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The Wisdom of Roth's
Old 01-12-2012, 04:15 PM   #1
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The Wisdom of Roth's

It seems these days, financial advice is always to fund a Roth account first. Now maybe for younger, low income people with 30 years before retirement - maybe. But it seems to me that most people do the lions share of retirement saving in the last 10-15 years of employment, when their income is higher. I think the idea that income taxes will be higher in retirement is just not usually the case. In the good old U.S., we don't make low income people (many retired) pay taxes - 46% of US households pay no federal income tax at all.

And what if we ever went to a consumption based tax? Would a traditional IRA/401k never have taxes assessed while the Roth folks prepaid? Grandfathering would sure get complex. Just some food for thought before you fund, or roll over, into a Roth.
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Old 01-12-2012, 04:36 PM   #2
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Originally Posted by Packman View Post
It seems these days, financial advice is always to fund a Roth account first. Now maybe for younger, low income people with 30 years before retirement - maybe. But it seems to me that most people do the lions share of retirement saving in the last 10-15 years of employment, when their income is higher. I think the idea that income taxes will be higher in retirement is just not usually the case. In the good old U.S., we don't make low income people (many retired) pay taxes - 46% of US households pay no federal income tax at all.

And what if we ever went to a consumption based tax? Would a traditional IRA/401k never have taxes assessed while the Roth folks prepaid? Grandfathering would sure get complex. Just some food for thought before you fund, or roll over, into a Roth.
Actually, IIRC, the current (often) suggested order would be: Invest in 401(k) up to the limit of your employee match. THEN invest to the max in a Roth. If more funds are available, go back and put more into your 401(k) unless you have a very good crystal ball about your tax rates in retirement. Alternately, after the Roth, choose taxable investments (again, depending upon your crystal ball). In any case, even those of us who sing the praises of the Roth would never suggest giving up employee match. Nor would we suggest you shouldn't cover all the bases (tax deferred - tIRA or 401(k), tax paid - i.e., Roth, and after tax - MFs, REITS, individual stocks, bonds, PMs(?) etc. in taxable accounts.) By covering the bases, you increase your diversity when it comes to the ever-changing tax rules. Naturally, YMMV.
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Old 01-13-2012, 03:30 PM   #3
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Actually, IIRC, the current (often) suggested order would be: Invest in 401(k) up to the limit of your employee match. THEN invest to the max in a Roth. If more funds are available, go back and put more into your 401(k) unless you have a very good crystal ball about your tax rates in retirement. Alternately, after the Roth, choose taxable investments (again, depending upon your crystal ball). In any case, even those of us who sing the praises of the Roth would never suggest giving up employee match. Nor would we suggest you shouldn't cover all the bases (tax deferred - tIRA or 401(k), tax paid - i.e., Roth, and after tax - MFs, REITS, individual stocks, bonds, PMs(?) etc. in taxable accounts.) By covering the bases, you increase your diversity when it comes to the ever-changing tax rules. Naturally, YMMV.
Do you know what the suggestion is if there is no employer match on the tax-deferred account? I am making maximum contributions to my 457 account at work but put the rest of my retirement savings last year and this into a Roth IRA rather than over-50 catchup contributions to tax deferred. Maybe this could be considered tax deferred contributions up to the match (i.e. zero), then Roth, then more to tax-deferred. (don't have a crystal ball or a taxable account )
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Old 01-13-2012, 03:53 PM   #4
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Do you know what the suggestion is if there is no employer match on the tax-deferred account? I am making maximum contributions to my 457 account at work but put the rest of my retirement savings last year and this into a Roth IRA rather than over-50 catchup contributions to tax deferred. Maybe this could be considered tax deferred contributions up to the match (i.e. zero), then Roth, then more to tax-deferred. (don't have a crystal ball or a taxable account )
Never saw a "suggested" approach to this. Personally, I think a mix of deferred and after tax (including a Roth) provides the most flexibility. Clearly the rules for tIRAs and 401(k)s are much more restrictive than after tax savings or even Roths. But, then there's that nice feature of tax deferment - giving the opportunity (crystal balls at the ready) to pay no tax now and lower tax later.

