Taxable/Deferred/Exempt Balancing

Lots to think about in this thread.

I just turned 59 1/2. I have saved in all of the above categories. Where I a standing right now my absolutely favorite pile is in our Roth IRA's.

Next is our taxable account with VG. Mostly SP Index, Total Stock Index and Tax Advantaged Fund. The LTG and Dividends are starting to be a tax problem...First world problem.

After that is our SEP IRA which happens to be in an annuity, thanks to a FA who made more money on it than me. I turned 59 1/2 in January and started drawing on this to live rather than leave a tax bomb to our estate.

Tax deferred accounts are fun until you get old and have to take RMD's or die. Use them up first and die with accounts with stepped up basis or Roth's. If we die with money we are lucky. Be responsible and have fun!
 
Warrior, The saying that capital gains in a traditional IRA (or 401K) are turned into ordinary income seems accurate to me. I'll give you an example, but not one where the tax rate is constant because that is not how it works. Ponder the following examples and see whether or not you agree...

First, here are the 2024 tax brackets for married filing jointly.

Brackets for Long Term Capital Gains:
0% - up to $94,050
15% - $94,051 to $583,650
20% - over $583,650

Brackets for Ordinary Income:
10% - up to $22,000
12% - $22,001 to $89,450
22% - $89,451 to 190,750
etc.

Assume a married couple has one income source, a pension that pays $69,200. After deducting the standard deduction of $29,200, their adjust income would be $40,000. So the portion of their income above $22,001 is taxed at 12%.

Now assume they hold stock in Apple, in a taxable account. Purchased for $60,000, now worth $100,000, and the $40,000 gain is a long term gain. If they were to sell their shares in Apple, that would immediately create an event that must be reported on their tax return.
The $40,000 long term gain would increase their income to $109,200, or $80,000 after the standard deduction. Since the tax bracket for long term capital gains is 0% up to $94,050, they would owe no tax on their $40,000 capital gain.

Now assume a different scenario - they hold stock in Apple, in a traditional IRA account. Again, it was purchased for $60,000, now worth $100,000, and the $40,000 gain is a long term gain. If they were to sell their shares in Apple, that would NOT create any type of taxable event, like it did above. It would just shuffle their holdings around within their traditional IRA. They no longer own Apple, and have more cash, but no impact to their taxes. To have a taxable event from their traditional IRA, they have to make a withdraw.
So, let's say they make a $40,000 withdraw from their IRA. Withdraws are taxed as ordinary income.
The $40,000 withdraw would increase their income to $109,200, or $80,000 after the standard deduction. Unlike the example above, the entire $80,000 is subject to the ordinary income tax bracket. So they would pay $40,000 & 12% ($4800) on their IRA withdraw.

In both cases, their income was $80,000. But in one case their taxes were lower. That is the basis behind the statement that capital gains, realized in a traditional IRA, will get taxed as (i.e turned into) ordinary income (when those gains are withdrawn).
In the first scenario the $60,000 is never taxed, but it came from somewhere. If it didn't come from ordinary income, then the comparison to a 401k account doesn't make sense since it's a deferred compensation plan.
I think this example does show how capital gains get taxed as ordinary income, but it is not a valid conclusion to skip the 401k for that reason and expect to be paying less tax overall.
 
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In the first scenario the $60,000 is never taxed, but it came from somewhere. If it didn't come from ordinary income, then the comparison to a 401k account doesn't make sense since it's a deferred compensation plan.
I think this example does show how capital gains get taxed as ordinary income, but it is not a valid conclusion to skip the 401k for that reason and expect to be paying less tax overall.
Correct. The original $60k investment in the first example was after tax and in the second example it was pre-tax.

But the point remains that capital gains - and qualified dividends too - have favorable tax treatment compared to ordinary income.

Note I never suggested one skip investing in a 401k. I was just illustrating how one doesn’t get the same tax benefits in a 401k.

Many try to structure their holdings to take advantage of this. If one has a 50/50 asset allocation, they may place the fixed income portion in the 401k / traditional IRA and the equity portion in Roth or taxable, where possible, to take advantage of the different tax situations.
 
... I think this example does show how capital gains get taxed as ordinary income, but it is not a valid conclusion to skip the 401k for that reason and expect to be paying less tax overall.
But skipping the 401k wasn't the point. The point was if you have taxable and tax-deferred money, avoid putting equities in tax deferred if you can, because equity growth which gets preferential tax rates in taxable accounts is taxed as ordinary income in tax deferred accounts
 
But skipping the 401k wasn't the point. The point was if you have taxable and tax-deferred money, avoid putting equities in tax deferred if you can, because equity growth which gets preferential tax rates in taxable accounts is taxed as ordinary income in tax deferred accounts
Ok, sure...your point is about asset placement, but that's not my point. The thread is about balancing among the account types which is mostly done as contributions are made (aside from conversions), so the implication is to avoid tax by using a regular brokerage which doesn't work out in most situations. My point is that it's foolish to emphasize the lower capital gains tax rate as an alternative to regular income tax rate on a 401k when considering where to save for retirement.
 
Warrior, The saying that capital gains in a traditional IRA (or 401K) are turned into ordinary income seems accurate to me. I'll give you an example, but not one where the tax rate is constant because that is not how it works. Ponder the following examples and see whether or not you agree...

