Quiz - $1 Million Tax Deferred or Not?

[Mach1]

Quote:

Originally Posted by Cut-Throat 2 options. 1.) You have $1 Million in a tax deferred account. All earnings are tax deferred. 2.) You have $1 Million in a non-tax deferred account and have to pay taxes each year on the gains realized. Hope this clears things up.

It depends on wheather you need to draw from this $1M or not. If money is not needed right now then I'd say option 1. Option 2 have to yield income before taxes is due so either way you'll come ahead.

[bongo2]

I recently looked at this in some detail. In my tax situation the deferred account and taxable account were nearly equal, with small changes in assumptions causing one or the other to win. However, I will not be withdrawing the money for many years, and expect to be in a much lower tax bracket when I do. In the situation you outlined (where all cap gains are realized), and if you are currently withdrawing the money, I think the taxable account would almost always win.

[scrinch]

Let's say your hypothetical $1.3 million is in a hypothetical IRA and will hypothetically sit there for 23 years until you have to start making withdrawals. At 8% return, the $1.3 million will turn into $7.6 million. From that your minimum annual withdrawal starts at $280K and goes up from there. Ouch...who knows what tax bracket that puts you in? I had better start making withdrawals when I'm 59-1/2...or substantially equal sooner!

[modhatter]

I have also ponderered the same question. Look at this example:

You are 65 years old, with no pension and a $1,500 a mo. Soc Sec check. You never worked for a company with a 401K plan, and you never opened an Ira.

If you have one million in cash, say after selling off real estate rentals you owned (and paid uncle sam his due) but none of it is deferred. So you will have to pay taxes on the whole gain of $1,000,000 each year from the start of your retirement. Anywhere from 15% to 32% depending on where you plumk your money.

You actually don't need more than another $20,000 to supplement your social security, but because none of it is deferred, you wind up paying a much bigger tax bill each year, and a healthy portion of your annual gain for the year goes to taxes instead of growing tax deferred. If it were in a tax deferred account, you would only have to pay taxes on the $20,000 that you took out plus on your social security, and the rest could be left in to grow.

So take that scenerio, and put it on a spread sheet, and I wonder where you would be 30 years from now at the end of your retirement.

[MasterBlaster]

The more interesting question is...

If I have some extra money (whatever that is) should I invest it pretax in a 401k/IRA type investment or should I invest it after-tax. As others have pointed out gains from after-tax accounts are taxed as (lower) capital gains. Whereas gains from qualified tax-deferred accounts are taxed at higher income tax rates.

It should be obvious that a dollar of gain from an after-tax account is always taxed lower than a dollar gain from the deferred tax account. Also capital gains are only paid once. So if you pay some capital gains cause' your mutual fund makes some trades then you basis is raised and the tax will not be levied (on those gains) at a later date.

One can make a case for putting money in a deferred account when you are working and are theoretically in a higher tax bracket than when you are retired. In that case, if your retired income is less then you'll come out ahead. However if you are like me, and will likely have a higher income in retirement then that will not be the case.

If you can choose your gains, then capital gains are the way to go for most cases. Subject of course to the rules changing by legislation.

[sgeeeee]

Okay, here's another way to look at it with numbers:

Tax deferred account assumptions:
Accumulation phase - $2000 per year contributed for 30 years
7% earnings each year
untaxed
Distribution phase - $2000 per year withdrawn for 30 years
7% earnings each year
withdrawals taxed at 28%
Result - total account balance after 60 years = $1,222,774

Taxable account assumptions:
Accumulation phase - $2000 per year contributed for 30 years
7% earnings each year
earnings taxed at X%
Distribution phase - $2000 per year withdrawn for 30 years
7% earnings each year
earnings taxed at X%
Result - The value of X that results in a total account balance after 60 years of $1,222,774 = 9.75%

[MasterBlaster]

Sgeeee:

Your model is flawed.

The taxable earnings are not taxed (each year) until withdrawal as capital gains in the distribution phase.

The only way for your assumptions to work is for an account with 100 percent/per year turnover. For buy and hold stocks (or low turnover index funds/tax-managed funds) without (or without large) dividends the gains will not be taxed until distributed.

[sgeeeee]

Quote:

Originally Posted by MasterBlaster Sgeeee: Your model is flawed. . . .

I love you guys.

I have not proposed a model. I simply ran numbers on a spreadsheet. As people requested different numbers, I ran them. I think I've presented results from 3 different cases. I've even offered to send people the spreadsheet for those who can't set one up themselves. They are just numbers that result from the various assumptions people have suggested.

But rather than suggest other data or run your own scenarios, why not simply criticize the numbers that have resulted and make statements like, "bad assumptions", or "your model is flawed".

[unclemick]

Hmmm

I feel at this point to interject a strong denial - "I am not now nor have I ever been an 'official' resident of Missoula."

As to $1 mil or spreadsheets - I plead the fifth.

heh heh heh heh - do have a whiskfull fondness for no. 2 pencils and K&E graph paper.