I did play it to get the match since my employer offered it. I think I overemphasized the tax deferred vehicles. At the time, I let the Roth be a leftover investment - anything left went to the Roth. Wish I hadn't done it that way. Now that it's too late to invest directly in Roths, I find myself converting which is tricky due to unintended consequences. YMMV
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Old 01-13-2012, 03:57 PM   #5
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Folks who make the maximum contributions to 401(k)'s and Roth IRAs don't have to make any choices until they started offering Roth 401(k)s. I am happy that we were not eligible for Roth IRAs until recently. That made us have no choices whatsoever. And it turns out that despite being in the 33% marginal income tax bracket in our best earning years, we will be able to convert traditional 401(k) assets to Roth IRAs at the 0% marginal income tax bracket. That is, tax-free going in and tax-free coming out. That's better than a straight-up Roth.

It is true that the conventional wisdom on all this probably makes folks pay extra taxes that they could have avoided.
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Old 01-13-2012, 04:01 PM   #6
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It definitely depends on your own situation. I started saving early on in a 403 b. All ever one said then that was the way to go. It never occurred to me at that point in my life that I would be retiring with a pension that put me in a higher tax bracket retired than when I contributed those dollars. I decided the best way to use that money was to purchase service years credit. I continue to work enough each year to max out yearly Roth contributions for future tax benefits.
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Old 01-13-2012, 04:02 PM   #7
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How were you able to convert any meaningful about at 0% rates?

What were you living on?


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Originally Posted by LOL! View Post
Folks who make the maximum contributions to 401(k)'s and Roth IRAs don't have to make any choices until they started offering Roth 401(k)s. I am happy that we were not eligible for Roth IRAs until recently. That made us have no choices whatsoever. And it turns out that despite being in the 33% marginal income tax bracket in our best earning years, we will be able to convert traditional 401(k) assets to Roth IRAs at the 0% marginal income tax bracket. That is, tax-free going in and tax-free coming out. That's better than a straight-up Roth.

It is true that the conventional wisdom on all this probably makes folks pay extra taxes that they could have avoided.
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Old 01-13-2012, 04:30 PM   #8
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What?

Wrong Roth?
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Old 01-13-2012, 05:08 PM   #9
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Gigolo!?!?!!? Hmmm... It's a job that makes one think of putting ER on hold for a few years.
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Old 01-13-2012, 05:16 PM   #10
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Yeah, but you have to be careful, Chuckanut. People know the part your playing.
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Old 01-13-2012, 05:17 PM   #11
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Originally Posted by Hamlet View Post
How were you able to convert any meaningful about at 0% rates?

What were you living on?
Not to speak for LOL, but in my case, early in retirement, I was sitting on a pile of cash (or equivalent investments with not much unrealized appreciation). Had I not had a pension (oh, darn!) I would have been in a position to have essentially 0% taxes. That would have been an excellent situation in which to do Roth conversions. As it was, the first couple of years of ER, my taxes were quite low, though never 0% - again, that pesky pension. YMMV.
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Old 01-13-2012, 05:51 PM   #12
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How were you able to convert any meaningful about at 0% rates?

What were you living on?
We have substantial assets in taxable accounts (Remember that 33% marginal income tax bracket? There are benefits to that after all) and substantial carryover losses from judicious tax-loss harvesting. Another hint: return of capital is tax-free. Plus I scrounged around.

Lots of early-retired folks on this forum have expressed how they pay no income taxes.
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Old 01-13-2012, 09:56 PM   #13
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...(snip)...
Lots of early-retired folks on this forum have expressed how they pay no income taxes.
Maybe it works for some cases but I wonder.

We could work it so that we paid no income taxes but then we'd just be deferring them into the future and pushing into higher future tax brackets.
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Old 01-13-2012, 10:36 PM   #14
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Maybe it works for some cases but I wonder.

We could work it so that we paid no income taxes but then we'd just be deferring them into the future and pushing into higher future tax brackets.
You don't want to pay no taxes, you want to use the entire 15% tax bracket to pay taxes on your Roth conversion while using already-taxed funds to live on and pay the conversion taxes so that you don't reduce the amount you can convert too much. The ideal case is that without the Roth conversion you would have paid no taxes. I'll be close to that for a few years as soon as DW retires, other than those pesky dividends.

