Author Topic: Should I Prioritize my Traditional or Roth?  (Read 7836 times)

Jimmyjon

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Should I Prioritize my Traditional or Roth?
« on: April 24, 2017, 12:49:04 PM »
I am trying to decide if I should prioritize putting money into a Roth IRA or a Traditional IRA.  Considering I have a $5,500 limit for either/or,  wouldn't it make more sense to pick one or the other and allow it grow to it's full potential rather than have two accounts with lower value not gaining compound interest as it could in one account?

It also seems that everyone seems to prioritize a traditional over the roth, but reading other blogs online i've gathered that a Roth will be worth more in the long run and also tax free when I take it out.  What is the reasoning behind people prioritizing the traditional?

Another thing i'm trying to decide on is what to put my Roth and Traditional IRA into.  Should I put them both into Index funds? Bonds? REITS for one and not the other? Etc?  Basically I am asking if people tend to invest their Roth into one type of account and vice versa.

Thanks!

TheStachery

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Re: Should I Prioritize my Traditional or Roth?
« Reply #1 on: April 24, 2017, 12:54:09 PM »
What is your income?  Maxing my traditional gives me a better tax reduction on high income now.  If you have lower income, I think I would tax the Roth route.

dandarc

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Re: Should I Prioritize my Traditional or Roth?
« Reply #2 on: April 24, 2017, 01:09:43 PM »
The money will compound the same regardless of whether you go Roth or Traditional or some combination, assuming you obtain the same investments.

If you're expecting your income to be substantially lower in retirement, traditional makes a lot of sense.  You're on a forum where most have 40% and higher savings rates.  That implies that in retirement, if expenses stay around the same, then income will be substantially lower.

Jrr85

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Re: Should I Prioritize my Traditional or Roth?
« Reply #3 on: April 24, 2017, 01:30:17 PM »
I am trying to decide if I should prioritize putting money into a Roth IRA or a Traditional IRA.  Considering I have a $5,500 limit for either/or,  wouldn't it make more sense to pick one or the other and allow it grow to it's full potential rather than have two accounts with lower value not gaining compound interest as it could in one account?

It also seems that everyone seems to prioritize a traditional over the roth, but reading other blogs online i've gathered that a Roth will be worth more in the long run and also tax free when I take it out.  What is the reasoning behind people prioritizing the traditional?

Another thing i'm trying to decide on is what to put my Roth and Traditional IRA into.  Should I put them both into Index funds? Bonds? REITS for one and not the other? Etc?  Basically I am asking if people tend to invest their Roth into one type of account and vice versa.

Thanks!

If you can max out your roth and don't have access to other tax advantaged savings, you should do the roth.  It's essentially the equivalent of putting $5,500 x (1 + your marginal tax rate) into a traditional, so you are effectively saving more money.  If you are not going to be able to max out your tax advantaged savings options, you need to do traditional unless you really expect to make and spend more in retirement than you do now. 

WildJager

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Re: Should I Prioritize my Traditional or Roth?
« Reply #4 on: April 24, 2017, 01:32:07 PM »
Traditional allows me to invest more dollars right now, since I save some money on taxes every year.  Since I'm planning to retire early, I expect to be in a low tax bracket after retirement.  Therefore, capital gains (as they are now) will be 0%.  So, even if I was using a Roth, there would be no difference in capital gains.  However, if I used a roth, I would have invested less money from the get go because I paid more income tax.

The basic concept is, if you expect to be in a higher tax bracket in retirement when you start with withdrawal, go Roth.  If you expect to be in a lower tax bracket, go traditional.

boarder42

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Spicolli

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Re: Should I Prioritize my Traditional or Roth?
« Reply #6 on: April 24, 2017, 02:36:19 PM »
I've heard of the choose your type based on "if you expect to be in a higher or lower tax bracket in retirement" argument before but aren't there other factors to consider? Other advantages of a Roth are that you can take out contributions penalty free (thereby less of a need for emergency funds), there are no RMDs at 70.5, and better advantages to heirs, right? 

boarder42

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Re: Should I Prioritize my Traditional or Roth?
« Reply #7 on: April 24, 2017, 02:38:59 PM »
I've heard of the choose your type based on "if you expect to be in a higher or lower tax bracket in retirement" argument before but aren't there other factors to consider? Other advantages of a Roth are that you can take out contributions penalty free (thereby less of a need for emergency funds), there are no RMDs at 70.5, and better advantages to heirs, right?

read the posts by MF i posted above.  should make your decision quite easy. 

merula

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Re: Should I Prioritize my Traditional or Roth?
« Reply #8 on: April 24, 2017, 02:40:45 PM »
My view is that, except for certain high-income situations, a traditional IRA is the better bet.

