Taxable Account question

[mustache110]

First, I am aware of the Roth ladder and other ways to access retirement accounts early, so I'm trying to avoid a discussion on that if possible.

My question comes around taxable accounts given my tax bracket. My goal this year is to max out my 401k, which will put me solidly in the 15% tax bracket. I will then have some money left over to invest. As I understand, the long term cap gains rate and dividends rate is 0% for this bracket.

 I know that the typical order given on this site is to fill all tax advantaged space first, so contributing to the Roth would be up next. However, since my understanding is that I won't be taxed on earnings if I remain in this bracket, would it make any sense to prioritize my taxable account over the Roth? I would much prefer the ease of access to the earnings of the taxable account, rather than the hoop jumping associated with conversion ladders and the like.

I understand that tax laws can change, but that is true for all types of accounts as well, so let's only consider what we know today.

What are your thoughts?

[GGNoob]

I've thought about this as well. After putting $54,000 into tax deferred employer retirement accounts (2x401k and 1x457), my wife and I will be in the 15% tax bracket. The other nice thing is that you can tax-gain harvest. The ease of account access sounds really nice!

[MDM]

seattlecyclone gave some good observations on Roth benefits over taxable in the 15% bracket in http://forum.mrmoneymustache.com/investor-alley/hsa-inflation-and-reimbursement/msg691348/#msg691348:

A taxable account isn't "basically a Roth" for someone in the 15% bracket. Just because the federal tax on long-term gains and qualified dividends is currently zero, there are a lot of other reasons why growth in a Roth account or HSA can be better than growth in a taxable account. Taxable investment income (even if taxed at 0%) can reduce your eligibility for ACA subsidies, the saver's credit, the earned income credit, and plenty of other things. If you're invested in a fund that distributes some non-qualified dividends, those will be better in a tax shelter as well. In the best case a taxable account is no worse than a Roth account or HSA from a tax perspective, but there are plenty of cases where it is worse.

This doesn't even touch on the possibility that you might not be in the 15% bracket forever, or the possibility that Congress would raise the long-term rate from zero (this rate has only been around since 2008 and I think it's foolish to assume it will be that way forever).

[Mirwen]

You are correct that you will not be taxed on ordinary dividends or long term capital gains in the year you earn them.  But what happens in 10 years when you are no longer in the 15% bracket?  Now you've just wasted 10 years of not sheltering your money and you can't get that back. 

Your best option is probably the Roth.  You get the same benefit of sheltering earnings from tax now, but you also get to do this forever, even if you are no longer in the 15% tax bracket.  You can always withdraw your contributions with no penalty.  It's only the earnings you can't touch (without penalty). 

I can't see any benefit of the taxable over the Roth, and I'm in the 15% bracket too.

[seattlecyclone]

In addition to what MDM quoted, keep in mind that you can always withdraw your Roth contributions at any time with no tax or penalty. So if you're worried about access to your funds, you really only need to worry about any investment gains between now and the time you would want to withdraw. Roth gains, if withdrawn early, are subject to tax at your current marginal rate plus a 10% penalty.

For this reason you really don't want to get yourself in a position where you have no taxable funds, you've rolled over all of your pre-tax retirement accounts to Roth, you've withdrawn all of your Roth principal, and all the money you have left to your name is Roth gains. If you think there's a danger of getting into this situation, don't contribute to a Roth account. However I would posit that for most of us, if we have gotten ourselves into this situation prior to age 59½, we have bigger problems (aka we're about to run out of money completely). I view my Roth gains as "old age money" that will be there for me to use after "normal" retirement age, and most likely won't be needed at all (since the studies that led to the 4% SWR show that you have good odds of not even coming close to running out of money during retirement if you only withdraw 4%).

[mustache110]

Thanks for the replies folks. This thought came to me after an article on Go Curry Cracker where he prioritized taxable over Roth investing, which ran counter to everything else I read.

There are some other advantages here as well it seems. My thought is that I will remain in the 15% bracket for quite some time, as my wife would likely quit her job if my salary increases more substantially.

While I am going for FI, I'm still not sure when and if I would actually retire as it's still at least 10 years out. If I decide not to retire, but instead use my investments to travel more, would it change your recommendation, because I might not be able to convert/ladder my 401k balance without a high tax bill if I am still working, right? In this case, I would have either access to my entire taxable balance (including earnings) vs only Roth contributions?

I will try to find that article, as it's much more comprehensive.

[mustache110]

http://www.gocurrycracker.com/roth-sucks/


Here it is...lots of debate in the comments, so clearly not an easy answer, and also would not make sense for the higher income brackets. However, it's an interesting point, since everything I've read until now puts Roth above taxable, whereas he is using his dividend checks for spending in lieu of reinvestment. He also seems to be quite good at avoiding tax in general.

[matchewed]

Remember it is taxed at the rate for the year you withdraw from the taxable, not the year you contributed to it. I say this as you haven't mentioned goals, timelines, or income before/expenses after FIRE.

That aside, traditional IRA instead of Roth IRA after 401k is the rule of thumb advice.