Potentially all savings into 401k/After-Tax, but how much into Taxable?

[kamesen]

I have access to after-tax contributions with my 401k. My main priority is to max my tax-deductible (pre-tax) 401k up to ~$18k plus company contribution. That leaves room for ~$30k after-tax contributions that can be split into a Roth IRA (with gains going into traditional IRA) at any point. http://www.madfientist.com/after-tax-contributions/. Verified with my provider.

So far so good. This allows me about ~$50k in retirement account savings per year. My question is conceptual so please forgive me for not detailing my case study specifically (an exercise for a separate occasion).

The question is:

Go Curry Cracker http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/ and MMM yearly incomes come from qualified dividends and capital gains to some degree. Strictly speaking, these cannot come from Roth/IRA investments and must come from taxable brokerage accounts else they would incur that tax penalty yearly when touching dividends.

If one of the keys to reaching FI is tax sheltering as much as possible (tax-free/tax-deferred, 401k/Roth IRA), would I allocate all my savings into 401k/Roth IRA if I could, and only start to fund taxable accounts 5 years or so before FIRE, enough to fund our lifestyle for the 5 year conversion pipeline?

Or is my livelihood from taxable investments so critical that I should only fund 401k and taxable accounts, and only begin to utilize Roth vehicles when I make use of the Roth conversion pipeline?

Thanks. 10-15 years until FIRE.

[LiseE]

following

[MDM]

I don't recall offhand - at what point can you freely withdraw from the Roth the amounts that came from the mega backdoor?  It's probably "immediately", "five years", or age 59 1/2, but which...?

[sirdoug007]

I'm with Go Curry Cracker on this one.

http://www.gocurrycracker.com/roth-sucks/

For people with MMM-esque spending levels, Roth does not offer much and has significant drawbacks in the distribution rules.

For a buy-and-hold, low spending situation using low cost ETFS, you simply will not be taxed much on capital gains and dividends.  In your working years, holding ETFs will limit your taxable gains to dividends at 15% of the 2-3% you receive each year in dividends (~0.3% to 0.45%).  In your nonworking years you will be well under the 15% bracket where capital gains and qualified dividend taxes are 0%. 

Personally I am maxing my traditional 401(k) and putting the rest in a taxable vanguard ETF account.

[MDM]

I'm with Go Curry Cracker on this one.

http://www.gocurrycracker.com/roth-sucks/

As that post says,

When Is The Roth A Good Idea?
...It is also not a bad idea if you’ve already maxed out your Traditional 401k and have additional funds to invest.

Traditional may be better than Roth, but Roth is still better (or at least no worse) than taxable. 

[sirdoug007]

I'm with Go Curry Cracker on this one.

http://www.gocurrycracker.com/roth-sucks/

As that post says,

When Is The Roth A Good Idea?
...It is also not a bad idea if you’ve already maxed out your Traditional 401k and have additional funds to invest.

Traditional may be better than Roth, but Roth is still better (or at least no worse) than taxable.

And he continues...

"For many, however, a brokerage account is just as good.  If during your retirement years you expect to earn less than ~$90k/year, staying below the 25% tax bracket, then all Long Term Capital Gains and Qualified Dividends are already taxed at 0%.  At these income levels, a brokerage account effectively has a 0% tax rate for stocks, much like a Roth

The brokerage account also has the advantage of being able to harvest capital losses, and to spend dividends or gains anytime before Age 59.5"

"For a rule of thumb, I would save funds into accounts in this order during the working years:

401k up to company match
HSA
401k up to maximum
Traditional IRA if tax deductible (subject to MAGI thresholds)
Brokerage account
Maybe $5k in a Roth (subject to MAGI thresholds)
Maybe after-tax contributions to a 401k for Backdoor Roth (pros/cons)"

[MDM]

Traditional may be better than Roth, but Roth is still better (or at least no worse) than taxable.

And he continues...

"For many, however, a brokerage account is just as good.

I'd say we agree more than disagree...unless you'd like to disagree? :)

[clifp]

And he continues...

"For many, however, a brokerage account is just as good.  If during your retirement years you expect to earn less than ~$90k/year, staying below the 25% tax bracket, then all Long Term Capital Gains and Qualified Dividends are already taxed at 0%.  At these income levels, a brokerage account effectively has a 0% tax rate for stocks, much like a Roth

The brokerage account also has the advantage of being able to harvest capital losses, and to spend dividends or gains anytime before Age 59.5"

"For a rule of thumb, I would save funds into accounts in this order during the working years:

401k up to company match
HSA
401k up to maximum
Traditional IRA if tax deductible (subject to MAGI thresholds)
Brokerage account
Maybe $5k in a Roth (subject to MAGI thresholds)
Maybe after-tax contributions to a 401k for Backdoor Roth (pros/cons)"

I agree with this order (although I am slightly more of a fan of Roth than he is for ACA subsidy reasons). Definitely max out your tax deferred savings when you are first start out.
In my experience, there are practical and psychological problems, to retiring with virtually all of your money in tax deferred before 55. Which is why I think most people will want to start reducing their tax deferred roughly 5 years from retirement.

