Author Topic: Do I Need Retirement Account If In 15% Bracket?  (Read 8879 times)

dtp1987

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Do I Need Retirement Account If In 15% Bracket?
« on: April 02, 2014, 05:49:08 AM »
I curious to know if there is any reason to have an IRA or Roth if my wife and I are in the 15% tax bracket, and do not foresee that changing anytime soon.

As long as I make withdrawals from taxable accounts after 1 year the rest doesn't matter, correct? I am currently investing in a regular taxable account.

Maybe I am missing something.....

Cromacster

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #1 on: April 02, 2014, 05:57:36 AM »
While the 15% bracket may be low, there are still ways to lower your tax burden.  Why give more to the government than you have to?

1)If you have access to a 401(k) and a traditional IRA and you are not using them, you are paying more in taxes than you have to.  This also means your initial investment is lower than it potentially could have been. 

2)You will still pay taxes on earnings from a taxable account.  If that money was put towards a Roth, you never have to pay taxes on the earnings.
« Last Edit: April 02, 2014, 06:03:08 AM by Cromacster »

TomTX

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #2 on: April 02, 2014, 06:28:50 AM »
Roth sounds very reasonable, but you can also put some in the 401(k) especially if you get a match.

With a mix of Roth/401(k)/taxable - you can much more easily control your taxes, post FI. You should be able to get yourself paying zero taxes.

kyleaaa

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #3 on: April 02, 2014, 07:06:04 AM »
Yeah, big reasons. Do the ROTH first, but a 401k is still a better deal than a taxable account for you.

foobar

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #4 on: April 02, 2014, 08:14:18 AM »
Simple answer is yes.
a) 0% is less than 15%.  You will be able to take out about 20k/yr out of a tIRA tax free when you retire.
b) 0% roth is less than 0% taxable. Having money in a ROTH is worth more than money  in a taxable account even if you pay 0% taxes on both. 40k out of a roth will not affect your ACA subsidy or cause you to pay taxes on SS. You can also invest in bonds/ REITS (OI) and not have to worry about realizing income.

You can debate if a ROTH or a tIRA makes more sense for a 15%. Personally I always vote for having a bigger pile of cash and worrying about the tax situation later.

I curious to know if there is any reason to have an IRA or Roth if my wife and I are in the 15% tax bracket, and do not foresee that changing anytime soon.

As long as I make withdrawals from taxable accounts after 1 year the rest doesn't matter, correct? I am currently investing in a regular taxable account.

Maybe I am missing something.....

oldladystache

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #5 on: April 02, 2014, 08:46:26 AM »
I curious to know if there is any reason to have an IRA or Roth if my wife and I are in the 15% tax bracket, and do not foresee that changing anytime soon.

As long as I make withdrawals from taxable accounts after 1 year the rest doesn't matter, correct? I am currently investing in a regular taxable account.

Maybe I am missing something.....

I'm with you on that. Of course, if you accidentally find yourself in a higher tax bracket you may regret it.

That's what I've been doing (retired now) and every year I figure out how much I can sell with no tax, then reinvest any I don't need to spend to increase the basis. So even though my taxable account has grown a lot over the years I wouldn't have to pay much in tax if I sold it all tomorrow because my basis is so high.




CB

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #6 on: April 02, 2014, 08:46:37 AM »
Think about it this way: for every $1000 you sock away in pre-tax retirement accounts, you save $150 on income tax.  It's like an instant 15% return on your investment.

You only pay taxes on that money if you aren't able to do a Roth pipeline, which you should be able to do if you're willing to also allocate savings to taxable accounts during your accumulation phase.

Frankies Girl

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #7 on: April 02, 2014, 08:47:39 AM »
I'm in the 15% bracket, and pretty much always have been as far as I remember. Putting money into a 401k or IRA pre-tax means I'm saving more money (especially with a match) than using a taxable account. I can max my 401k to make sure I am never going to go over the 15% cap, and I can hold less tax efficient funds in a pre-tax account (like bond funds or anything with a high turnover rate/throw off lots of dividends and cap gains) to avoid even having to worry over whether they are producing enough cap gains or dividends that might push me up over the threshold as well, since I don't have to pay on those as long as they stay in that account.   

I fund my Roth in full (and the husband's as well) so we have that also in a tax efficient vehicle, able to invest in whatever, and the money is available to withdraw (contributions) at any time tax/penalty free (within certain parameters).

I do have a taxable account that I'll be using to live off of in the first stage, but it's only got one fund in there - the most tax efficient one - as I do have to report the gains and include it in my income... and it might push me over if I wasn't already maximizing my other accounts to reduce income in general.

