Author Topic: Should I use Roth IRA funds to wipe out student loans?  (Read 16045 times)

Slam

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Should I use Roth IRA funds to wipe out student loans?
« on: July 23, 2015, 09:48:26 AM »
My understanding of Roth IRA funds is that I have already paid taxes on the money that I contribute to the account, so I will not have to pay taxes on the money that I withdraw, as long as I do not withdraw any gains.  Are there other fees that would make this not worth it?

Here are the numbers:
I have contributed $10,000.
The account now has $12,500.
My student loans are $9,500 at 6.8%.
I am currently paying about $1,400/month towards student loans.
Currently contributing $200/month to Roth IRA.

At this rate I will have the last chunk of my student loans paid off by January or February.  But I would rather have them paid off now.  When I get them paid off I plan to up my contributions to Roth to $433/month (the maximum), and also increase contributions to 401k at work.

Should I use the money to wipe out the loans, or just wait 6 months?

Cheddar Stacker

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #1 on: July 23, 2015, 09:52:00 AM »
The problem with taking the funds out is you can't put them back. Those are contributions from prior years, and that $5,500 window has closed.

6.8% sucks, and if you weren't going to be done in 6 months I'd tell you to refinance them, but I'd just be patient and leave the Roth's alone.

Another option, get yourself a 0% interest credit card for all your day-to-day and monthly expenses freeing up more cash flow to pay the SL's off quicker, then pay off the credit card after that.

Gin1984

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #2 on: July 23, 2015, 10:23:56 AM »
This is was not your question but depending on your income it may be better to refi the 6.8% debt at sofi! max out both your Roth and 401k and take a little longer to pay off the debt.

forummm

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #3 on: July 23, 2015, 10:49:31 AM »
No way would I empty my IRA to pay off a relatively small amount of student loan debt like that. Just keep being aggressive and pay it off by saving. I would max out the IRA each year, even if it means paying off the loans a little bit less.

Slam

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #4 on: July 23, 2015, 11:40:48 AM »
The way I'm seeing it is that my net worth will not change.  Take some assets, put them towards debts.  The 6.8% that I'm losing to loans is equivalent to the standard 7% that I could gain from investments.

No, I can't go back and put more than $5,500 per year in the Roth, but I am still not maxed out on 401k, so I could always put it there.

Maybe I can go take another look at sofi.  I'm pretty sure the only reason I didn't do it a couple months ago was because I was refinancing my mortgage and didn't want the hit on my credit report.

Slam

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #5 on: July 23, 2015, 11:49:16 AM »
Anything you earn in the Roth is tax-free forever, and that's a hell of a benefit, especially if you are still relatively young. That vastly outweighs paying interest for a few more years on your loans.

We delayed paying off the student loans by an extra 2 years in order to max IRAs every year and it was well worth it.

Yeah I guess I am overlooking the time value of money aspect of it.  It's just that I'm so close to the finish line...

KCM5

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #6 on: July 23, 2015, 11:57:40 AM »
Like you said, you're close to the finish line. Just throw your extra money at it and finish it. So you're going to pay a few hundred dollars in interest. Meh. Don't take it out on your Roth-it's just sitting there earning you tax free interest/dividends.

GoldenStache

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #7 on: July 23, 2015, 01:33:57 PM »
NO.

slugline

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #8 on: July 23, 2015, 02:41:53 PM »
Something else to consider: In the event of bankruptcy, your IRA is shielded from creditors:

http://www.nolo.com/legal-encyclopedia/retirement-plan-bankruptcy-chapter-7-13-32410.html

Yeah, I know -- bankruptcy is probably the furthest thing from your mind as you're building a Mustache. But if your net worth won't really change much either way, why give up that protection if you don't have to?

forummm

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #9 on: July 23, 2015, 03:10:34 PM »
What marginal tax bracket are you in? It might not even be a good idea to pay off the loans early if you aren't maxing out your 401k.

Slam

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #10 on: July 23, 2015, 03:49:24 PM »
be patient and leave the Roth's alone.
take a little longer to pay off the debt.
No way
Don't take it out on your Roth
NO.

OK I get it.  I won't do it. Gah! thanks for the advice...

What marginal tax bracket are you in? It might not even be a good idea to pay off the loans early if you aren't maxing out your 401k.

