Author Topic: Too Many Tax-Advantaged Accounts - Need Help Prioritizing  (Read 4624 times)

mammothunder

  • 5 O'Clock Shadow
  • *
  • Posts: 16
Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« on: September 01, 2015, 02:02:51 PM »
Due to a recent job change, my husband and I now have more retirement plans than we can possibly max out.  We each have a 403(b), a 457(b), and an IRA = 4*$18,000 + 2*$5,500 = $83,000 of tax sheltered space.  We make $106,524 gross combined.  We need help prioritizing which accounts to fill first.  Here is our current strategy:
  • Mandatory 5% into 403(b) = $5,326.20
  • Employer contributes 9.29% into 403(b) = $9,896.08
  • Governmental 457(b) = $12,000
  • Roth IRA = $11,000 (since we end up in the 15% tax bracket after contributing enough to the tax-deferred plans)
The investment options and expense ratios seem to be comparable for all of the plans.  Our 403(b) and 457(b) plans are with TIAA-CREF, and our IRAs are with Vanguard.  We’re just doing the target date funds until I have time to write a different post with questions regarding specific funds and asset allocation.

If we want to put more into the 403(b) beyond the mandatory 5% contribution, we can choose either tax-deferred or Roth.  The 457(b) doesn’t have this choice; it’s always tax-deferred.

Goals:  Minimize taxes.  Diversify when we pay taxes.  Withdraw money easily in early retirement, presumably through the 457(b) plans and Roth IRA contributions.

General Questions:  Do you agree with our current strategy?  If we start saving more money (which I’m hoping we will now that we’re switching from Mint to YNAB), where should we put it?

Specific Questions:  Lots of people here seem to think Traditional IRAs are better than Roth IRAs, and I’m trying to figure out what is best for our situation.
  • I read that one can convert Traditional IRAs to Roth IRAs in early retirement and pay no taxes.  This seems to depend on living off of capital gains and dividends from a taxable account though.  So this doesn’t apply to us, right?
  • I’ve always understood that Traditional IRAs and Roth IRAs are equivalent if you’re in the same tax bracket now and in retirement.  I assume we’ll be in the same tax bracket in retirement, so I chose the Roth IRA just to diversify when we pay taxes.  Then, I read that I need to compare my marginal tax rate today to my effective tax rate in retirement.  Mind blown.  If I go with all tax-deferred plans, then I’m eliminating all of my 25% burden and a good chunk of my 15% burden now… and I’m paying 0%, 10%, and some 15% in retirement.  I don’t even know what my specific question is here.  Someone please help!

MDM

  • Senior Mustachian
  • ********
  • Posts: 10112
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #1 on: September 01, 2015, 02:24:22 PM »
...I need to compare my marginal tax rate today to my effective tax rate in retirement.

Let's start with this one.  In short, that statement is not correct. 

Go back to what you have "always understood that Traditional IRAs and Roth IRAs are equivalent if you’re in the same tax bracket now and in retirement."

The analysis can get a lot more complex than either of the phrases above, but the "use marginal rates for comparison" approach is more likely to apply.

themagicman

  • Bristles
  • ***
  • Posts: 394
  • Age: 30
  • Location: Atlanta, GA
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #2 on: September 01, 2015, 02:28:12 PM »
Due to a recent job change, my husband and I now have more retirement plans than we can possibly max out.  We each have a 403(b), a 457(b), and an IRA = 4*$18,000 + 2*$5,500 = $83,000 of tax sheltered space.  We make $106,524 gross combined.  We need help prioritizing which accounts to fill first.  Here is our current strategy:
  • Mandatory 5% into 403(b) = $5,326.20
  • Employer contributes 9.29% into 403(b) = $9,896.08
  • Governmental 457(b) = $12,000
  • Roth IRA = $11,000 (since we end up in the 15% tax bracket after contributing enough to the tax-deferred plans)
The investment options and expense ratios seem to be comparable for all of the plans.  Our 403(b) and 457(b) plans are with TIAA-CREF, and our IRAs are with Vanguard.  We’re just doing the target date funds until I have time to write a different post with questions regarding specific funds and asset allocation.