For example a couple with the goal of retiring in their late 40s, once their stash hits a $1 million. May have found that after the last couple of their 401K balance hit 700K but no other savings other than an emergency fund, with combined contributions of 35K+5K match they will easily hit a $1 million in the next 5 year baring a bad bear market. At this point they probably want to scale back their 401K to hit the match say $10K, fund a Roth and open a brokerage account. Perhaps even eliminate the Roth contribution the last year or two before retirement.

[Wolf359]

I'm with Go Curry Cracker on this one.

http://www.gocurrycracker.com/roth-sucks/

As that post says,

When Is The Roth A Good Idea?
...It is also not a bad idea if you’ve already maxed out your Traditional 401k and have additional funds to invest.

Traditional may be better than Roth, but Roth is still better (or at least no worse) than taxable.

And he continues...

"For many, however, a brokerage account is just as good.  If during your retirement years you expect to earn less than ~$90k/year, staying below the 25% tax bracket, then all Long Term Capital Gains and Qualified Dividends are already taxed at 0%.  At these income levels, a brokerage account effectively has a 0% tax rate for stocks, much like a Roth

The brokerage account also has the advantage of being able to harvest capital losses, and to spend dividends or gains anytime before Age 59.5"

"For a rule of thumb, I would save funds into accounts in this order during the working years:

401k up to company match
HSA
401k up to maximum
Traditional IRA if tax deductible (subject to MAGI thresholds)
Brokerage account
Maybe $5k in a Roth (subject to MAGI thresholds)
Maybe after-tax contributions to a 401k for Backdoor Roth (pros/cons)"

I agree with Curry Cracker's analysis.  He's basically saying max out all the tax deductible avenues first.  Only after that does the Roth contribution makes sense. The OP fits this profile. 

So, to answer your question, map out your retirement income plan.  How are you going to access your money given the limitations of the types of savings vehicles available?  That will inform your decision about what vehicles to fund.

We're not in the same situation as you, although I wish we were.  I'm a bit older, so by the time we have enough savings to retire, I'm actually going to be over 59 and can tap the retirement accounts without penalty.  However, I ran through the exercise for if I wanted to retire early, what accounts would be used, and how.  The results then made it into my personal investment plan.

Both Roth and taxable have their place.  I think you need both.  The proportion you fund depends upon your end game.  Once you lock things in, they get harder to change.  (For example, if you have 5 years of savings in a taxable account and decide to move it to a Roth as an after-tax contribution, you may have capital gains taxes to pay.)

[seattlecyclone]

I don't recall offhand - at what point can you freely withdraw from the Roth the amounts that came from the mega backdoor?  It's probably "immediately", "five years", or age 59 1/2, but which...?

D) All of the above.
Principal that you didn't pay tax on at the time of conversion: immediately
Principal that you paid tax on at the time of conversion (i.e. earnings that accumulated within the after-tax account before you converted): five years
Any post-conversion earnings: age 59˝

Note that the ordering rules in place say that Roth conversions are withdrawn in first-in, first-out order. Also, when a single Roth conversion contains both pre-tax and post-tax amounts, the pre-tax amount is withdrawn first. This means that you may have to pay a penalty on some of this money in order to get at some of the penalty-free money, depending on your exact situation.

[kmt88]

I'm happy to see a thread on this because I have similar questions after reading Go Curry Cracker's article.  I plan on maxing out my 401(k) this year and because of income limits, cannot contribute to a traditional IRA.  I also put additional money away in a taxable brokerage account (all VFIAX/VTSAX).  Since I'm a little cash heavy, I can't decide if I should put some of that savings into a 2014 Roth IRA before April, or continue dumping money into the taxable account. 

Assuming a MMM lifestyle after early retirement, Go Curry Cracker doesn't see any value to the Roth IRA vs taxable account (if I am reading the article correctly).
But I also feel strange choosing a taxable account over a tax advantaged account, especially at age 26 with ~10 years before retirement.  I've read some people talk about tax diversification, but I don't want to make a choice based on "feeling strange" or an arbitrary "tax diversification" principle with no basis.

Maybe I am talking myself into using the brokerage account and I just need encouragement from y'all because all these conversations happen in my head!

[brooklynguy]

Traditional may be better than Roth, but Roth is still better (or at least no worse) than taxable.

And he continues...

"For many, however, a brokerage account is just as good.

