 2017. Hoping it will be 28% for 2018 .

I've been plowing money into Roth accounts since I've graduated college. Between my Roth 401k and Roth IRA, I have built up a balance of $158k. I think it will be amazing to be able to W/D and not have to pay taxes. But lately I've been concerned if the IRS were either A) to change the rule down the road and/or B) perform an audit on my tax return and make me prove out my post-tax contributions over a 30+ year period. I suppose on B) I could print out statements from my paystubs, etc. I'd imagine a number of folks could be audited on this with little proof on their balances. Does anyone have any insight on this concern? Or is the IRS audit only valid dating back a certain amount of years?

 

[kaneohe]

............................

I think most people here have given similar advice, though it's really based on income, not age. The young tend to have incomes this works for, but why not use the direct factor instead of equating young with low income, which may not be true.

....................................

The heart of the matter................

 

[CRLLS]

+1 IF your tax rates are the same when you defer as when you withdraw then tax-deferred vs Roth doesn't matter.

A brief example... a 30 year old with a 30% marginal tax rate has a decision to defer $10 of income or not.

If they defer the income and the $10k grows at 7%, in 30 years it is $76k.... and if they withdraw the $76k they end up with $53k that they can spend.

OTOH, if they go with a Roth then $3k is used to pay taxes on the $10 of incomeso only $7k ends up in the Roth. That $7k grows at 7% in 30 years to $53k that can be spent.

All else being equal, and advantage is gained only if the tax rate when withdrawn is lower than when deferred.

For me, when I deferred that income I expected that my tax rate in retirement would be lower than my tax rate while working and in early retirement that has been the case so I am coming out ahead.... but once we start SS I suspect that advantage will be diminished somewhat.

If I end up with a higher tax rate in retirement than when I deferred that income then it is a nice problem to have and the excess is a "success tax".

All I can say is, in my case, it does matter. Like another one, Roth conversion was delayed so that I could take advantage of the ACA subsidies. When I started saving in an IRA and 401K, 1) there was no such thing as a Roth, 2) there was no such thing as the ACA with, or without subsides and 3) SS was not taxed at all. I went full in on IRA's and 401K's at the time and I foolishly followed the mantra of "your taxes will be lower in retirement". It is now that I find my taxes will be essentially the same bracket as before since SS will be taxed 85%. Ignoring the equal tax bracket is a wash argument for a moment, I have to now consider SS being taxed, Medicare part B, Medicare part D being increased because of my income. Had I put money in Roth's way back then, those items would not cost me more than the guy down the street.

Roth conversions were not in my plan while working. "Don't pay for the conversion with IRA monies", they said. Then life changed and I needed to provide my own medical insurance. The ACA subsidies prevented me from doing Roth conversions.

I tell my kids now that, yeah, taxes may be a wash, but there are so many other things that you may be paying higher for just because you didn't put retirement investments in a Roth of some kind.

 

[Mulligan]

I don't really agree with your statement about most people's income and taxes after retirement. Over the last 8 years of early retirement, my income is 1/10 of my pre-retirement income and my taxes have been next to zero.

I am a pensioner of the dinosaur type so I fit the exception. Most of my career my tax rate was lower than my retirement income and I retired into my highest working tax rate. Ya, I blew it mostly blowing off Roth contributions. I have been retired 7 years and made a point to make enough gig income to fully fund Roth every year in retirement. Funny how I am more worried about funding a Roth now, arguably when I need it the least.

 

[growing_older]

But lately I've been concerned if the IRS were either A) to change the rule down the road and/or B) perform an audit on my tax return and make me prove out my post-tax contributions over a 30+ year period.

Of these two, I think A is more of a real concern. Once a program like this is started, it gets politically harder to change it, but there is always a possibility that could happen. One way to mitigate the risk is to put some eggs in all of the baskets. If tax law changes make Roth less advantageous, then having some of the portfolio in non-Roth IRA/401k softens the blow. There are no guarantees, but it is likely that sometime in a long career, Roth will be better some years and Trad in other years. Maybe you'll even want to save so much you get some taxable accounts, too. With the portfolio spread around you'll never get the maximum you could have, but you'll also spread the risks and can maybe increase the chances that you have "enough"

As for B, there is no specific reporting of after-tax contributions. The custodian will have records of your investments, and your tax returns will have records that you DIDN'T take a deduction, so they much be after tax. I've never heard of anyone being asked to prove this.

 

[pb4uski]

All I can say is, in my case, it does matter. Like another one, Roth conversion was delayed so that I could take advantage of the ACA subsidies. When I started saving in an IRA and 401K, 1) there was no such thing as a Roth, 2) there was no such thing as the ACA with, or without subsides and 3) SS was not taxed at all. I went full in on IRA's and 401K's at the time and I foolishly followed the mantra of "your taxes will be lower in retirement". It is now that I find my taxes will be essentially the same bracket as before since SS will be taxed 85%. Ignoring the equal tax bracket is a wash argument for a moment, I have to now consider SS being taxed, Medicare part B, Medicare part D being increased because of my income. Had I put money in Roth's way back then, those items would not cost me more than the guy down the street.