If we want to put more into the 403(b) beyond the mandatory 5% contribution, we can choose either tax-deferred or Roth.  The 457(b) doesn’t have this choice; it’s always tax-deferred.

Goals:  Minimize taxes.  Diversify when we pay taxes.  Withdraw money easily in early retirement, presumably through the 457(b) plans and Roth IRA contributions.

General Questions:  Do you agree with our current strategy?  If we start saving more money (which I’m hoping we will now that we’re switching from Mint to YNAB), where should we put it?

Specific Questions:  Lots of people here seem to think Traditional IRAs are better than Roth IRAs, and I’m trying to figure out what is best for our situation.
  • I read that one can convert Traditional IRAs to Roth IRAs in early retirement and pay no taxes.  This seems to depend on living off of capital gains and dividends from a taxable account though.  So this doesn’t apply to us, right?
  • I’ve always understood that Traditional IRAs and Roth IRAs are equivalent if you’re in the same tax bracket now and in retirement.  I assume we’ll be in the same tax bracket in retirement, so I chose the Roth IRA just to diversify when we pay taxes.  Then, I read that I need to compare my marginal tax rate today to my effective tax rate in retirement.  Mind blown.  If I go with all tax-deferred plans, then I’m eliminating all of my 25% burden and a good chunk of my 15% burden now… and I’m paying 0%, 10%, and some 15% in retirement.  I don’t even know what my specific question is here.  Someone please help!

I would do 1 and 2 the same. Then I would max out the 457 (I love these) and then put the rest in a traditional IRA instead

seattlecyclone

  • Walrus Stache
  • *******
  • Posts: 5292
  • Age: 35
  • Location: Seattle, WA
    • My blog
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #3 on: September 01, 2015, 02:39:55 PM »
General Questions:  Do you agree with our current strategy?  If we start saving more money (which I’m hoping we will now that we’re switching from Mint to YNAB), where should we put it?

I think your general strategy makes sense. Do whatever you need to do to get the maximum 403(b) match first. After that, the 457(b) plans are great because they're easy to withdraw from during early retirement without paying penalties or needing to go through any of the shenanigans like the Roth ladder or SEPP withdrawals. Once you're in the 15% bracket, putting a bit into Roth accounts to get some tax diversification isn't a terrible idea, but you may still want to prefer traditional IRAs if you expect your tax bracket to be lower than 15% during your retirement.

Quote
I read that one can convert Traditional IRAs to Roth IRAs in early retirement and pay no taxes.  This seems to depend on living off of capital gains and dividends from a taxable account though.  So this doesn’t apply to us, right?

Roth conversions and straight withdrawals from pre-tax retirement accounts both count as "regular income" and are taxed accordingly. To the extent that your regular income is less than your standard deduction ($12,600 for a married couple) plus your personal exemptions ($4,000 per family member), you do not need to pay tax on this income.

If it's just you and your spouse in your family at the time of your retirement, that means the first $20,600 of withdrawals/conversions are tax free. If you plan to retire with all of your savings in your retirement accounts, and you plan to spend more than $20,600 per year (in today's dollars), you will pay some tax on any excess. Depending on when you retire and how big your 457(b) balance is at that time, Roth conversions may not be necessary at all for you though.

Quote
I’ve always understood that Traditional IRAs and Roth IRAs are equivalent if you’re in the same tax bracket now and in retirement.  I assume we’ll be in the same tax bracket in retirement, so I chose the Roth IRA just to diversify when we pay taxes.  Then, I read that I need to compare my marginal tax rate today to my effective tax rate in retirement.  Mind blown.  If I go with all tax-deferred plans, then I’m eliminating all of my 25% burden and a good chunk of my 15% burden now… and I’m paying 0%, 10%, and some 15% in retirement.  I don’t even know what my specific question is here.  Someone please help!

No, don't worry about your effective rate in retirement. Compare marginal dollars now to marginal dollars later. Suppose you're currently on track to have 75% of your money in pre-tax retirement accounts and 25% in Roth accounts when you retire. To maximize your post-tax money, you'll probably want to withdraw 75% from pre-tax and 25% from Roth in a typical year to keep things in balance.

