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I find these discussions interesting. I think, (in a small way) whether pre-tax(Tax deferred) or post-tax(Roth) works out better mathematically is (partially) missing the point. I look at it slightly differently.

While I am actively working (i.e., not retired) I can afford to pay the tax up front to fully fund the Roth.

But when I retire, and no longer earning, I know that I will (possibly) not be able to work (due to health) or strongly desire not to work. So I am much more dependent on my savings to maintain my standard of living.

If the majority of my retirement savings are in a Roth, I know that the entire amount saved is what I can potentially spend towards my living expenses. If the majority of my savings is in conventional/traditional 401k or IRA, I know that Federal taxes (and possibly state) MUST be paid on any amounts I withdraw. The amount I have saved in a traditional 401k/IRA will deplete much more rapidly than with Roth, because I have to also pay taxes. Exactly how much those taxes will be I don't know, but I do know taxes must be paid.

So, effectively, with a Roth, I have more money to put towards my retirement expenses during retirement than I would with traditional tax deferred. The fact that it might be possible that mathematically I may have come out ahead with traditional IRAs/401k I won't care about - all I know at retirement is that I have less to spend on retirement. I won't be able to change this since at retirement, it's too late.

Regardless of whether, during my working years I contributed to traditional or Roth, I have maxed out contributions to either.

Now, the only flaw I can see in my thinking is that if one diligently always invests the tax savings of initial contributions to traditional 401k/IRA into savings that is never touched until retirement, perhaps I still might have the same savings as Roth, but I do not think so, since those invested amounts would be taxable as well, before retirement.

Does anyone out there agree with this, or am I deluding myself? At any rate, I am so close to retirement it's too late to change my philosophy if I am wrong :-)
 
Posts: 959 | Location: Glendale, AZ | Registered: February 23, 2008Reply With QuoteReport This Post
Partial dichotomy
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quote:
We have a Roth 401-k option, but that is just a post tax 401-k so still has RMD,


I'm not sure, but I don't think this is correct. I think that's the whole point of a Roth 401k.

As for not being able to contribute to a Roth after other contributions...if it's a matter of being able to fund it, that's one thing. If it's a matter of the penalty, as I poster earlier, contributing and paying the penalty was worth it to me.




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Posts: 40143 | Location: SC Lowcountry/Cape Cod | Registered: November 22, 2002Reply With QuoteReport This Post
Partial dichotomy
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btanchors, as indicated in my posts here, I'm a HUGE fan of the Roth. I'm with ya!




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Posts: 40143 | Location: SC Lowcountry/Cape Cod | Registered: November 22, 2002Reply With QuoteReport This Post
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Picture of konata88
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quote:
Originally posted by Fly-Sig:
Figuring if, when, and how much to ROTH convert can be pretty complicated, especially once you hit 63 yrs old.

First, there are the 5-Year rules.

Second, a ROTH conversion gets taxed today, so if you are earning well at the end of your career, it may not make a lot of sense. This is where you need to consider how you will access $ to spend in retirement.

Third, Medicare costs are based on your income 2 years ago.

Good financial advisors can put your numbers into software to optimize your specific situation.

Imho, good advisors really shine in this, much more so than in picking stocks.


Yea, I need to go see the FA, sooner if possible. Aware of the 5 year rule (just aware, not details) but I have no idea if my situation would benefit from any conversion at this point. I read these threads and still can't figure it out. Trying to learn so that I don't just have to take a FA's recommendation at face value.

I didn't know about the medicare costs - who explains this stuff to you ahead of time? This sounds like I should unemployed and minimizing 401k withdrawals for the 2 years ahead of medicare enrollment. Or is this a rolling thing - every year, the medicare premium will be based on the income from 2 years prior - so it doesn't matter - the two years of medicare premium will generally always be high if you work until enrollment.

As it has been, retirement seems more complicated than being employed.




"Wrong does not cease to be wrong because the majority share in it." L.Tolstoy
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Posts: 13693 | Location: In the gilded cage | Registered: December 09, 2007Reply With QuoteReport This Post
Ammoholic
Picture of Skins2881
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quote:
Originally posted by 6guns:
quote:
We have a Roth 401-k option, but that is just a post tax 401-k so still has RMD,


I'm not sure, but I don't think this is correct. I think that's the whole point of a Roth 401k.