I pay a small amount in taxes currently, but that will go away completely once I'm RE, as I'm doing the Roth pipeline when I retire so I never have to pay any taxes again. 
« Last Edit: April 02, 2014, 08:50:37 AM by Frankies Girl »

sol

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #8 on: April 02, 2014, 09:18:11 AM »
I'm going to disagree with some previous posters here.  If you're in the 15% bracket now and later, then you can

1.  invest in a 401k type plan, pay 0% now, and pay 15% in retirement. 

2.  invest in a Roth IRA, pay 15% now and pay 0% in retirement.

3.  invest in a taxable account, pay 15% now and pay 0% after one year as long as your income stays in the 15% bracket, due to the favorable rate on long term capital gains.

In this case, I think you are correct that the taxable account is a better deal than the Roth IRA.  The tax treatment is identical and you're not age-restricted like you would be with a Roth IRA.

I still think the 401k plan is a viable option for you, if you can handle the age constraints, because by paying less tax now you have more money to grow tax free over time. 

dtp1987

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #9 on: April 02, 2014, 09:50:18 AM »
I'm going to disagree with some previous posters here.  If you're in the 15% bracket now and later, then you can

1.  invest in a 401k type plan, pay 0% now, and pay 15% in retirement. 

2.  invest in a Roth IRA, pay 15% now and pay 0% in retirement.

3.  invest in a taxable account, pay 15% now and pay 0% after one year as long as your income stays in the 15% bracket, due to the favorable rate on long term capital gains.

In this case, I think you are correct that the taxable account is a better deal than the Roth IRA.  The tax treatment is identical and you're not age-restricted like you would be with a Roth IRA.

I still think the 401k plan is a viable option for you, if you can handle the age constraints, because by paying less tax now you have more money to grow tax free over time.

Yeah this is exactly what I was wondering and thinking.....

sol

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #10 on: April 02, 2014, 10:08:47 AM »
Yeah this is exactly what I was wondering and thinking.....

I think this plan only works for people who are going to stay in the 15% tax bracket, and thus qualify for the 0% tax rate on long term capital gains.  I suspect that most people here are in the accumulation phase and are not accustomed to thinking about selling their investments, so they aren't as informed about capital gains rates.

The 401k, still has a couple of benefits for you.  If there's an employer match you'd be dumb not to take it. 

But perhaps more important is the tax haircut of the 401k, in which you contribute at your marginal rate (15% taxes saved by investing pre-tax) but then withdraw at your effective rate (significantly less than 15% because of exemptions and deductions, maybe zero).  Done correctly, you need never pay any taxes at all on 401k contributions even if withdrawn before retirement age, and you're in the right income zone to make that happen.


dtp1987

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #11 on: April 02, 2014, 10:25:03 AM »
Yeah this is exactly what I was wondering and thinking.....

I think this plan only works for people who are going to stay in the 15% tax bracket, and thus qualify for the 0% tax rate on long term capital gains.  I suspect that most people here are in the accumulation phase and are not accustomed to thinking about selling their investments, so they aren't as informed about capital gains rates.

The 401k, still has a couple of benefits for you.  If there's an employer match you'd be dumb not to take it. 

But perhaps more important is the tax haircut of the 401k, in which you contribute at your marginal rate (15% taxes saved by investing pre-tax) but then withdraw at your effective rate (significantly less than 15% because of exemptions and deductions, maybe zero).  Done correctly, you need never pay any taxes at all on 401k contributions even if withdrawn before retirement age, and you're in the right income zone to make that happen.

Thanks for your help! Don't qualify for 401k because I own a small business, and am not an employee.

So I guess I will just stick with the regular taxable accounts for now, and pay the tax on the income now. If I ever do leave the 15% bracket, what should I do as far as money in taxable accounts?


skyrefuge

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #12 on: April 02, 2014, 10:45:12 AM »
I think this plan only works for people who are going to stay in the 15% tax bracket, and thus qualify for the 0% tax rate on long term capital gains.

It's also worth noting that it only works as long as the 0% tax rate remains in effect. The 0% rate has only existed since 2008, and historically, capital gains rates have been much higher. And I speculate that it was only changed to 0% as political cover, not for some more-principled economic purpose; if the reduction had been to an equal 15% across all tax brackets, Democrats would have cried "regressive tax!!" and "tax cuts for the rich!!", so dropping the rate to 0% for the lower brackets was a way for Republicans to say "hey, look, we're giving better tax cuts to the poor, so it's ok!" All this tells me that there's a pretty good chance it could rise back up sometime over the next 60 years (which is presumably the length of time that the OP will have to worry about it increasing, since he'll be realizing capital gains over that period).

Thanks for your help! Don't qualify for 401k because I own a small business, and am not an employee.