I'm interested in where you are going with this.  Marginal rate is 25%.

Gin1984

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #11 on: July 23, 2015, 04:15:46 PM »
If you are in the 25% bracket, you need to be more worried about using your 401k to get into the 15% bracket and not about maxing out your Roth or paying down the student loans.

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #12 on: July 23, 2015, 04:44:38 PM »
Here's the quick math on traditional vs. Roth.  Note: the subject can get much more complicated than what follows, but this should be a reasonable start.

Traditional:  Contribute amount P now,           get annual returns of i for n years, then pay      tax at rate_2 when withdrawing.  Net amount = P * (1 + i)^n * (1 - rate_2)
Roth: Take amount P, pay tax at rate_1 now, get annual returns of i for n years, then pay no tax when withdrawing.                  Net amount = P * (1 - rate_1) * (1 + i)^n

If rate_1 = rate_2, those amounts are identical.  If, for example, rate_1 = 25% (current marginal rate) and rate_2 = 15% (possible marginal rate in retirement) then Traditional will be better than Roth.  Of course, if rate_2 = 28% then Roth will be better.

sol

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #13 on: July 23, 2015, 04:45:29 PM »
If you are in the 25% bracket, you need to be more worried about using your 401k to get into the 15% bracket and not about maxing out your Roth or paying down the student loans.

9500 at 7 percent over six months is going to cost you about $300.

Every dollar that you can contribute to your 401k instead of your Roth saves you 25 cents, so your 200/mo that is currently going to your Roth is costing you 300 over six months (200x6x.25).

So just switching from Roth to 401k is the same as wiping out the student loan debt immediately, except you get to keep the Roth benefits of the tax shelter. 

The usual advice around here is to use the 401k and ignore your Roth until you can get down to the 15 percent tax bracket or your 401k is maxed out.



MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #14 on: July 23, 2015, 04:46:35 PM »
If you are in the 25% bracket, you need to be more worried about using your 401k to get into the 15% bracket and not about maxing out your Roth or paying down the student loans.

+1

Do this, get your adjusted gross income into the 15% bracket, and a lot of 'qualified' dividends & long term capital gains taxes drop to 0%

forummm

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #15 on: July 23, 2015, 04:48:07 PM »
If you are in the 25% bracket, you need to be more worried about using your 401k to get into the 15% bracket and not about maxing out your Roth or paying down the student loans.

Yes, that's what I was getting at. I would make the minimum loan payments and max out the 401k and IRA. Your student loan interest is also tax deductible, so the interest rate is effectively lower than it appears.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #16 on: July 23, 2015, 04:49:33 PM »
If you are in the 25% bracket, you need to be more worried about using your 401k to get into the 15% bracket and not about maxing out your Roth or paying down the student loans.

9500 at 7 percent over six months is going to cost you about $300.

Every dollar that you can contribute to your 401k instead of your Roth saves you 25 cents, so your 200/mo that is currently going to your Roth is costing you 300 over six months (200x6x.25).


And then once your loans are completely paid for, redirect that $200 per month payment back into your Roth IRA, once you have either maxed your 401k (about $17K for the year) or are comfortablely within the 15% AGI bracket.

Slam

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #17 on: July 23, 2015, 07:19:37 PM »
Man, this is on a whole other level now.  I'm high enough in the 25% bracket that I'll never be completely in the 15% bracket, even if I max out the 401k and Roth IRA, but I understand that every dollar closer I get saves me $0.25 towards my net worth.

Minimum loan payment is $175.  I'm gonna talk to HR tomorrow to see how close I can get to maxing out 401k.

Just a little background: I found MMM around February this year.  Before that I had set a goal to pay off my student loans before I turn 30...in August 2016.  And that was pushing it.  I was on pace for October 2016.  Then I found MMM, and as I mentioned in a previous post, am currently on pace to pay them off in Jan/Feb 2016.  The information here is life changing.

Gin1984

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #18 on: July 23, 2015, 07:21:45 PM »
Man, this is on a whole other level now.  I'm high enough in the 25% bracket that I'll never be completely in the 15% bracket, even if I max out the 401k and Roth IRA, but I understand that every dollar closer I get saves me $0.25 towards my net worth.

