Author Topic: Another Traditional vs. Roth IRA question  (Read 8236 times)

Philociraptor

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Another Traditional vs. Roth IRA question
« on: August 07, 2014, 11:00:28 AM »
Help me decide whether to contribute to a Traditional or Roth IRA in 2015.

Expected gross income in 2015: $127,000
Federal taxable after full 401(k)'s, standard deductions, personal exemptions: $71,700 (may be lower actually, these are using 2014 numbers)

This will put us entirely in the 15% bracket.

Our current non-debt spending (and this approximate income needed in retirement) comes out to around $3,000/month, which would require ~$45,000 before taxes to cover, also in the 15% bracket.

Based on this, both contributions and withdrawls would be made in the same bracket, making the tax savings a wash. 

I may be missing something, but at the moment I can't see which IRA would be preferred. Halp!

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #1 on: August 07, 2014, 11:06:00 AM »
This is one of the interesting cases.  What I would do is try to estimate how much you'll have in your 401ks when you retire, by using your current balance, current contribution rate, and estimated future returns until your expected retirement.  From there, you can figure out an estimated safe withdrawal rate (4%) and compare that to your expected spending, and to possible tax brackets.  If those funds already get you up to the 15% tax bracket, I would put your additional funds into Roth IRAs, to preserve upside potential as well as to guarantee your maximum tax rate.  If your 401k funds don't get you to the 15% tax bracket, I would use the traditional IRA in order to benefit from the difference in tax rates.

FrugalSpendthrift

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Re: Another Traditional vs. Roth IRA question
« Reply #2 on: August 07, 2014, 11:28:34 AM »
Like beltim said, you want to make sure your balance in the traditional account is large enough in retirement to fill the lower tax brackets.  Your effective tax rate in the future will be much lower than your marginal (15%) tax bracket.

The standard deduction (12,400) plus two exemptions (3,950 + 3,950) plus the 10% tax bracket (18,150) = $38,450 that you could withdraw with taxes lower than 15%.  It doesn't make sense to pay 15% now, for the money that will be taxed lower in the future.  If your traditional account balance is on track to support that level, then you would be at a good point to switch to a ROTH.

Dyk

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Re: Another Traditional vs. Roth IRA question
« Reply #3 on: August 08, 2014, 10:59:48 AM »
Okay, I am pretty new to the investing side of things.  So I need some help.

How does this scenario fall outside of:  http://www.madfientist.com/traditional-ira-vs-roth-ira/ ?
So, wouldn't we need to know how much money is currently in after tax accounts, how long until retirement, etc.?
« Last Edit: August 08, 2014, 11:01:31 AM by Dyk »

Mother Fussbudget

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Re: Another Traditional vs. Roth IRA question
« Reply #4 on: August 08, 2014, 01:29:19 PM »
My answer would be:  Roth IRA

At your age, you have a quarter century to save, and watch that Roth IRA 'stache grow!  Unlike a regular IRA, where funds grow on a tax-deferred basis (you're taxed when you withdraw) funds in a Roth IRA grow on a TAX-FREE basis in the account until you withdraw them.  When you eventually reach age 59.5 (or become a first-time-home-buyer), have held funds in the account for over 5 years, and withdraw funds, you won't have to pay taxes on the earnings you accumulated over the years.


beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #5 on: August 08, 2014, 01:34:11 PM »
Okay, I am pretty new to the investing side of things.  So I need some help.

How does this scenario fall outside of:  http://www.madfientist.com/traditional-ira-vs-roth-ira/ ?
So, wouldn't we need to know how much money is currently in after tax accounts, how long until retirement, etc.?

The OP has expenses large enough to negate the possibility of tax-free conversions of traditional to Roth IRAs.  This is true for the vast majority of people.

bluebell

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Re: Another Traditional vs. Roth IRA question
« Reply #6 on: August 09, 2014, 05:06:35 AM »
Another vote for Roth. As you say, it looks like a wash (15% either way).

What tips the balance to Roth (IMHO at least) is that you can effectively save more in a Roth since it is after tax money. Also, Roth money you can withdraw on your own timeline rather than having to take required minimum distributions from a traditional IRA.

FastStache

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Re: Another Traditional vs. Roth IRA question
« Reply #7 on: August 09, 2014, 03:56:26 PM »
Surprised this hasn't been brought up, http://www.madfientist.com/traditional-ira-vs-roth-ira/.

Based on that article, a traditional IRA is a good way to go.

But at the moment I am doing a Roth IRA since I can use it as an emergency too. Now, that I have done this a few years I will be doing a traditional IRA in the future to lower my current tax burden.

marblejane

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Re: Another Traditional vs. Roth IRA question
« Reply #8 on: August 09, 2014, 04:10:25 PM »
Okay, I am pretty new to the investing side of things.  So I need some help.