A "401(k)" is not actually the operative feature. It's a "tax-deferred investment vehicle" that you're looking for. A 401(k) is one popular tax-deferred investment vehicle, so people frequently (and inaccurately, since there are Roth 401(k)s too) use the terms interchangeably. But a personal Traditional IRA, or a SEP (self-employed) IRA also provide the same tax-deferment, and both are available to you. And I think tax-deferment would still be a more optimal choice for you.
« Last Edit: April 02, 2014, 12:29:46 PM by skyrefuge »

seattlecyclone

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #13 on: April 02, 2014, 10:59:03 AM »

Thanks for your help! Don't qualify for 401k because I own a small business, and am not an employee.


You should look into a "solo 401(k)." Basically it's possible to open a 401(k) for your small business. Because you are the employer, the "employer match" can potentially be quite large, sheltering a huge amount of income from tax. If your business grows and you move up to the 25% bracket, this feature becomes even more attractive.

sherr

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #14 on: April 02, 2014, 11:43:23 AM »
1)If you have access to a 401(k) and a traditional IRA and you are not using them, you are paying more in taxes than you have to.  This also means your initial investment is lower than it potentially could have been. 

Not necessarily to the first sentence, a flat "no" to the second.

1) Pre-tax investment accounts like a traditional 401(k) or IRA are only a good deal if your tax rate is lower in retirement than it is when you are contributing. That may or may not be the case here. Money you withdraw from a pre-tax investment account is taxable as normal income when you retire. Most people's tax rate in retirement is lower than when they're working, primarily because you don't need to withdraw as much to live as you need to make to live + invest. However if the tax rates go up in the future or they end up spending a lot of money in retirement it's possible they'll have to pay more in taxes by using a 401(k) or IRA.

2) Your second sentence assumes that it's mathematically better to defer paying taxes because you have a higher "initial investment". It's not. Assuming that your tax rate in retirement is equal to your tax rate while your working, they are mathematically guaranteed to be equivalent due to the associative property of multiplication. The higher "initial investment" is no better than investing with a lower initial amount but then not having to pay taxes later.

P (principle) * 0.85 (less 15% taxes) * 1.07 ^ 20 (invested at an average of 7% interest for 20 years)
is equivalent to
P * 1.07 ^ 20 * 0.85
The order in which you multiply makes no difference at all.

Yeah, big reasons. Do the ROTH first, but a 401k is still a better deal than a taxable account for you.

Possibly correct, but it's not as clear cut as you seem to think.

a) 0% is less than 15%.  You will be able to take out about 20k/yr out of a tIRA tax free when you retire.

It's only 0% if he will not have to pay any income taxes at all on the money he withdraws from his tIRA. How do you figure on the $20k bit? It seems to me that the standard deductible is $12k for a couple, and after that they'll be paying 10% income taxes.

Think about it this way: for every $1000 you sock away in pre-tax retirement accounts, you save $150 on income tax.  It's like an instant 15% return on your investment.

You only pay taxes on that money if you aren't able to do a Roth pipeline, which you should be able to do if you're willing to also allocate savings to taxable accounts during your accumulation phase.

Incorrect, you still have to pay income taxes on money converted through a Roth pipeline on the year that you convert it from a traditional IRA to a Roth IRA. A Roth pipeline is a method to avoid paying the 10% early withdrawal penalty, not income tax altogether.

As such your first paragraph is incorrect because they would not be saving $150, just deferring taxes until later, when it may be more or less than the equivalent of $150 (probably less, but could be more).


All that being said, I agree with Frankies Girl and Sol. If I were you I would max out my contributions to Roth accounts (IRA, 401k if you can get one) to lock in the low tax rate and guarantee that you will never have to pay taxes on earnings, regardless of what your income does later. After that I would still invest in a traditional 401k, but only because I believe it is likely that your average tax rate in retirement will be lower than your marginal tax rate now. If you don't think that's true then don't do it. And yes, do take seattlecyclone's advice and look into a Solo 401k. You are an employee of your company, and as such you can contribute to a 401k that your company (you) sets up, and can contribute as both the employee (you) and company (you), enabling you to contribute much more than the employee-alone limit of $17.5k. Worked wonders for my wife and I's taxes this year.

foobar

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #15 on: April 02, 2014, 11:57:31 AM »
As far as paying 15% on your 401(k), you need to run your assumptions through some tax calculators.  Let say you had 1 million dollars in one, so you are sucking out 40k/yr.  How much tax does a family of 3 (2 adults, 1 kid under 16) pay? 613 bucks or about 1.5%.

Lets compare the ROTH and a taxable account (assume same family)
-Own bonds that generate 40k in income: 0 dollars roth 613 taxable.

-Now lets say that you have 20k of OI from stuff and 40k of QD or a ROTH for a total of 60k
ACA subsidy on 60k (2 40 year olds and a kid): 2400
ACA Subsidy on 20k: 7600

Basically using a ROTH instead of a taxable account makes you 5k/yr . Pretty much the same thing happens when you start to collect SS where getting 40k in income results in you having to pay taxes on SS income.

