Author Topic: Withdrawing principle from Roth IRA, does it make sense?  (Read 5224 times)

Chuck

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Withdrawing principle from Roth IRA, does it make sense?
« on: March 22, 2015, 07:32:21 PM »
Hello all.

I am considering withdrawing all the principle in my Roth IRA, and instead investing it in a non-tax advantaged account.

For the first two years that I invested seriously, I maxed out a Roth IRA. I did so because blogs I read at the time recommended it, and I was very out of my depth when it came to personal finance. Then I found this place, along with a few places that regulars here recommend, and I now believe that the money I invested in the Roth would be better off growing in a non-tax advantaged account. The first dollar/last dollar taxation of the different IRAs, and the ability to access capital gains in a Trad. IRA through a Roth IRA rollover convinced me to start putting my money into a Traditional IRA going forward, but I still need to deal with the money I put in the Roth several years ago.

My taxable income puts me in the 15% tax bracket, and will for the foreseeable future. So, after the first year, I will have tax free growth on the non-tax advantaged account along with the ability to access both principle and capital gains without penalty. If I leave my money in the Roth, it will continue to grow tax free, and I can withdraw the principle whenever I like, but the capital gains are locked down for nearly four decades unless I want to pay a penalty and doubletax.

Since I can take the principle out of the account (which amounts to 10,500) I figure that I should do so now, before even more capital gains get locked inside. Am I missing anything? Is there a reason that I shouldn't do this?

« Last Edit: March 22, 2015, 08:08:11 PM by Chuck »

johnny847

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #1 on: March 22, 2015, 07:41:59 PM »
I don't understand what you're saying at all.

You've already paid the taxes to put money into the Roth. This is a sunk cost. Because you've already paid the cost of putting money in a Roth, that money will grow tax free, forever. You can invest in Vanguard's funds and get incredibly low cost index funds that will serve you well.

So why would you want to take this money out now to invest in a taxable account? Best case scenario, you live in a no tax state, you remain at the 15% or lower tax bracket forever, and the tax code doesn't change such that you can always realize capital gains for free. But you can always never pay any tax on gains if you just leave the money in the Roth, because you've already paid that tax when you put that money in.

MikeBear

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #2 on: March 22, 2015, 07:52:37 PM »
You can remove the gains from the Roth after 5 YEARS from the day of opening the account. Not "4 decades".

Like the other poster said, it'll all be tax-free at that point, as you've already paid into it with post-tax dollars.

Chuck

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #3 on: March 22, 2015, 08:03:25 PM »
I don't think I made myself clear: I made contributions to a Roth IRA, not a rollover. You CAN NOT withdraw gains in a Roth IRA until you are 59 1/2 years old.

If this was a rollover from a Traditional IRA -> Roth IRA, then all of the rollover the Trad. IRA would be treated as a withdrawable contribution after 5 years, but any gains that occur within the Roth IRA in that time frame could still NOT be withdrawn (unless you want to get hit with a second round of taxation AND penalty).

This is why it makes sense not to open a Roth IRA until five years before you are ready to retire, and even then to keep your rollovers from your Trad. IRA to the minimum that you require: Growth in the Trad. IRA will always be accessible within five years through rollover, but gains in the Roth IRA are trapped. 

I opened a Roth IRA too soon, and sunk two years of contributions into it. Gains from those contributions are stuck until I'm old, but the principle can be taken out and invested in a standard brokerage account to free future growth from the same trap. It's too late to make Trad IRA contributions for those years, so I think this is my best remaining option.
« Last Edit: March 22, 2015, 08:04:59 PM by Chuck »

Middlesbrough

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #4 on: March 22, 2015, 08:12:25 PM »
I would say what Johnny said. You already paid your dues. Let it sit. I am guessing that this is a small sum of money by the way you are talking and if you get all the best cases in the world, the earnings on this by the time you will want it will be minimal. If it is a ways off before you need the money, this is another way to manipulate you tax bracket into the vast unknown. If you do want this money sooner, why isn't getting your principle back enough anyway? How much money will it make for you in the short term to make that headache marginally beneficial?

seattlecyclone

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #5 on: March 23, 2015, 09:04:21 AM »
You're right that an early retiree probably shouldn't have all of their money in a Roth IRA, because the gains shouldn't be withdrawn until age 59, and the principal is unlikely to last that long. You're also right that new contributions are usually better off in a traditional IRA, both because you have easier access to the money before age 59 and also because your tax rate is likely to be higher now than when you retire. However if you've already contributed a bit to a Roth IRA, there's nothing wrong with leaving that money there to grow for a few decades.