Roth conversions were not in my plan while working. "Don't pay for the conversion with IRA monies", they said. Then life changed and I needed to provide my own medical insurance. The ACA subsidies prevented me from doing Roth conversions.

I tell my kids now that, yeah, taxes may be a wash, but there are so many other things that you may be paying higher for just because you didn't put retirement investments in a Roth of some kind.

The impact of the taxation of SS is an interesting angle and arguably impacts the retirement marginal tax rate in making a decision and certainly tilts the decision in favor of the Roth for a lot of people.

But I guess the same argument could be made for Roth conversions... IOW, there is a tradeoff between doing higher Roth conversions now, say to the top of the 25% tax bracket rather than the top of the 15% tax bracket and pay more taxes now, in the hope of paying much less or no taxes later because SS would not be taxed.

Not quite sure how to qualtify it but it may make me rethink, and increase, my Roth conversions.

 

[CRLLS]

The impact of the taxation of SS is an interesting angle and arguably impacts the retirement marginal tax rate in making a decision and certainly tilts the decision in favor of the Roth for a lot of people.

But I guess the same argument could be made for Roth conversions... IOW, there is a tradeoff between doing higher Roth conversions now, say to the top of the 25% tax bracket rather than the top of the 15% tax bracket and pay more taxes now, in the hope of paying much less or no taxes later because SS would not be taxed.

Not quite sure how to qualtify it but it may make me rethink, and increase, my Roth conversions.

It's not SS taxation throughout our lives, it is also higher tax brackets during the conversion process and higher costs for various Medicare premiums small as they may be. Perhaps even controlling RMD taxation rates. To be perfectly honest, the number of variables for us trying to optimize Roth Conversions under these situations are beyond my comprehension. I know how "this" affects "that", and all the variables one on one. I have a hard time combining and quantifying them, then optimizing my choices under the current tax laws and other laws all around. Without invoking Porky, I won't mention about the possible upcoming uncertainty of changes in tax laws.

As much as I am against FA's in general, we have decided to hire one on a fixed-pay for services basis to run the numbers thru his "system" and come up with an optimal financial plan for us. He seems to think he can do that for us. If it passes the sniff test, then we may follow it. We have no other obligation to him beyond that.

So I go back to "I wish I knew then, what I know now." But hindsight is almost always 20/20. I have no regrets on what is past. I want to make the right choices going forward.

 

[Bogie]

One thing to keep in mind is money contributed to a pre-tax account is at a high marginal tax rate but when is it withdrawn, unless there is a lot of other income, it is not all at the marginal rate. Some of it may be tax-free. The tax-rate is an effective rate.

 

[kaneohe]

................ But lately I've been concerned if the IRS were either A) to change the rule down the road and/or B) perform an audit on my tax return and make me prove out my post-tax contributions over a 30+ year period. I suppose on B) I could print out statements from my paystubs, etc. I'd imagine a number of folks could be audited on this with little proof on their balances. Does anyone have any insight on this concern? Or is the IRS audit only valid dating back a certain amount of years?

You should be keeping a record of your Roth contributions/conversion in case you need to withdraw from the Roth before age 59.5. You will need to determine your basis in Roth contributions/conversions to demonstrate that there should be no penalty. Keep the 5498 that shows contributions/conversions each yr. Those records will also show the age of the oldest Roth.

 

[sunsnow]

I think it is important to consider investment return in addition to marginal tax rates before and after retirement. Suppose that I invested $1,000 in a Roth when I was 20, and it grows to $32,000 before I take it out 50 years later (average return around 7%). Suppose that my initial tax rate was 40% and my ending tax rate is also 40%. Even though my marginal rate hasn't changed, I am better off with the Roth. I paid taxes of $400 in the beginning, and I pay no more when I withdraw. Now compare that to a traditional IRA. I set aside my initial $400 tax savings into an account that gets exactly the same return as my IRA, and I have the discipline not to touch it. At the end, it is worth $12,8000, which equals the taxes due on my withdrawal from a taxable IRA, so it seems like a wash -- but it is not, because I will now also have to pay capital gains taxes on $12,400 of the money I set aside to pay for the taxes. Today, that would be 20% for a total extra tax of $2,480. My post-retirement tax rate would need to be substantially lower than my pre-retirement rate to break even in this scenario, because of the large amount of gains.

