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Old 11-03-2020, 08:56 AM   #21
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Originally Posted by SALTedOut View Post
Unless I missed something above there is a very important issue not discussed above.... tax free growth. ...
No, its all tax rates. Extending your example, you have a choice at age 40 of deferring in a tIRA or a Roth IRA.

Alternative 1: You save $1,000 a tIRA that grows to $3,000 over 25 years. At a 39% tax rate the $3,000 is "worth" $1,830... at 22% the $3,000 is "worth" $2,340.

Alternative 2: You pay the 39% tax and invest the remaining $610 in a Roth IRA that grows to $1,830 over 25 years.

So the entirety of the $510 benefit is due to tax rates, not growth.
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Old 11-03-2020, 09:01 AM   #22
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Originally Posted by pb4uski View Post
No, its all tax rates. Extending your example, you have a choice at age 40 of deferring in a tIRA or a Roth IRA.

Alternative 1: You save $1,000 a tIRA that grows to $3,000 over 25 years. At a 39% tax rate the $3,000 is "worth" $1,830... at 22% the $3,000 is "worth" $2,340.

Alternative 2: You pay the 39% tax and invest the remaining $610 in a Roth IRA that grows to $1,830 over 25 years.

So the entirety of the $510 benefit is due to tax rates, not growth.

Agree, with one exception. Your Alt 2 assumes the person only contributes $610 in the ROTH. My assumption is that most people would put $1,000 in either and if they had saved the $390 in taxes by putting it in a tIRA they would have spent that $390 on something and would not have separately saved/invested that $390.

Your assumption is the person purposely invests less in the ROTH.
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Old 11-03-2020, 09:02 AM   #23
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Yes, and that flawed assumption results in a flawed conclusion because your starting point isn't economically equivalent... it's like putting your thumb on the scale.
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Old 11-03-2020, 09:33 AM   #24
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Originally Posted by SALTedOut View Post
Agree, with one exception. Your Alt 2 assumes the person only contributes $610 in the ROTH. My assumption is that most people would put $1,000 in either and if they had saved the $390 in taxes by putting it in a tIRA they would have spent that $390 on something and would not have separately saved/invested that $390.

Your assumption is the person purposely invests less in the ROTH.
We're ultimately doing these exercises to figure out what we as individuals should do, right? If we can help someone else decide, that's nice. If someone points out a flaw in our scenario then we learn something and adjust.

Applying it here, it's totally legit for some of us to look at putting the whole $1000 in the Roth, and pay taxes out of a taxable account. However, to say in the other case that we would spend that $390 is very questionable. Is that what you would do? I sure wouldn't. Most people here have the mentality to LBYM. Spend what you need to, not what you have available.

You might as well compare the $1000 or $690 going to a Roth with someone who would spend that $1000, since that's what a lot of the population would do, but not here.
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Old 11-03-2020, 10:13 AM   #25
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EDIT: Dang it, I got caught out by the fact that the post I quoted was the last one on the page. I hadn't seen the answers of PB4 and R.B. before I posted.


Quote:
Originally Posted by SALTedOut View Post
Unless I missed something above there is a very important issue not discussed above.... tax free growth.
Well, that issue has been discussed (debunked?) many times on E-R. See the following.

Quote:
For example let's say you put $1,000 into an IRA at age 40 because you are at the 39% bracket. That money triples before you withdraw it 25 years later and you are in the 22% bracket. You are now paying 22% on $3,000 which is more than the 39% at $1,000. The longer that money is left in the IRA the more it grows and the worse this answer gets.
OTOH, if you paid $390 tax on that $1000, you would have only $610 to put into a Roth. It, too, would triple to $1830, all of which is spendable. In the tIRA case, you would have $3000*(1-0.22) = $2340 in spendable funds.

Your very example proves why the first-order way to look at Roths is as a tax-rate arbitrage.

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I realize this ignores the impact of the money you could have invested by not paying the taxes in the year of ROTH contribution but many people would have spent that money anyways and not saved it.
Well, sure, if you want to assume sub-optimal behavior, then a sub-optimal solution may be best.

Quote:
Also by saving lot of $$ in a tIRA the tIRA decision misses the impact of RMDs. When I look at my tIRA balance (at 53) and grow that balance by another 20-40 years, the RMDs alone will fill up the 22% bracket and that is before SS, pension, investment income, etc. I really with ROTHs were created 20 years earlier than they were.
Yes, there are second-order effects. This is the origin of one rule of thumb, namely, to seek to levelize your taxable income over time, using a combination of tIRA/t401(k) accounts and Roth accounts and/or conversions.


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As an offset to that negative above, it also ignores the likely possibility of tax rate increases, the power of tax free income on future subsidies, tax credits, SS taxation, IRMAA, etc. It also ignores the higher tax rates of a surviving spouse and the inheritance benefits of a ROTH on the recipient. I think all these can more than offset the negative issue above. This is especially true the higher tax rates go up to pay for our growing debt load.
Agreed.
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Old 11-03-2020, 03:25 PM   #26
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I have this image in my mind of pb4 drooling on his keyboard while reading post #20. Anywho...