Minimum loan payment is $175.  I'm gonna talk to HR tomorrow to see how close I can get to maxing out 401k.

Just a little background: I found MMM around February this year.  Before that I had set a goal to pay off my student loans before I turn 30...in August 2016.  And that was pushing it.  I was on pace for October 2016.  Then I found MMM, and as I mentioned in a previous post, am currently on pace to pay them off in Jan/Feb 2016.  The information here is life changing.
Can you get low enough, with your 401k, that you are eligible to use a traditional IRA and get out of it that way?

Slam

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #19 on: July 23, 2015, 07:52:23 PM »
Can you get low enough, with your 401k, that you are eligible to use a traditional IRA and get out of it that way?

Are you referring to below the $61,000 limit for traditional IRA deductions?  I can get below 61k with 401k contributions.  But wouldn't it be better long term to use the Roth so my gains aren't taxed?  My understanding is that if I convert to Roth later, I still have to pay taxes on my contributions.

forummm

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #20 on: July 23, 2015, 07:55:02 PM »
Can you get low enough, with your 401k, that you are eligible to use a traditional IRA and get out of it that way?

Are you referring to below the $61,000 limit for traditional IRA deductions?  I can get below 61k with 401k contributions.  But wouldn't it be better long term to use the Roth so my gains aren't taxed?  My understanding is that if I convert to Roth later, I still have to pay taxes on my contributions.

Yes, that's what Gin is saying. The idea is that your tax rate will be lower in retirement, so you'll be paying less tax when you do the conversions later.

Gin1984

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #21 on: July 23, 2015, 07:59:59 PM »
Can you get low enough, with your 401k, that you are eligible to use a traditional IRA and get out of it that way?

Are you referring to below the $61,000 limit for traditional IRA deductions?  I can get below 61k with 401k contributions.  But wouldn't it be better long term to use the Roth so my gains aren't taxed?  My understanding is that if I convert to Roth later, I still have to pay taxes on my contributions.
Yes, but the likelyhood of paying 25% is not high.  My mom is single and spends a ton and still stays in the 15% once she retired and she is paying Ca taxes (and is rolling a couple thousand into a Roth every year still within the 15% bracket).

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #22 on: July 23, 2015, 08:57:10 PM »
But wouldn't it be better long term to use the Roth so my gains aren't taxed?  My understanding is that if I convert to Roth later, I still have to pay taxes on my contributions.
Remembering that A * B * C = A * C * B, do you see how this post addresses that question?

sol

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #23 on: July 23, 2015, 09:42:10 PM »
Remembering that A * B * C = A * C * B, do you see how this post addresses that question?

If only rates 1 and 2 were equal, then sure.  But OP is guaranteed to pay 25% off the top for rate 1, and will have thousands of dollars of 0% tax rate (standard deduction, personal exemptions, etc) on the bottom before rate 2.  So even if the tax bracket doesn't change, the effective rates are not the same if the income level does.

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #24 on: July 23, 2015, 09:48:18 PM »
So even if the tax bracket doesn't change, the effective rates are not the same if the income level does.

Having trouble following that.  If the tax bracket doesn't change, then by definition the effective rates are the same - aren't they?

asiljoy

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #25 on: July 23, 2015, 09:58:32 PM »
Following.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #26 on: July 23, 2015, 11:03:42 PM »
Man, this is on a whole other level now.  I'm high enough in the 25% bracket that I'll never be completely in the 15% bracket, even if I max out the 401k and Roth IRA,

I earned $129K last year, and my AGI rang in at just over $50K.  It has taken me years to arrange my finances to this end, but it is possible.  Do you make more than I?

With regards to FI, a quote from Rich Dad, Poor Dad seems appropriate here.  The rich do not work for money.  The rich work for assets.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #27 on: July 23, 2015, 11:12:23 PM »
So even if the tax bracket doesn't change, the effective rates are not the same if the income level does.

Having trouble following that.  If the tax bracket doesn't change, then by definition the effective rates are the same - aren't they?