How does this scenario fall outside of:  http://www.madfientist.com/traditional-ira-vs-roth-ira/ ?
So, wouldn't we need to know how much money is currently in after tax accounts, how long until retirement, etc.?

The OP has expenses large enough to negate the possibility of tax-free conversions of traditional to Roth IRAs.  This is true for the vast majority of people.

Isn't another issue also that the OP's AGI is too high to get the tax deduction for the Traditional IRA? I'm curious about this because I will be in a similar situation, with an estimated 2014 MAGI around $80k. It looks like I would have to put after tax money into a traditional IRA, and would get no tax benefit through my tax return.

Philociraptor

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Re: Another Traditional vs. Roth IRA question
« Reply #9 on: August 09, 2014, 06:39:26 PM »
Phase out starts at $96,000 for married. I'm aiming towards traditional given the tax-avoidance opportunities in retirement.

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #10 on: August 10, 2014, 08:46:09 AM »
Surprised this hasn't been brought up, http://www.madfientist.com/traditional-ira-vs-roth-ira/.

Based on that article, a traditional IRA is a good way to go.

But at the moment I am doing a Roth IRA since I can use it as an emergency too. Now, that I have done this a few years I will be doing a traditional IRA in the future to lower my current tax burden.

Really?  1/3 of the replies before you addressed this very topic, and why it might not apply.

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #11 on: August 10, 2014, 08:47:07 AM »
Phase out starts at $96,000 for married. I'm aiming towards traditional given the tax-avoidance opportunities in retirement.

If you provide actual numbers, the people here may be able to help you run the calculations.

Philociraptor

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Re: Another Traditional vs. Roth IRA question
« Reply #12 on: August 10, 2014, 09:45:20 AM »
Phase out starts at $96,000 for married. I'm aiming towards traditional given the tax-avoidance opportunities in retirement.

If you provide actual numbers, the people here may be able to help you run the calculations.
What numbers are you looking for?

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #13 on: August 10, 2014, 09:47:25 AM »
Phase out starts at $96,000 for married. I'm aiming towards traditional given the tax-avoidance opportunities in retirement.

If you provide actual numbers, the people here may be able to help you run the calculations.
What numbers are you looking for?

More or less what I said before: "estimate how much you'll have in your 401ks when you retire, by using your current balance, current contribution rate, and estimated future returns until your expected retirement.  From there, you can figure out an estimated safe withdrawal rate (4%) and compare that to your expected spending, and to possible tax brackets."

Philociraptor

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Re: Another Traditional vs. Roth IRA question
« Reply #14 on: August 10, 2014, 09:50:43 AM »
That's a lot of hubbub, we're 25 and expected retirement is when we have "enough". I see our current non-debt spending at $3k per month, $36k per year. Plan is to retire when we have 25x that amount saved up, accounting for taxes.

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #15 on: August 10, 2014, 09:55:19 AM »
That's a lot of hubbub, we're 25 and expected retirement is when we have "enough". I see our current non-debt spending at $3k per month, $36k per year. Plan is to retire when we have 25x that amount saved up, accounting for taxes.

That's because it's a tough problem with many variables.  What's your current 401K balance?

Philociraptor

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Re: Another Traditional vs. Roth IRA question
« Reply #16 on: August 10, 2014, 10:00:10 AM »
I'm not entirely sure, around $6k I think.  Wife has $0. I put in $360 each month, which gets a match if I stay at my job until the end of the year (vesting period is 3 years, almost there!). We get balance statements twice a year and it grows 1-3% each year.  We each have Roth IRA balances around $16k currently, adding $416.67 to each one each month.

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #17 on: August 10, 2014, 10:04:32 AM »
I'm not entirely sure, around $6k I think.  Wife has $0. I put in $360 each month, which gets a match if I stay at my job until the end of the year (vesting period is 3 years, almost there!). We get balance statements twice a year and it grows 1-3% each year.  We each have Roth IRA balances around $16k currently, adding $416.67 to each one each month.

Thanks.  I'm working on a spreadsheet for you but I'm confused about one thing.  I thought you said in your first post that you maxed out your 401ks?  But at $360/month, that's just $4320 per year. 

Philociraptor

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Re: Another Traditional vs. Roth IRA question
« Reply #18 on: August 10, 2014, 10:06:32 AM »
We don't max out yet, going to start next year; they only allow 401(k) changes in June and December. I currently put in $360 per month, but my wife doesn't contribute anything since there's no match.  After I ran the numbers and realized the tax savings I decided that we should max them out, to start next year.