First off, all the money you choose to put into a Roth instead of a tIRA is taxed at your marginal rate. (Because, if you put it into a tIRA instead, you'd reduce your taxable income dollar-for-dollar (except for high-income situations).) But when you withdraw from a tIRA in retirement, you're withdrawing income you need for your expenses, which you'd probably need anyway, and so you can consider it to be taxed at your average tax rate. (Except for RMDs.)

(There is a website or blog post that explains this concept extremely well, with graphs and charts and everything, but I cannot for the life of me find it now.) Found it: http://www.gocurrycracker.com/roth-sucks/

What are the specifics of your situation? Are you limited by the income requirements for a tIRA? Are you planning to retire early and therefore have years or decades of free Roth ladder space? Or, do you think you might run into RMDs?
« Last Edit: April 24, 2017, 02:43:40 PM by merula »

Spicolli

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Re: Should I Prioritize my Traditional or Roth?
« Reply #9 on: April 24, 2017, 03:28:56 PM »
My view is that, except for certain high-income situations, a traditional IRA is the better bet.

First off, all the money you choose to put into a Roth instead of a tIRA is taxed at your marginal rate. (Because, if you put it into a tIRA instead, you'd reduce your taxable income dollar-for-dollar (except for high-income situations).) But when you withdraw from a tIRA in retirement, you're withdrawing income you need for your expenses, which you'd probably need anyway, and so you can consider it to be taxed at your average tax rate. (Except for RMDs.)

(There is a website or blog post that explains this concept extremely well, with graphs and charts and everything, but I cannot for the life of me find it now.) Found it: http://www.gocurrycracker.com/roth-sucks/

What are the specifics of your situation? Are you limited by the income requirements for a tIRA? Are you planning to retire early and therefore have years or decades of free Roth ladder space? Or, do you think you might run into RMDs?

I think you were addressing me in this (and sorry if I'm hijacking the OP) so here is my situation: I'm 50 now and plan to retire in 5 years, at which time my wife (who plans to have a post-military job) and I will both have pensions and will be going from a 28% to 25% tax bracket. I believe my wife's job and the pensions will be able to fund the majority of our daily living expenses and we'll rely on our savings for the occasional big expense (RV, cars, son's non GI-Bill covered college expenses, etc). Anyways, I believe we'll still have a significant amount in savings at 70.5 when the traditional RMDs kick in...money that we may not need at that time (tough problem to have!).

So, in our case, where we don't drop in tax brackets too much and won't have much of a window to do a conversion ladder to Roth, shouldn't we be putting at least some of our money into a Roth now?

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #10 on: April 24, 2017, 03:45:26 PM »
I am trying to decide if I should prioritize putting money into a Roth IRA or a Traditional IRA.  Considering I have a $5,500 limit for either/or,  wouldn't it make more sense to pick one or the other and allow it grow to it's full potential rather than have two accounts with lower value not gaining compound interest as it could in one account?
As dandarc noted, (1+i)^n * A + (1+i)^n * B is the same as (1+i)^n * (A + B) so compounding is the same no matter how many buckets you have.

Quote
It also seems that everyone seems to prioritize a traditional over the roth, but reading other blogs online i've gathered that a Roth will be worth more in the long run and also tax free when I take it out.  What is the reasoning behind people prioritizing the traditional?
Mathematically, the only thing that matters is the marginal tax rate you would save this year by using traditional, compared with the marginal tax rate you would pay when withdrawing this year's traditional contribution + its gains.  See https://www.bogleheads.org/wiki/Traditional_versus_Roth for perhaps the definitive article.

GoCurryCracker's post is incorrect because it uses the "effective" rate for withdrawals and that makes traditional look better than it really is.

