Author Topic: Should I use Roth IRA funds to wipe out student loans?  (Read 13862 times)

beltim

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #50 on: July 24, 2015, 08:57:09 PM »

Everything about this scenario - including your hypothesis that future taxes are more likely to be higher than lower - favors a Roth.
Wait, when did I state that I favored a 401k over a Roth?  If I ever gave that impression, I'm sorry, because I don't believe that. 

I was just talking about the specific scenario that MDM set up:

Quote
- need to decide whether to contribute to traditional or Roth
   - any taxable withdrawal will be taxed at the 28% marginal rate (per the base income given above)
   - average tax rate for the withdrawal year will be ~18%

Should the contribution be made to a traditional or Roth?  Why?

Both, because it's a useful tool in retirement to have both types of accounts to draw from,but even this contrived example supports my point.

In this case the traditional has no possible advantage.  So why suggest splitting the contribution?  The Roth will always be better.
« Last Edit: July 24, 2015, 09:10:17 PM by beltim »

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #51 on: July 24, 2015, 09:25:26 PM »

In this case the traditional has no possible advantage.  So why suggest splitting the contribution?  The Roth will always be better.

Because whatever you think you are seeing doesn't exist.  There are simply too many variables that are undefined, or otherwise unsaid, that I could nitpick back to the point that the traditional is reasonable.  Or I could nitpick the other way, and prove your assumptions.  The difference is really in the unstated assumptions, which is the reason I asked "Why?" when presented with a condition that a person earns in the 25% bracket before retirement, but can't keep the base income out of the 28% bracket afterwards.  That's (probably) an impossible condition, or at least an extremely rare one.  Honestly, who works for less than they would earn not working?  This strawman retiree was FI a decade or two ago.  No one does this, at least no one that actually has to save for his own retirement, using his own wages.  I actually love my job, and so long as I continue to love it, I don't see myself retiring early; but even I would walk away today if my employer offered me a pension that paid me more than I make working.

beltim

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #52 on: July 24, 2015, 09:44:42 PM »

In this case the traditional has no possible advantage.  So why suggest splitting the contribution?  The Roth will always be better.

Because whatever you think you are seeing doesn't exist.  There are simply too many variables that are undefined, or otherwise unsaid, that I could nitpick back to the point that the traditional is reasonable.  Or I could nitpick the other way, and prove your assumptions.  The difference is really in the unstated assumptions, which is the reason I asked "Why?" when presented with a condition that a person earns in the 25% bracket before retirement, but can't keep the base income out of the 28% bracket afterwards.  That's (probably) an impossible condition, or at least an extremely rare one.  Honestly, who works for less than they would earn not working?  This strawman retiree was FI a decade or two ago.  No one does this, at least no one that actually has to save for his own retirement, using his own wages.  I actually love my job, and so long as I continue to love it, I don't see myself retiring early; but even I would walk away today if my employer offered me a pension that paid me more than I make working.

You yourself pointed out a plausible scenario for that sort of situation - a pension for which you weren't yet eligible.  Pensions generally don't go above 100% of earnings, but pensions can easily be added to Social Security, which would raise your marginal tax rate.

I don't think you "can nitpick back to the point where a traditional is reasonable" if we're using "reasonable" to mean "which is better" since that's what we were talking about.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #53 on: July 24, 2015, 10:03:41 PM »

In this case the traditional has no possible advantage.  So why suggest splitting the contribution?  The Roth will always be better.

Because whatever you think you are seeing doesn't exist.  There are simply too many variables that are undefined, or otherwise unsaid, that I could nitpick back to the point that the traditional is reasonable.  Or I could nitpick the other way, and prove your assumptions.  The difference is really in the unstated assumptions, which is the reason I asked "Why?" when presented with a condition that a person earns in the 25% bracket before retirement, but can't keep the base income out of the 28% bracket afterwards.  That's (probably) an impossible condition, or at least an extremely rare one.  Honestly, who works for less than they would earn not working?  This strawman retiree was FI a decade or two ago.  No one does this, at least no one that actually has to save for his own retirement, using his own wages.  I actually love my job, and so long as I continue to love it, I don't see myself retiring early; but even I would walk away today if my employer offered me a pension that paid me more than I make working.

You yourself pointed out a plausible scenario for that sort of situation - a pension for which you weren't yet eligible.  Pensions generally don't go above 100% of earnings, but pensions can easily be added to Social Security, which would raise your marginal tax rate.

I don't think you "can nitpick back to the point where a traditional is reasonable" if we're using "reasonable" to mean "which is better" since that's what we were talking about.

Sure I can.  I have a pension that starts at 60, but my SS full-retirement age is 67.  So even if I don't retire early, there is 7 years that I won't have my full 'base' in this context.  That's one variable I can play with right there, the differences between different income sources and their starting (and maybe stopping) times.

