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Roth vs Traditional IRAs (esp regarding tax rates)
Old 11-01-2020, 08:43 PM   #1
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Roth vs Traditional IRAs (esp regarding tax rates)

I posted this elsewhere https://money.stackexchange.com/ques...ras-determined

Thought I'd toss this out for general discussion as it impacts whether to go Roth or Traditional. Frankly I'm not seeing the advantage to Roth, making of course some assumptions about where I'll be in retirement. I don't see me "earning" (pulling out) as much or more then as I am making now. That plus how I get the tax shelter now for my Traditional.
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Old 11-02-2020, 06:43 AM   #2
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Well, you can pull out as much or as little as you want so that isn't really a relevant factor.

What is most relevant is your current marginal tax rate since that is the tax avoided and your expected marginal tax rate in retirement. If your marginal tax rate in retirement is lower than your current marginal tax rate then you'll likely save.

During most of my savings years I was in the 28% tax bracket. Since we retired we've been in a low tax bracket despite low six-figure income. From 2013 to 2019, we withdrew ~$390k and paid about 8.5% in tax and I expect that we'll pay a little over 12% in tax on future withdrawals... so we have and will save big time.

OTOH, if one expects their marginal tax rate applicable to tIRA withdrawals or RMDs in retirement to be higher that their current marginal tax rate while working then tax-deferred saving doesn't make sense and Roth is the way to go.

At the end of the day it is just a tax arbitrage game.
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Old 11-02-2020, 08:58 AM   #3
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Depends on what your current tax bracket is versus what your tax bracket will be once you have Soc Sec, RMDs (and other unavoidable income streams) all turned on. In our case that income was much more than we need for spending. If that future tax rate is higher than your paying now, it’s worth looking into. There’s also taxes on widows/heirs to consider. And if you believe tax rates will increase in the future while you’re retired, it’s even more worthwhile to understand your current and future tax liabilities now while you can still act - eyes wide open. Taxes are almost a wash in the very long run if rates stay the same.

IOW, same as pb4uski said...
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Old 11-02-2020, 09:37 AM   #4
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Quote:
Originally Posted by pb4uski View Post
... At the end of the day it is just a tax arbitrage game.
I agreed but with a small caution: I took this position talking to an FA friend of mine and he pointed out that medicare costs and social security taxability are driven by current income. So even if the tax rates are the same at the end as they were at the beginning (no arbitrage gain) there may be an advantage to the Roth because of these surreptitious taxes. At that point I decided that while predicting future tax rates is hard, predicting future secondary effects has to be worse. So I am back to thinking of the conversions strictly as tax rate arbitrage.

There are also some second order effects of putting money in Roths. For example, we have a testamentary special needs trust for a grandchild where we expect the trust to run for most or all of his lifetime. It will be funded with retirement accounts, which must (currently) be drained within 10 years. We have directed that this trust be funded from our Roths because there are no tax consequences in the trusts, where if the trust was funded with IRAs, a bunch of undistributed bucks would end up being taxed at the rapacious trust rate. Currently, IIRC it is 40% plus whatever the state takes.

Basically, this is a chess game where our opponent can change the rules at any time during the game.
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Old 11-02-2020, 09:55 AM   #5
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The important thing is to save for retirement. Taxable or Roth, both are far better than doing nothing.

I prefer the Roth accounts for most people (and that includes myself) for several reasons:

1. Simplicity. You need $1000, you take out $1000. No need to take out anything extra for the tax man. No need to make an estimated payment.

2 Tax rates are at a relatively low point in my life time. I think they are more likely to go up than down in the future. This is just a feeling on my part. So unless one is a BIG earner (ie. the top current tax brackets), the vast majority of us will be better in the long run with a Roth.

3. Other taxes and fees that go up with income. Currently, Roths don't raise income (though that could change ).

4. Taxable IRAs convert lower taxed capital gains into higher taxed ordinary income. Not so good. Yes, we can take steps to protect capital gains, but I don't want that to drive my AA and other investment choices.

A question for those who live in states with an income tax. Does your state treat Roth withdrawals as a tax free event?
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Old 11-02-2020, 10:10 AM   #6
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As others have stated - a lot comes down to your current tax rates, your future earning tax rates retirement tax rates.

If you are young and at the start of your career - might be better to do Roth vs. if you are at peak earnings IMO.

Tax rates are also based on marital status - currently single, will get married, widowed down the lined?