Now lets say JR is ready to go to college
a) 1 million dollars in a taxable account means a parental contribution of ~50k
b) 1 million dollars in a tax advantaged account means a parental contribution of 0k

Now you may or may not benefit from everything but it is really hard to come up with cases where the ROTH doesn't win out.

I'm going to disagree with some previous posters here.  If you're in the 15% bracket now and later, then you can

1.  invest in a 401k type plan, pay 0% now, and pay 15% in retirement. 

2.  invest in a Roth IRA, pay 15% now and pay 0% in retirement.

3.  invest in a taxable account, pay 15% now and pay 0% after one year as long as your income stays in the 15% bracket, due to the favorable rate on long term capital gains.

In this case, I think you are correct that the taxable account is a better deal than the Roth IRA.  The tax treatment is identical and you're not age-restricted like you would be with a Roth IRA.

I still think the 401k plan is a viable option for you, if you can handle the age constraints, because by paying less tax now you have more money to grow tax free over time.
« Last Edit: April 02, 2014, 12:01:31 PM by foobar »

Eric

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #16 on: April 02, 2014, 12:04:23 PM »
a) 0% is less than 15%.  You will be able to take out about 20k/yr out of a tIRA tax free when you retire.
It's only 0% if he will not have to pay any income taxes at all on the money he withdraws from his tIRA. How do you figure on the $20k bit? It seems to me that the standard deductible is $12k for a couple, and after that they'll be paying 10% income taxes.

Aren't you forgetting the personal exemptions of $3900/person?  3900*2 personal exemptions + $12,200 standard deduction = $20,000 tax free  (2013 tax numbers)

sherr

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #17 on: April 02, 2014, 12:18:18 PM »

P (principle) * 0.85 (less 15% taxes) * 1.07 ^ 20 (invested at an average of 7% interest for 20 years)
is equivalent to
P * 1.07 ^ 20 * 0.85
The order in which you multiply makes no difference at all.

Sure, but the present value of the future tax is essentially worth 1/4 of what you pay today.  The net amount is the same, the value is significantly different.

If that's how you're defining terms then sure, but "value" is an abstract concept that has no physical bearing on reality. The number you see on the computer screen may be bigger, but that doesn't mean you actually have more money to use. "Net amount" is the only thing that can possibly matter.

Aren't you forgetting the personal exemptions of $3900/person?  3900*2 personal exemptions + $12,200 standard deduction = $20,000 tax free  (2013 tax numbers)

Thanks, I thought I was probably forgetting something.

sherr

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #18 on: April 02, 2014, 12:27:50 PM »

P (principle) * 0.85 (less 15% taxes) * 1.07 ^ 20 (invested at an average of 7% interest for 20 years)
is equivalent to
P * 1.07 ^ 20 * 0.85
The order in which you multiply makes no difference at all.

Sure, but the present value of the future tax is essentially worth 1/4 of what you pay today.  The net amount is the same, the value is significantly different.

If that's how you're defining terms then sure, but "value" is an abstract concept that has no physical bearing on reality. The number you see on the computer screen may be bigger, but that doesn't mean you actually have more money to use. "Net amount" is the only thing that can possibly matter.

Whoops, I completely failed at recognizing what you were saying. No, you're wrong, the present value of future taxes paid will be exactly equal to the current value of your theoretical taxes if both rates are the same. Let's use numbers, assuming a $10k principle, 15% taxes now or in retirement, and 7% interest for 30 years.

Pre-tax:
10,000 * 1.07^30 * 0.85 = 64,704.17
Paying tax (multiplying by 0.85) reduced the value by $11,418.38.

Post-tax:
10,000 * 0.85 * 1.07^30 = 64,704.17
Paying tax reduced the value of your initial investment by $1,500.

The present value of the future $11.4k is exactly $1,500:
$1,500 * 1.07^30 = $11,418.38

Cromacster

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #19 on: April 02, 2014, 12:45:48 PM »

P (principle) * 0.85 (less 15% taxes) * 1.07 ^ 20 (invested at an average of 7% interest for 20 years)
is equivalent to
P * 1.07 ^ 20 * 0.85
The order in which you multiply makes no difference at all.

Sure, but the present value of the future tax is essentially worth 1/4 of what you pay today.  The net amount is the same, the value is significantly different.

If that's how you're defining terms then sure, but "value" is an abstract concept that has no physical bearing on reality. The number you see on the computer screen may be bigger, but that doesn't mean you actually have more money to use. "Net amount" is the only thing that can possibly matter.

Whoops, I completely failed at recognizing what you were saying. No, you're wrong, the present value of future taxes paid will be exactly equal to the current value of your theoretical taxes if both rates are the same. Let's use numbers, assuming a $10k principle, 15% taxes now or in retirement, and 7% interest for 30 years.