I'd say we agree more than disagree...unless you'd like to disagree? :)

Go Curry Cracker actually went further, arguing (in the "Addendum" to, and the comments section of, the linked article) that the prototypical aspiring early retiree may come out ahead by forgoing all Roth options in favor of taxable investing (and the conversation was continued in this thread, for anyone interested in reading it).

[seattlecyclone]

Go Curry Cracker actually went further, arguing (in the "Addendum" to, and the comments section of, the linked article) that the prototypical aspiring early retiree may come out ahead by forgoing all Roth options in favor of taxable investing (and the conversation was continued in this thread, for anyone interested in reading it).

I agree with most of Go Curry Cracker's article, but just can't get behind the "addendum" that recommends taxable investing over Roth accounts. The reasoning behind it relies on the fact that we have a 0% capital gains and dividend tax rate for people in lower tax brackets, therefore you pay no more tax by investing in a taxable account and you have much easier access to that money. This logic is sound enough, but I think it's important to remember that the 0% capital gains rate is a relatively recent invention, having only been around since 2008. This tax-free situation may well continue forever, but if it changes I'm better off having assets in a Roth account than a taxable account (provided that I don't need access to the Roth earnings before age 59˝.

Even if you do assume that the 0% capital gains rate will be around forever, if you're currently earning enough to put yourself in the 25% or higher bracket you can save tax money on dividends from now until retirement by sheltering those assets in a Roth account.

Also if you plan on purchasing ACA insurance during your retirement, withdrawing Roth principal may result in a higher premium subsidy than incurring capital gains in a taxable account, even if those gains are taxed at 0%.

[MrMoogle]

I'd say once you get into retirement taxable is better.  If you're in the net worth building state, Roth is better if you're in the 25% or higher bracket.  If you have taxable and it takes 15 years to RE, that's 15 years of dividends and capital gains you have to pay.  Yes you can do tax-loss harvesting, so it's not so bad.  I've learned more as my NW accumulated, and I didn't know about that when it would have been available to me.

If hypothetically, you only had tax-advantaged accounts, as you near RE, I would start taxable accounts.  It's certainly nice to have multiple options when taking money out. 

Tax laws are certainly going to change in the next ~70 years, which is around my retirement horizon, so I want to be agile, and have some in all three pots.  Maybe they move the 25% bracket limit down to the 10%.  Maybe they change the rules on Roth.  Anything can happen over that long of a period, so be agile :)

[LiseE]

If you're in the net worth building state, Roth is better if you're in the 25% or higher bracket.  If you have taxable and it takes 15 years to RE, that's 15 years of dividends and capital gains you have to pay.

If I have a brokerage account now (we're 7 years to FIRE) and we adopt a Buy and Hold strategy .. we don't tap into the funds in this brokerage account until we're FIRE.  Now we are retired and are in the 10-15% tax bracket .. we start accessing money in this brokerage account.  Aren't the funds taxed at 0%? 

[MDM]

If I have a brokerage account now (we're 7 years to FIRE) and we adopt a Buy and Hold strategy .. we don't tap into the funds in this brokerage account until we're FIRE.  Now we are retired and are in the 10-15% tax bracket .. we start accessing money in this brokerage account.  Aren't the funds taxed at 0%?

For the next 7 years you will pay tax (assuming you are above the 15% bracket) on any dividends, distributions, long and short term capital gains generated by the funds within the account, even if you don't sell any fund shares.

Then yes, provided the tax laws don't change again, you will pay 0% on qualified dividends and long term capital gains.  You will pay tax on any short term capital gains, non-qualified dividends, etc.

[brooklynguy]

I agree with most of Go Curry Cracker's article, but just can't get behind the "addendum" that recommends taxable investing over Roth accounts. The reasoning behind it relies on the fact that we have a 0% capital gains and dividend tax rate for people in lower tax brackets, therefore you pay no more tax by investing in a taxable account and you have much easier access to that money. This logic is sound enough, but I think it's important to remember that the 0% capital gains rate is a relatively recent invention, having only been around since 2008. This tax-free situation may well continue forever, but if it changes I'm better off having assets in a Roth account than a taxable account (provided that I don't need access to the Roth earnings before age 59˝.

Yep.  And even today, Go Curry Cracker's analysis only applies at the federal level.  If in retirement you live in a jurisdiction with local taxes that do not follow the 0% federal scheme (like NY), the Roth will still save you tax dollars even as a low-income retiree.

[johnny847]

I agree with most of Go Curry Cracker's article, but just can't get behind the "addendum" that recommends taxable investing over Roth accounts. The reasoning behind it relies on the fact that we have a 0% capital gains and dividend tax rate for people in lower tax brackets, therefore you pay no more tax by investing in a taxable account and you have much easier access to that money. This logic is sound enough, but I think it's important to remember that the 0% capital gains rate is a relatively recent invention, having only been around since 2008. This tax-free situation may well continue forever, but if it changes I'm better off having assets in a Roth account than a taxable account (provided that I don't need access to the Roth earnings before age 59˝.