I like having options - We currently have about 50% traditional and 50% Roth and basically nothing in taxable accounts <5%. We do have about 1/3 of our net worth in rental property equity that will be balancing the equation in the end.
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Old 11-02-2020, 10:14 AM   #7
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Originally Posted by OldShooter View Post
I agreed but with a small caution: I took this position talking to an FA friend of mine and he pointed out that medicare costs and social security taxability are driven by current income. So even if the tax rates are the same at the end as they were at the beginning (no arbitrage gain) there may be an advantage to the Roth because of these surreptitious taxes. At that point I decided that while predicting future tax rates is hard, predicting future secondary effects has to be worse. So I am back to thinking of the conversions strictly as tax rate arbitrage.

There are also some second order effects of putting money in Roths. For example, we have a testamentary special needs trust for a grandchild where we expect the trust to run for most or all of his lifetime. It will be funded with retirement accounts, which must (currently) be drained within 10 years. We have directed that this trust be funded from our Roths because there are no tax consequences in the trusts, where if the trust was funded with IRAs, a bunch of undistributed bucks would end up being taxed at the rapacious trust rate. Currently, IIRC it is 40% plus whatever the state takes.

Basically, this is a chess game where our opponent can change the rules at any time during the game.
+1

Spot on, OldShooter

The only tweak I might make, in all humility and as a "new guy" here, is replacing "opponent" with "government" in the above.

In my view, governments provide critically needed services (health care, roads, police, defense -- and all of the other "common goods"). Others might have a different view. I am in no position to judge. The election taking place tomorrow in the USA bears on these issues.

If one's retirement depends upon government programs, however, take caution, as such programs can change. And in saying this, I mean no criticism of government (see above). It is no different than saying one's retirement is dependent upon XOM dividends. As Darwin might suggest, we are presented with stressors, then evolve.
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Old 11-02-2020, 10:27 AM   #8
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Tax Diversification.

You build a portfolio of investments with various asset classes, so make part of your retirement with various types of taxable status. Generally, tax-free Roth IRA and municipal bonds, tax deferred traditional IRA and annuities, and currently taxable.

Since the future is unknown with regards to tax policy use all of the options available to you. At retirement you may not have a lot of control over the taxability of certain items (ie social security, RMD's, pensions, etc.) however, you can have some control over how other items may or may not add to your taxable income. Seriously, consider the Roth IRA for your tax diversification.
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Old 11-02-2020, 11:33 AM   #9
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... The only tweak I might make, in all humility and as a "new guy" here, is replacing "opponent" with "government" in the above. ...
Well, I tend libertarian not anarchist, but in taxation I see the government clearly as an "opponent." This is the government's classic view of taxation:
“The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”
So on my side I endeavor to minimize the number of feathers I lose and to maximize my hissing so as to dissuade my opponents.

Besides, the chess metaphor demand two opponents.
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Old 11-02-2020, 12:02 PM   #10
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As most here already know there are many moving pieces in deciding between TIRA and a Roth, both for contributions and for conversions. As noted, it is arbitrage of taxes. However there are many taxes other than income tax that you may have to deal with in retirement. I'm paying a IRMAA for DW medicare, others ACA limits; What tax bracket will the surviving spouse be in after one spouse checks out and taxed as single. There was a thread about all the limits that would cost you if you go over them. Might be worth searching for.

With financial matters, you normally get paid to assume risk. 30 year loans are more expensive than 15, 30 year bonds pay more than 10, and so on. Why take the risk of an unknown future tax liability and not get paid for it. That is my bottom line for preferring a Roth.
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Old 11-02-2020, 12:24 PM   #11
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The tax arbitrage is not just Federal. It is also state level. I currently live in Illinois where IRA's, Pensions, 401Ks etc. are not currently taxed. Given our state's financial woes and ever increasing departure, I don't expect that retirement income not being taxed will last over the next 30 years. If the do start taxing retirement income, and I'm fairly certain they will, anything I can convert to Roth today should save me future state income tax in the long run. A secondary effect is that if my taxable income is low enough, I can qualify for a "Senior Citizens Assessment Freeze Homestead Exemption". Currently, any federally taxable retirement income is added to get to their "test" income level. With Roth income, it is not part of the formula. As other homes around you increase in assessed value, those homes will take a larger share than you of the tax burden. Now they may also change that formula in the future too. As already stated, the opponent can change the rules at any time.
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Old 11-02-2020, 12:39 PM   #12
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I expect to pay the same tax rate in retirement as I do now. Generally I would say that makes Roth the better option. However, I contribute to Traditional because it reduces my MAGI by up to $6K so I get a much better ACA subsidy.
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Old 11-02-2020, 01:42 PM   #13
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previous thread on income limits is at