As for not being able to contribute to a Roth after other contributions...if it's a matter of being able to fund it, that's one thing. If it's a matter of the penalty, as I poster earlier, contributing and paying the penalty was worth it to me.


Oh! There's a number of changes that happened last year and will happen. I was unaware.

SECURE 2.0 Act Summary: New Retirement Savings Changes to Know

Maybe I will move to putting some contributions in there now that I know this. If I do though it's a big hit to my taxable income.

I would not consider contributing to one at a penalty though.



Jesse

Sic Semper Tyrannis
 
Posts: 21526 | Location: Loudoun County, Virginia | Registered: December 27, 2014Reply With QuoteReport This Post
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Just a comment. I did not know of RMD,{required minimum distribution.} until recently. It requires taking money out of your plan whether you need it or not. It is like the government making changes in the middle of the game,
 
Posts: 18108 | Location: Stuck at home | Registered: January 02, 2015Reply With QuoteReport This Post
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quote:
Originally posted by Keystoner:
I'm putting $5,000 into the Roth account. This isn't complicated.


One more swing at this to show the difference.

I understand what you are saying -- $5k in ea retirement savings.
Essentially what you are comparing is whether a non-taxed retirement savings has an advantage to a taxed retirement savings. Well duh it does. Any option where there is no tax is the cheapest option.

There is a part that may not be getting enough consideration. If you decide to do the roth option, your personal spending power decreases by the difference between the two tax rates. In this example, $1250. If you can live without this money, you should calculate your brokerage account's value when you use that money to invest for 40 yrs at a set interest rate (Y=Yoe^kt). Add these values together and compare to the Roth option. This comparison would be more apples to apples since the amount you will have each payday is the same with this scenario.



--K
 
Posts: 215 | Registered: January 27, 2017Reply With QuoteReport This Post
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Picture of Keystoner
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quote:
Originally posted by SIG4EVA:
Roth is betting the tax rate will be higher when you retire than it is now.

It could be lower, to a point, and the Roth would still be better.

I mentioned this earlier, but in my original example, when the future tax rate comes down to 20.1% do the two options equalize.



Year V
 
Posts: 2753 | Registered: November 05, 2012Reply With QuoteReport This Post
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Picture of chellim1
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quote:
Originally posted by ZSMICHAEL:
Just a comment. I did not know of RMD,{required minimum distribution.} until recently. It requires taking money out of your plan whether you need it or not. It is like the government making changes in the middle of the game,

Since 1986... and it used to start at age 70 1/2.
So, it's been the same game for almost 40 years.
The government takes the view that this type of account has been tax-deferred for the benefit of retirement but at some point should be subject to taxation.

Required Minimum Distributions (RMDs) from qualified retirement accounts, like IRAs and employer-sponsored plans, started with the passage of the Tax Reform Act of 1986. Initially, RMDs were required once individuals turned 70 1/2. The age for RMDs has since been increased to 72, then 73, and will eventually be 75, but these changes have been phased in.



"Some things are apparent. Where government moves in, community retreats, civil society disintegrates and our ability to control our own destiny atrophies. The result is: families under siege; war in the streets; unapologetic expropriation of property; the precipitous decline of the rule of law; the rapid rise of corruption; the loss of civility and the triumph of deceit. The result is a debased, debauched culture which finds moral depravity entertaining and virtue contemptible."
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Posts: 25812 | Location: St. Louis, MO | Registered: April 03, 2009Reply With QuoteReport This Post
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Picture of Keystoner
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quote:
Originally posted by Kranky:
There is a part that may not be getting enough consideration. If you decide to do the roth option, your personal spending power decreases by the difference between the two tax rates. In this example, $1250. If you can live without this money, you should calculate your brokerage account's value when you use that money to invest for 40 yrs at a set interest rate (Y=Yoe^kt). Add these values together and compare to the Roth option. This comparison would be more apples to apples since the amount you will have each payday is the same with this scenario.
--K

I did this. It's in the original spreadsheet at the top of page 1.

I assumed 10% annual returns over 40 years for that $1,250 side-bucket. At the end, I taxed its gains at 25%. The Roth still wins.