Yep.  And even today, Go Curry Cracker's analysis only applies at the federal level.  If in retirement you live in a jurisdiction with local taxes that do not follow the 0% federal scheme (like NY), the Roth will still save you tax dollars even as a low-income retiree.

And these two reasons are exactly why I disagree with Go Curry Cracker. Maybe he's just not used to thinking about state taxes because he lives in a no tax state (Washington), but most states do not have favorable taxes on LTCG, and tax based on your federal AGI. LTCG are included in your federal AGI, and are typically subject to state tax.

Because the Roth IRA is limited to a mere $5500 a year (and it really is a "mere" $5500 if you've already maxed out your 401k and HSA) I would do this first or at least split the next $5500 between a Roth and a taxable. I agree with brooklynguy that hedging your bets against future tax increases with the Roth is a good idea.

[LiseE]

For the next 7 years you will pay tax (assuming you are above the 15% bracket) on any dividends, distributions, long and short term capital gains generated by the funds within the account, even if you don't sell any fund shares.

Really? If I'm a buy and hold investor and I'm not realizing any of the LTCG and just letting it sit, I'm still taxed on it during the 7 years it's just sitting there?  I thought you were only taxed when the gains are realized?

Let's say I'm taxed, as you point out, over the 7 years that my brokerage account is just sitting and growing on my capital gains.  And sometime during those 7 years the market takes a dip and the gains are wiped out .. but I've paid taxed on those gains already?  I'm guessing this would be a harvested loss then?

[Scandium]

For the next 7 years you will pay tax (assuming you are above the 15% bracket) on any dividends, distributions, long and short term capital gains generated by the funds within the account, even if you don't sell any fund shares.

Really? If I'm a buy and hold investor and I'm not realizing any of the LTCG and just letting it sit, I'm still taxed on it during the 7 years it's just sitting there?  I thought you were only taxed when the gains are realized?

Let's say I'm taxed, as you point out, over the 7 years that my brokerage account is just sitting and growing on my capital gains.  And sometime during those 7 years the market takes a dip and the gains are wiped out .. but I've paid taxed on those gains already?  I'm guessing this would be a harvested loss then?

No, you're not taxed on gains (i.e. rise in share price), but you are taxed on dividends, even if they are reinvested as they usually are. If you had a taxable account last year just check the 1099 form you got from your broker and put those numbers into your tax software. If you're in the 25% or higher tax bracket you will be taxed 15% on the dividends, even though you don't see a single dollar of that directly (only as increased number of shares). For most total market funds this is ~2% at the moment, or $2,000 per year if you have $100k, giving you $300 in taxes every year.

If you own shares in google and the price double you don't pay any tax on that until you sell. (This is not a recommendation to buy shares of google or any other company..)

[LiseE]

No, you're not taxed on gains (i.e. rise in share price), but you are taxed on dividends, even if they are reinvested as they usually are.

Whew!  So my brokerage account can grow and earn (while we work and are in a higher tax bracket) until we are fully FIRE at which time our earned income will be under the 73K for married filing jointly and the gains will not be taxed at the Federal level? 

[tdogz]

So my brokerage account can grow and earn (while we work and are in a higher tax bracket) until we are fully FIRE at which time our earned income will be under the 73K for married filing jointly and the gains will not be taxed at the Federal level?

Yes and no. If you have individual stocks in the account, then you won't have capital gains (or losses) until you sell your shares. However, if you own a mutual fund, they will likely might pay out at least some short term and long term capital gains each year (depending on the type of fund), in addition to the dividends. This happens because funds are buying and selling stocks and bonds to keep the mix the way they want it. They then distribute these gains to the fund owners (you). You should be able to tell your brokerage whether you want dividends and/or capital gains automatically reinvested in the mutual fund, paid to you, etc.

The details for my Vanguard Roth IRA in 2014 are in the image attached below. This account ended 2014 with just under $10,000. If held in a taxable account, I would have had to pay taxes on these amounts, regardless of if they are reinvested or distributed to me.

**Edited to make the wording a little more clear (bolded text), per skyrefuge's post below

[skyrefuge]

However, if you own a mutual fund, they will likely pay out at least some short term and long term capital gains each year, in addition to the dividends. This happens because funds are buying and selling stocks and bonds to keep the mix they way they want it. They then distribute these gains to the fund owners (you).

While you are correct about the mechanism, your portrayal of the frequency is not necessarily true. For actively-managed stock funds that don't have a tax-minimization strategy, yes, they are fairly likely to distribute capital gains. But index funds do less selling. Most of Vanguard's stock index funds, for example, haven't distributed any capital gains in the last decade. The STCG from your TR fund likely came from the underlying bond fund, which are more likely to distribute capital gains than stock funds.