Those who focus on "tax free when withdrawing" misunderstand the commutative property of multiplication, so they think Roth is better than it really is.

Quote
Another thing i'm trying to decide on is what to put my Roth and Traditional IRA into.  Should I put them both into Index funds? Bonds? REITS for one and not the other? Etc?  Basically I am asking if people tend to invest their Roth into one type of account and vice versa.
It may not matter much, but some advocate putting the higher-expected-return portion of your asset allocation in a Roth, with the lower-expected-return portion in traditional.  See Tax-efficient fund placement - Bogleheads for various pro/con perspectives.

merula

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Re: Should I Prioritize my Traditional or Roth?
« Reply #11 on: April 24, 2017, 04:00:36 PM »
I think you were addressing me in this (and sorry if I'm hijacking the OP) so here is my situation: I'm 50 now and plan to retire in 5 years, at which time my wife (who plans to have a post-military job) and I will both have pensions and will be going from a 28% to 25% tax bracket. I believe my wife's job and the pensions will be able to fund the majority of our daily living expenses and we'll rely on our savings for the occasional big expense (RV, cars, son's non GI-Bill covered college expenses, etc). Anyways, I believe we'll still have a significant amount in savings at 70.5 when the traditional RMDs kick in...money that we may not need at that time (tough problem to have!).

So, in our case, where we don't drop in tax brackets too much and won't have much of a window to do a conversion ladder to Roth, shouldn't we be putting at least some of our money into a Roth now?

My question was to anyone who wants to answer it, although yours is interesting because it's one of those situations where the devil is in the details.

It sounds like your pensions are going to be taxable? If so, I agree with your take: you don't have the time or tax-free space to convert from tIRA to Roth, and if you're relatively healthy at 50 it seems a safe bet to say you'll be around for the 70.5 RMDs.

I guess the real question is, why are you working? :P

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #12 on: April 24, 2017, 04:08:07 PM »
I'm 50 now and plan to retire in 5 years, at which time my wife (who plans to have a post-military job) and I will both have pensions and will be going from a 28% to 25% tax bracket. I believe my wife's job and the pensions will be able to fund the majority of our daily living expenses and we'll rely on our savings for the occasional big expense (RV, cars, son's non GI-Bill covered college expenses, etc). Anyways, I believe we'll still have a significant amount in savings at 70.5 when the traditional RMDs kick in...money that we may not need at that time (tough problem to have!).

So, in our case, where we don't drop in tax brackets too much and won't have much of a window to do a conversion ladder to Roth, shouldn't we be putting at least some of our money into a Roth now?
Probably.  The general rule (see my previous post in this thread and Investment Order) is
- use traditional if current marginal rate is higher than withdrawal marginal rate
- use Roth if current marginal rate is lower than withdrawal marginal rate
- use either if the marginal rates are equal.

There is an exception to that rule if one's "pre-tax contribution to a Roth" is more than the IRS maximum - in other words, if (Roth contribution)/(1 - marginal tax rate) is greater than the IRS maximum.  In that case, comparing apples vs. apples requires that we assume the pre-tax amount all (after paying tax) goes into the Roth if going that way, while the pre-tax amount must be split between a traditional account and a taxable account if going that way.  Depending on one's taxable account tax rate, that can make the Roth better than traditional even if the withdrawal marginal rate is "slightly" lower than the current one.  See Maxing out your retirement accounts for more.

You may fit the exception to the rule.  That, in addition to the RMD (and SS?) effects, is the reason for the "probably".  Either way it appears you will be fine.

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #13 on: April 24, 2017, 04:16:43 PM »
My question was to anyone who wants to answer it....
The "marginal vs. effective" analysis is one of those things that seems self-evident at first glance, but in reality is not correct. 

There have been several threads here and at Bogleheads discussing this.  If the wiki referenced above doesn't explain it well enough, I can probably dig up links to some of those threads.

Spicolli

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Re: Should I Prioritize my Traditional or Roth?
« Reply #14 on: April 24, 2017, 04:45:18 PM »
I guess the real question is, why are you working? :P

I ask my wife that question quite a bit!

She's the conservative one though.

jeromedawg

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Re: Should I Prioritize my Traditional or Roth?
« Reply #15 on: April 24, 2017, 05:46:17 PM »
What is your income?  Maxing my traditional gives me a better tax reduction on high income now.  If you have lower income, I think I would tax the Roth route.