Pre-tax:
10,000 * 1.07^30 * 0.85 = 64,704.17
Paying tax (multiplying by 0.85) reduced the value by $11,418.38.

Post-tax:
10,000 * 0.85 * 1.07^30 = 64,704.17
Paying tax reduced the value of your initial investment by $1,500.

The present value of the future $11.4k is exactly $1,500:
$1,500 * 1.07^30 = $11,418.38

Yea I removed my comment. You just saw and quoted it to fast >.<

#mathhard

dtp1987

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #20 on: April 02, 2014, 12:48:30 PM »
I am really lost with this whole conversation, lol.

I am just looking for a way to invest, while being able to take out money when need be, without being killed with taxes or withdrawal fees.

Should I just stick to the taxable account for now, and if the capital gains tax comes back again start putting the money into an IRA?

The reason I don't really want all my savings to go into retirement accounts is because I really don't want to wait until after 65 to start withdrawing money. The purpose of my saving and investing now is so that I can be financially independent and use money that I invest in 15-20 years rather then 40 years.


foobar

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #21 on: April 02, 2014, 12:50:34 PM »
The assumptions of the rates being the same is always the tough one to quantify.  Take your example. A couple taking 40k out of their IRA would pay about 5%. At 80k it is 10% and at 120k it is over 15% so unless the OP plans on living on more money in retirement than he did while working, he will pay lower taxes with the tIRA.  On the other hand do the math on what happens if he earns 12% for 40 years and has to start doing RMDs at 70. You go from 10% tax to 40% in a hurry and you wish you would have signed up for the ROTH.



P (principle) * 0.85 (less 15% taxes) * 1.07 ^ 20 (invested at an average of 7% interest for 20 years)
is equivalent to
P * 1.07 ^ 20 * 0.85
The order in which you multiply makes no difference at all.

Sure, but the present value of the future tax is essentially worth 1/4 of what you pay today.  The net amount is the same, the value is significantly different.

If that's how you're defining terms then sure, but "value" is an abstract concept that has no physical bearing on reality. The number you see on the computer screen may be bigger, but that doesn't mean you actually have more money to use. "Net amount" is the only thing that can possibly matter.

Whoops, I completely failed at recognizing what you were saying. No, you're wrong, the present value of future taxes paid will be exactly equal to the current value of your theoretical taxes if both rates are the same. Let's use numbers, assuming a $10k principle, 15% taxes now or in retirement, and 7% interest for 30 years.

Pre-tax:
10,000 * 1.07^30 * 0.85 = 64,704.17
Paying tax (multiplying by 0.85) reduced the value by $11,418.38.

Post-tax:
10,000 * 0.85 * 1.07^30 = 64,704.17
Paying tax reduced the value of your initial investment by $1,500.

The present value of the future $11.4k is exactly $1,500:
$1,500 * 1.07^30 = $11,418.38

matchewed

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #22 on: April 02, 2014, 01:22:47 PM »
I am really lost with this whole conversation, lol.

I am just looking for a way to invest, while being able to take out money when need be, without being killed with taxes or withdrawal fees.

Should I just stick to the taxable account for now, and if the capital gains tax comes back again start putting the money into an IRA?

The reason I don't really want all my savings to go into retirement accounts is because I really don't want to wait until after 65 to start withdrawing money. The purpose of my saving and investing now is so that I can be financially independent and use money that I invest in 15-20 years rather then 40 years.

You don't have to wait until 65 to start withdrawing money. Depending on your particular circumstances there is the Roth Pipeline strategy and 72(t) or SEPP as options to access your stash prior to 59.5. It is completely fine to take advantage of tax advantaged accounts until you understand your options better. It won't be a mistake to do so.

MooseOutFront

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #23 on: April 02, 2014, 01:34:13 PM »
I'm having a hard time with this whole 15% thing myself.  We have $76k of tax advantaged space we can fill entirely with pre-tax dollars.  I love saving on taxes, but in the 15% bracket I also feel pretty good about filling our Roths and that I won't get taxed on my taxable investments. 

My retirement entails starting a business and just only working as hard as I feel like, but I fully expect there to be decent income from it.  At least enough to fill the space for 0% income taxes.  And then there's the ACA subsidies which I bet I won't want to burn with rollovers.  Meanwhile if I build up my taxable and Roths I can live off Roth contributions and tax gain harvested taxable for free as supplements to my income.  But I'm pre-paying 15% right the eff now to set that option up.  As foobar points out, it may take quite the income to get up to 15% taxes on this same money.  But then again it will be 6+ years before I'm pulling anything out and then who knows what tax law says then.  I just want to make the perfect decision is all. :)
« Last Edit: April 02, 2014, 01:44:03 PM by MooseOutFront »

matchewed

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #24 on: April 02, 2014, 01:39:09 PM »
Something about perfect being the enemy of good. Run the scenarios if you have questions. Find out what is best, nothing will be perfect.

sherr

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #25 on: April 02, 2014, 01:43:38 PM »
I am really lost with this whole conversation, lol.