They will all still regularly distribute dividends, however.

http://www.bogleheads.org/wiki/Category:Vanguard_funds:_distributions

[sirdoug007]

However, if you own a mutual fund, they will likely pay out at least some short term and long term capital gains each year, in addition to the dividends. This happens because funds are buying and selling stocks and bonds to keep the mix they way they want it. They then distribute these gains to the fund owners (you).

While you are correct about the mechanism, your portrayal of the frequency is not necessarily true. For actively-managed stock funds that don't have a tax-minimization strategy, yes, they are fairly likely to distribute capital gains. But index funds do less selling. Most of Vanguard's stock index funds, for example, haven't distributed any capital gains in the last decade. The STCG from your TR fund likely came from the underlying bond fund, which are more likely to distribute capital gains than stock funds.

They will all still regularly distribute dividends, however.

http://www.bogleheads.org/wiki/Category:Vanguard_funds:_distributions

+1

And ETFs by definition do not distribute yearly capital gains.  Any ETF capital gains are only created from you selling shares.

To me, the 15% tax on the 2% annual dividends (0.3% tax expense of the overall taxable portfolio each year) is a small price to pay for complete access to the funds.

[Vilgan]

I'm in a very similar position to OP: ~10 years from FIRE and have the ability to sneak an extra 30k into my Roth IRA using the backdoor method. Unlike OP and several posters here, I think that getting every penny I can into my Roth IRA is a NO BRAINER and will be contributing 18k to 401k, 2-3k employer match, 5.5k Roth IRA and ~32k Backdoor Roth IRA using the traditional after-tax + mega backdoor Roth method.

I don't see how people are reading what Go Curry Cracker posted and think there is any debate about maxing out Roth IRA space. There's a reason that Obama is recommending removing the aftertax rollover into Roth IRA method because it saves the people who use it (even Mustachian types) a lot of money.

A few thoughts on this:
1) Other than it being slightly harder to access the $$, taxable has no advantages over Roth IRA money
2) It is relatively easy to access Roth IRA funds
3) It is especially silly to consider not maxing out Roth IRA possibilities with more than 5 years to FIRE
4) If 10 years from FIRE, that's 10+ years of paying tax on dividends. Yuck!
5) In a taxable you have to worry about turnover, capital gains, etc. Not true in a Roth IRA account
6) There's no guarantee that capital gains stays so low or remains at 0 for 15% bracket. It could easily go up or there could be a wealth check added. Why put your money in the "hopefully won't get taxed very much" pool when you can put it in the "won't pay any tax" pool?
7) Roth IRA accounts get lots of protections that taxable accounts do not.

The opportunity to get $$ into a "never pay any taxes again even if capital gains rates are increased or the 0% rate for 15% bracket goes away" status is limited. The opportunity to get $$ into a taxable account has no such restrictions. Take advantage of the Roth IRA space you can now, and when that is capped out or taken away, THEN worry about taxable accounts.

[johnny847]

6) There's no guarantee that capital gains stays so low or remains at 0 for 15% bracket. It could easily go up or there could be a wealth check added. Why put your money in the "hopefully won't get taxed very much" pool when you can put it in the "won't pay any tax" pool?

The opportunity to get $$ into a "never pay any taxes again even if capital gains rates are increased or the 0% rate for 15% bracket goes away" status is limited. The opportunity to get $$ into a taxable account has no such restrictions. Take advantage of the Roth IRA space you can now, and when that is capped out or taken away, THEN worry about taxable accounts.

I agree - this is huge. I mean it's great to see other view points, but I don't agree with Go Curry Cracker on taxable before Roth. And he lives in a no tax state so he can ignore that, but many people can't. Maybe they can in retirement, but you have less mobility when working towards FIRE than you do when you're FIRE'd.

[LiseE]

I'm in a very similar position to OP: ~10 years from FIRE and have the ability to sneak an extra 30k into my Roth IRA using the backdoor method.

 .. sorry for the ignorant question but you're doing this over time right?  I thought you could only contribute 5500 annually (6500 if over 50) to IRA which you can then convert?

[johnny847]

I'm in a very similar position to OP: ~10 years from FIRE and have the ability to sneak an extra 30k into my Roth IRA using the backdoor method.

 .. sorry for the ignorant question but you're doing this over time right?  I thought you could only contribute 5500 annually (6500 if over 50) to IRA which you can then convert?