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For us, with the exception of a couple of (relatively) low late-career income years that we took advantage of, roths made no sense when we were working. (And were not even available to us for most of our work years)

Once we retired, converting aggressively has made sense--so far. (Working was 39.6 marginal, now converting to top of 24)...
Similar story here, though not quite as good. We deferred at 28-33%; now converting at a mix of 12% and 22%, pre SS/RMD. At 52, we were 60/40 tax-deferred/taxable. At 70ish, it should be one giant Roth... plus it's shiny little cousin, the HSA.

I think it's a bit more difficult for early-30-somethings in the 22% and 24% brackets. Historically, those are great rates that cover a ton of territory in the MFJ brackets. And that would favor the Roth. Both my kids are in that scenario. They do tax-deferred only for the match and then all Roth.

Plus if you want a blank stare, tell an early-30-something it depends on their tax rate in retirement. You might as well have said, it depends on whether or not the universe is infinite. It's like an unknowable concept at that age. So they go with what they know and love, and that's the Roth.
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Old 11-04-2020, 06:54 AM   #27
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Originally Posted by Cobra9777 View Post
I have this image in my mind of pb4 drooling on his keyboard while reading post #20. ...
It was more rolling my eyes.
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Old 11-04-2020, 08:44 AM   #28
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It was more rolling my eyes.
That logic has been hashed over so many times, correctly, by you and others. I read the post and was going to chime in, but without the thoroughness and example numbers. But yes, on the ease with which the alternative unequal scenario is accepted...
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Old 11-04-2020, 09:24 AM   #29
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It was more rolling my eyes.
The Roth/tIRA scenario is pretty simple and clear once you "get it." Before enlightenment I spent a number of years thinking that in our tIRAsI we were making money by investing the government's money. Not so, of course. So I have some sympathy for those on the path.

I still roll my eyes at all the secondary effects of these decisions, like taxing SS, ACA cliffs, Medicare premium cliffs, etc. I'd bet that it is the minority of FAs/CFPs who really understand it all.
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Old 11-04-2020, 10:23 AM   #30
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^^^ Yes, if you have those second order implications the modeling can get real complicated real quick.
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Old 11-04-2020, 01:28 PM   #31
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I still roll my eyes at all the secondary effects of these decisions, like taxing SS, ACA cliffs, Medicare premium cliffs, etc. I'd bet that it is the minority of FAs/CFPs who really understand it all.
I can't say how to quantify those secondary effects with certainty, but I understand the meaning of those factors. And for that matter, since I don't know future tax rates or investment returns, I have no certainty with the primary factor. Everything is an educated guess.

I could list out how I'm factoring in all of those secondary effects, but I wouldn't want you to hurt your eyes over-rolling them. Quick summary is that I think I can get my Roth fully converted before I start SS unless I start SS early, and I can do it without going over the ACA cliff. So I'm doing the best I can to avoid the SS tax hump and impacting IRMAA by not having RMDs.

What advice I'd give for anyone else would require knowing their full financial picture, and it'd be a lot of work for me, so I don't really try. I just remind people that those are factors in play.

None of this is a huge game changer, unless a few thousand here and there is really meaningful. I figure, why not take my best guess on getting those right, and if I'm wrong, oh well.
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Old 11-04-2020, 02:09 PM   #32
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..............................
For example let's say you put $1,000 into an IRA at age 40 because you are at the 39% bracket. That money triples before you withdraw it 25 years later and you are in the 22% bracket. You are now paying 22% on $3,000 which is more than the 39% at $1,000. The longer that money is left in the IRA the more it grows and the worse this answer gets.

...............................
I believe your focus is on the wrong thing here.......taxes you pay. You should be looking at the return after taxes , not the taxes alone.

e.g. suppose someone offered to make your money increase by 10x instead of the 3x here. Would you turn that offer down because the taxes would be higher?
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Old 11-04-2020, 06:26 PM   #33
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I was actually taking with a friend today and that came up... he said that in years where his business did well he would pay big bonuses to employees since it reduced his taxes so much... I told him that he didn't really come out ahead as long as his tax rate was less than 100%... I'm not sure if he got my point.
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Old 11-04-2020, 06:41 PM   #34
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Originally Posted by SALTedOut View Post
For example let's say you put $1,000 into an IRA at age 40 because you are at the 39% bracket. That money triples before you withdraw it 25 years later and you are in the 22% bracket. You are now paying 22% on $3,000 which is more than the 39% at $1,000. The longer that money is left in the IRA the more it grows and the worse this answer gets.
Focusing on the amount of tax paid may not be best. Consider focusing instead on the amount remaining after tax is paid. Looking at the tax amount is the second of two Common misconceptions in this area.