First, here are the 2024 tax brackets for married filing jointly.

Brackets for Long Term Capital Gains:
0% - up to $94,050
15% - $94,051 to $583,650
20% - over $583,650

Brackets for Ordinary Income:
10% - up to $22,000
12% - $22,001 to $89,450
22% - $89,451 to 190,750
etc.

Assume a married couple has one income source, a pension that pays $69,200. After deducting the standard deduction of $29,200, their adjust income would be $40,000. So the portion of their income above $22,001 is taxed at 12%.

Now assume they hold stock in Apple, in a taxable account. Purchased for $60,000, now worth $100,000, and the $40,000 gain is a long term gain. If they were to sell their shares in Apple, that would immediately create an event that must be reported on their tax return.
The $40,000 long term gain would increase their income to $109,200, or $80,000 after the standard deduction. Since the tax bracket for long term capital gains is 0% up to $94,050, they would owe no tax on their $40,000 capital gain.

Now assume a different scenario - they hold stock in Apple, in a traditional IRA account. Again, it was purchased for $60,000, now worth $100,000, and the $40,000 gain is a long term gain. If they were to sell their shares in Apple, that would NOT create any type of taxable event, like it did above. It would just shuffle their holdings around within their traditional IRA. They no longer own Apple, and have more cash, but no impact to their taxes. To have a taxable event from their traditional IRA, they have to make a withdraw.
So, let's say they make a $40,000 withdraw from their IRA. Withdraws are taxed as ordinary income.
The $40,000 withdraw would increase their income to $109,200, or $80,000 after the standard deduction. Unlike the example above, the entire $80,000 is subject to the ordinary income tax bracket. So they would pay $40,000 & 12% ($4800) on their IRA withdraw.

In both cases, their income was $80,000. But in one case their taxes were lower. That is the basis behind the statement that capital gains, realized in a traditional IRA, will get taxed as (i.e turned into) ordinary income (when those gains are withdrawn).
Everything in your post seems correct in that is how things work. You are talking about where to take money from. I thought the context of this thread was about where to put money. I have been posting in that context.

I still believe the saying that a pre-tax account converts capital gains to ordinary income is very mis-leading. One could more accurately say a pre-tax account only has ordinary income tax and a taxable account has ordinary income tax plus tax on dividends plus tax on capital gains. A pre-tax account normally beats a taxable account. That is the point.
 
... My point is that it's foolish to emphasize the lower capital gains tax rate as an alternative to regular income tax rate on a 401k when considering where to save for retirement.
Agreed. Two different points.

First, and the main point of this thread is to make tax deferred savings contributions when your tax savings exceed what you expect to pay when withdrawn... and importantly, if your expectations change so yu expect to pay more when withdrawn that when contributing then adjust your tax deferred contributions accordingly.

Second, IF you have both taxable account savings and tax-deferred savings, then avoid placing equities in tax-deferred accounts if possible. However, if your overall allocation to equities exceeds your taxable and tax-free accounts then you'll have no choice but to include equities in tax deferred accounts. This came as a tangent to the main thread.
 
Agreed. Two different points.

First, and the main point of this thread is to make tax deferred savings contributions when your tax savings exceed what you expect to pay when withdrawn... and importantly, if your expectations change so yu expect to pay more when withdrawn that when contributing then adjust your tax deferred contributions accordingly.

Second, IF you have both taxable account savings and tax-deferred savings, then avoid placing equities in tax-deferred accounts if possible. However, if your overall allocation to equities exceeds your taxable and tax-free accounts then you'll have no choice but to include equities in tax deferred accounts. This came as a tangent to the main thread.
I halfway agree, but it depends on your AA and how much $$$.
Let's say you're still working with an AA of 60/40 and have:
$200k in your taxable account
$200k in your Roth accounts
$600k in your tax-deferred 401(k)

So you need $600k total in stock funds to achieve your AA. That's $400k in taxable+ Roth plus $200k in tax-deferred.

Better to say that whatever fixed income you do decide to hold should be in tax-deferred...
 
Back when I worked in NYC, our marginal tax rate, state plus federal, exceeded 46%. So we stuffed as much money as we possibly could into tax deferred vehicles, like 401k, 403b, 457 and tIRA. We were only briefly eligible for a Roth one year when I switched jobs, and then only for a couple hundred dollars (I'm ever so glad now that we nonetheless did contribute so that the 5 year clock started). So we entered retirement in 2019 with the vast majority of our portfolio in tax deferred, some in taxable and a tiny amount in Roths. We've made Roth conversions over the last six years, just to build up a fund for unexpected large expenses that we can tap without a tax hit. But we still have over 60% of our assets in tax deferred. Fortunately, our pension and SS income pays our expenses, so RMDs are really the only tax issue in the years ahead. I expect we will stay in the 22% bracket into our 80s and never get above 24%. QCDs will also help with that.
 
.... However, if your overall allocation to equities exceeds your taxable and tax-free accounts then you'll have no choice but to include equities in tax deferred accounts. ...

... Better to say that whatever fixed income you do decide to hold should be in tax-deferred...
You say po-tay-toe... I say po-tah-toe.
 
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