Let me put it this way: suppose you leave your Roth money where it is and never contribute another cent to it. What are the odds that you'll be retired, not 59 yet, the only money you have left to your name is Roth gains, and that money would otherwise be enough to sustain the rest of your retirement? It's extremely unlikely. If a Roth IRA only makes up a small percentage of your portfolio at the time of retirement, you should be able to count on the rest of your accounts (plus Roth principal) to sustain you until 59. The Roth gains will be there if you need them later, or if you don't need them they can make a wonderful tax-free inheritance for your heirs.

ac

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #6 on: March 23, 2015, 09:13:55 AM »
You're also right that new contributions are usually better off in a traditional IRA, both because you have easier access to the money before age 59 ...

Wait what?  I thought a Roth gave easier access to the money before age 59.5 because you can withdraw the principal tax and penalty free.  Why would a traditional ira give me better access?

Chuck

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #7 on: March 23, 2015, 09:40:03 AM »
You're also right that new contributions are usually better off in a traditional IRA, both because you have easier access to the money before age 59 ...

Wait what?  I thought a Roth gave easier access to the money before age 59.5 because you can withdraw the principal tax and penalty free.  Why would a traditional ira give me better access?
Because I'm retiring at ~35, not at 59 1/2. I don't want to lock up a large portion of my money for 25 years. I might need it before then.

Quote from: seattlecyclone
Let me put it this way: suppose you leave your Roth money where it is and never contribute another cent to it. What are the odds that you'll be retired, not 59 yet, the only money you have left to your name is Roth gains, and that money would otherwise be enough to sustain the rest of your retirement? It's extremely unlikely. If a Roth IRA only makes up a small percentage of your portfolio at the time of retirement, you should be able to count on the rest of your accounts (plus Roth principal) to sustain you until 59. The Roth gains will be there if you need them later, or if you don't need them they can make a wonderful tax-free inheritance for your heirs.
Seattle, your argument is that this small inefficiency is unlikely to be the breaking point between success and failure, and I agree with that.

But think of it this way: Bascially I'm losing the opportunity cost of 10,500 dollars, spent very early in the accumulation process. I've already accumulated nearly 5000 in gains on that money. That is 5000 dollars that needs to be excluded from my FIRE number, because I can't access the money. Think of how much will be there in another eight years...

At my current income, and under current law, I don't think I will lose any benefit by simply pulling the principle now and investing it non-tax advantaged. It will still grow tax free and all of that money will be accessible when I need it, not just principle.

Even if this inefficiency isn't fatal, doesn't fixing it still make sense? What benefit do I get from leaving the money to grow in a cage?

brooklynguy

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #8 on: March 23, 2015, 10:11:05 AM »
Chuck, your plan makes perfect sense to me, as long as you're confident in your decision to favor taxable investing over Roth investing (which is the approach favored by some very smart people, like Go Curry Cracker).

What you are doing is the equivalent of opting to invest new after-tax money (in an amount equal to the Roth principal that you plan to withdraw) in a taxable account instead of a Roth account (assuming you had the option to choose either alternative).

In other words, someone like me is currently maxing out the Mega Backdoor Roth option while it is available to me.  If, instead, I decided not to utilize that option and stick those funds in a taxable account (which is the approach Go Curry Cracker advocates), that would be an equivalent decision to your proposal.

johnny847

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #9 on: March 23, 2015, 10:13:00 AM »
Seattle, your argument is that this small inefficiency is unlikely to be the breaking point between success and failure, and I agree with that.
You're starting to disprove yourself here.

But think of it this way: Bascially I'm losing the opportunity cost of 10,500 dollars, spent very early in the accumulation process. I've already accumulated nearly 5000 in gains on that money. That is 5000 dollars that needs to be excluded from my FIRE number, because I can't access the money. Think of how much will be there in another eight years...

At my current income, and under current law, I don't think I will lose any benefit by simply pulling the principle now and investing it non-tax advantaged. It will still grow tax free and all of that money will be accessible when I need it, not just principle.

Even if this inefficiency isn't fatal, doesn't fixing it still make sense? What benefit do I get from leaving the money to grow in a cage?

Let's try to establish some context around this: What is your predicted FIRE number and how much you put into investments every year? Basically, why don't we calculate how much more time you'll need to spend working if you leave the money in the Roth.

Also, the key phrase in your argument is "under current law." Tax code can change. You may move to a not tax free state. Either of these things can cause you to pay capital gains tax.
Suppose you had a crystal ball that told you the long term capital gains tax rates would all increase by 5%. And that you would end up moving to a state with a marginal income rate of 6%. With this information, does it make sense to pull the money out of the Roth? No it does not.
Unfortunately you don't know this. However, in the context of saving for FIRE, at this point in your life honestly $10.5k isn't a huge sum or anything. As seattlecyclone said, it's not going to make or break anything.