When you say "high income" what level of income are you talking about roughly? Also, is that in the context of contributing to a 401k as well?

I thought if you're over a certain AGI and you contribute to a 401k, you can't deduct tIRAs... I guess this is a moot point if a 401k is out of the question though.
« Last Edit: April 24, 2017, 11:48:00 PM by jplee3 »

firechief

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Re: Should I Prioritize my Traditional or Roth?
« Reply #16 on: April 24, 2017, 07:27:34 PM »
Traditional allows me to invest more dollars right now, since I save some money on taxes every year.  Since I'm planning to retire early, I expect to be in a low tax bracket after retirement.  Therefore, capital gains (as they are now) will be 0%.  So, even if I was using a Roth, there would be no difference in capital gains.  However, if I used a roth, I would have invested less money from the get go because I paid more income tax.

The basic concept is, if you expect to be in a higher tax bracket in retirement when you start with withdrawal, go Roth.  If you expect to be in a lower tax bracket, go traditional.

Isn't there a 10% penalty for withdrawing before 59 from a traditional? Say you retire at 40, how are you going to get your money out of a traditional IRA without accruing the penalty?

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #17 on: April 24, 2017, 07:34:21 PM »
Isn't there a 10% penalty for withdrawing before 59 from a traditional? Say you retire at 40, how are you going to get your money out of a traditional IRA without accruing the penalty?

See How to withdraw funds from your IRA and 401k without penalty before age 59.5 for some ideas.

merula

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Re: Should I Prioritize my Traditional or Roth?
« Reply #18 on: April 25, 2017, 09:19:18 AM »
My question was to anyone who wants to answer it....
The "marginal vs. effective" analysis is one of those things that seems self-evident at first glance, but in reality is not correct. 

There have been several threads here and at Bogleheads discussing this.  If the wiki referenced above doesn't explain it well enough, I can probably dig up links to some of those threads.

I think it is correct IF you expect tIRA withdrawals or trad to Roth conversions to be the your sole taxable income in retirement. In that situation (which I think many people fall in), "marginal vs. effective" is correct and accurate.

For example, my personal situation is that I'm a relatively high-earner right now (HH income at 80th percentile nationally), and I hope to retire by 40-45 and spend several years using my tax-free space to do Roth conversions while living on savings in taxable accounts.

My calculations are that I'll have the following tax-free income limits (depending on my children's ages when I retire and assuming that the basics of the standard deduction, exemptions and Child Tax Credit remain the same):
-3 years of ~$50k tax-free while I have two kids under 17
-2 years of ~$40k tax-free while I have one kid under 17 and both kids as dependents
-2 years of ~$30k tax-free while both are over 17 but still dependents
-2 years of ~$25k tax-free while one is still a dependent
-??? years of ~$20k tax-free with no dependents other than my husband and myself

That's $340k worth of completely tax-free conversions over 9 years, while also paying 0% LTCG on the taxable withdrawals. If needed, I could bump my withdrawals up to the top of the 10% bracket, gaining an extra $10k-$20k/year, plus there may be college tax credits that I'm not considering.

Obviously, this won't work if your situation is different, and there's a clear difference between having dependents and not from a tax perspective. PFT's situation is significantly different without a way to get this kind of tax-free conversion space (because he's using it on the pensions), but I think I'm pretty safe in saying that pensions are the exception rather than the rule these days.
« Last Edit: April 25, 2017, 09:20:55 AM by merula »

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #19 on: April 25, 2017, 11:20:41 AM »
My question was to anyone who wants to answer it....
The "marginal vs. effective" analysis is one of those things that seems self-evident at first glance, but in reality is not correct. 

There have been several threads here and at Bogleheads discussing this.  If the wiki referenced above doesn't explain it well enough, I can probably dig up links to some of those threads.

I think it is correct IF you expect tIRA withdrawals or trad to Roth conversions to be the your sole taxable income in retirement. In that situation (which I think many people fall in), "marginal vs. effective" is correct and accurate.
Actually, it is neither correct nor accurate in general.

Now, in your situation, if marginal=effective=0% then it doesn't matter what you call it because the answer is the same.