This is possible every year if your 401k/403b/457b allows you to pull off the Megabackdoor Roth. http://thefinancebuff.com/rollover-after-tax-to-roth.html

[sirdoug007]

6) There's no guarantee that capital gains stays so low or remains at 0 for 15% bracket. It could easily go up or there could be a wealth check added. Why put your money in the "hopefully won't get taxed very much" pool when you can put it in the "won't pay any tax" pool?

The opportunity to get $$ into a "never pay any taxes again even if capital gains rates are increased or the 0% rate for 15% bracket goes away" status is limited. The opportunity to get $$ into a taxable account has no such restrictions. Take advantage of the Roth IRA space you can now, and when that is capped out or taken away, THEN worry about taxable accounts.

I agree - this is huge. I mean it's great to see other view points, but I don't agree with Go Curry Cracker on taxable before Roth. And he lives in a no tax state so he can ignore that, but many people can't. Maybe they can in retirement, but you have less mobility when working towards FIRE than you do when you're FIRE'd.

Good point.  I also live in a no income tax state (TX) so Go Curry Cracker's advice works well for me.

Most people here don't post where they live so it is hard to tell if this is an issue for any given person asking the question.  If I lived in California and had to pay 9.3% marginal income tax, I would definitely be all for a Roth IRA.  In the seven states without income taxes (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) taxable wins in my opinion.

[johnny847]

Most people here don't post where they live so it is hard to tell if this is an issue for any given person asking the question.  If I lived in California and had to pay 9.3% marginal income tax, I would definitely be all for a Roth IRA.  In the seven states without income taxes (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) taxable wins in my opinion.

Well at the same time, you're assuming that the 0% LTCG bracket will continue to exist as Vilgan pointed out. Maybe it will, maybe it won't. But considering the Roth IRA limit is a "mere" $5500, I'd max that first or at least split my contributions b/w Roth and taxable to get some tax hedge.

[Jeremy]

Good discussion.  I especially like the "I disagree with Go Curry Cracker" comments :P

Generally speaking, if you like Roth IRAs then I wouldn't argue with you for using them (although I might give you some friendly crap over beers)
(Assuming you are already maxing maxing out the 401k, the HSA (if available), and are not able to deduct contributions to a Traditional IRA)

As johnny847 says, it's only $5500.  Since e/r is a goal, presumably you would be saving a high percentage of income.  As such, you have a Roth AND a brokerage account.  All is well

Money put into a Roth is guaranteed* to never be taxed again.  The price you pay for that guarantee is no access to earnings until Age 59.5
For somebody retiring quite young, I think the price is too high. 

I have another 20+ years before I can touch the earnings tax and penalty free
Meanwhile, the value of the contributions decrease each year with inflation. 

A simplified example using numbers:
Contributions: $10k
Inflation: 3%
Stock growth: 8%
Years to Age 59.5: 20

At age 59.5:
Value of contributions in 2015 $s: $5500
Value of earnings: $20k ($36k in future $s)


Access to the earnings is worth 4x access to contributions.  And since we worked so hard to get the funds into the Roth in the first place, why take out the contributions in the short term?  Since we will never pay taxes on those dollars, my goal is to spend them last (or at least strategically) so they can grow for as long as possible (ideally for 50+ years)



Taxes while working:
I minimized taxes while working in part by holding some taxable assets that paid no dividends, namely Berkshire Hathaway.  Using a robo advisor (e.g. Betterment) is also an option to minimize taxes via tax loss harvesting, or it can be done manually.  Foreign Tax Credits are also available if investing internationally (A Roth allows for tax free gains, but disallows loss deductions or tax credits - pros/cons)

Or worst case, current yield on VTI / VTSAX is 1.75%.  Let's call it 2% for easier math. 

2% yield * 15% tax = 0.3% of assets in tax.  Add more for State taxes if applicable.  It isn't zero, but it also isn't something that I would work hard to avoid in the short term (some people pay more than this on fund expense ratios in the 401k)

On $100k of assets this would be $300, or $25/month.  Would you pay $25/month/$100k of assets in the short term to have access to all of the earnings on your assets for 20 years?  I would.  I did.  I can see how others would not



Future tax law:
Tax law will change, of that I'm 100% confident.  Since I don't write legislation, and am not an active lobbyist or member of Congress (yet?) I have no idea what those changes will be.  I could guess, but I can also pick lottery numbers and play roulette

Obviously I bet with our own money that time was on our side

In the mean time, a retired married couple filing jointly can do an annual $20k Roth IRA Conversion tax free, and earn or harvest up to ~$73k in dividends and long term capital gains, also tax free.  By comparison, a $5500 IRA contribution looks laughably small.

