IRA-401k Trap :)

[LongPrime]

So how many discovered that the tIRA and more so the 401k is a trap for people who are big savers-investors and need to convert to Roth inorder to control later tax consequences?

 

[samclem]

So how many discovered that the tIRA and more so the 401k is a trap for people who are big savers-investors and need to convert to Roth inorder to control later tax consequences?

It's a major theme here, we've had several recent threads on it. Do a search for "Roth Conversion" for more info. The problem is accentuated when one spouse dies and the remaining spouse is still subject to the same RMDs but reduced standard deduction/reduced personal exemption, and the much lower brackets of Single vs MFJ.

 

[pb4uski]

To me it reinforces the need to be diversified, not only across asset classes but also across tax attributes (taxable, tax-deferred and tax-free).

That said, I'm glad that I have a lot of tax deferred savings. I was solidly in the 25-28% marginal bracket or more when I was working and if I manage Roth conversions right should be in 15% land for most withdrawals, so I'm coming out ahead by a bunch. Worst case, if one of us dies, we'll pay taxes about equal to what we saved during accumulation so its not a huge problem IMO.

 

[GrayHare]

Uncle Sam says, "You can pay me now, or you can pay me later."

 

[RetireAge50]

For the most part paying later is better as they will probably take between zero and 15% instead of a for sure 25% or more (in our case).

 

[RunningBum]

I've heard a couple people complaining that they will be in a higher bracket withdrawing from their 401K/IRA than while earning, but I'm guessing not too many people maxed out their 401K while in the 15% bracket.

I also don't view Roth conversion as a "need" but rather a nice tool to smooth out income over my retirement. Certainly not a "trap". Looking at old tax tables, I find that I was almost always in the 30+% bracket except for the late 80s, and I don't see how I'll exceed 25% in retirement.

I think the common advice here has been to take full advantage of your employer 401K match, if they give one. After that max out a Roth IRA. After that you may want to invest in a taxable account with tax efficient investments such as index funds, and stick to long term capital gains, though if you are in a high bracket maxing out your 401K almost always makes sense.

 

[travelover]

Something tells me that the OP has a product to sell that is a "solution" to this problem.

 

[GrayHare]

The 401k employer match is free money and probably always worth doing. The potential tax trap area for big savers arises when adding to a 401k beyond the employer match.

 

[Texas Proud]

I do not see it as a 'trap'... I am well aware of the future tax liability and plan for it accordingly....

In the end, I will save many 10s of thousands of dollars in taxes... so I do not see how it can be a trap....

I would say that the only people who get trapped are the ones who do not plan...

 

[foxfirev5]

I've heard a couple people complaining that they will be in a higher bracket withdrawing from their 401K/IRA than while earning, but I'm guessing not too many people maxed out their 401K while in the 15% bracket.

As a lifelong LBYM'er I maxed out my 401k contributions while in the 15% tax bracket for many years. My DW and I slid into the 25% bracket for a few years, however this was offset by college costs for three kids. Now she has retired to take care of this tax problem.
We also maxed out our Roth contributions.
Now we could very well find ourselves in a higher tax bracket in retirement - but I'm not complaining.

 

[daylatedollarshort]

I do not see it as a 'trap'... I am well aware of the future tax liability and plan for it accordingly....

In the end, I will save many 10s of thousands of dollars in taxes... so I do not see how it can be a trap....

I would say that the only people who get trapped are the ones who do not plan...

+1. I don't see it as a trap at all. I think it is highly unlikely we will be in as high a tax bracket when we are 70 and have to take out our RMDs than when we were younger and both had full time IT jobs, especially adding in state income tax.

 

[brewer12345]

Something tells me that the OP has a product to sell that is a "solution" to this problem.

Gee, ya think?

Personally, if this is a trap I have been hammering on the door for 20 years to get in. I will save six figures easily by jumping into this so-called "trap."

 

[NW-Bound]

Uncle Sam says, "You can pay me now, or you can pay me later."

Yes. I take "later", please.

Is it not like we all have to die sooner or later, but the later the better, oui?

OK, just kidding as the analogy is not quite apt.

I can see myself being in a bit of a tight spot, if I do not have quite a bit of after-tax savings to live on until I can get my IRA and 401k penalty-free, and I do not like the 72t options.

On the other hand, while one has to pay taxes at some point, the tax-deferred nature of 401k and IRA has the advantage of "income smoothing", hence "tax smoothing", between the working and retiring phases of life.

 

[ajs56]

I do not see it as a 'trap'... I am well aware of the future tax liability and plan for it accordingly....

In the end, I will save many 10s of thousands of dollars in taxes... so I do not see how it can be a trap....

I would say that the only people who get trapped are the ones who do not plan...

I totally agree, I do not see it as a trap. In our case, for many years we assumed we would retire to a lower (than 28%) tax bracket, so we utilized tax deferred 401ks and spousal IRAs heavily. Now at 57, it is becoming clear that we will likely retire to a similar tax bracket as when we were working due to some rental investments that are doing quite well.

So... now we will likely pay taxes on these deferred accounts at a similar tax rate. It seems to me that it is still better to have had the use of those deferred tax $$ over the years, and pay the taxes later. If one somehow knew one would retire to a higher tax bracket, that might be a different story.

But I don't see the value of converting to Roth in my situation, unless I am missing something?

 

[Which Roger]

Another benefit for DW and I is that without the 401k contributions reducing out income, our income would have been too high to be eligible to contribute to a Roth. That's probably true for many others.