Whether you have a high enough pension, or have already accumulated enough in your traditional accounts, such that any additional traditional contributions will be withdrawn at a high marginal rate, the effect is identical.

Yes, it does take a lot of traditional contributions and growth to reach that point - but if you do reach it then Roth becomes better.

See
Roth vs Traditional 401K - earliest Bogleheads thread
https://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/
the OMG I get it one: https://www.bogleheads.org/forum/viewtopic.php?f=1&t=200071&p=3066486#p3065160
for some other discussions about this.

boarder42

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Re: Should I Prioritize my Traditional or Roth?
« Reply #20 on: April 25, 2017, 11:54:11 AM »
yeah what MDM is trying to explain is something it took me a bit to grasp. 

Basically if you've saved 25x the 15% bracket in your trad accounts you should switch to Roth if you plan to be in the 15% bracket.  if you plan to be in the 25% bracket you can go ahead and save up to 25x the 25% bracket threshold.

merula

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Re: Should I Prioritize my Traditional or Roth?
« Reply #21 on: April 25, 2017, 12:30:14 PM »
MDM, are you saying that, if I contributed to a Roth instead of a tIRA, those contributions are NOT taxed at my current marginal rate?

Because when I say "marginal vs effective", I'm saying that the tax rate on Roth contributions as compared to tIRA contributions is my current marginal tax rate, and the tax rate on tIRA withdrawals as compared to Roth withdrawals is the effective rate of the entire withdrawal.

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #22 on: April 25, 2017, 01:00:07 PM »
MDM, are you saying that, if I contributed to a Roth instead of a tIRA, those contributions are NOT taxed at my current marginal rate?

Because when I say "marginal vs effective", I'm saying that the tax rate on Roth contributions as compared to tIRA contributions is my current marginal tax rate, and the tax rate on tIRA withdrawals as compared to Roth withdrawals is the effective rate of the entire withdrawal.
Yes, I understand what you are saying.  I even understand how that can seem correct, because it seemed reasonable the first time I heard it.  But it is not correct.

Take a look at the Bogleheads wiki, plus the three threads other threads linked previously, to see if they help. 

One thing to remember: you don't have to make a lifelong choice of traditional vs. Roth.  You get to choose every time you make a new contribution.  All those previous contributions are "water under the bridge" but do affect the marginal rate you will pay on withdrawals from new contributions.

merula

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Re: Should I Prioritize my Traditional or Roth?
« Reply #23 on: April 25, 2017, 01:07:29 PM »
I've looked at the links you provided. I know you think that they're universally illuminating but I'm still completely baffled as to how you are saying that Roth contributions are NOT taxed at the marginal rate.

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #24 on: April 25, 2017, 01:15:10 PM »
I've looked at the links you provided. I know you think that they're universally illuminating but I'm still completely baffled as to how you are saying that Roth contributions are NOT taxed at the marginal rate.
The contribution side is not where we disagree.  Yes, one pays the marginal rate on Roth contributions - no disagreement.

The point is that one pays a marginal rate on the withdrawal side also.  I thought you were saying that every traditional contribution will be taxed at the average rate on withdrawals.  That is not correct, but maybe that isn't what you are saying...?

boarder42

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Re: Should I Prioritize my Traditional or Roth?
« Reply #25 on: April 25, 2017, 01:43:29 PM »
I've looked at the links you provided. I know you think that they're universally illuminating but I'm still completely baffled as to how you are saying that Roth contributions are NOT taxed at the marginal rate.

this was extremely hard for me to wrap my head around ... but if you plan on a 4% SWR everything in traditional over ~1.875MM for a married filing joint couple will/can be assumed to be taxed at the marginal rate of 25% b/c you've maxed out your 15% tax bucket.  think of each tax level as a bucket once your traditional reaches the top of that bucket evaluate it as compared to your current marginal tax rate.  if your current marginal is higher keep filling up the tax deferred bucket but if its not then you should strongly consider Roth.  i dont know how to describe it but it took awhie for me to have the aha moment and having it described as buckets is what made it click for me. 

if you fill a bucket up to 1.875MM and you withdraw at 4% you'll be withdrawing at the top of the 15% bracket.  if you save over that to withdraw means it will come out of the 25% tax bracket. 

after writing this i think my 1.875MM could be wrong.  should we be including at least the standard deductions on this number MDM?