Not completely, the tax brackets are 'progressive'.  This means that everyone is in the 15% bracket up to the point that they cross into the 25% bracket, and that the income they earned first is only taxed at 15%, regardless of how high they go.  So if you can reduce your adjusted gross income using tax breaks, credits & deductions today; you will save those taxes from the top of your income, at the full 25% rate.  However, after FIRE, those funds that were never taxed start at the bottom of the progressive tax structure, so that most of them are taxed at, in order 0% till you hit the standard deduction, 10% till you hit that level and then 15% till you hit the next level.  So even if you end up back in the 25% tax bracket in retirement (unlikely for most of us), your effective tax rate, or average tax rate, is certain to be lower.

The advantage for investments, held outside of tax advantaged accounts, getting special tax treatments simply because you can stay inside the 15% tax bracket range is just a bonus to that.

sol

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #28 on: July 23, 2015, 11:19:19 PM »
Having trouble following that.  If the tax bracket doesn't change, then by definition the effective rates are the same - aren't they?

If you are currently in the 25% tax bracket and not maxing your 401k, then you definitely save 25% this year by contributing, because that's your marginal rate.

If you are in the 0% or 15% tax brackets in retirement and then withdraw those same dollars, you can be paying 0 or 15% tax on them in the future instead of 25% today.  By lowering your income in retirement, you lower the tax rate you pay on those dollars.

The traditional argument, which MDM reiterated, is that paying taxes now or later doesn't matter if the tax rates are the same, but the tax rates are never the same for someone who is saving money for retirement because as soon as they retire their "income" drops because they are no longer "spending" money on investments.  By virtue of being a saver, your expenses (aka income) in retirement will by definition be lower than they were while working.  Lower income translates into that income ending up in a a lower tax bracket.

It's really no different than the plan commonly discussed around here by people (like me) who intend to never pay a dime of taxes on their 401k contributions.  They will get slowly converted to a Roth IRA over many years of retirement, each year's conversion amount staying low enough to fit in the 0% tax bracket.  For a MFJ couple with deductions and exemptions and kids, that can easily be 50k/year.  5 years later they can come out of the Roth tax free, and I've never paid any income tax on those dollars.  Not when I earned it, not as it grew, not when it converted, not when it was withdrawn.

This is why tax deferred plans are so much better than Roth plans for anyone who actually pays income taxes.  If you're low-income enough (or have a large enough familiy) to not pay income taxes anyway, then the Roth is generally a better deal.  And of course the Roth is usually considered a better deal than just investing in a straight up taxable brokerage account, so most of us above 25% fill the 401k first, then the Roth, then the taxable.

sol

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #29 on: July 23, 2015, 11:25:21 PM »
So even if the tax bracket doesn't change, the effective rates are not the same if the income level does.

Having trouble following that.  If the tax bracket doesn't change, then by definition the effective rates are the same - aren't they?

I think MDM already knows everything I just posted, and the confusion is my fault for not being clear in my original post.  When I said "even if the tax bracket doesn't change" what I meant was "even if Congress doesn't change the structure of the tax code or raise the bracket cutoff amounts."  If your marginal income were to fall in the 25% bracket both before or after retirement, then assuming all else was equal (kid deductions, for example) then yes the effective rates would be the same.

But as we discussed, your income in retirement is determined by your expenses, which are lower than your income while working because while working you were putting some of that money into savings.  So every saver (with taxable savings like a Roth) who keeps a constant level of spending across the FIRE threshhold is going to pay a lower tax rate after retirement than before.

GreenPen

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #30 on: July 23, 2015, 11:45:29 PM »
Just a quick note to the OP.

The final year that my wife and I were both in graduate school, we actually took out a student loan that we used to fund a Roth while our marginal tax rate was at zero. The next year, when our income jumped considerably, we paid off that loan and still maxed out our retirement accounts.

I think that's basically the opposite of what you are thinking of doing.

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #31 on: July 24, 2015, 01:12:56 AM »
When I said "even if the tax bracket doesn't change" what I meant was "even if Congress doesn't change the structure of the tax code or raise the bracket cutoff amounts."  If your marginal income were to fall in the 25% bracket both before or after retirement, then assuming all else was equal (kid deductions, for example) then yes the effective rates would be the same.
Thanks, that makes sense.  And I agree with all the rest.