 

[Lucantes]

I don't see it as a "trap"?
I max out my 401k annually (get a 9% employer match, use a ROTH within it (just started to use this year and will fill the +17K max), and fill the rest up to the after-tax +50K limit.
Save everything else available into taxable accounts.
Will use the taxable accounts to support us from 2017 to 2027 (retiring at age 50) while doing ROTH conversions within the 401K.
Use the 401K to support us from 2027 onwards.
How could it be considered to be a "bad" thing?

 

[samclem]

But I don't see the value of converting to Roth in my situation, unless I am missing something?

Something to consider, and a possible reason to convert some money to a Roth: Take a quick look to see what the situation would be like for you (or your spouse) if the other were to pass away after age 70. Look at the RMDs, SS, pensions, etc, then at the tax brackets, standard deduction, etc for a single person. If the couple is MFJ and near the top of the 15% bracket, a single surviving souse can find herself well into the 25% bracket--paying 10% more taxes on the RMDs and also losing all the zero-tax CG and dividends--it can be a big hit. This can be one reason to pay taxes now to convert tIRA funds to a Roth IRA, even at the same tax rate--to lower the RMDs for the surviving spouse and provide a pot of taxes-already-paid money if that person would be in a higher bracket.

 

[LongPrime]

Please sell me the solution.

Something tells me that the OP has a product to sell that is a "solution" to this problem.

In 2008 and in 2012 , when we bought and transfered tIRA annuities, I didn't give much thought to RMA or conversions because it was 10-5 years ahead, and I was more focused on preserving the funds. Now, with the run up in the stock market, I too am looking a conversion. We did some in 2013. FA advised us to not to do anymore without careful analysis .

The other issue is that I have some loser stock in tIRA. I don't get any tax benefit from losses vs a taxable situation if I increase the tIRA in good stock selection.

Since this is a free forum, I hope to get some free ideas.
travelover, can you please sell a free idea or one that I can beat the system.

 

[travelover]

............travelover, can you please sell a free idea or one that I can beat the system.

Ask again when you have as many posts as I do.

 

[ajs56]

Something to consider, and a possible reason to convert some money to a Roth: Take a quick look to see what the situation would be like for you (or your spouse) if the other were to pass away after age 70. Look at the RMDs, SS, pensions, etc, then at the tax brackets, standard deduction, etc for a single person. If the couple is MFJ and near the top of the 15% bracket, a single surviving souse can find herself well into the 25% bracket--paying 10% more taxes on the RMDs and also losing all the zero-tax CG and dividends--it can be a big hit. This can be one reason to pay taxes now to convert tIRA funds to a Roth IRA, even at the same tax rate--to lower the RMDs for the surviving spouse and provide a pot of taxes-already-paid money if that person would be in a higher bracket.

Thanks very much for the reply samclem. I had not considered this scenario at all. So... the main change in the event of one of us passing with respect to this discussion is the switch from MFJ tax tables to single tax tables, correct? We are in the 25% bracket now and will liklely be similar at age 70, but I will look to see where within that bracket we are.

 

[marko]

I will save six figures easily by jumping into this so-called "trap."

+1. I will also easily save six figures. If I have to pay a bit more in taxes at withdrawal time, that's a deal I'll take.

 

[rbmrtn]

But I don't see the value of converting to Roth in my situation, unless I am missing something?

I could see it being a trap... being caught in something you weren't expecting with no easy way out. But it's not the worst problem to have. I was in a high bracket when working, currently in 15%, and will be in 25% by 70. I don't see any way to avoid that short of not taking SS and pension income.

The roth conversion gives you a tax free income source as opposed to tax deferred. So if rates go up in the future the roth is exempt from that ( assuming they don't change the rules )

 

[pb4uski]

I could see it being a trap... being caught in something you weren't expecting with no easy way out. ...

We should have been expecting it if we were paying attention since it was pretty obvious.

While we were saving tax-deferred while working it was easy to overlook that when we withdraw that the piper would need to be paid. Out of sight, out of mind and a long ways down the road.

It is very unlikely that I will come out poorly (marginal rates during withdrawal are higher than when i was working) and highly likely that I will come out ahead (marginal rates lower when withdrawn than when contributed) so I still think it was a good thing for me to do ---- but I still wish I didn't have to pay the piper at all!!

 

[Golden sunsets]

One way to look at this is investing in Pretax accounts is a partnership with the government. Uncle Sam owns a portion of your account-did from the day you deposited funds and avoided paying taxes. The government is patiently waiting to cash in on its investment and may collect nothing from the taxpayer who is in the 0 percent tax bracket or a bonanza from the taxpayer who is in a high tax bracket at the time of withdrawal. It therefore behooves the taxpayer to manage withdrawals via conversions if necessary, so as to lessen the governments partnership.

 

[samclem]

So... the main change in the event of one of us passing with respect to this discussion is the switch from MFJ tax tables to single tax tables, correct?

Yes, in your case the biggest change would probably be the tax tables. Also, taking one personal exemption rather than two will mean a further increase in taxable income of $3,950, and if you are taking the standard deduction (rather than itemizing) the change from MFJ to single will mean the loss of $6200 in deductions (all figures for 2014).

For couples who are now in the 15% bracket and the survivor is pushed into the 25% bracket, the increase in taxes can be dramatic (increased tax rate, decreased deductions, loss of 0% CG and dividend treatment.).