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #26 on: April 25, 2017, 02:08:08 PM »
should we be including at least the standard deductions on this number MDM?
Yes, and exemptions.

See cells S1:U19 on the 'Calculations' tab in the case study spreadsheet.
« Last Edit: April 25, 2017, 06:19:49 PM by MDM »

Joel

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Re: Should I Prioritize my Traditional or Roth?
« Reply #27 on: April 25, 2017, 02:19:00 PM »

Whether you have a high enough pension, or have already accumulated enough in your traditional accounts, such that any additional traditional contributions will be withdrawn at a high marginal rate, the effect is identical.

Yes, it does take a lot of traditional contributions and growth to reach that point - but if you do reach it then Roth becomes better.

This distinction is what so many people don't understand. Yes, MDM is 100% correct here.

merula

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Re: Should I Prioritize my Traditional or Roth?
« Reply #28 on: April 26, 2017, 10:59:35 AM »
I've looked at the links you provided. I know you think that they're universally illuminating but I'm still completely baffled as to how you are saying that Roth contributions are NOT taxed at the marginal rate.
The contribution side is not where we disagree.  Yes, one pays the marginal rate on Roth contributions - no disagreement.

The point is that one pays a marginal rate on the withdrawal side also.  I thought you were saying that every traditional contribution will be taxed at the average rate on withdrawals.  That is not correct, but maybe that isn't what you are saying...?

Thanks for the clarification on the contributions. That is not what I'm saying on the withdrawals, so maybe I can clarify as well.

When you withdraw from a tIRA or 401k, you are incurring taxable income. You'll fill up your tax-free bucket, then your 10% bucket, and so on, depending on how much income you need or need to convert.

If you have a lot of other taxable income (PeachFuzzTom's situation), and you need to do withdrawals/conversions only to avoid/reduce RMDs and not for the sake of the income itself, then your withdrawals are taxed at your marginal rate. In the absence of the withdrawals, you'd fill up your tax-free buckets with the income you're already getting, and one or two or three more buckets, too, so the withdrawal income is added to the last bucket and taxed at that rate.

If you have no other taxable income, then your withdrawals/conversions are the only income you're paying tax on, meaning that they are taxed at your effective or average tax rate. You are filling up all your buckets with withdrawals, tax-free on up, and not just the marginal one.

In a middle-of-the-road situation, let's say that you have $20k in taxable income from some other source (pension? part-time job) but need $40k to live on, so you made $20k of withdrawals. You could say that the first $20k fills up your tax-free bucket, so the withdrawals are taxed at 10% (your marginal rate), but I think that's a little disingenuous. You need the full $40k, including the withdrawals, so why are we counting non-withdrawals as the "extra" income and not the other income as "extra" taxed at 10% and the withdrawals as tax-free? Neither is really "right", because neither income is "extra"; the most honest consideration is to call them both as taxed at the effective or average rate (5% in this case).

boarder42

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Re: Should I Prioritize my Traditional or Roth?
« Reply #29 on: April 26, 2017, 11:13:47 AM »
You're still missing the point. Once a bucket is full with 25x the top of the marginal tax rate after deductions and exemptions. It can be assumed the extra money being saved will be withdrawn at the next higher bracket. If your current marginal rate is 25% or higher the number is incredibly large for mfj couple. Around 2.4MM saved in tax deferred accounts before you hit it. Which is why most mustachians never worry about this. But 15% bracketers likely should pay attention.
« Last Edit: April 26, 2017, 11:17:31 AM by boarder42 »

MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #30 on: April 26, 2017, 12:29:56 PM »
Thanks for the clarification on the contributions. That is not what I'm saying on the withdrawals, so maybe I can clarify as well.
When you withdraw from a tIRA or 401k, you are incurring taxable income. You'll fill up your tax-free bucket, then your 10% bucket, and so on, depending on how much income you need or need to convert.
So far so good, although "need" is a debatable term - see below.