I am just looking for a way to invest, while being able to take out money when need be, without being killed with taxes or withdrawal fees.

Should I just stick to the taxable account for now, and if the capital gains tax comes back again start putting the money into an IRA?

The reason I don't really want all my savings to go into retirement accounts is because I really don't want to wait until after 65 to start withdrawing money. The purpose of my saving and investing now is so that I can be financially independent and use money that I invest in 15-20 years rather then 40 years.

Any advice people give you about what you should do about retirement accounts involves a certain amount of predicting the future, so it's hard and should always be taken with a grain of salt. You are right on the edge of where there starts being a clear winner, so it's really hard in your case. The bottom line though is that it's probably best for you to invest in Roth IRAs first, then traditional accounts (401k or whatever) second, before you invest in taxable accounts.

Taxable accounts are bad because not only do you have to pay income tax on your contributions you also (generally) have to pay capital gains tax on the interest accrued, which can end up being more than the principle invested. In your case under current law it doesn't matter so much because IF you keep the money in the accounts for longer than a year and IF your tax bracket is still 15% or lower when you sell and IF they don't change tax law back to what it was pre-2008, then you don't have to pay capital gains tax. However, that's a lot of "if"s.

Roth accounts are good for people who pay lower taxes now than in retirement. You get to "lock in" your low tax rate now and not have to pay taxes on that money ever again, including any capital gains taxes. Will taxes be lower for you in retirement than they are now? It depends on how much you spend in retirement and if they change the tax rates. It seems likely to me that a traditional IRA would save you some money, but not a lot, and a Roth is a guaranteed thing because you've already paid taxes instead of having to speculate about future tax rates with a traditional. A Roth account is almost strictly better than a taxable account.

Traditional accounts are good for people who expect to pay lower taxes in retirement than they do now. Almost everyone does this. As foobar said a couple posts ago, if you're spending the equivalent of $40k a year your average tax rate is probably going to be around 5%. That means you'd have saved 10% in taxes.

If you were in the 25% bracket I would say it's a no-brainer for traditional retirement accounts. At 15% the best option is a lot less clear. In any case, just because the retirement age is 65 doesn't mean you have to wait that long to withdraw your money from retirement accounts. You can always withdraw money you have contributed to a Roth account (but not interest you have accrued) at any time 5 years after you contributed it for no penalty. They don't care; you've already paid taxes on it. If you're contributing to a traditional retirement account you can simply convert it to a Roth (paying income taxes when you do), wait 5 years, and take it out. Either way, you can get at your money pretty much any time you want as long as you have a little foresight and planning.

Given that, if you can save an extra 10% by contributing to traditional retirement accounts, why not? If you can lock in a guaranteed no-future-taxes by contributing to a Roth instead of relying on things continuing the way they are now, then why not?

BigRed

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #26 on: April 02, 2014, 01:50:43 PM »
To what extent does an expectation of pensions and/or social security change this analysis, due to those income streams removing the lower tax bracket space that allows you to (1) use a Roth Pipeline and/or (2) lower the effective tax rate on tax-deferred income streams?  It seems to me that it might be the case that lower capital gains rates (max 15%), as Sol mentioned, might actually favor taxable accounts in the event that the deduction/exemption space and 10% bracket are used by pension/SS.  My guess is that tax-deferred still gives you enough flexibility that when the time comes you could engineer a good strategy depending on the tax law at the time, but who knows.

Yes, this would be a "Better than first world problem" situation where an actual mustachian might not need any additional funds, taxable or tax-deferred, so perhaps MMM is not the place to ask.

dtp1987

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #27 on: April 02, 2014, 02:25:14 PM »
I am really lost with this whole conversation, lol.

I am just looking for a way to invest, while being able to take out money when need be, without being killed with taxes or withdrawal fees.

Should I just stick to the taxable account for now, and if the capital gains tax comes back again start putting the money into an IRA?

The reason I don't really want all my savings to go into retirement accounts is because I really don't want to wait until after 65 to start withdrawing money. The purpose of my saving and investing now is so that I can be financially independent and use money that I invest in 15-20 years rather then 40 years.

Any advice people give you about what you should do about retirement accounts involves a certain amount of predicting the future, so it's hard and should always be taken with a grain of salt. You are right on the edge of where there starts being a clear winner, so it's really hard in your case. The bottom line though is that it's probably best for you to invest in Roth IRAs first, then traditional accounts (401k or whatever) second, before you invest in taxable accounts.