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #19 on: August 10, 2014, 10:07:29 AM »
We don't max out yet, going to start next year; they only allow 401(k) changes in June and December. I currently put in $360 per month, but my wife doesn't contribute anything since there's no match.  After I ran the numbers and realized the tax savings I decided that we should max them out, to start next year.

Okay, that makes sense.  Give me just a minute

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #20 on: August 10, 2014, 10:38:35 AM »
Okay, so I've attached a spreadsheet that calculates the basics with three editable fields to play around with.  With maxing out your 401k accounts and Roth IRAs, and a 5% annual real return (that is, 5% after inflation), you'll have enough to safely withdraw $3k per month at the age of 39.  In fact, using a SEPP you can withdraw 3.8% annually, and get $26.5k from your 401k and $10.6k from your Roths.  $26.5k of taxable income puts your in the 10% tax bracket, suggesting that there's some amount more that you could contribute to a traditional IRA to further reduce your tax burden.

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #21 on: August 10, 2014, 10:45:57 AM »
Wait.  The standard deduction and personal exemptions for a married couple is $20k.  The 10% tax bracket goes up to $17,850.  So the first $37,850 should come from tax-deferred instead of Roth accounts.  I think that means that you should only contribute to traditional accounts from this point.  See attached spreadsheet


beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #22 on: August 10, 2014, 10:56:17 AM »
You're basically at the inflection point.  If $3k on the dot is where your spending will be in retirement, then you're better off maxing your traditional IRA and contributing nothing to the Roth.  If it turns out that $3.5k / month will be your spending, then maxing out your Roth is the right strategy.

Philociraptor

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Re: Another Traditional vs. Roth IRA question
« Reply #23 on: August 10, 2014, 11:28:03 AM »
This is really cool, thanks so much!

beltim

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Re: Another Traditional vs. Roth IRA question
« Reply #24 on: August 10, 2014, 11:35:02 AM »
No problem.  Like I said in my first response, this is one of the really interesting cases, precisely because you are right at the border.

There are second- or third-order considerations that are worth thinking about, if you're interested.  They get even harder to predict 10-20 years, out, but things such as health insurance and the role of your taxable income on ACA premiums and subsidies.  Or how Social Security may affect the situation, 40 years from now.  But you've got the basics down save a lot, and save in tax-advantaged accounts.

Philociraptor

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Re: Another Traditional vs. Roth IRA question
« Reply #25 on: August 11, 2014, 08:26:19 AM »
I realized something: I'm mixing up taxable income and AGI. Taxes apply after exemptions and deductions, while IRA limits apply before. It still works out, because our MAGI is looking to be $92k next year, while phase out starts at $96k. I'll have us contribute to traditional next year but may have to recharacterize contributions if our income increases too much.

not_a_trex

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Re: Another Traditional vs. Roth IRA question
« Reply #26 on: August 11, 2014, 07:48:32 PM »
Isn't another issue also that the OP's AGI is too high to get the tax deduction for the Traditional IRA? I'm curious about this because I will be in a similar situation, with an estimated 2014 MAGI around $80k. It looks like I would have to put after tax money into a traditional IRA, and would get no tax benefit through my tax return.

Assuming you aren't married (I don't know the AGI cut off for married couples) have you considered a backdoor Roth? That's probably your best bet if you aren't able to make deductible contributions towards a traditional IRA.
http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

dandarc

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Re: Another Traditional vs. Roth IRA question
« Reply #27 on: August 12, 2014, 08:26:35 AM »
I realized something: I'm mixing up taxable income and AGI. Taxes apply after exemptions and deductions, while IRA limits apply before. It still works out, because our MAGI is looking to be $92k next year, while phase out starts at $96k. I'll have us contribute to traditional next year but may have to recharacterize contributions if our income increases too much.

This - do the traditional while you can.  Even in the 15% bracket, odds are that you'll be withdrawing at a lower effective tax rate in the future.

marblejane

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Re: Another Traditional vs. Roth IRA question
« Reply #28 on: August 12, 2014, 05:57:49 PM »
Isn't another issue also that the OP's AGI is too high to get the tax deduction for the Traditional IRA? I'm curious about this because I will be in a similar situation, with an estimated 2014 MAGI around $80k. It looks like I would have to put after tax money into a traditional IRA, and would get no tax benefit through my tax return.

Assuming you aren't married (I don't know the AGI cut off for married couples) have you considered a backdoor Roth? That's probably your best bet if you aren't able to make deductible contributions towards a traditional IRA.
http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

Right...I guess I just don't see why, in my situation, I wouldn't just straight contribute to the Roth IRA, since I'll be under the phase out limit for contributing to a Roth, but above the tax deductible limit for the traditional.

Maybe I should post a separate thread, sorry.