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #32 on: July 24, 2015, 01:54:47 AM »
So even if you end up back in the 25% tax bracket in retirement (unlikely for most of us), your effective tax rate, or average tax rate, is certain to be lower.
If you end up back at exactly the same place in retirement, both your marginal and effective (aka average) tax rates will be the same as they were before retirement.  That's simply by definition.

I'm guessing (please correct if otherwise) that you may be referring to the "Traditional plans are good because you save at the marginal rate but pay at the average rate" belief.  Traditional plans can indeed be great for early retirees because their marginal rates are lower in retirement.  E.g., sol's description:
Quote
It's really no different than the plan commonly discussed around here by people (like me) who intend to never pay a dime of taxes on their 401k contributions.  They will get slowly converted to a Roth IRA over many years of retirement, each year's conversion amount staying low enough to fit in the 0% tax bracket.  For a MFJ couple with deductions and exemptions and kids, that can easily be 50k/year.  5 years later they can come out of the Roth tax free, and I've never paid any income tax on those dollars.  Not when I earned it, not as it grew, not when it converted, not when it was withdrawn.

It is somewhat difficult in real life to keep track of what money was contributed at what tax, and how much tax was taken on that same money and its returns when withdrawn.  For discussion purposes, let's assume that each year's 401k/IRA/etc. contribution will be placed in a separate account so it can be tracked.  Let's also assume there will be a base annual income, $Base, available in retirement.  This base can be anything from $0 on up, and can come from pension, rentals, Soc. Sec., inherited IRAs, part-time work, etc.

The first year one makes a 401k/IRA contribution, any taxable withdrawals will be taxed at the marginal rate starting at $Base.  Compare the marginal contribution tax to the marginal withdrawal tax and make the consequent trad vs. Roth decision.

The second year one makes a 401k/IRA contribution, one then knows that withdrawals will be taxed at the marginal rate starting at ($Base + any withdrawal coming from a previous traditional contribution).  Compare the marginal contribution tax to the marginal withdrawal tax and make the consequent trad vs. Roth decision.  Repeat for each subsequent year.

The more one contributes to traditional accounts, the higher the marginal rate on withdrawals becomes.  If, as in sol's example, the marginal rate in retirement is always lower than when contributing, traditional is always better.  But, due for example to a high $Base or high traditional contributions and/or returns, one can get to a point at which any further traditional contributions will be withdrawn at a marginal rate higher than the contributory rate.  When that happens, Roth becomes better.

Of course, one can instead start by contributing to a Roth.  Doing this, the marginal withdrawal rate stays at whatever corresponds to $Base until the first traditional contribution is made.

Knowing one's marginal rate(s) in retirement does require an unnaturally clear crystal ball, so there will be some guesswork.  Just keep the guesswork to marginal rates and ignore average rates.

Slam

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #33 on: July 24, 2015, 10:35:12 AM »
But wouldn't it be better long term to use the Roth so my gains aren't taxed?  My understanding is that if I convert to Roth later, I still have to pay taxes on my contributions.
Remembering that A * B * C = A * C * B, do you see how this post addresses that question?
After some research and a better understanding of the situation, yes, I now understand your previous post.

Basically if I were in a lower tax bracket, then a Roth would be the way to go.  For people that make more money, traditional tax deferred contributions accounts are what they should be maxing out.

Bob W

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #34 on: July 24, 2015, 10:38:05 AM »
Nope,  no way. 

sol

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #35 on: July 24, 2015, 11:35:44 AM »
Quote from: Slam link=topic=40912.msg743019#msg743019
Basically if I were in a lower tax bracket, then a Roth would be the way to go.  For people that make more money, traditional tax deferred contributions accounts are what they should be maxing out.

Hooray!  I love it when new people get on board and listen to good advice.  Not everyone understand the point you've just made, so congratulations for being adept enough to see the benefits of this strategy.

Now to complicate that happy little story, there are always exceptions to worry about.  If you have crazy high deductions, like from bad rental properties, you might already be in a low bracket with high income.  If you're active military the rules are totally different due to tax exclusions.  If you're trying to game the ACA cutoffs then you might be trying to show more taxable income, not less.  If you're trying to build a five year cushion to live off of during the Roth pipeline seasoning period it might make sense to forego the tax savings this year in order to retire earlier.  And importantly for some folks here, if your projected retirement income is significantly higher than your working income then the rules are exactly backwards.  That last one mostly applies to people with long careers and good pensions.