 

[bingybear]

You should be keeping a record of your Roth contributions/conversion in case you need to withdraw from the Roth before age 59.5. You will need to determine your basis in Roth contributions/conversions to demonstrate that there should be no penalty. Keep the 5498 that shows contributions/conversions each yr. Those records will also show the age of the oldest Roth.

My understanding is you should keep date, contribution/conversion and amount. Conversions will be in your taxes.. There should be no pre-tax dollar put into a roth (on a conversion taxes would be paid if there were). I would save the roth contribution details for each contribution from the broker ( I just download the electronic copy and store it with my list of roth transaction data. Most of this may not be necessary after 59.5.

 

[CRLLS]

One more thing I forgot to mention yesterday in my ROTH is better scenario. When a couple are married filing joint and socking away for their retirement they may be in one tax bracket. assuming they are in the same tax bracket later-on in years and doing well in retirement, inevitably one will die first, leaving the other filing "single". I presume that they lose one SS check at that time but all other retirement streams continue. Since singles use a diff tax table, that generally puts them in a higher "effective" and maybe even marginal tax bracket. Typically, they live for 5-10 more years paying higher dollars. Another +1 for the Roth where nothing is taxed later during withdrawals. Roth withdrawals don't even come into play in the various means testing formulas for other programs.

 

[bingybear]

One more thing I forgot to mention yesterday in my ROTH is better scenario. When a couple are married filing joint and socking away for their retirement they may be in one tax bracket. assuming they are in the same tax bracket later-on in years and doing well in retirement, inevitably one will die first, leaving the other filing "single". I presume that they lose one SS check at that time but all other retirement streams continue. Since singles use a diff tax table, that generally puts them in a higher "effective" and maybe even marginal tax bracket. Typically, they live for 5-10 more years paying higher dollars. Another +1 for the Roth where nothing is taxed later during withdrawals. Roth withdrawals don't even come into play in the various means testing formulas for other programs.

+1
this is part of the reason I'm doing roth conversions in ER.

 

[pb4uski]

I think it is important to consider investment return in addition to marginal tax rates before and after retirement. Suppose that I invested $1,000 in a Roth when I was 20, and it grows to $32,000 before I take it out 50 years later (average return around 7%). Suppose that my initial tax rate was 40% and my ending tax rate is also 40%. Even though my marginal rate hasn't changed, I am better off with the Roth. I paid taxes of $400 in the beginning, and I pay no more when I withdraw. Now compare that to a traditional IRA. I set aside my initial $400 tax savings into an account that gets exactly the same return as my IRA, and I have the discipline not to touch it. At the end, it is worth $12,8000, which equals the taxes due on my withdrawal from a taxable IRA, so it seems like a wash -- but it is not, because I will now also have to pay capital gains taxes on $12,400 of the money I set aside to pay for the taxes. Today, that would be 20% for a total extra tax of $2,480. My post-retirement tax rate would need to be substantially lower than my pre-retirement rate to break even in this scenario, because of the large amount of gains.

Correct when comparing taxable account to Roth, but not when comparing tax-deferred account to Roth.

Using your example, you have $1,000 of income and choice is to defer or not.

If you defer, your tax-deferred account has $1,000 in it and grows at 7% to $29,457 in 50 years... you withdraw and pay 40% tax and end up with $17,674 to spend.

If you pay the tax and put $600 in a Roth, it grows to $17,674 in 50 years at 7%/year.

If you pay the tax and put $600 in taxable and pay 20% tax on income/gains each year, then at the end of 50 years you have $9,148.

 

[Free bird]

Diversify & do both. Unless you can predict tax policy as it applies to you 30 years in the future with certainty.

 

[Cassius King]

Personally I've always followed this order:

1. 401k, HSA
2. T-IRA (though I haven't been able to contribute to T-IRA due to the AGI limits)
3. ROTH (many years I haven't qualified for this either due to the AGI limits)
4. Taxable accounts

See, some good did come out of this post. I've been doing 1, 3, then 4. And I fully expect my tax rate to be lower when I retire. So I should be doing it in the order listed above.

 

[sunsnow]

Correct when comparing taxable account to Roth, but not when comparing tax-deferred account to Roth.

Using your example, you have $1,000 of income and choice is to defer or not.

If you defer, your tax-deferred account has $1,000 in it and grows at 7% to $29,457 in 50 years... you withdraw and pay 40% tax and end up with $17,674 to spend.

If you pay the tax and put $600 in a Roth, it grows to $17,674 in 50 years at 7%/year.

If you pay the tax and put $600 in taxable and pay 20% tax on income/gains each year, then at the end of 50 years you have $9,148.

In my scenario we are working with $1,400. $1,000 goes into Roth and $1,000 into a tax-deferred IRA. The other $400 either gets paid in taxes or gets put into a fund for future taxes. If you put the same amount into both IRA's, it looks to me like you are ahead with the Roth.