The 401(k) wins if the future tax rate falls below 20.1%.



Year V
 
Posts: 2753 | Registered: November 05, 2012Reply With QuoteReport This Post
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quote:
Since 1986... and it used to start at age 70 1/2

^^^^^^^^^^^^^^
My retirement plan started well before then. I guess I can blame my CPA. I guess it is better than stuffing it under the mattress.
 
Posts: 18108 | Location: Stuck at home | Registered: January 02, 2015Reply With QuoteReport This Post
Lawyers, Guns
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Picture of chellim1
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quote:
My retirement plan started well before then. I guess I can blame my CPA.

Hmmm.... if your retirement plan starts mandatory RMDs well before age 72 then you can roll it into an IRA.



"Some things are apparent. Where government moves in, community retreats, civil society disintegrates and our ability to control our own destiny atrophies. The result is: families under siege; war in the streets; unapologetic expropriation of property; the precipitous decline of the rule of law; the rapid rise of corruption; the loss of civility and the triumph of deceit. The result is a debased, debauched culture which finds moral depravity entertaining and virtue contemptible."
-- Justice Janice Rogers Brown

"The United States government is the largest criminal enterprise on earth."
-rduckwor
 
Posts: 25812 | Location: St. Louis, MO | Registered: April 03, 2009Reply With QuoteReport This Post
No More
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quote:
Originally posted by konata88:

Yea, I need to go see the FA, sooner if possible. Aware of the 5 year rule (just aware, not details) but I have no idea if my situation would benefit from any conversion at this point. I read these threads and still can't figure it out. Trying to learn so that I don't just have to take a FA's recommendation at face value.


The 5 year rules have specific details, including whether you are over 59.5 yrs old. And the 5 year period starts Jan 1 of the year no matter when you started the account. The conversion 5 year rules also have details. It is really difficult to get comprehensive explanations on the web other than in the IRS publications. Even then it is government legalese.


quote:
Originally posted by konata88:

I didn't know about the medicare costs - who explains this stuff to you ahead of time? This sounds like I should unemployed and minimizing 401k withdrawals for the 2 years ahead of medicare enrollment. Or is this a rolling thing - every year, the medicare premium will be based on the income from 2 years prior - so it doesn't matter - the two years of medicare premium will generally always be high if you work until enrollment.

As it has been, retirement seems more complicated than being employed.


It is called IRMAA. It is a perpetual 2 year lookback, so my 2024 taxable income determines my 2026 Medicare Part B costs. My 2025 income determines my 2027 income. It is a hard step function, not just a marginal rate. IOW, hit the threshold and you get screwed. This is one place that RMDs can hurt.

The FA should be able to look at your overall situation and show what your RMDs are projected to be and how those affect IRMAA.

A typical recommendation is to live off of your traditional 401k and IRA for a few years, delaying Social Security. This reduces your future RMDs and increases your Social Security. But it all depends on what your different types of accounts will be worth, whether you have a pension, your life expectancy, etc.
 
Posts: 10224 | Location: On the mountain off the grid | Registered: February 25, 2002Reply With QuoteReport This Post
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quote:
Originally posted by Keystoner:
quote:
Originally posted by Kranky:
There is a part that may not be getting enough consideration. If you decide to do the roth option, your personal spending power decreases by the difference between the two tax rates. In this example, $1250. If you can live without this money, you should calculate your brokerage account's value when you use that money to invest for 40 yrs at a set interest rate (Y=Yoe^kt). Add these values together and compare to the Roth option. This comparison would be more apples to apples since the amount you will have each payday is the same with this scenario.
--K

I did this. It's in the original spreadsheet at the top of page 1.

I assumed 10% annual returns over 40 years for that $1,250 side-bucket. At the end, I taxed its gains at 25%. The Roth still wins.

The 401(k) wins if the future tax rate falls below 20.1%.


Long term cap gains is not taxed the same as income. In this example it would be 15% with today's tax code.
Still not exactly the same, but closer at about $5k.