Quote:
I realize this ignores the impact of the money you could have invested by not paying the taxes in the year of ROTH contribution but many people would have spent that money anyways and not saved it.
Well, yes, contributing more money now is likely to provide more money later.
To make it strictly a fair "traditional vs. Roth" question, one needs to start with the same pre-tax amount for both options.
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Old 11-10-2020, 05:52 PM   #35
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I do not think there is a clear answer since everyone's situation is different.

I have a traditional IRA because I was earning a lot of money as an engineering manager....and taxes at that time were killing me. I elected a traditional IRA to reduce my taxes on my high earnings. Now that I am retired, I have to be careful how to withdraw in order to avoid my withdrawal income from pushing my retirement income into a higher tax bracket. This is manageable and my tax avoidance during my contribution years allow my next egg to grow more using the tax avoidance money that I would have paid Uncle Sam and the State of California.

On the other hand, my young wife opened a business and her net reportable income is relatively low because of her business deductions. In her relatively lower income situation, we decided on a Roth IRA since the tax avoidance money during her earning years is relatively small for a traditional IRA. I also expect her retirement income will be higher than her current income after she cash out her business, sell some of our properties and she inherit my traditional IRA after I kick the bucket.

Having both taxible income and non-taxible income during retirement have some advantages to my wife since she can withdraw taxible income until she reach a certain tax threshhold then then withdraw non-taxible income from her Roth IRA to maintain her standard of living.

Hence, a traditional IRA made sense to me since I was a high earner while a Roth IRA made sense to my wife since her current income was relatively low but her retirement income is expected to be high.
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Old 11-11-2020, 08:03 AM   #36
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I do not think there is a clear answer since everyone's situation is different.

This is manageable and my tax avoidance during my contribution years allow my next egg to grow more using the tax avoidance money that I would have paid Uncle Sam and the State of California.

Hence, a traditional IRA made sense to me since I was a high earner while a Roth IRA made sense to my wife since her current income was relatively low but her retirement income is expected to be high.
To clarify using tax avoidance money to grow my nest egg...my nest egg included a traditional IRA, taxible mutual funds, rental property income and government pensions. Tax avoidance money generally went into my taxible mutual funds because there is a yearly cap on contributions to a traditional IRA.
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Old 11-11-2020, 04:35 PM   #37
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We currently have a mix of both Roth and traditional IRAs. I can control my taxable income this way and if we need a little more for big purchases during the year then we just pull from the Roth.
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Old 11-11-2020, 08:54 PM   #38
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We currently have a mix of both Roth and traditional IRAs. I can control my taxable income this way and if we need a little more for big purchases during the year then we just pull from the Roth.

That works.

Here are the federal taxable income brackets for a married couple.

https://www.nerdwallet.com/article/t...e-tax-brackets

Note that a married couple tax rate is 12% up to $80,250 and then it jumps to 22% which is a HUGE 10% difference. The next bracket is $171,051 but the difference is only 2%. Having both a traditional IRA and a Roth IRA, you can play this game to your advantage.

IRA withdrawals are taxed as "income" while cashing out taxable mutual funds are usually taxed as "long term capital gains" which is 0% if a married couple income is less than $80,000 and 15% $80,000 to $496K. This is illustrated in the following link:

https://www.nerdwallet.com/article/t...ains-tax-rates

For 2019-2020, the $80,000 should be the maximum retirement income that you can have to minimize your retirement taxes for a married couple. However, be aware that these tables may change in the future depending on the new administration. If there are some talk about raising the capital gain tax, I suspect the stock market may decline in December because people may cash out to take advantage of the current low capital gain taxes in the above link.
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Old 11-11-2020, 09:07 PM   #39
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That works.

Here are the federal taxable income brackets for a married couple.

https://www.nerdwallet.com/article/t...e-tax-brackets

Note that a married couple tax rate is 12% up to $80,250 and then it jumps to 22% which is a HUGE 10% difference. The next bracket is $171,051 but the difference is only 2%. Having both a traditional IRA and a Roth IRA, you can play this game to your advantage.

IRA withdrawals are taxed as "income" while cashing out taxable mutual funds are usually taxed as "long term capital gains" which is 0% if a married couple income is less than $80,000 and 15% $80,000 to $496K. This is illustrated in the following link:

https://www.nerdwallet.com/article/t...ains-tax-rates

For 2019-2020, the $80,000 should be the maximum retirement income that you can have to minimize your retirement taxes for a married couple. However, be aware that these tables may change in the future depending on the new administration. If there are some talk about raising the capital gain tax, I suspect the stock market may decline in December because people may cash out to take advantage of the current low capital gain taxes in the above link.
You add the standard deduction of $24,800 onto that don't you?
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Old 11-11-2020, 09:13 PM   #40
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Yes, so if a couple had $24,800 of Roth conversions and $80,000 of preferenced income their total tax bill would be zero.
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