EDIT: Missed the fact that you currently live in VA, which has an income tax. As seattlecyclone says below, you will owe taxes on any dividends while you're still living there.
« Last Edit: March 23, 2015, 10:40:05 AM by johnny847 »

seattlecyclone

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #10 on: March 23, 2015, 10:25:25 AM »
You're also right that new contributions are usually better off in a traditional IRA, both because you have easier access to the money before age 59 ...

Wait what?  I thought a Roth gave easier access to the money before age 59.5 because you can withdraw the principal tax and penalty free.  Why would a traditional ira give me better access?

With a Roth IRA, you can withdraw the principal penalty-free, but after a couple of decades of growth the principal is likely to be only a fraction of the total balance. Any earnings have a pretty huge tax hit attached if you take them out before age 59.

With a traditional IRA, you can roll over any amount (principal or earnings) to a Roth IRA, pay tax on it, wait five years, and withdraw the full amount penalty-free. The only bit you lose access to is the growth that happens during the five-year waiting period.

Each method has its pluses and minuses, but I think that the traditional wins out in most cases in terms of access to the funds before age 59.

Aphalite

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #11 on: March 23, 2015, 10:28:01 AM »
I don't understand - you are voluntarily giving up guaranteed tax free compounding to gamble that the current tax system that gives you 0% cap tax rate on regular brokerage will hold up in the future?

seattlecyclone

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #12 on: March 23, 2015, 10:30:57 AM »
Quote from: seattlecyclone
Let me put it this way: suppose you leave your Roth money where it is and never contribute another cent to it. What are the odds that you'll be retired, not 59 yet, the only money you have left to your name is Roth gains, and that money would otherwise be enough to sustain the rest of your retirement? It's extremely unlikely. If a Roth IRA only makes up a small percentage of your portfolio at the time of retirement, you should be able to count on the rest of your accounts (plus Roth principal) to sustain you until 59. The Roth gains will be there if you need them later, or if you don't need them they can make a wonderful tax-free inheritance for your heirs.
Seattle, your argument is that this small inefficiency is unlikely to be the breaking point between success and failure, and I agree with that.

But think of it this way: Bascially I'm losing the opportunity cost of 10,500 dollars, spent very early in the accumulation process. I've already accumulated nearly 5000 in gains on that money. That is 5000 dollars that needs to be excluded from my FIRE number, because I can't access the money. Think of how much will be there in another eight years...

At my current income, and under current law, I don't think I will lose any benefit by simply pulling the principle now and investing it non-tax advantaged. It will still grow tax free and all of that money will be accessible when I need it, not just principle.

Even if this inefficiency isn't fatal, doesn't fixing it still make sense? What benefit do I get from leaving the money to grow in a cage?

Do you live in a state with income tax? Your reported location says you do. You'll be paying state tax on the dividends from now until retirement, and likely thereafter. The 0% federal capital gains tax has only been around since 2008. It has acquired nowhere near the same political staying power as social security or other programs. It's nice while it lasts, but I'm not betting that it will stay that way forever.

Regardless, there's a lot of life after age 59. There's nothing at all wrong with having a small portion of your money that you shouldn't touch until then.

Chuck

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #13 on: March 23, 2015, 11:16:23 AM »
I forgot to account for state taxes. You guys are right, this requires a little more thought on my part. The point about current law changing is also well taken (though I could quip that Roth's are subject to this exact same vulnerability- look at the President's proposed changes to 529's)

I am inclined to think that 6% of dividends is fairly insignificant as far as expenses go though: with dividend yields on VSTAX at 1.7%, this amounts to an effective .1% expense... that can be written off of federal taxes!

I am still inclined to move forward, but I am going to give this more thought than I have up to this point. I am no longer certain this is the best move.

brooklynguy

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #14 on: March 23, 2015, 11:51:02 AM »
The point about current law changing is also well taken (though I could quip that Roth's are subject to this exact same vulnerability- look at the President's proposed changes to 529's)

Although nothing is impossible, the likelihood that a future iteration of Congress will effectively renege on the deal being struck with today's taxpayers/Roth-account-holders is in my view far more remote than the possibility that tax laws will change in a manner that makes holding funds in a Roth account a more attractive option.  The President's proposed changes to 529s would not have retroactively taken away the tax benefits for existing, grandfathered contributions.

forummm

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #15 on: March 23, 2015, 11:57:02 AM »
You can also take out up to $10k (tax and penalty free) to buy a house or contribute to a housing purchase for you or a qualified relative (as long as they haven't owned a house in the last 2 years). And you can also take out funds (tax and penalty free) to be used for higher education expenses for you or a qualified relative. And there are also ways to take out funds to use for health expenses.

I think it's somewhat likely that 0% CG taxes will go away in the next 20 years. And most states already tax them.

forummm

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #16 on: March 23, 2015, 12:01:21 PM »
Also, I am planning on having quite a bit of money left by the time I hit 59.5. You probably will need some money at that point in your life as well, since SS will not be available to you that early, and most pensions don't kick in until later (especially for people who retire at 35).