If you plan to withdraw $40k per year, that means you'll have $30k of gross income subject to tax, and $10k that is untaxed. As I said above, the first $20,600 of gross income is tax free. That leaves $9,400 of taxable income, which puts you right in the middle of the 10% tax bracket.

If you switched some of your Roth conversions to traditional and kept that up as long as you're working, you might put yourself on track to have 90% traditional and 10% Roth at the time of retirement. That decision would increase your taxable income during retirement because you have less Roth money to withdraw. This income would be taxed at your marginal retirement rate (10%). The 15% bracket doesn't start until you're past $39k of gross income. Compare this rate to what you're paying now. Are you in the 15% bracket? Maybe decreasing your Roth contributions in favor of more traditional contributions would make sense.

Note that the effective tax rate doesn't come into play here. It's all marginal. If you change your saving behavior now, how will that change your withdrawal behavior later? Those dollars are taxed based on marginal rates at that income level.

MDM

  • Senior Mustachian
  • ********
  • Posts: 10112
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #4 on: September 01, 2015, 02:51:45 PM »
General Questions:  Do you agree with our current strategy?  If we start saving more money (which I’m hoping we will now that we’re switching from Mint to YNAB), where should we put it?
Appears you are off to a good start.  Also take note everything seattlecyclone said - it's good advice.

See http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/ if you want even more details on that topic.

In the lists below, thinking "first your 457, then your 401k and/or 403b" wherever "401k" appears will (as s.c. noted) serve you well.  Also, these are more "guidelines" than "rules".

WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Roth or Traditional IRA based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in taxable account with any extra.

WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.
4. Rule of thumb: trad if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between
5. See #4 for choice of traditional or Roth for 401k
6. Applicability depends on the rules for the specific 401k
7. Again, take the risk-free return if high enough
8. Because earnings, even if taxed, are beneficial

mammothunder

  • 5 O'Clock Shadow
  • *
  • Posts: 16
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #5 on: September 03, 2015, 11:16:14 AM »
I actually saw the “guidelines” in the case study spreadsheet last week, and that’s what prompted my questions.  I wasn’t sure where to put the 457(b) in the list, and I wanted a more rigorous approach to #4 than flipping a coin.  :)  Thank you for bringing me back to reality with respect to the Traditional vs. Roth debate!  The thread that MDM linked was very helpful, and then I found the Bogleheads link on the topic.

seattlecyclone – Thanks for providing some simple examples to show that we could easily end up in the 10% bracket when we retire.  It seems like a good strategy would be to withdraw just enough from the Roth so that you end up at the top of the 10% bracket.  We ran some numbers to see what would happen:  Suppose we want to spend $44,000 per year in retirement.  Add 10%*$18,450 = $1,845 for taxes to see that we need to withdraw $45,845.  Subtract $45,845 - $20,600 - $18,450 = $6,795.  Therefore, we’d want to withdraw $6,795 from Roth and the remaining $39,050 from Traditional, which is a 15% Roth / 85% Traditional split.

Our current contributions are split 29% Roth / 71% Traditional, so I see a few options:
  • Ideally, just save more, and put all extra savings in the 457(b).
  • Might be hard to save more, so put less in the Roth IRAs and more in the 457(b).
  • Keep putting too much in the Roth IRAs for now since the yearly limit is low compared to the 457(b).  Then, we can always put more in the 457(b) later.

Question:  Is there a typical Roth / Traditional split that people like to have when they retire?  I know there are lots of factors to consider, but there seems to be a pretty big difference between say 25%/75% and 10%/90%.

After considering the tax implications, my husband started worrying about having enough money available to withdraw without penalty before turning 59 ½.  We might be able to retire as early as 45 and 47.  (We’re 28 and 30 now.)  To keep things simple, I only considered the 457(b) for funding the 12.5 year gap even though we’ll probably withdraw some of the Roth contributions too.