--K
 
Posts: 215 | Registered: January 27, 2017Reply With QuoteReport This Post
No More
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quote:
Originally posted by Kranky:

There is a part that may not be getting enough consideration. If you decide to do the roth option, your personal spending power decreases by the difference between the two tax rates. In this example, $1250. If you can live without this money, you should calculate your brokerage account's value when you use that money to invest for 40 yrs at a set interest rate (Y=Yoe^kt). Add these values together and compare to the Roth option. This comparison would be more apples to apples since the amount you will have each payday is the same with this scenario.

--K


For the ROTH the $1250 is a tax expense paid with post-tax dollars. Meaning, that $1250 comes from some pot of money already earned and taxed. Assuming the 25% marginal rate, the worker first had to earn $1667 to have $1250 to pay taxes. This is why the ROTH entry cost is neither $5000 nor $6250. It is $6,667. Which is money taken from the workers total pay (unless gifted it by a rich uncle!).

For the traditional 401k (or traditional IRA), one should then start with the same $6667 from the workers total pay if you wish to compare like to like. This is where it gets messy. If we are only putting $5000 into the 401k, we still have to have $1667 total pre-tax money to invest on the side. Remember, we're reducing the worker's total pay by the same amount, $6667, if we are to compare final numbers meaningfully.

$1667 pre-tax results in $1250 post tax to invest in that side investment account.

So we put $1250 in the side taxable regular brokerage account in the identical investments as the 401k. At the end of road, the future value of that will be exactly 25% of the value of the 401k.

So we started with a stack of 6667 dollar bills in both cases, and ended up with exactly the same number of spendable dollar bills from both accounts upon withdrawal.

One thing to consider is that it is very rare not to have capital gains, losses, dividends, or bond interest along the way which provoke various taxes in the interim. e.g. Federal Treasury bonds are not taxed by states, but if the 401k is taxed by the state then you indeed do pay state income taxes on bond income inside your 401k.
 
Posts: 10224 | Location: On the mountain off the grid | Registered: February 25, 2002Reply With QuoteReport This Post
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Picture of Keystoner
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quote:
Originally posted by Kranky:
Long term cap gains is not taxed the same as income. In this example it would be 15% with today's tax code.
Still not exactly the same, but closer at about $5k.
--K


Yes, thank you!

I mentioned the exact same thing to 6guns on page 1. This is exactly why I created this thread. I'll tweak the spreadsheet.



Year V
 
Posts: 2753 | Registered: November 05, 2012Reply With QuoteReport This Post
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Picture of Keystoner
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Oh, you're back.
quote:
Originally posted by Fly-Sig:
So we started with a stack of 6667 dollar bills in both cases, and ended up with exactly the same number of spendable dollar bills from both accounts upon withdrawal.

Really? Prove it.



Year V
 
Posts: 2753 | Registered: November 05, 2012Reply With QuoteReport This Post
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Picture of Keystoner
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Kranky,

The difference is always going to be whatever the tax drag is on that brokerage account. I actually stated this explicitly in that original spreadsheet but didn't fully digest it.



Year V
 
Posts: 2753 | Registered: November 05, 2012Reply With QuoteReport This Post
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quote:
Originally posted by Keystoner:
quote:
Originally posted by Kranky:
Long term cap gains is not taxed the same as income. In this example it would be 15% with today's tax code.
Still not exactly the same, but closer at about $5k.
--K


Yes, thank you!

I mentioned the exact same thing to 6guns on page 1. This is exactly why I created this thread. I'll tweak the spreadsheet.


I think the only other part that may need an adjustment is the assumption on the tax rate.
Both situations currently do not get charged at a straight 25%; even if you are in the 25% tax bracket.
We have a progressive tax system, so the values from the previous tax bracket to the 95k (or 100k) will also create some spread that should be added to the brokerage investment.

--k
 
Posts: 215 | Registered: January 27, 2017Reply With QuoteReport This Post
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Picture of Keystoner
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Of course, agreed.

I don't think that would be necessary to model though. 25% is shorthand for a single marginal rate, not a literal flat tax on all income. Whatever the marginal rate, deferring tax on a 401(k) frees up that marginal amount today, which still faces tax on its growth outside the account, whereas a Roth contribution invests the full net amount tax-free.

The system is progressive, but I don't think it's necessary to get lost in bracket arithmetic.



Year V
 
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