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #54 on: July 24, 2015, 10:15:44 PM »
Sure I can.  I have a pension that starts at 60, but my SS full-retirement age is 67.  So even if I don't retire early, there is 7 years that I won't have my full 'base' in this context.  That's one variable I can play with right there, the differences between different income sources and their starting (and maybe stopping) times.
You would do this to get your marginal withdrawal tax rate below the contributory rate, thus causing the traditional to be better, correct?

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #55 on: July 24, 2015, 10:27:35 PM »
Sure I can.  I have a pension that starts at 60, but my SS full-retirement age is 67.  So even if I don't retire early, there is 7 years that I won't have my full 'base' in this context.  That's one variable I can play with right there, the differences between different income sources and their starting (and maybe stopping) times.
You would do this to get your marginal withdrawal tax rate below the contributory rate, thus causing the traditional to be better, correct?

In this case, I wouldn't be doing it, but the different rules of the two sources of base income would be doing it; but otherwise yes.  Even if the combination of both a traditional pension and SS would result in as much or more taxable income (for me, never going to happen), I could chose whether or not to withdraw from the 401k in the 7 year period, or not.  If I need the cash for whatever reason, but don't want to take the income tax hit, I could withdraw it from my Roth instead.  Or, alternatively, I could rollover funds from the 401k into the Roth and bring my taxable income right up next to the next tax bracket, and keep the Roth funds as an inheritance if I really had that much money.  It's the control over one's own income sources that, in many ways, defines financial independence.
« Last Edit: July 24, 2015, 10:29:53 PM by MoonShadow »

beltim

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #56 on: July 25, 2015, 10:57:59 AM »

In this case the traditional has no possible advantage.  So why suggest splitting the contribution?  The Roth will always be better.

Because whatever you think you are seeing doesn't exist.  There are simply too many variables that are undefined, or otherwise unsaid, that I could nitpick back to the point that the traditional is reasonable.  Or I could nitpick the other way, and prove your assumptions.  The difference is really in the unstated assumptions, which is the reason I asked "Why?" when presented with a condition that a person earns in the 25% bracket before retirement, but can't keep the base income out of the 28% bracket afterwards.  That's (probably) an impossible condition, or at least an extremely rare one.  Honestly, who works for less than they would earn not working?  This strawman retiree was FI a decade or two ago.  No one does this, at least no one that actually has to save for his own retirement, using his own wages.  I actually love my job, and so long as I continue to love it, I don't see myself retiring early; but even I would walk away today if my employer offered me a pension that paid me more than I make working.

You yourself pointed out a plausible scenario for that sort of situation - a pension for which you weren't yet eligible.  Pensions generally don't go above 100% of earnings, but pensions can easily be added to Social Security, which would raise your marginal tax rate.

I don't think you "can nitpick back to the point where a traditional is reasonable" if we're using "reasonable" to mean "which is better" since that's what we were talking about.

Sure I can.  I have a pension that starts at 60, but my SS full-retirement age is 67.  So even if I don't retire early, there is 7 years that I won't have my full 'base' in this context.  That's one variable I can play with right there, the differences between different income sources and their starting (and maybe stopping) times.

Okay, so in that scenario, how would a traditional be better?

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #57 on: July 25, 2015, 12:44:55 PM »

In this case the traditional has no possible advantage.  So why suggest splitting the contribution?  The Roth will always be better.

Because whatever you think you are seeing doesn't exist.  There are simply too many variables that are undefined, or otherwise unsaid, that I could nitpick back to the point that the traditional is reasonable.  Or I could nitpick the other way, and prove your assumptions.  The difference is really in the unstated assumptions, which is the reason I asked "Why?" when presented with a condition that a person earns in the 25% bracket before retirement, but can't keep the base income out of the 28% bracket afterwards.  That's (probably) an impossible condition, or at least an extremely rare one.  Honestly, who works for less than they would earn not working?  This strawman retiree was FI a decade or two ago.  No one does this, at least no one that actually has to save for his own retirement, using his own wages.  I actually love my job, and so long as I continue to love it, I don't see myself retiring early; but even I would walk away today if my employer offered me a pension that paid me more than I make working.

You yourself pointed out a plausible scenario for that sort of situation - a pension for which you weren't yet eligible.  Pensions generally don't go above 100% of earnings, but pensions can easily be added to Social Security, which would raise your marginal tax rate.

I don't think you "can nitpick back to the point where a traditional is reasonable" if we're using "reasonable" to mean "which is better" since that's what we were talking about.

Sure I can.  I have a pension that starts at 60, but my SS full-retirement age is 67.  So even if I don't retire early, there is 7 years that I won't have my full 'base' in this context.  That's one variable I can play with right there, the differences between different income sources and their starting (and maybe stopping) times.