I did a PV annuity for the 12.5 years with monthly withdrawals of $3,800 and 6% rate of return to get PV=$400,329.91.  In other words, we would need to have $400,329.91 in the 457(b) at the beginning of retirement.  Then, I did an FV annuity for 17 years with monthly contributions of $1,000 and 6% rate of return to get FV=$353,231.11.  Conclusion:  We really should increase our contributions to the 457(b).

Here’s the question:  My husband doesn’t trust any of my calculations because I didn’t account for inflation.  He thinks the situation is much worse.  I told him that doing all of the calculations in today’s dollars is okay as long as we increase our contributions each year with inflation.  Also, it’s not like I was doing a 10% rate of return.  Are my calculations valid?

JLee

  • Walrus Stache
  • *******
  • Posts: 6047
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #6 on: September 03, 2015, 11:26:24 AM »
I actually saw the “guidelines” in the case study spreadsheet last week, and that’s what prompted my questions.  I wasn’t sure where to put the 457(b) in the list, and I wanted a more rigorous approach to #4 than flipping a coin.  :)  Thank you for bringing me back to reality with respect to the Traditional vs. Roth debate!  The thread that MDM linked was very helpful, and then I found the Bogleheads link on the topic.

seattlecyclone – Thanks for providing some simple examples to show that we could easily end up in the 10% bracket when we retire.  It seems like a good strategy would be to withdraw just enough from the Roth so that you end up at the top of the 10% bracket.  We ran some numbers to see what would happen:  Suppose we want to spend $44,000 per year in retirement.  Add 10%*$18,450 = $1,845 for taxes to see that we need to withdraw $45,845.  Subtract $45,845 - $20,600 - $18,450 = $6,795.  Therefore, we’d want to withdraw $6,795 from Roth and the remaining $39,050 from Traditional, which is a 15% Roth / 85% Traditional split.

Our current contributions are split 29% Roth / 71% Traditional, so I see a few options:
  • Ideally, just save more, and put all extra savings in the 457(b).
  • Might be hard to save more, so put less in the Roth IRAs and more in the 457(b).
  • Keep putting too much in the Roth IRAs for now since the yearly limit is low compared to the 457(b).  Then, we can always put more in the 457(b) later.

Question:  Is there a typical Roth / Traditional split that people like to have when they retire?  I know there are lots of factors to consider, but there seems to be a pretty big difference between say 25%/75% and 10%/90%.

After considering the tax implications, my husband started worrying about having enough money available to withdraw without penalty before turning 59 ½.  We might be able to retire as early as 45 and 47.  (We’re 28 and 30 now.)  To keep things simple, I only considered the 457(b) for funding the 12.5 year gap even though we’ll probably withdraw some of the Roth contributions too.

I did a PV annuity for the 12.5 years with monthly withdrawals of $3,800 and 6% rate of return to get PV=$400,329.91.  In other words, we would need to have $400,329.91 in the 457(b) at the beginning of retirement.  Then, I did an FV annuity for 17 years with monthly contributions of $1,000 and 6% rate of return to get FV=$353,231.11.  Conclusion:  We really should increase our contributions to the 457(b).

Here’s the question:  My husband doesn’t trust any of my calculations because I didn’t account for inflation.  He thinks the situation is much worse.  I told him that doing all of the calculations in today’s dollars is okay as long as we increase our contributions each year with inflation.  Also, it’s not like I was doing a 10% rate of return.  Are my calculations valid?
6% should be a relatively safe inflation-adjusted number.

seattlecyclone

  • Walrus Stache
  • *******
  • Posts: 5292
  • Age: 35
  • Location: Seattle, WA
    • My blog
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #7 on: September 03, 2015, 11:49:21 AM »
Question:  Is there a typical Roth / Traditional split that people like to have when they retire?  I know there are lots of factors to consider, but there seems to be a pretty big difference between say 25%/75% and 10%/90%.

After considering the tax implications, my husband started worrying about having enough money available to withdraw without penalty before turning 59 ½.  We might be able to retire as early as 45 and 47.  (We’re 28 and 30 now.)  To keep things simple, I only considered the 457(b) for funding the 12.5 year gap even though we’ll probably withdraw some of the Roth contributions too.