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If you have a lot of other taxable income (PeachFuzzTom's situation), and you need to do withdrawals/conversions only to avoid/reduce RMDs and not for the sake of the income itself, then your withdrawals are taxed at your marginal rate. In the absence of the withdrawals, you'd fill up your tax-free buckets with the income you're already getting, and one or two or three more buckets, too, so the withdrawal income is added to the last bucket and taxed at that rate.
We have to assume the tIRA contributions will be withdrawn at some point, correct?  If not by the original contributor, then by the contributors heirs.  In the latter situation we would have to posit marginal rates for any number of heirs.  It's much simpler, and likely correct enough, to assume withdrawals are proportional (e.g., at a 4% or other WR) to contributions.  Do you agree?

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If you have no other taxable income, then your withdrawals/conversions are the only income you're paying tax on, meaning that they are taxed at your effective or average tax rate. You are filling up all your buckets with withdrawals, tax-free on up, and not just the marginal one.
This is correct, but not pertinent to deciding between Roth vs. traditional for future contributions.  One can always put on hindsight glasses to decide if past decisions have been correct, but simply because they are past decisions they can't be changed.

Let's say you are 10 years away from starting to withdraw from your traditional accounts.  If you never make another traditional contribution, you will withdraw a certain amount on which you will pay tax.  That base doesn't change.  Now, if you do make additional contributions, the withdrawals due to those contributions and their growth come on top of the base established by prior contributions.  That means they are taxed at your marginal rate when withdrawn.

One has to distinguish what was done in the past, thus no longer changeable, from choices you can make now and in the future.  Those choices affect you "at the margin."

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In a middle-of-the-road situation, let's say that you have $20k in taxable income from some other source (pension? part-time job) but need $40k to live on, so you made $20k of withdrawals. You could say that the first $20k fills up your tax-free bucket, so the withdrawals are taxed at 10% (your marginal rate), but I think that's a little disingenuous. You need the full $40k, including the withdrawals, so why are we counting non-withdrawals as the "extra" income and not the other income as "extra" taxed at 10% and the withdrawals as tax-free? Neither is really "right", because neither income is "extra"; the most honest consideration is to call them both as taxed at the effective or average rate (5% in this case).
It's not disingenuous at all.   The pension is fixed: you can't change it.  The changes you can make affect you at the margin.

See Marginal Vs Effective Tax Rates And When To Use Each in case that explains it better than I and others have been trying to do here.

Jrr85

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Re: Should I Prioritize my Traditional or Roth?
« Reply #31 on: April 26, 2017, 12:38:47 PM »
I've looked at the links you provided. I know you think that they're universally illuminating but I'm still completely baffled as to how you are saying that Roth contributions are NOT taxed at the marginal rate.
The contribution side is not where we disagree.  Yes, one pays the marginal rate on Roth contributions - no disagreement.

The point is that one pays a marginal rate on the withdrawal side also.  I thought you were saying that every traditional contribution will be taxed at the average rate on withdrawals.  That is not correct, but maybe that isn't what you are saying...?

Thanks for the clarification on the contributions. That is not what I'm saying on the withdrawals, so maybe I can clarify as well.

When you withdraw from a tIRA or 401k, you are incurring taxable income. You'll fill up your tax-free bucket, then your 10% bucket, and so on, depending on how much income you need or need to convert.

If you have a lot of other taxable income (PeachFuzzTom's situation), and you need to do withdrawals/conversions only to avoid/reduce RMDs and not for the sake of the income itself, then your withdrawals are taxed at your marginal rate. In the absence of the withdrawals, you'd fill up your tax-free buckets with the income you're already getting, and one or two or three more buckets, too, so the withdrawal income is added to the last bucket and taxed at that rate.

If you have no other taxable income, then your withdrawals/conversions are the only income you're paying tax on, meaning that they are taxed at your effective or average tax rate. You are filling up all your buckets with withdrawals, tax-free on up, and not just the marginal one.

In a middle-of-the-road situation, let's say that you have $20k in taxable income from some other source (pension? part-time job) but need $40k to live on, so you made $20k of withdrawals. You could say that the first $20k fills up your tax-free bucket, so the withdrawals are taxed at 10% (your marginal rate), but I think that's a little disingenuous. You need the full $40k, including the withdrawals, so why are we counting non-withdrawals as the "extra" income and not the other income as "extra" taxed at 10% and the withdrawals as tax-free? Neither is really "right", because neither income is "extra"; the most honest consideration is to call them both as taxed at the effective or average rate (5% in this case).