And market returns are unpredictable. You don't want to plan to be just scraping by. Your portfolio should be large enough to satisfy your needs in a somewhat conservative scenario--especially considering that the market may already be 20-80% overvalued right now. So if you are planning to have no money left at 59.5, you're probably making a mistake.

johnny847

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #17 on: March 23, 2015, 12:54:30 PM »
Although nothing is impossible, the likelihood that a future iteration of Congress will effectively renege on the deal being struck with today's taxpayers/Roth-account-holders is in my view far more remote than the possibility that tax laws will change in a manner that makes holding funds in a Roth account a more attractive option.  The President's proposed changes to 529s would not have retroactively taken away the tax benefits for existing, grandfathered contributions.

I concur. Even a proposal of taxation of Roth withdrawals is political suicide. There's just way too many people invested with way too much money for the implicit contract of a Roth for a politician to seriously consider taxing Roth withdrawals.
What's far more feasible is RMD's on Roth IRAs.

I forgot to account for state taxes. You guys are right, this requires a little more thought on my part. The point about current law changing is also well taken (though I could quip that Roth's are subject to this exact same vulnerability- look at the President's proposed changes to 529's)

I am inclined to think that 6% of dividends is fairly insignificant as far as expenses go though: with dividend yields on VSTAX at 1.7%, this amounts to an effective .1% expense... that can be written off of federal taxes!

I am still inclined to move forward, but I am going to give this more thought than I have up to this point. I am no longer certain this is the best move.

What's more important is what state you plan on retiring in. But also, recognize that life may not go as planned and you may not retire where you intend on retiring now.

skyrefuge

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #18 on: March 23, 2015, 03:04:14 PM »
But think of it this way: Bascially I'm losing the opportunity cost of 10,500 dollars, spent very early in the accumulation process. I've already accumulated nearly 5000 in gains on that money. That is 5000 dollars that needs to be excluded from my FIRE number, because I can't access the money. Think of how much will be there in another eight years...

Your youthful recency bias is showing, not just in your tax-law perspective, but perhaps in your investment expectations as well. If you were 15 years older, investing in 1998-1999, you also would have seen your $10.5k investment grow by $5k. Then, think of how much would have been there in another eight years! Hey, thankfully our time machine allows us to look into the "future" in that case for the answer: about $15k total, same as 8 years before. And soon to drop to ~$9k, an amount lower that your initial $10.5k investment. There you go, problem solved! You don't have to worry about your "trapped" earnings, because you have no earnings at all.

Yes, that's an extreme example, but the point is that there is no guarantee that your Roth contributions will end up as a meaningless fraction of your overall Roth balance.

I am inclined to think that 6% of dividends is fairly insignificant as far as expenses go though: with dividend yields on VSTAX at 1.7%, this amounts to an effective .1% expense... that can be written off of federal taxes!

Well, to make a decision here, you at least need to do the math, so I'll help get you started. A 0.09% "expense" over a 30-year period reduces your portfolio value by 2.67%. That's a lot more than 0.09%, though still not a giant number. But say the federal dividend tax rate, which has changed several times in the last decade alone, goes from 0% to a still-historically-low 15%. Then you're looking at something more like a 0.37% "expense", which adds up to a 10.52% portfolio-reduction over 30 years. That's more paid in dividend taxes than if you just paid the 10% tax for early withdrawal from the Roth. If VTSAX's dividend rate increases, or you make more money than you expect, or if dividends go back to being federally taxed at ordinary income rates and the tax brackets change, or if you move to another state with higher taxes, or your state raises its taxes, than the portfolio reduction will be even greater than that 10.52%.

So if you can plug in numbers for the likelihood of any of those things happening, you can come up with an "expected value" for your portfolio-reduction due to dividend tax exposure over its lifetime. That's hard to do, but I'd say you can be fairly confident that your reduction will never be less than 2.67% over 30 years, and there is, I dunno, maybe a 30% chance of any or all of those things turning it into a ~10% reduction?

Is that reduction a fair price to pay for the ability to access money earlier than 59.5, an age where you're likely to need money for 40 more years anyway? Maybe it is, but that's at least the framework you should be using to make the decision.

Finally, remember, just like in school, the principal is your PAL! Not your PLE. Who the hell wants a PLE?

Chuck

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Re: Withdrawing principle from Roth IRA, does it make sense?
« Reply #19 on: March 23, 2015, 03:26:06 PM »
Excellent point. Basically if I leave the money alone, worst case is that I need it and I pay a 10% tax on earnings... which is still very low historically and might even be lower than what I would pay in a taxable account anyway.

If I move it, I expose it to much more risk...

Alright. Consider me convinced. Thank you all for your time and input, especially skyrefuge and seattlecyclone!