A "typical" Roth/traditional split is highly dependent on the person, how much they have available to save, and what tax shelters they have available. I'm in a higher tax bracket than you, so I don't even think about Roth contributions until all pre-tax saving is maxed out. My wife and I can't contribute to pre-tax IRAs and we don't have 457(b) plans, but we do have access to mega backdoor Roths through our jobs, so our contributions tend to be about 50/50 traditional/Roth each year. We also make HSA contributions and save a bit in a taxable account on top of that, so we'll have a pretty diverse set of withdrawal options in retirement.

I think you should try to max out the 457(b) before contributing at all to your Roth IRA. Don't worry about pushing yourself into the lower end of the 15% tax bracket during retirement. If you contribute "too much" to your 457(b) and end up in the 15% bracket during retirement, that's no worse than if you paid 15% on that money now and put it in a Roth IRA. If you contribute too little on the other hand, you might not even be able to fill up the 10% bracket, which will mean you're wasting that space in the lower bracket by having contributed too much to your Roth IRA. You will have the added advantage of increasing the fraction of your money that you have easy access to prior to 59½, since there's no penalty for early withdrawals of earnings from the 457(b) but there are for the Roth IRA.

Quote
Here’s the question:  My husband doesn’t trust any of my calculations because I didn’t account for inflation.  He thinks the situation is much worse.  I told him that doing all of the calculations in today’s dollars is okay as long as we increase our contributions each year with inflation.  Also, it’s not like I was doing a 10% rate of return.  Are my calculations valid?

I tend not to worry too much about inflation in my calculation. The contribution limits and tax brackets are already indexed to inflation, so you might as well use current dollars when modeling those quantities. If you're using current dollars for some things, you might as well use them everywhere. However if you're modeling inflation-adjusted rates of return, 6% may be a bit on the high side. Per this page, the average inflation-adjusted return of the S&P 500 from 1950-2009 was 7%. However this number varies widely from year to year. Since 1950, there have been three decades with average return over 10%, and two decades with negative real return. Also this 7% average is only for the S&P 500. You may want to invest some of your stash in bonds, which have a lower average real return but help protect you from variability, allowing you to sell fewer stocks in the bad years.

seattlecyclone

  • Walrus Stache
  • *******
  • Posts: 5292
  • Age: 35
  • Location: Seattle, WA
    • My blog
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #8 on: September 03, 2015, 11:58:58 AM »
Another thing I forgot to mention is the saver's credit. If you contribute enough to your pre-tax retirement accounts to get your AGI in the $39.5k-$61k range, you'll be eligible for a $400 tax credit. If you get your AGI down below $36k (which you could do if you both maxed out your 403(b) and 457(b) accounts), the credit can go up to $2,000. It can't be higher than your total tax bill, so it would probably just bring your total tax down to zero in this case.

MDM

  • Senior Mustachian
  • ********
  • Posts: 10112
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #9 on: September 03, 2015, 01:58:19 PM »
I actually saw the “guidelines” in the case study spreadsheet last week, and that’s what prompted my questions.  I wasn’t sure where to put the 457(b) in the list, and I wanted a more rigorous approach to #4 than flipping a coin.  :)
Hah - good points!

Online version of the spreadsheet now includes explanations similar to those in this thread.

mammothunder

  • 5 O'Clock Shadow
  • *
  • Posts: 16
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #10 on: September 03, 2015, 06:39:46 PM »
If you contribute "too much" to your 457(b) and end up in the 15% bracket during retirement, that's no worse than if you paid 15% on that money now and put it in a Roth IRA.

Ugh, I should have seen this myself.  This is perfect.  Thank you so much.  Going to stop the Roth contributions and start contributing 1.15*(old Roth contributions) to the 457(b).

mammothunder

  • 5 O'Clock Shadow
  • *
  • Posts: 16
Re: Too Many Tax-Advantaged Accounts - Need Help Prioritizing
« Reply #11 on: September 03, 2015, 06:47:16 PM »
And thanks for mentioning the saver's credit.  We might be able to reach a low enough AGI next year.  Confession... I had to look up how to calculate our AGI.  I feel like I'm back in grad school where it dawns on you that you didn't even know what you don't know.