Taxable accounts are bad because not only do you have to pay income tax on your contributions you also (generally) have to pay capital gains tax on the interest accrued, which can end up being more than the principle invested. In your case under current law it doesn't matter so much because IF you keep the money in the accounts for longer than a year and IF your tax bracket is still 15% or lower when you sell and IF they don't change tax law back to what it was pre-2008, then you don't have to pay capital gains tax. However, that's a lot of "if"s.

Roth accounts are good for people who pay lower taxes now than in retirement. You get to "lock in" your low tax rate now and not have to pay taxes on that money ever again, including any capital gains taxes. Will taxes be lower for you in retirement than they are now? It depends on how much you spend in retirement and if they change the tax rates. It seems likely to me that a traditional IRA would save you some money, but not a lot, and a Roth is a guaranteed thing because you've already paid taxes instead of having to speculate about future tax rates with a traditional. A Roth account is almost strictly better than a taxable account.

Traditional accounts are good for people who expect to pay lower taxes in retirement than they do now. Almost everyone does this. As foobar said a couple posts ago, if you're spending the equivalent of $40k a year your average tax rate is probably going to be around 5%. That means you'd have saved 10% in taxes.

If you were in the 25% bracket I would say it's a no-brainer for traditional retirement accounts. At 15% the best option is a lot less clear. In any case, just because the retirement age is 65 doesn't mean you have to wait that long to withdraw your money from retirement accounts. You can always withdraw money you have contributed to a Roth account (but not interest you have accrued) at any time 5 years after you contributed it for no penalty. They don't care; you've already paid taxes on it. If you're contributing to a traditional retirement account you can simply convert it to a Roth (paying income taxes when you do), wait 5 years, and take it out. Either way, you can get at your money pretty much any time you want as long as you have a little foresight and planning.

Given that, if you can save an extra 10% by contributing to traditional retirement accounts, why not? If you can lock in a guaranteed no-future-taxes by contributing to a Roth instead of relying on things continuing the way they are now, then why not?

Excellent excellent post. Learned a lot from that post. Think I understand it now.

innerscorecard

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #28 on: April 02, 2014, 07:02:50 PM »
Someone should tell Jason Fieber from Dividend Mantra all this stuff. He is making a huge mistake only investing in his taxable account.

foobar

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #29 on: April 02, 2014, 08:36:09 PM »
Pensions are pretty much OI. SS has some messy taxation rules but in general if you make under like 20k it is tax free and over that it starts to count as OI. 
The whole 0% tax rate out of your tIRA is pretty much impossible for most people (you need a small tIRA and low returns). Getting it out at a 5-10% rate is pretty doable for most people.

It should be mentioned again that bond income is not in the 0% tax bracket. If you plan on getting more conservative when you get older you need to factor in the pluses of having bonds in tax deferred versus taxable.

And at the end of the day you can't optimize this perfectly. There isn't enough info. Imagine for example if we switch to a 30% national sales tax. All of a sudden the tIRA looks great and the ROTH makes you feel like a sucker.:)  Or that is too far out for you, how does the math change between taxable and tIRAs if capital gains (or even just dividends) go back to be treated as OI like they were in the late 80s. You can't plan for stuff like that.

To what extent does an expectation of pensions and/or social security change this analysis, due to those income streams removing the lower tax bracket space that allows you to (1) use a Roth Pipeline and/or (2) lower the effective tax rate on tax-deferred income streams?  It seems to me that it might be the case that lower capital gains rates (max 15%), as Sol mentioned, might actually favor taxable accounts in the event that the deduction/exemption space and 10% bracket are used by pension/SS.  My guess is that tax-deferred still gives you enough flexibility that when the time comes you could engineer a good strategy depending on the tax law at the time, but who knows.

Yes, this would be a "Better than first world problem" situation where an actual mustachian might not need any additional funds, taxable or tax-deferred, so perhaps MMM is not the place to ask.

BigRed

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #30 on: April 03, 2014, 01:43:27 PM »
Thanks for the reply foobar.  It seemed to me that the idea of being able to withdraw my tax-deferred money tax free was pretty impractical, but I did want to make sure I wasn't missing something.

It is always good to think about the possibility that tax reform could significantly change the tax structure; changing the way deductions work, eliminating exemptions, reducing the number of brackets, or even moving from income to consumption taxes.  Dave Camp's recent proposal was a very interesting study in what kind of changes might be plausible in a real proposal.  It's pretty likely we'll see some sort of significant change in the next 20 years, it's been 30 years since the last one, and treatment of capital gains/dividends has been pretty unstable over the last decade.

Given that, I think it's still likely that I should expect that the following conditions will hold (for me)
1) Retirement Expenses(and thus Income) < Current Income
2) Therefore Future Effective tax rate < Current (State+Fed) Marginal Tax Rate (39.3% due to child tax credit phase out)
3) Flexibility from deferred taxes will allow some optimization in the future to keep effective rate lower

Short of a massive tax increase on income in the (inflation adjusted) $100,000 range, chances are very good that I'll be better off with tax-deferred savings, but it is always good to remember that's not a slam dunk or a sure thing.