If during my working years I was absolutely convinced that taxes would go up in the future, and therefore put as much as possible into backdoor Roths (particularly the mega backdoor Roth with maybe $30k limit), I would have significantly reduced cash flow (no dividends from the Roth), and less opportunity to use all of the tax free space allowed (hard to get $73k in dividends and gains from less taxable assets)

Note that these two years of tax free income has more than made up for any taxes paid on dividends while working



Which is how I arrived at the recommended investment order for people targeting early retirement (meaning <40):
401k to match
HSA
401k to max
Traditional IRA if deductible
taxable
Roth IRA if possible
Mega backdoor Roth (more interesting if able to do in service distributions)

brooklynguy recommended, based on my position, that I just take Roth off the list completely, but I left them there because obviously people will disagree.  Then just move taxable down until you are happy or it meets your goals



I think this touches most of the comments.  If anybody happens to be in the neighborhood, I'd be glad to discuss more over beers.  If my tax bill hasn't gone up, you buy.  If it has, they are on me

[Rein1987]

I have a similar question as the OP. If roth limit is only 5500, I'd be happy to maximize that. However, this year, both my DH and I have access to mega backdoor, which leaves more than 55k room for us to do the mega backdoor...

So here is our situation:
- maximized pre-tax 401k (36000)
- Employer match (13500)
- backdoor roth ira (11000)
- No HSA (we chose low deductible plan so not eligible for HSA)

We maybe able to save another 50k-60k, and the backdoor roth limit is 53000*2 - 36000 - 13500 = 56500. We do want to take advantage of this retirement account. Then the question is: all in roth or some roth and some taxable or all taxable??

I'd love to FIRE but my DH just wants to FI not RE. He has a workaholic soul....In other words, he will keep working and get W2, so not very possible for us to achieve 0 tax rate as Go Curry Cracker :(  Therefore, roth would be better than taxable. On the other hand, I do not feel safe to put all money into retirement account, with more than 30 years to go..I like the feeling to have money accessible immediately, which enables us a lot of investment opportunities (e.g., real estate).

Our current plan is half/half: 50% saving go to roth and 50% go to taxable, because I cannot reach a conclusion which one is better than the other..

[brooklynguy]

Jeremy, nice recap of the arguments supporting your position.  I think this is a case where there is no clear winner (since the answer will depend on whose assumptions about the ultimately unknowable future pan out), and especially no one-size-fits-all winner (since the answer also depends in part on individual circumstances, such as the existence and extent of applicable local taxes above and beyond one's federal tax liability).

Mega backdoor Roth (more interesting if able to do in service distributions)

This will be a bit of a tangent, but an interesting twist is the idea of using the mega backdoor Roth without doing in-service distributions in order to build up earnings inside the after-tax 401k account during the duration of your working career to be transferred into your traditional IRA account upon retirement (which can then be early-access through the Roth conversion pipeline just like any of your other tax-deferred dollars).  This idea was discussed in detail in this thread, but the not-insignificant risk of that strategy is that the mega back door Roth option could get shut down (especially since Obama's budget proposal already proposed as much), which would then restrict your access to all the contributions made to the after-tax 401k account and partially defeat the purpose of the strategy.

[Jeremy]

I agree, no clear winner

Unless there are beers involved.  Then we all win

[brooklynguy]

Rein, I am currently maxing out mega-back door Roth space (after maxing out all tax-deferred space) even though I do plan to FIRE at a young age, in part because I plan to remain in high-tax NYC indefinitely, but thankfully I earn enough to have plenty left over for taxable investing as well.  If that weren't the case, I personally would not be comfortable plowing every last dollar into retirement accounts with no (or virtually no) taxable investments.

[Rein1987]

Rein, I am currently maxing out mega-back door Roth space (after maxing out all tax-deferred space) even though I do plan to FIRE at a young age, in part because I plan to remain in high-tax NYC indefinitely, but thankfully I earn enough to have plenty left over for taxable investing as well.  If that weren't the case, I personally would not be comfortable plowing every last dollar into retirement accounts with no (or virtually no) taxable investments.

This makes perfect sense to me. If I can manage to have taxable investment after the mega backdoor roth space, I'll maximize it.

Actually I'm thinking of a third scenario. I'll maximize the after-tax 401k without converting to roth immediately. Then, this is equal to taxable investment (I can withdraw immediately, no need to wait for 5 years, or pay tax on the gain). When we have more asset and we are comfortable to convert them to roth, we do it later. Of course, this way I lose some tax benefit from roth, but this gives me more flexibility than roth. Also, I kept the roth space open for me.

[ZiziPB]

Rein, I am currently maxing out mega-back door Roth space (after maxing out all tax-deferred space) even though I do plan to FIRE at a young age, in part because I plan to remain in high-tax NYC indefinitely, but thankfully I earn enough to have plenty left over for taxable investing as well.  If that weren't the case, I personally would not be comfortable plowing every last dollar into retirement accounts with no (or virtually no) taxable investments.

This makes perfect sense to me. If I can manage to have taxable investment after the mega backdoor roth space, I'll maximize it.