But generally speaking, for most situations, you're right on the money.  Max your tax deferred accounts first if you're paying a high marginal rate this year.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #36 on: July 24, 2015, 11:37:34 AM »
So even if you end up back in the 25% tax bracket in retirement (unlikely for most of us), your effective tax rate, or average tax rate, is certain to be lower.
If you end up back at exactly the same place in retirement, both your marginal and effective (aka average) tax rates will be the same as they were before retirement.  That's simply by definition.

I'm guessing (please correct if otherwise) that you may be referring to the "Traditional plans are good because you save at the marginal rate but pay at the average rate" belief.

Well, sort of; but it's not belief.  I can prove it mathmaticly.  I don't disagree with Sol or yourself are saying about high rate savers always having a lower income in retirement, due mostly to the fact that our income put towards savings is currently part of that income, that we will not need.  Add to that the fact that early retirees have a great deal of control over what their taxable income will be, and it works well.  My additional point above is that, because a high income earner that puts anything into a traditional pre-tax IRA or 401k is reducing their current adjusted gross income, when the income comes back out of those accounts, the first dollars will always be taxed at a lower rate than what went in, simply due to the nature of the progressive tax bracket structure plus the standard deductions.  The additional tricks advocated by forum members here, such as the roth ladder, are just bonuses on top.  The 0% tax bracket trick that you are shooting for is a hard target to hit, and requires a great deal of advance & ongoing planning; but the 'first dollar' advantage of a pre-tax account is pretty much automatic. 
« Last Edit: July 24, 2015, 11:40:45 AM by MoonShadow »

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #37 on: July 24, 2015, 11:52:21 AM »
Well, sort of; but it's not belief.  I can prove it mathmaticly.
It would be very interesting to see that.  Other analyses have shown that the average rate is irrelevant and the marginal rate is what is important.

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My additional point above is that, because a high income earner that puts anything into a traditional pre-tax IRA or 401k is reducing their current adjusted gross income, when the income comes back out of those accounts, the first dollars will always be taxed at a lower rate than what went in, simply due to the nature of the progressive tax bracket structure plus the standard deductions.
In any given year there is only one "first dollar."  One can't assume that every traditional contribution gets to use that first dollar.  And if there is a base income, the first withdrawal dollar comes on top of that base income.
In effect, every withdrawal dollar other than the first comes on top of some base, and is thus taxed at the pertinent marginal rate.  Think of this in terms of each year's contributions, and the tax rate for that year's contribution upon withdrawal.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #38 on: July 24, 2015, 12:23:44 PM »

My additional point above is that, because a high income earner that puts anything into a traditional pre-tax IRA or 401k is reducing their current adjusted gross income, when the income comes back out of those accounts, the first dollars will always be taxed at a lower rate than what went in, simply due to the nature of the progressive tax bracket structure plus the standard deductions.
In any given year there is only one "first dollar."  One can't assume that every traditional contribution gets to use that first dollar.  And if there is a base income, the first withdrawal dollar comes on top of that base income.
In effect, every withdrawal dollar other than the first comes on top of some base, and is thus taxed at the pertinent marginal rate.  Think of this in terms of each year's contributions, and the tax rate for that year's contribution upon withdrawal.

Yes, each year there is a 'first dollar', and a 0% bracket, and a 10% bracket and a 15% to fill up before you get to the 25% bracket.  So even if you end up in the 25% bracket every time, some portion of what you saved in your 401k will always be taxed at a lower rate than what it went into the 401k to avoid.  It may not save much, and I neither advocate a 401k over a Roth, nor do I personally operate this way (in part, because I stay down in the 15% bracket, where neither type of tax advantaged account has an overwelming advantage); but the math is easy, and should be obvious.  Yes, the average tax you pay does matter.  For example, I'm in the 15% bracket, but my actual average is about 7%.  The Roth IRA, with planning, is an excellent tool to get that average down in retirement; which is exactly the goal with the "0% tax bracket" concept.  There is no 0% tax bracket, really; your goal is to suppress your average tax to zero.  I'm not really motivated to step through the math at the moment, but it's pretty straight forward if you want to take it on.

