Trying to understand how investments now will change taxes later

[BMEPhDinCO]

Hi all,

Not sure if this is better here or in the tax form, but here goes...

We are in the 12% bracket right now for federal taxes after maxing a 403(b), 401(k), 457, and putting mandatory amount into a 401(a). We are able to also max an IRA, but my question is which one? We have both a traditional and a Roth open right now so I know that makes a backdoor Roth an issue. I started on early on when I knew *something* was better than *nothing* but with no clear understanding beyond that - so now we have almost half of our current network in RIRAs, although the last few years I switched to tIRAs.

My estimation is that we will withdraw around $60k per year for retirement from these accounts (current dollar worth) (if we do get SS, then I would reduce the withdrawal to account for that income and we aren't anticipating any pensions). From my understanding, with current dollar amounts, the first $77,400 of long-term gains is tax-free for a married, filing joint couple. So, if we are taking out less than that, we would be paying no taxes on the money (I'm going off of GoCurryCracker here for this understanding, but any mistakes are mine).

Thus, if we are paying $0 in taxes when we take the money out, we should continue to contribute to the traditional IRA since that goes in with $0 taxes. Can someone confirm this logic? Is there anything else I need to account for? In general, for those expecting to take out less than $77k in retirement, what is the value in a rothIRA?

tl;dr - expect to pay $0 in taxes upon retirement, should I do a tIRA or rIRA now?

[terran]

Since you'll have plenty in tax deferred to fill the standard deduction and lower brackets and the 12% bracket you're currently in is pretty low I would make this decision based on state taxes. How do your current marginal state taxes compare to what you expect them to be in the future? If you pay state tax and expect not to at withdrawal I'd probably go traditional. If you expect to pay state taxes at withdrawal but don't know then I would go Roth. If you expect no change in your tax situation at withdrawal compared to now then it really doesn't matter and I would probably do Roth just for a bit of flexibility and diversification of tax treatment.

[Riptoast]

You need to consider whether you are pulling money out of a pre-tax retirement account or a taxable account in your retirement. The former would be subject to regular income tax at the point you take it out, so taking 60k out would mean about 36k is taxed (after your 24k standard deduction). If you are pulling money from a taxable account then you won't be taxed until you are realizing more than the 77k in long-term cap gains/qualified dividends mentioned by gocurrycracker. It sounds like you are putting a lot into pre-tax accounts right now, which is great, but if you don't also have some solid savings in taxable accounts you may end up paying income taxes in retirement as you access that money. So the issue of tIRA vs rIRA is more about your current and projected balance of pre-tax and post-tax savings, in my opinion.

If you are planning on retiring early and using some of your retirement funds to support yourself that adds complications. For example if you are doing the Roth conversion ladder strategy that will take up your 24k/yr at 0% income tax level, and you will have to fund the rest of your 36k from long-term cap gains/qualified dividends from your taxable account if you want to avoid paying any taxes. Unless you already have a significant amount built up in taxable accounts, it may make more sense for you to actually pay some of your relatively low 12% tax and build those up so you can best avoid taxes later on, and also have some added flexibility in early retirement to spend bigger in a given year or two (buy a house, do a big vacation, unexpected medical/kid related spending) and not see a big spike in your taxes or penalties because it all came out of your retirement accounts.

[BMEPhDinCO]

@Riptoast - thank you! That is what I was missing - that money going into a pre-tax retirement account is taxed as ordinary income at withdrawal and not at long-term capital gain rates.

I think for now we will still dump a large amount into the pre-tax accounts, but go ahead and do a RothIRA instead of the tIRA. Then, with the next boost of income, we will be able to put that into taxable accounts to start building those up with the $13k or so we have left in the 12% bracket. We have at least 15 years to go so we have time (I'm aiming for FI around 50, no later than 55)

[Frankies Girl]

Another thing to consider in playing the really long game...

You'll be forced to take RMDs (required minimum distributions) out of any tax deferred accounts like traditional IRAs/401K/403Bs once you hit 70.5 years.

Making sure you've converted over a goodly amount from traditional to Roth is one way to minimize the hit when the RMDs kick in, but it may be a case of fighting decades of growth by the time you get to RMD stage. Coupled with the fact that taxable brokerage accounts will still be throwing off dividends/cap gains that fill up the income bucket, you could suddenly be hit with enough money to push you into a higher taxable bracket in your old age that triggers taxes owed on the dividend/cap gains. So making sure your taxable account has no/low dividend/cap gains is a priority as you age up and your tax deferred accounts grow.

Another thing - if you have the possibility of inheriting significant amounts from relatives in the form of taxable/tax deferred accounts, that can throw an interesting curve ball. I received a pretty large inheritance in the form of an IRA (now inherited IRA or iIRA) and taxable investments. I sold off the initial holdings and simplified into index funds, but I still have a pretty nice chunk from the iIRA I have to take, and my taxable account throws off a 5 figure amount despite being as tax efficient as I can get it. I decided to stop reinvestments on the taxable and use the gains/dividends as expenses (so no sell off in there as of now) and I take extra out of the iIRA in an attempt to spend it down sooner rather than later and also keep it from growing... so far, it keeps topping itself up, so at least I'm treading water, but I know when I hit RMD age for my own IRAs, I'm going to likely be unable to avoid paying taxes.

First world problem really.