https://www.early-retirement.org/for...-a-101090.html


Good to know limits for TIRA vs Roth and conversions
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Old 11-02-2020, 02:14 PM   #14
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Quote:
Originally Posted by motley View Post
I posted this elsewhere https://money.stackexchange.com/ques...ras-determined



Thought I'd toss this out for general discussion as it impacts whether to go Roth or Traditional. Frankly I'm not seeing the advantage to Roth, making of course some assumptions about where I'll be in retirement. I don't see me "earning" (pulling out) as much or more then as I am making now. That plus how I get the tax shelter now for my Traditional.


I advise some of both. I am glad I have a pool of ROTH to pull from prior to age 65 to pay my annual expenses without contributing to my MAGI. This will give me ACA subsidies.
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Old 11-02-2020, 02:51 PM   #15
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I expect to pay the same tax rate in retirement as I do now. Generally I would say that makes Roth the better option. However, I contribute to Traditional because it reduces my MAGI by up to $6K so I get a much better ACA subsidy.
I think pb4uski's earlier comment about tax rate arbitrage is still the right way to think about it; you just have to include all of the tax effects.

All of the tax effects can include:

1. Federal income taxes
2. State income taxes
3. ACA PTC effects (and CSRs)
4. FAFSA EFC effects
5. IRMAA effects

There are probably others.

It does get hard to figure these out exactly (especially for anything several years in the future) and to do sensitivity analyses, but one can certainly get a rough idea.
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Old 11-02-2020, 05:58 PM   #16
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This thread is an exhaustive discussion on this issue & has a lot of really great information including software suggestions to model it based on your unique profile

https://www.early-retirement.org/for...ion-99854.html
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Old 11-02-2020, 06:50 PM   #17
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This thread is an exhaustive discussion on this issue & has a lot of really great information including software suggestions to model it based on your unique profile

https://www.early-retirement.org/for...ion-99854.html
Yes, that's a great thread. It talks primarily about whether, when, and how much Roth conversion to do, but it's the same principle as deciding whether to contribute to Roth or tIRA/401K.
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Old 11-02-2020, 09:13 PM   #18
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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).

Clearly a tax arbitrage. Run your numbers, which will be your numbers, and not necessarily anyone else's (and it is always dependent upon the vagaries of congressional action).
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Old 11-03-2020, 07:25 AM   #19
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Not discussed often, since this group is money saavy, and it is really just more tax arbitrage, is the psychological aspect of “how much saved”. Us old school mere mortals think of savings as post tax. “I have $50,000 saved” is $50,000. We never think “oh, thats just like having $70,000 in a tIRA”. So, of course, when planning for income, we consider taxes, but using FIREcalc for instance, taxes are ignored. Saying and seeing “wow, I have $1M for retirement in my IRA” is more comforting than “I only have $750k to spend”. When I was w*orking, I loved investing in & watching that pretax account just shoot right up. When I realized, thanks to pensions + SS, that my withdrawal of those funds in retirement would be the same rate or higher, especially if I were single, I transitioned to all Roth, since company match was always deferred. It made the growth look less but the reality is, after tax it was the same with less worries. I still have too much in tIRA, and will only have a few years to convert as much as makes sense, but in no way will I convert it all. I just wanted to avoid the RMAs all being taxed at the next bracket. Hitting the $2M invested mark pretax is a lot easier and mentally sounds more impressive than only $1.5M or less, despite it being the same spendable amounts.
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Old 11-03-2020, 07:48 AM   #20
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Unless I missed something above there is a very important issue not discussed above.... tax free growth.

Since many people don't need the retirement money they are putting away for 10, 20, 30 or even 40 years, the money you put into an IRA or Roth IRA may double, triple or hopefully more. That changes everything, IMO. I was at high tax brackets when ROTHs were created and I switched ASAP for this tax free growth reason.

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.

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.

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.

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.

So in conclusion, my view is that a ROTH is almost always better in the long run. But people like the short term benefit of paying less taxes so everyone needs to make their own decisions.
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