Actually I'm thinking of a third scenario. I'll maximize the after-tax 401k without converting to roth immediately. Then, this is equal to taxable investment (I can withdraw immediately, no need to wait for 5 years, or pay tax on the gain). When we have more asset and we are comfortable to convert them to roth, we do it later. Of course, this way I lose some tax benefit from roth, but this gives me more flexibility than roth. Also, I kept the roth space open for me.

I think your third scenario makes sense, as long as the conversion rules do not change.  Clearly this has been a hot topic recently (I think the most recent budget proposal from President Obama talked about closing that loophole), so I wouldn't be surprised if at some point it is going to go away.

[Rein1987]

Rein, I am currently maxing out mega-back door Roth space (after maxing out all tax-deferred space) even though I do plan to FIRE at a young age, in part because I plan to remain in high-tax NYC indefinitely, but thankfully I earn enough to have plenty left over for taxable investing as well.  If that weren't the case, I personally would not be comfortable plowing every last dollar into retirement accounts with no (or virtually no) taxable investments.

This makes perfect sense to me. If I can manage to have taxable investment after the mega backdoor roth space, I'll maximize it.

Actually I'm thinking of a third scenario. I'll maximize the after-tax 401k without converting to roth immediately. Then, this is equal to taxable investment (I can withdraw immediately, no need to wait for 5 years, or pay tax on the gain). When we have more asset and we are comfortable to convert them to roth, we do it later. Of course, this way I lose some tax benefit from roth, but this gives me more flexibility than roth. Also, I kept the roth space open for me.

I think your third scenario makes sense, as long as the conversion rules do not change.  Clearly this has been a hot topic recently (I think the most recent budget proposal from President Obama talked about closing that loophole), so I wouldn't be surprised if at some point it is going to go away.

Ah, yes, I need to consider policy change as well :(

So, maybe I'll stick to my previous strategy....half roth and non-roth >.<

[brooklynguy]

Ah, yes, I need to consider policy change as well :(

So, maybe I'll stick to my previous strategy....half roth and non-roth >.<

But even if the backdoor Roth loopholes get closed, that would just stop you from moving the contributions into a Roth IRA (effectively it would make the decision for you to move it all the contributions into a taxable account).

If you're inclined to hedge your bets and do a 50/50 split between Roth and taxable, you might still consider doing your third strategy with respect to the taxable half.  That way, if the loophole isn't closed, you have flexibility to decide to turn the contributions into Roth or taxable when you retire, and if it is closed, the contributions just become taxable (the only difference from doing taxable in the first place is that the earnings accrued during your working career get moved into tax-deferred instead of staying in the taxable account, but you can still early-access those by folding them into a Roth conversion pipeline).

[MrMoogle]

Rein, I am currently maxing out mega-back door Roth space (after maxing out all tax-deferred space) even though I do plan to FIRE at a young age, in part because I plan to remain in high-tax NYC indefinitely, but thankfully I earn enough to have plenty left over for taxable investing as well.  If that weren't the case, I personally would not be comfortable plowing every last dollar into retirement accounts with no (or virtually no) taxable investments.

This makes perfect sense to me. If I can manage to have taxable investment after the mega backdoor roth space, I'll maximize it.

Actually I'm thinking of a third scenario. I'll maximize the after-tax 401k without converting to roth immediately. Then, this is equal to taxable investment (I can withdraw immediately, no need to wait for 5 years, or pay tax on the gain). When we have more asset and we are comfortable to convert them to roth, we do it later. Of course, this way I lose some tax benefit from roth, but this gives me more flexibility than roth. Also, I kept the roth space open for me.

I don't think this is true.  You'll pay income tax on the gain, which increases your taxes compared to having it in a taxable account.  I don't see what this buys you.

[Cressida]

following. thanks everyone.

[brooklynguy]

Actually I'm thinking of a third scenario. I'll maximize the after-tax 401k without converting to roth immediately. Then, this is equal to taxable investment (I can withdraw immediately, no need to wait for 5 years, or pay tax on the gain). When we have more asset and we are comfortable to convert them to roth, we do it later. Of course, this way I lose some tax benefit from roth, but this gives me more flexibility than roth. Also, I kept the roth space open for me.

I don't think this is true.  You'll pay income tax on the gain, which increases your taxes compared to having it in a taxable account.  I don't see what this buys you.

I missed the bolded words.  I thought the proposal was to roll the gains into a tIRA - that's how this strategy can be beneficial.  But I personally wouldn't go down the path of doing delayed (for too long) rollovers -- it's not clear how any changes in law would affect last years IRS guidance on splitting apart distributions so perhaps if the backdoor loopholes were shut it would no longer be possible to get the after-tax 401k earnings into a tIRA.