Converting to Roth saves on future taxes if you can use the Roth accounts keep your taxable income within the 15% tax bracket, filling in the remainder of your income with a Roth withdrawal. Plus it lowers your RMD's, which may again help you stay within the 15% bracket.

The effectiveness of all of this will depend on your specific income sources Roth/traditional balances, and required income level.
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Old 01-13-2012, 11:01 PM   #15
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Yep, kwow the drill. We've converted IRA -> Roth's big time for years.

This year it's payoff time. Am taking some money out of Roth's and blending with income from IRA plus small amount of SS.

My point above was that some folks are kidding themselves by trying to pay zero taxes. But so much depends on the individual circumstances and future tax policy.
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Old 01-14-2012, 06:59 AM   #16
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I am not even sure that paying 15% taxes now on conversions is wise. The reason is that calculations show that one's tax rate may only be 15% later on the RMDs anyways. One thing that everyone ignores is that the standard deduction and exemptions are indexed to inflation. It may be that the standard deduction grows to over $50,000 due to inflation by the time one needs to start messing with RMDs.

So pay 15% marginal or pay 15% marginal later? Does it matter? One's effective tax rate is even lower.

Finally, don't forget that something like 36% of tax returns show the filers pay no income taxes. So it is quite common that folks do pay zero income taxes.

And yes, I do realize that many folks do have pensions which bump them up into paying taxes. And yes, I do realize that many folks do not have already taxed assets to draw down when doing Roth conversions.
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Old 01-14-2012, 09:20 AM   #17
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LOL, that's a good point about the standard deduction. In our case we itemize taxes and have no trouble meeting that criteria.

For me, the best way to look at this was to do several TurboTax runs with different income mix conditions and put those results in a table. Every couple of years the table would be redone as tax laws and personal circumstances change.

Quote:
Finally, don't forget that something like 36% of tax returns show the filers pay no income taxes. So it is quite common that folks do pay zero income taxes.
I'll have to remember this when I hear people saying they're a red blooded retired tax paying American.
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Old 01-14-2012, 09:49 AM   #18
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For me, the best way to look at this was to do several TurboTax runs with different income mix conditions and put those results in a table. Every couple of years the table would be redone as tax laws and personal circumstances change.
Yes, tax software is very helpful. With the mortgage paid off, we have figured out that we should bunch prop taxes and charitable contributions into even years and take the standard deduction in odd years. That means more Roth conversions in even years.
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Old 01-14-2012, 10:20 AM   #19
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I'm going to be the contrarian here. I think Roth accounts do not create wealth. It is pay me now (US) or pay me later. Say you're in 30% tax bracket state and federal. You have 100,000 and convert. Now you have 70,000. Now in 5 years for example this money doubles to 140,000. Great, all tax free. Now if that same person decides to convert after 5 years he has doubled his money to 200,000 but after tax at 30% he is back to 140,000. So really the government is just getting their money upfront. Now you say, Yeah, but won't you be in a higher tax bracket then. Well, how would anyone no for sure. Also who says that Congress won't change their minds about this Roth deal and make it taxable?
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Old 01-14-2012, 10:25 AM   #20
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Folks who are close to retirement can easily know for sure what taxes they will pay in the next 3 to 5 years.

And some folks do not realize that in retirement they will
Not be paying FICA, medicare taxes
Not be contributing to IRAs and 401(k)s
and thus will have an immediate lower set of expenses that will require lower withdrawals and thus lower taxes.

And some folks still have figured out that some of their income is tax-free (think exemptions and Schedule A or standard deduction), the next bit of income is taxed at a low rate like 10%, and only the last bit of their income is taxed at their marginal income tax rate. That is, not everything is taxed at 30%. It ain't all about tax bracket.

Yes, some folks maybe should not do conversions, but they should be able to figure this out. I argued elsewhere for not doing a conversion now when the converters were in the 37% or higher tax bracket. However, if one is in the 0% tax bracket, it surely is a no-brainer to do a conversion.
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