Newbie questions

[Sugaree]

I understand that one should choose a traditional IRA/401(k) if they believe that their tax bracket will be smaller when they retire and otherwise use a Roth.  But how do you make that determination?

Right now, I have a Roth IRA that I max out each year and a TSP (basically a 401(k)) in which my contributions go into a Roth bucket and matching funds go into a traditional bucket by default; there's no way to change how this is classified.  I'm not maxing it out yet, and won't for awhile, but I'm working on it.  I'm starting to question whether that is the right setup.  When I retire, I'll have a pension worth ~$24k a year in today's dollars, assuming that I make it to minimum retirement age, otherwise I'll defer the pension, but it will be reduced by 1% for each year until MRA.  For example, if I retire at 52 rather than 57 then I'll only get ~$21k a year and will have to defer those payments for five years.

The plan is to move somewhere warm and cheap so I can't see needing to pull more than $25k a year from my TSP, maybe a little more depending on what Central American inflation looks like by then so $650-750k is my goal for the TSP and maybe the IRA.  The IRA is meant to be college savings for my kid, so it should probably stay Roth.  There are various reasons that I use a Roth instead of a 529 but the main one is that I live in a state that only recognizes it's own plan for tax purposes, but also has a history of severely mismanaging college plans.  I usually don't weight it very heavily in my retirement plans. 

So, given that load of babble, would you start contributing more to a traditional TSP and up the amount you could save by a percentage or two or continue to contribute to the Roth version at the current percentage?  I think I know the answer, but want to make sure that there's not something I'm not thinking about.

[terran]

It sounds like you understand the basic concept of choosing Roth vs (traditional): marginal bracket now vs in retirement, so the simple but frustrating answer to your question is: just guess.

That said, you can make an educated guess. The usual advice is to assume that taxes will work the same in retirement as they do now because that's the information we have. Since the individual tax code changes that just happened are set to expire in 2025 I might also consider what things would look like under last year's tax code too.

Do everything is today's dollars, not future dollars since your spending will adjust with inflation, but so do the tax brackets.

It sounds like you think you'll have $24k pension + $25k retirement plan withdrawals = $49k spending. If you're married and if all of the retirement plan withdrawals came from tax deferred accounts (so subject to tax at withdrawal) that would put you about $6k above the 10% bracket into the 12% bracket. Under the old tax code you'd be about $10k over the 10% bracket into the 15% bracket (although this would have been less this year thanks to inflation adjustment of the brackets if the old code had continued).

How does this compare to your current income? If you're in the 22% bracket or higher I would max traditional at least until you're in the 12% bracket.

Do you currently pay state taxes, and are traditional contributions deductible in your state? Presumably you'll establish residency in a no income tax state before moving out of the country, so add your marginal state tax rate to your federal. This probably makes traditional the right choice in both the 10% and 12% bracket.

If you're decision is close (meaning you're in the 10% or 12% bracket now and have no/low state taxes), then what do you think will happen in the future? Are are tax rates on "low income" people making "only" $49k going to go up or down? Don't put too much weight on this as it's pretty impossible to accurately weigh all the possibilities, but if you're in a no-lose situation (where it probably doesn't really matter either way), then go with your gut.

I'd want at least enough in traditional to fill the standard deduction+exemptions (which you already will with your pension) and the 10% bracket, so that would be $19000 under the current tax code and almost $15k under the old code coming from tax deferred accounts. This would indicate you want 60-75% of your retirement plan contributions to be tax deferred and the rest Roth to probably fill the 10% bracket given an overall withdrawal of $25k.

[Sugaree]

Thanks!  That makes it a little clearer.  Now to digest that and come up with a plan. 

[MDM]

Thanks!  That makes it a little clearer.  Now to digest that and come up with a plan.

See cells A198:C210 in the 'Misc. calcs' tab of the case study spreadsheet (and then the 'Calculations' tab) to reinforce what terran described.

[MustacheAndaHalf]

Let me make a couple arguments in both directions so you have even more uncertainty.  :)

I favor Roth because it's "what you see is what you get".  The money has already been taxed, and the contributions can be withdrawn early, as part of early retirement.

But you could also contribute to a traditional IRA/401(k) while working, and once you quit begin a "Roth Conversion Ladder" where all of your pre-tax retirement assets slowly get turned into after-tax retirement assets at low tax rates.  On the downside, that requires having money outside your retirement accounts for both several years of living expenses and several years of paying tax on Roth Conversions.