Gin1984

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #31 on: April 03, 2014, 02:21:44 PM »
Yeah this is exactly what I was wondering and thinking.....

I think this plan only works for people who are going to stay in the 15% tax bracket, and thus qualify for the 0% tax rate on long term capital gains.  I suspect that most people here are in the accumulation phase and are not accustomed to thinking about selling their investments, so they aren't as informed about capital gains rates.

The 401k, still has a couple of benefits for you.  If there's an employer match you'd be dumb not to take it. 

But perhaps more important is the tax haircut of the 401k, in which you contribute at your marginal rate (15% taxes saved by investing pre-tax) but then withdraw at your effective rate (significantly less than 15% because of exemptions and deductions, maybe zero).  Done correctly, you need never pay any taxes at all on 401k contributions even if withdrawn before retirement age, and you're in the right income zone to make that happen.

Thanks for your help! Don't qualify for 401k because I own a small business, and am not an employee.

So I guess I will just stick with the regular taxable accounts for now, and pay the tax on the income now. If I ever do leave the 15% bracket, what should I do as far as money in taxable accounts?
Why not open a SEP-IRA?

SDREMNGR

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #32 on: April 03, 2014, 07:53:23 PM »
I think some important pieces of information that you left out are...

1. How much are you making?  Is it $50k / year or $30k / year?  I know you said 15% tax bracket but what is the amount?
2. How many employees in your company?
3. What is the legal structure?  Self, C corp, S corp, llc???

The information will help determine what is your best path.

I will share my setup.  I have a C corp with 5 employees.  I am also an employee of my company.  For my needs, I found that the simple ira was the best choice for me to provide tax advantaged investing for myself and my employees.  I give them 3% matching, which I can also give to myself.  It's only $12k / year capped pretax investing by the employee, but I can give 3% of total gross wage as my matching, so on salary of $40k, that'd be $2k extra, so $14k in that example.  Vanguard and Fidelity both run simple iras.

If you are a solo employee or just you and wife, you can do a SEP ira which allows the lesser of 25% of wage or $52k.  Pretty damn good option for the self-employeed person who has that much to save.  If you have employees, you have to do exactly same thing and it's all employer funded, so I didn't want to give a 25% pay increase to all employees, so this was out.

401ks are expensive for the company and needlessly complicated.

The 2nd phase of the plan is to max out your Roth ira.  Another $5.5k.  Easy.  I personally like this even better than the Simple because it's easy to take it out without having to do brain damage of how it may affect your taxes... because it doesn't!  Sweet!

The 3rd phase is to max out your HSA along with getting a HSA compatible plan.  If it's compatible, 99% of the time, the name of the plan with have HSA in there somewhere.  That is another $3.35k or $6.55k depending on single or family.  You can take it out at age 65 for whatever, or before for healthcare expenses.  Very nice.

For my instance, I am doing all 3 for myself and my wife who also works in the company, so that's $26k (with company match) into the simple ira.  $11k to roth ira.  $6.5k to HSA.  That's $43.5 into our family pot of tax advantaged investing into stocks and bonds.  That's a sizeable chunk to invest each year, and in 10 years, we should have built up our tax advantaged accounts to

 The other part of the savings that we can access is our taxed accounts which we are building up at 15% tax bracket.  We are saving about $5k/month extra outside of the ira stock investing to invest into real estate in our personal names.  We currently draw rental income from several properties but the long term plan isn't to landlord, but to sell them for tax free capital gains by living in them for 2 years at a time (most of our investments are in residential homes) when the time comes.  And the proceeds will go into a taxed account that will be pumping out qualified dividends for some tax free spending money during ER until I hit age 60 and can start tapping into the bulk of the retirement account.  I should be able to do ok in the mean time on the real estate income and .

I know you want to access your money right away, but if you want to retire then you need tax advantaged investing on your side.  I will let you read all the other posts and blogs about why tax sheltered investing gets you lot more money than taxed investing.  And others have explained how to Roth IRA ladder and SEPP and all those other fancy tricks to get your retirement money out sooner than you think.  And the HSA is a nice way to take some income off the taxable item line if you need to in order to qualify for lower tax bracket.

Joel

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Re: Do I Need Retirement Account If In 15% Bracket?
« Reply #33 on: April 03, 2014, 08:37:02 PM »
The answer is yes. Your current marginal tax rate is higher than your effective tax rate at retirement. That is almost always the case until someone builds a size able tax deferred balance (or has the expectation of other ordinary income upon retirement that will force one into the marginal 15% bracket or higher)