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #39 on: July 24, 2015, 12:37:38 PM »
... the math is easy, and should be obvious. 
I'm not really motivated to step through the math at the moment, but it's pretty straight forward if you want to take it on.
If it is obvious, it would be good to see it, as I (and others) have taken it on and the answer has been "marginal vs. marginal" as the correct basis for comparison.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #40 on: July 24, 2015, 01:31:00 PM »
You seem convinced in your position.  I have neither the motivation nor the inclination to change your mind.  The differences, to myself, are small enough to not be worth the argument.  If it means that much to you, please feel free to change my mind.  I suspect I'm not as rigid in my position as you are in yours.

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #41 on: July 24, 2015, 02:02:07 PM »
You seem convinced in your position.  I have neither the motivation nor the inclination to change your mind.  The differences, to myself, are small enough to not be worth the argument.  If it means that much to you, please feel free to change my mind.  I suspect I'm not as rigid in my position as you are in yours.

This is a very data-based forum. People generally come to share ideas and evidence. I've noticed you like to make claims that don't comport with how other people see the world. If you do that, you should expect people to want to learn what it is you have to share and why you think that way. If you know better than they about a topic, they are here to learn from you. The culture here is that people generally share the information that leads them to make a claim (bold or otherwise). So if you make bold claims but don't want to or can't provide something to back them up, expect people to be curious why that is. People here generally like to learn.

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #42 on: July 24, 2015, 02:03:28 PM »
You seem convinced in your position.  I have neither the motivation nor the inclination to change your mind.  The differences, to myself, are small enough to not be worth the argument.  If it means that much to you, please feel free to change my mind.  I suspect I'm not as rigid in my position as you are in yours.
Quick example:
 - no previous 401k/IRA contributions
 - currently in 25% marginal bracket
 - retirement base income reaches the bottom of the 28% bracket
 - 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?

frugaliknowit

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #43 on: July 24, 2015, 02:16:14 PM »
1.  No, don't withdraw from the Roth to pay off a student loan.

2.  I realize people on this site are big on saving pre-tax on the theory that you will be able to withdraw the funds at a lower rate.  I am of the belief that you should diversify your tax exposure (some pre-tax, some tax-free) to lower your risk.  With tax rates at historic lows, sorry, but I'm not going to bet that tax rates will be the same or lower when I am ready to tap the pre-tax funds (Roth IRA pipline or not). 

3.  Tax deferall IS NOT TAX SAVINGS unless you withdraw the money at a lower rate.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #44 on: July 24, 2015, 03:00:32 PM »
You seem convinced in your position.  I have neither the motivation nor the inclination to change your mind.  The differences, to myself, are small enough to not be worth the argument.  If it means that much to you, please feel free to change my mind.  I suspect I'm not as rigid in my position as you are in yours.
Quick example:
 - no previous 401k/IRA contributions
 - currently in 25% marginal bracket
 - retirement base income reaches the bottom of the 28% bracket

Why?  If you are going to contrive a rigid base income, please explain how that happens.  I could see how an old fashioned pension could do this, but not before an official retirement age, say 60.  The age at which such a pension starts is also important, because the roth ladder can be employed up until this point to bleed off 401k funds.  If the base income comes from work or business income, you still have great control on how it happens, and you're not likely actually retired if you are in the 28% tax bracket with regular income.  Still, this would be a wonderful problem to have.

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.

Pre-retirement funds hit 25% marginal rate, and the post-retirement average hits 18%.  That's a 7% advantage to the 401k, but we have 401k's to form our base income.  If you have a pension that pay's out into the 28% marginal tax bracket, you don't need the 401k at all, and can simply leave it alone till age 70.5.  In this case, paying equal taxes on those withdrawn funds may be eventually unavoidable, but paying more is always avoidable; simply by donating those required distributions to your church, thereby creating a new deduction for the following tax year.  The short story is that, if you are in a high marginal bracket, the funds you put into a pre-tax account helps now & the risk of it making things worse after retirement are extremely low (under current tax law).

That said, I consider future income tax changes to be more likely to go up than down, so I put funds into a Roth just so I can have another "bucket" to draw from in the event I need a spike in funds that would otherwise throw me into a higher bracket.

MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #45 on: July 24, 2015, 03:06:14 PM »
You seem convinced in your position.  I have neither the motivation nor the inclination to change your mind.  The differences, to myself, are small enough to not be worth the argument.  If it means that much to you, please feel free to change my mind.  I suspect I'm not as rigid in my position as you are in yours.

This is a very data-based forum. People generally come to share ideas and evidence. I've noticed you like to make claims that don't comport with how other people see the world. If you do that, you should expect people to want to learn what it is you have to share and why you think that way. If you know better than they about a topic, they are here to learn from you. The culture here is that people generally share the information that leads them to make a claim (bold or otherwise). So if you make bold claims but don't want to or can't provide something to back them up, expect people to be curious why that is. People here generally like to learn.

Noted.  Still not convinced that it's worth my effort here, this argument about Roth versus Traditional has been going on by professionals for more than a decade, and seems more like ideology than reason, and I'm not interested in debating dogma.

beltim

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #46 on: July 24, 2015, 03:20:02 PM »
- 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.

Pre-retirement funds hit 25% marginal rate, and the post-retirement average hits 18%.  That's a 7% advantage to the 401k, but we have 401k's to form our base income.  If you have a pension that pay's out into the 28% marginal tax bracket, you don't need the 401k at all, and can simply leave it alone till age 70.5.  In this case, paying equal taxes on those withdrawn funds may be eventually unavoidable, but paying more is always avoidable; simply by donating those required distributions to your church, thereby creating a new deduction for the following tax year.  The short story is that, if you are in a high marginal bracket, the funds you put into a pre-tax account helps now & the risk of it making things worse after retirement are extremely low (under current tax law).

That said, I consider future income tax changes to be more likely to go up than down, so I put funds into a Roth just so I can have another "bucket" to draw from in the event I need a spike in funds that would otherwise throw me into a higher bracket.

Everything about this scenario - including your hypothesis that future taxes are more likely to be higher than lower - favors a Roth.  MDM set it up so there is literally no possible way the traditional pre-tax account is better.

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #47 on: July 24, 2015, 03:49:49 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 actually think that personal conditions determine which is better for the individual, and that almost everyone should have both; favoring each in different years for different reasons.  I was pointing out as a generality, and under current tax laws; a high marginal tax rate favors the current tax deduction in the current year, because it helps now and is as least as likely to improve in retirement, due to a lower averaged rate (when the 401k is used as the base taxable income) as it is to actually make things worse.

Quote
  MDM set it up so there is literally no possible way the traditional pre-tax account is better.

Yes, he did set it up.  Contrived, really.  In practice, the individual has a lot more control over his income in retirement than before. 

MDM

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #48 on: July 24, 2015, 05:45:27 PM »
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 actually think that personal conditions determine which is better for the individual
Assuming you meant "traditional over a Roth" then I agree neither is always better.

Quote
I was pointing out as a generality, and under current tax laws; a high marginal tax rate favors the current tax deduction in the current year, because it helps now and is as least as likely to improve in retirement, due to a lower averaged rate (when the 401k is used as the base taxable income)
Here's where it seems - although maybe not - that we disagree.  Where "averaged" appears in the quote, "marginal" seems more correct* as it doesn't require any qualifying phrases. 

We also agree that one might "favor... each in different years."  Assuming (yes, one can split contributions in a given year but for simplicity...) that each year's contribution goes either to traditional or Roth, one faces a new decision each year.  For a new year's contributions, one has to estimate the rate at which they will be taxed when withdrawn and compare that to the tax for the contributing year.  That estimate should include as a base both any "outside" income (pension, SS, whatever) plus withdrawals from traditional contributions already made.  Thus the new year's withdrawals will be taxed at the withdrawal year's marginal rate.

Quote
Yes, he did set it up.  Contrived, really.
Yes, it was contrived to illustrate the point between averaged and marginal.  Not (as I hope is clear by now) to claim either traditional or Roth is inherently better than the other.


*Although, if one's withdrawal spans a bracket, the "average" tax paid for withdrawal of a specific year's contribution would be a correct input to the analysis.


MoonShadow

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Re: Should I use Roth IRA funds to wipe out student loans?
« Reply #49 on: July 24, 2015, 06:05:03 PM »
MDM, I don't think our particular perspectives are as far removed from each other as it may have at first appeared.