Okay, so in that scenario, how would a traditional be better?
  Because after you have saved 25% on your taxes in the years leading up to retirement, you can roll over the 401k funds into your Roth up to at least the bottom of the 25% bracket for at least the 7 years till you claim SS.  Or you could just delay SS, and keep rolling with your Roth ladder, and taking the delay bonus that SS offers.  If you retire before 60, the 401k becomes your base income up until 60 anyway, in which case, all of that base income you withdraw up until the bottom of the 25% bracket is improved overall, and anything you take out above the 25% bracket line is simply an even push.

But even then, it wouldn't necessarily be better than withdrawing from the roth, it really depends on variables that can't be predicted.

beltim

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #58 on: July 25, 2015, 11:13:45 PM »
I may be missing something but I don't see how that would be better than a Roth. At best it's the same as a Roth. So if the Roth is never worse in this situation, but sometimes better, then shouldn't you choose the Roth?

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #59 on: July 27, 2015, 07:34:47 PM »
I may be missing something but I don't see how that would be better than a Roth. At best it's the same as a Roth. So if the Roth is never worse in this situation, but sometimes better, then shouldn't you choose the Roth?

The real answer is that you should have both.  Get the Roth early in your career, as in the same year that you start working as a teenager, and fund it as much as you can for as long as that seems reasonable.  As you start making real money, and running up into the higher brackets, more of your savings should be going into traditional pre-tax accounts, such as a 401k.  Considering that a roth has a pretty low annual limit, it would be reasonable to say "max out the roth every year first, then worry about the 401k"; but there are other complications that make that not straightforward.

beltim

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #60 on: July 27, 2015, 08:05:03 PM »
I may be missing something but I don't see how that would be better than a Roth. At best it's the same as a Roth. So if the Roth is never worse in this situation, but sometimes better, then shouldn't you choose the Roth?

The real answer is that you should have both.  Get the Roth early in your career, as in the same year that you start working as a teenager, and fund it as much as you can for as long as that seems reasonable.  As you start making real money, and running up into the higher brackets, more of your savings should be going into traditional pre-tax accounts, such as a 401k.  Considering that a roth has a pretty low annual limit, it would be reasonable to say "max out the roth every year first, then worry about the 401k"; but there are other complications that make that not straightforward.

You're completely changing the subject. I asked about a specific situation, that you previously gave a specific answer to, and you responded completely off topic. 

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #61 on: July 28, 2015, 09:22:34 AM »
Even limiting ourselves to the contrived situation presented, the answer is still both, as I have already explained, due to many common variables that were neither mentioned nor are they predictable.  On it's face, the above mentioned condition, while not impossible, is rather improbable; and would imply that the Roth should be favored in the year that 25% rate is earned.  The Roth, generally, should be favored early in the career, both for reasons of longer term untaxable growth and because the tax bracket is typically lower in the early years.  However, the traditional typically wins closer to the target retirement date; because Roth has the advantage with long compound growth times, while the 401k has the advantage with high tax brackets & short compound growth times.

So, generally speaking, as well as specificly speaking to this contrived example; most people should have both.

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #62 on: July 28, 2015, 11:02:46 AM »
On it's face, the above mentioned condition, while not impossible, is rather improbable; and would imply that the Roth should be favored in the year that 25% rate is earned.
Probable or improbable (a high earner retiring partway through the year would be one example), yes, anytime one expects a higher marginal rate on withdrawal, Roth is preferable.  E.g., in the example given.

Quote
The Roth, generally, should be favored early in the career, both for reasons of longer term untaxable growth and because the tax bracket is typically lower in the early years.
Yes.  This one does require a particularly clear crystal ball, but if either growth in base income or investment growth itself puts one in a higher marginal rate on withdrawal, Roth is preferable.

Quote
However, the traditional typically wins closer to the target retirement date; because Roth has the advantage with long compound growth times, while the 401k has the advantage with high tax brackets & short compound growth times.
Yes.  The reverse of the Roth-supporting logic is also true: whenever one expects a lower marginal rate on withdrawal, traditional is preferable.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #63 on: July 28, 2015, 11:42:41 AM »
There is also the concept of your total risk across accounts to consider.  When possible, it's preferable to put those investments with a higher growth potential into the Roth, and keep the traditional accounts as conservative as is reasonable to maintain the balance.  In this way, the Roth accepts the higher risk, but also the potentially higher gains; while the traditional forms your 'rainy day' crash protection funds.  If your traditional account(s) only average 3%, but your roth is hammering a rising market at 12%, you could still be averaging a respectable 6 or 7% across the entire portfolio.

If the market does great over the course of your career, your roth balance will likely be huge, and forever untaxable; while your traditional is likely to have grown, but not to an outstanding degree.  On the flip side, if the market sucked during your career; your roth balance wouldn't be something to crow about, but your traditional is still likely to be at least as much as what you actually contributed.  In the prior condition, life is good and your tax bracket in retirement is a good problem to have, but you have minimized it.  In the latter, you are not likely going to be in a high bracket in any condition.