This is still not right.  If you had to go 100% traditional or 100% roth, it would be the right way to look at it.  But you get to choose how to allocate each dollar of contribution to your an IRA between traditional or Roth.  So in order to determine how to allocate each dollar, you have to make some assumptions about how much you will spend in retirement and how much non-401k/tira/rira income you will have coming in, and then use that to back into whether you are better off contributing your next IRA dollar to a traditional or roth account.  For each dollar, you will be looking at the marginal tax now versus the expected marginal tax in retirement.   

 

boarder42

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Re: Should I Prioritize my Traditional or Roth?
« Reply #32 on: April 26, 2017, 01:06:30 PM »
merula this is likely one of the most difficult concepts to grasp as i was stuck in your same situation going round and round with MDM on this til it finally clicked. 

Jimmyjon

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Re: Should I Prioritize my Traditional or Roth?
« Reply #33 on: April 26, 2017, 02:01:03 PM »
So in my specific situation:
I am 26 years old and I made 120k last year and contributed to my company 401k which is worth 40k currently.  I also contributed to a Roth IRA $2,200 last year which is currently worth $8,000. This year I have made 40k so far, but plan on quitting soon to travel for the rest of the year. I still plan on making contributions to whatever route I decide to go.  I also JUST put $10,000 into a individual account with Vanguard into the Vanguard Total Stock Market Index Funds.  I have 70k sitting in savings right now doing nothing.  After travelling, I plan on going back to school for a couple years, so I will possibly not be making money for a while.

When I leave the company I will move my 401k into a traditional (after reading everybody's replies this seems the way to go) and continue to max that out if I'm able.   My Roth IRA, however, I'm unsure what to do with it.  I would like to move it into a Vanguard account regardless (currently with American Funds), but should I continue to contribute or just leave it and focus on the tIRA?  Or with me potentially not making money for a while, would it make more sense to contribute to the rIRA instead of the tIRA?


fatcow240

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Re: Should I Prioritize my Traditional or Roth?
« Reply #34 on: April 26, 2017, 02:12:33 PM »
My first goal would be to max out the 401k for this year before you quit (18k).  If you do this you will likely be down in the 15% marginal bracket and I would suggest putting the rest in a ROTH IRA (5.5k).

The 70k is a lot to just have sitting around.  Are you planning on using the 70k anytime soon?

I believe you have to assess each year how much income you have and decide which account to contribute to.  In very low income years, you may consider converting some tIRA to rIRA.

Jimmyjon

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Re: Should I Prioritize my Traditional or Roth?
« Reply #35 on: April 26, 2017, 02:24:32 PM »
Yep pretty dumb on my part to have 70k sitting around but I didn't have much focus on my retirement prior to now.  About 20k will be used for travel and I estimate another 10-20k for school.

How do I even go about maxing out my 401k?  Right now my employer is taking out 6% on each check and TBH I don't even know what it's invested in.

So... keep the Roth and contribute on my low income years? And contribute to the traditional if I'm making more in the future?

Another question I have.... I plan on going with the core four strategy (US Stock, Int. Stock, US Bonds, REITs) for both IRAs.  Should I do the same with my individual account with Vanguard or should I diversify?  I wouldn't mind being a little riskier on that but am unsure what would be a good bet...


MDM

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Re: Should I Prioritize my Traditional or Roth?
« Reply #36 on: April 26, 2017, 02:34:26 PM »
Or with me potentially not making money for a while, would it make more sense to contribute to the rIRA instead of the tIRA?
Depends on some specifics.

If you actually "make" (from work) $0, then you can't contribute anything to either traditional or Roth.

You could try entering your expected 2017 numbers into the case study spreadsheet and checking your marginal saving rate....

fatcow240

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Re: Should I Prioritize my Traditional or Roth?
« Reply #37 on: April 27, 2017, 09:46:25 AM »
How do I even go about maxing out my 401k?  Right now my employer is taking out 6% on each check and TBH I don't even know what it's invested in.

At my company I can set my contributions up to 50% through HR systems or Fidelity.  I would contact HR to learn more about your 401k program.