Author Topic: Tax Free, Tax Deferred and Fully Taxable - How to distribute your investments  (Read 2656 times)

mb196

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The more I read about this topic the more confused I get.  Here's what I know:

                                   what you save is                                ||           what you withdraw will be
Tax Free:   your money is taxed, i.e.: taxed money          ||         withdrawals are NOT taxed.  Example:529s
Deferred:    your money is NOT taxed, i.e.: pre-tax money   ||         withdrawals are taxed at whatever rate one is in at retirement.  Example: 401K
Fully Taxable:     This is the worst kind -- compared to the other two -- since your money is taxed when you save it and is taxed once again when you withdraw.  Example, money you place in savings accounts or regular mutual funds (outside IRAs).

What I want to know is how other mustachians allocate their invesments.  The advice I have read is that one should distribute their investments/savings among these three categories, but no one says what the percentages should be. 

Does anyone out there care to throw percentages or to start the debate about which factors one should consider.

If there are mistakes on my post, please remember my opening about being very confused.

Also, and maybe this last part should be another thread, but what are the options available for either of those categories, especially the first two.

Pancho


AJ

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Fully Taxable:     This is the worst kind -- compared to the other two -- since your money is taxed when you save it and is taxed once again when you withdraw.  Example, money you place in savings accounts or regular mutual funds (outside IRAs).

You aren't really taxed when you withdraw, you are just taxed on your earnings. So, if you have $100k in a savings account at 1%, and you spend half of it in a year ($50k) you are taxed on the 1% you earned, not the $50k you spent.

That being said, we max out our 401(k) for the tax deduction because we are in a higher tax bracket now than we expect to be later. We also contribute to a Roth because the first $20k of income isn't taxed anyway.

So, for example, let's say we need $30k to live in retirement. The first $20k or so isn't taxable (standard deduction/exemptions). So, we'll pull $20k from our traditional 401(k), and the other $10k from Roth (also not taxable). In effect, paying no taxes. That's all really quite theoretical, as many factors can change, but that's the general idea of why you want money in multiple buckets.

We also save in taxable accounts for flexibility. For example, while there are ways to buy real estate within retirement accounts, it is more complex than buying it with post-tax money.

I can't really help you with percentages, since we max out the tax-deferred/exempt options. It is really going to depend on your income, goals, timeline, investment preferences, and guess about future tax rates.