Debt Payoff Versus Pre-Tax Investing -- What About RMDs?

[ReadySetMillionaire]

Probably the most common question on this forum is some variance of debt payoff versus investing. 

I think the most common advice is that you should stick as much as humanly possible in a pre-tax account, essentially because your tax bracket will be lower in retirement than it is now.  This is a fair assumption -- one can expect to make more money while working than when they are in retirement, and thus taxes should be lower in retirement.

However, what has me pausing to invest *too much* into pre-tax is RMDs and their effect on my taxes.  I did some quick compound interest and then RMD math and found that if I went hog-wild on pre-tax investing, my RMDs would be astronomically higher than my current tax rate.

In one simulation, in which I leveraged almost as much pre-tax investing as currently possible, our investment accounts would total $11.49M at age 70.  Using the Schwab RMD calculator (assuming equal retirement accounts of $5.75M), we could expect RMD's of $210,000 EACH.  This would be $420,000 income for the year, which would put us in quite easily the highest of tax brackets.

And in that scenario, my tax rate this year is mostly 12%.  Am I not better off just taking this money and paying off debt, or investing in brokerage accounts and/or Roths, than stuffing way too much into tax-deferred accounts?

I understand that a lot of this money would be from gains, but it's hard for me to conceptualize and/or calculate how much of my *investment* was taxed versus how much of my *investment plus gains* are being taxed. 

But that said, I'm starting to believe that you could invest *too much* in pre-tax when you could be paying off debt, investing in post-tax accounts (Roth, brokerage, etc.).

Thoughts?

[FIRE@50]

I would recommend you investigate the RE portion of FIRE. :p

If you will have more money than you need(I assume $11.5M qualifies), then you should stop making/saving so much of it. I hope that makes sense. I'm not trying to be smug.

[walkwalkwalk]

I would say a version of the above but wanted to also point out that you WILL (from your other posts) be in a higher bracket in future years, so at the very least (even if at the same tax rate at withdrawal as contribution) would be deferring when you pay taxes on that income. Sure this year you're in the 12% bracket, so it may make sense this year to throw more at debt. Also as a business owner, asset protection is another consideration.

[seattlecyclone]

As you point out, tax rates do increase with your income. That first dollar you withdraw from your pre-tax retirement accounts each year is going to be under the standard deduction and taxed at 0%. Even when you have $1 million in these accounts as a married couple, that's only about $40k in RMDs starting out, still putting you in a pretty low tax bracket. $10 million is a different beast entirely.

I think the general investment ordering prioritization advice does make sense for most of us. Prefer pre-tax contributions by default unless you have some reason to expect that your tax bracket will be higher in retirement. A traditional pension could make this happen. A big enough pre-tax retirement account balance that you expect RMDs in the same ballpark as your current income (even if you never contribute another penny) would be another good reason to consider switching away from pre-tax contributions. If you do get there, Roth is still going to be a better deal in most cases than taxable.

This doesn't mean that you should start out making Roth contributions because maybe making maximum pre-tax contributions for three decades will give you an absurd result. Instead, remember we have progressive tax brackets, and it's in your best interest to do what will fill up those lower tax brackets. That means pre-tax contributions starting out.

[BicycleB]

I think it could depend on what you want to do with the money.

For example, I am unlikely to ever spend more than 30k to 40k per year. Over $1M ($2M to be safe), I'm sooner or later likely to give away the extra. For me, the fact that RMDs up to $100,000/year ($200,000 for couples) can be given directly to qualified charities is helpful.

https://money.usnews.com/money/retirement/iras/articles/2017-12-04/how-to-donate-your-required-minimum-distribution-to-charity
https://www.vanguardcharitable.org/news/thinking-of-using-your-rmd-for-charitable-giving

Perhaps scenario planning would be helpful. For example, spreadsheet out your income and spending year by year for life, even if you have to make some guesses. Then figure out the best way year to year to meet the scenarios. Just a thought.

For what it's worth, after a few scenarios, I began evaluating such decisions based on the idea I could probably keep my tax rate under 20%, but maybe not 15%. So any cash I can get in the 12% bracket, I take straight into taxable investments; if there's any more room in the bracket, transfers to Roth. At 24% bracket, I go with the traditional pre-tax contribution wherever possible. Since your income is much higher, you may have a different cutoff.

[AccidentalMiser]

And in that scenario, my tax rate this year is mostly 12%.  Am I not better off just taking this money and paying off debt, or investing in brokerage accounts and/or Roths, than stuffing way too much into tax-deferred accounts?

Yes.  You should invest in Roth and after tax if your marginal rate is 12%.  No question.