[sgeeeee]

Quote:

Originally Posted by unclemick2 Hmmm I feel at this point to interject a strong denial - "I am not now nor have I ever been an 'official' resident of Missoula." As to $1 mil or spreadsheets - I plead the fifth. heh heh heh heh - do have a whiskfull fondness for no. 2 pencils and K&E graph paper.

Has anyone ever accused your graph paper of making bad assumptions?

[unclemick]

Unfortunately yes

I gave up public exposure of my graph paper years ago - let alone even discussing my assumptions.

heh heh heh heh heh heh heh heh heh

[azanon]

Quote:

2.) You have $1 Million in a non-tax deferred account and have to pay taxes each year on the gains realized.

I would take this option, except elect to not pay any tax, any year (except when i want the money) by investing exclusively in a portfolio of common stocks that exhibit growth entirely by capital gains (small companies and/or aggressive companies) and not dividends.* *Buy and hold those puppies myself and pay no tax!

That way i have all the benefits of no taxes year after year (option 1), yet have the power to liquidate all of it if need be penalty free, and only have to pay taxes on the portion that I liquidate should i decide to do so at any given point in time.

Guess i tend to want my cake and eat it too.* *

---* the fact that one can do this emphasises that the real beauty of IRAs really isnt the tax deferred growth;* there are enough good investments that can give you that anyway (such as common stocks held personally (not in a mutual fund) that dont pay dividends).* *The unique beauty in them is the tax exemption of earned income in the year that you earned it for money deposited (traditional), or the ability to delay paying taxes on the orignally earned income till you withdraw it while using that same money for compounded growth (Roth).

[Texas Proud]

Quote:

Originally Posted by sgeeeee I have not proposed a model. I simply ran numbers on a spreadsheet. As people requested different numbers, I ran them.

OK.. why not run mine... saves me time and effort in doing it as I still do that nasty thing that starts with a W....

I would say that the portfolio will earn 8%... 1.5% of that will be dividends... 1.0% interest and the rest capital gain.. the capital gain will only have 25% taxable each year with the rest deferred until you start to withdrawl..

Marginable tax rate is 28%.. but your income after retirement will be 100% from this account..

I see you getting the benefit of the low tax rates today on your earnings, but will get the benefit of the low rates on the withdrawl on the first X amount until you reach the marginal rate..

Throw in if SS is taxable way out when...

NOW, this has a LOT of assumptions that to me is more real life..

[dmpi]

Quote:

Originally Posted by Azanon I would take this option, except elect to not pay any tax, any year (except when i want the money) by investing exclusively in a portfolio of common stocks that exhibit growth entirely by capital gains (small companies and/or aggressive companies) and not dividends.* *Buy and hold those puppies myself and pay no tax!

I wish I knew how to pick small aggressive companies that only go up, so you never have to sell it!

[azanon]

Quote:

I wish I knew how to pick small aggressive companies that only go up, so you never have to sell it!

Me too!* That way I could just buy the one winner instead of having to build a whole portfolio of them so that the winners offset the losers!*

Anyone else?

BTW, small and aggressive dont necessarily have to go together.* *There are plenty of sizable (read:* stable) companies out there that dont pay dividends.* Heck, even Microsoft didnt until just a few (couple?) years ago.

Another tip: With long term capital gains caped at 15% now, that makes these types of stocks very attractve. No tax when you dont sell, .... and not a lot of tax when you do.

[sgeeeee]

Quote:

Originally Posted by Texas Proud OK.. why not run mine... saves me time and effort in doing it as I still do that nasty thing that starts with a W.... I would say that the portfolio will earn 8%...* 1.5% of that will be dividends... 1.0% interest and the rest capital gain..* the capital gain will only have 25% taxable each year with the rest deferred until you start to withdrawl.. Marginable tax rate is 28%.. but your income after retirement will be 100% from this account.. . . .

42. . .

Obviously, you haven't provided enough information to run the simulation.

[Texas Proud]

Quote:

Originally Posted by sgeeeee 42. . . Obviously, you haven't provided enough information to run the simulation.

What else do you want

[Nords]

Quote:

Originally Posted by sgeeeee I love you guys.* * * But rather than suggest other data or run your own scenarios, why not simply criticize the numbers that have resulted and make statements like, "bad assumptions", or "your model is flawed".* *

Hey, SG, can we presume that you're on board to develop the next version of FIRECalc?

If it helps get you to say "Yes!", we'll ask TH to write the user's guide!

[sgeeeee]

Quote:

Originally Posted by Nords Hey, SG, can we presume that you're on board to develop the next version of FIRECalc? If it helps get you to say "Yes!", we'll ask TH to write the user's guide!

Yeah. Put my name down. We'll do lunch and talk about a schedule sometime. Of course if TH writes the user's guide it will probably say simply: "You blockhead. You don't need a stupid simulation."

[HFWR]

And split out that hairball...