Author Topic: Marginal rates, effective rates, and tax-free income, oh my!  (Read 1786 times)

Villanelle

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Marginal rates, effective rates, and tax-free income, oh my!
« on: November 01, 2016, 01:45:38 AM »
Thanks to a HELOC pay off, I've now got about $500/mo additional to invest, and am trying to figure out where the heck to put it, and this seems like a good time to reevaluate all of of choices, some of which have been more or less on auto-pilot for some time.  I know what funds I'll put it in, but not what account type.

I've found the general advice that with a marginal tax rate of 25%+ should go traditional.  Much of DH's income and all of my meager income is untaxed.  He's military and much of his compensation is "allowances" rather than "pays", and as such is untaxed.  I have essentially a side hustle working overseas teaching private English lessons.  Does our untaxed income change that at all.  I feel like I should be able to figure this out, but my brain feel confuzzled. I'm not necessarily looking for someone to actually do the math for me.  I just want to know what math I need to be doing, and whether anything matters other than really that marginal tax rate.  (And yes, I understand there's a certain amount of guess work about future tax rates and laws, and all that, making this more of an art than a hard science.)

Other potentially relevant factors.  We expect much of our FIRE funds to come from a military pension, and have a fairly high (by MMM standards) estimated FIRE budget.  Haven't settled on a hard number, but ~$60-75k is probably the right ballpark.

I'm starting from a clean slate trying to make sure everything is going to the most efficient places, not just the new $500.  Can someone tell me how to evaluate them? 

We have available to us the following:
Roth TSP  (no match)
TSP (no match)
Roth IRAs (2)
Traditional IRAs (currently only I have one, but we could open another)
and of course regular, non-retirement accounts

No 401k, HSA, or anything else I can think of. 

Right now we have maxed the Roth TSP and then are putting money in our Roth IRAs, with a small bit going into a non-retirement account.

Can someone help me figure out how to prioritize?  Obviously some of these preclude others (Trad IRA/Roth), but I'd like to set up a priority list so that I can just max each one and move down the list until I'm out of investments to make.

(I feel like I've got a pretty good handle on what types of investments in our allocation to put in what types of accounts, so it's just what types of accounts are best in general that I need advice about.)

ooeei

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Re: Marginal rates, effective rates, and tax-free income, oh my!
« Reply #1 on: November 02, 2016, 10:57:06 AM »
It really depends on your tax rate.  You mention a lot of untaxed income, but can you estimate what your tax rate will actually end up being at the end of the year (or next year)?  That's what's going to drive the Roth vs Traditional decision.

You should also factor estimated retirement taxes into your calculation.  For example, if the pension is taxed, and is expected to be large, that may mean that you'll be in a higher bracket in retirement than you are now.  If that's the case, the Roth option makes more sense. 

TSP vs IRA depends on your investment options in the TSP.  If you have some sort of institutional funds that get crazy low expense ratios, it's likely better to max that out before the IRA.  If it has mediocre options, max out the IRAs first.

Hopefully this isn't as confusing to read as it was to write.

Villanelle

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Re: Marginal rates, effective rates, and tax-free income, oh my!
« Reply #2 on: November 02, 2016, 11:46:57 PM »
It really depends on your tax rate.  You mention a lot of untaxed income, but can you estimate what your tax rate will actually end up being at the end of the year (or next year)?  That's what's going to drive the Roth vs Traditional decision.

You should also factor estimated retirement taxes into your calculation.  For example, if the pension is taxed, and is expected to be large, that may mean that you'll be in a higher bracket in retirement than you are now.  If that's the case, the Roth option makes more sense. 

TSP vs IRA depends on your investment options in the TSP.  If you have some sort of institutional funds that get crazy low expense ratios, it's likely better to max that out before the IRA.  If it has mediocre options, max out the IRAs first.

Hopefully this isn't as confusing to read as it was to write.

TSP has insanely low expense rations, which is why we've done that first up until now (and will continue to do so).

When you ask about me calculating my tax rate, are you referring to my effective rate (i.e. made $120k, paid $12, so 10%) or my marginal rate?  Military retirement is taxed, and we expect it to be anywhere from $45-75k/yr, depending on a few factors. 

MDM

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Re: Marginal rates, effective rates, and tax-free income, oh my!
« Reply #3 on: November 03, 2016, 01:14:09 AM »
When you ask about me calculating my tax rate, are you referring to my effective rate (i.e. made $120k, paid $12, so 10%) or my marginal rate?
Definitely marginal.  Both your marginal tax savings rate and your marginal withdrawal tax rate.

See https://www.bogleheads.org/wiki/Traditional_versus_Roth.

MDM

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Re: Marginal rates, effective rates, and tax-free income, oh my!
« Reply #4 on: November 03, 2016, 01:15:41 AM »
Can someone help me figure out how to prioritize?  Obviously some of these preclude others (Trad IRA/Roth), but I'd like to set up a priority list so that I can just max each one and move down the list until I'm out of investments to make.
See the 'Investment Order' tab in the case study spreadsheet.  Does that help?

MustacheAndaHalf

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Re: Marginal rates, effective rates, and tax-free income, oh my!
« Reply #5 on: November 03, 2016, 01:52:11 AM »
Your "side hustle" is probably under the foreign income exclusion of roughly ~$85k, so that won't be taxed.

Villanelle

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Re: Marginal rates, effective rates, and tax-free income, oh my!
« Reply #6 on: November 03, 2016, 02:53:45 AM »
If comparing marginal now to projected marginal rate in retirement, now is likely higher, so I guess that means we should go trad IRA, not Roth.

But I'll play around with the Case Study Spreadsheet. Thanks!

Your "side hustle" is probably under the foreign income exclusion of roughly ~$85k, so that won't be taxed.

Yes, it's well, well (well) under that, so I've included it in the portion of our income that won't be taxed.