Does tax-deferred $$ make sense for us?

[TDub]

I could use a sanity check here as I'm re-thinking our current strategy.
Specifically, I've only recently realized our maxing out our tax deferred accounts (Thrift Savings Plans) may not be the wisest decision given that the Tax Cuts and Job Act (TCJA) has an expiration date just 5 years before we pull the plug.

In 2030, our target RE year, we anticipate our COLA'd pensions to equal $137,800/year after federal income taxes (we don't plan on living in a state that taxes military pensions). There are two possibilities:

The TCJA expires in '25 and the tax brackets revert to the '17 model. We will fall in the 25% to 28% depending on how much we withdraw from brokerage.​

The TCJA is extended for income taxes and we fall in the 24% bracket like we're in now.​

At best, it looks like we are deferring taxes to end up in the same tax bracket, best case. And there is no guarantee the '17 tax brackets won't return. It feels like a gamble with odds not in our favor.

If we stop contributing to our tax deferred accounts (TSP), our marginal tax rate will increase. Still, I'm not convinced a higher marginal rate is enough of a reason to contribute 41K/year to our TSPs ('22 limit). The risk seems high that we're missing a lower tax rate between now and retirement. We could take that 41K/year and throw it into our after-tax account at Vanguard.

What am I missing?

TIA!

 

[pb4uski]

What is most relevant is the marginal taxes on the $41k/year of tax deferred savings... IOW the difference in taxes with and without tax deferred savings.... this might be different from your marginal tax bracket if you're tax deferred savings changes your tax bracket.

Then compare that to your expected marginal tax for withdrawals in retirement.

From what you wrote it sounds like you'll be around 25% no matter what, which means that tax-deferred savings are of negligible benefit for you.

I'm betting that Congress does nothing... which is their specialty... and as a result rates revert to 2017 rates.

 

[SnowballCamper]

Yeah, with substantial pension income the tax deferral is less of an advantage. To get the real answer, you probably need to look at the overall tax situation. Current long term capital gains rate is probably 15% for you, so better to invest in a taxable brokerage than to defer to the higher regular income rate later.

It's not quite as simple as that though. If you reinvest the capital gains, and then sell at a later date at a loss, then you've paid tax that might not have been paid in a tax deferred account. This is likely a minor effect overall.

 

[TDub]

I wonder if the better choice, given the relatively negligible cost/benefit, is to stop TSP contributions, throw them into Vanguard instead, and lessen our TSP to Roth Conversion headache down the road.

 

[frayne]

Good post and I think you are on to something in your sanity check. That said, I can't see our politicians from either party letting the current tax cuts sunset, unless of course they want to be tarred, feathered and run out of town on a rail. In the past, conventional wisdom has always been to max out tax deferred accounts to lessen tax liability, thinking retirement time would bring less income/lower taxes which may or may not be the case depending upon your situation. Converting deferred accounts to Roths and taking the tax hit later almost seems like a wash in some respects. Regardless, Sam will alway figure out a way to get his cut, not to mention the 800# elephant in the room, the uncertainty of new tax legislation.

 

[Kork13]

You're on the same thought I was a couple years ago. I realized that my military pension would top out most of our lower tax brackets. So I decided to switch my TSP to 100% Roth contributions. I'll probably be in the 25% tax bracket range for the duration of my career as well as during retirement... So it's probably a wash anyway. But I would definitely not stop TSP contributions entirely. Just switch to Roth.

 

[TDub]

You're on the same thought I was a couple years ago. I realized that my military pension would top out most of our lower tax brackets. So I decided to switch my TSP to 100% Roth contributions. I'll probably be in the 25% tax bracket range for the duration of my career as well as during retirement... So it's probably a wash anyway. But I would definitely not stop TSP contributions entirely. Just switch to Roth.

Hey, we're in the same YG! Nice to meet you and thanks for the input.

Great point about switching over to Roth in TSP instead of stopping TSP contributions altogether.

 

[RLTW]

TDub - Good question and definitely smart to be thinking like this. I don't think there is a right answer and you probably need to just think about it at the beginning of each year. What do we value more this year - the current tax advantage or the unknown later one. Then compare what you have in each account. I think it is smart to have good balance in each investment account type. 1. Tax deferred, 2. Tax free (roth), 3. Taxable (brokerage).

Because you should have a high COLA protected (but taxable) pension. It is probably a good idea to have some good numbers in your Tax free and Taxable buckets. But no one really knows what congress will do with the tax code. They could just as easily, raise the amount you pay on capital gains as they could lower the taxes brackets.