Author Topic: For future flexibility, should I prioritize a taxable brokerage?  (Read 755 times)

DadJokes

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First of all, I am aware of the Investment Order. However, I think that I can get the same tax results but with greater flexibility if I prioritize a taxable brokerage over the Roth IRA.

Current Allocation
AccountCurrent Balance   Annual Contributions
457(b)$54k$19.5k
401(k)$75k$14k
HSA$21k$7.2k
Roth IRA$35k$6k

By the time we anticipate having enough to “retire,” we’ll be 45 or so, and we’ll have enough in the 457(b) to carry us to 59.5 and beyond. However, I would like to have the ability to pay off our mortgage before I stop working, which will be around $200k by then. I’d rather not take that much out of the 457(b) and have to pay ordinary income taxes on it.

With that in mind, I see a few options:

1. Continue maxing out the Roth IRA and use the contributions to pay off the mortgage when we cross that threshold. We could even reduce pre-tax contributions and max an additional Roth IRA.

2. Swap from the Roth to a taxable brokerage. Our taxable income is low enough that dividends wouldn’t be taxed, and we could tax gain harvest every couple years to reset the basis without paying taxes.

3. Reduce pre-tax contributions so that we could fund a taxable brokerage account while continuing to fund the Roth. However, we might eventually push close to the taxable income threshold if we did that.

Now, we may not pay off the mortgage when we stop working, but I would like to be able to.

If my taxable income is low enough, what actual reason is there to prioritize the Roth over a taxable brokerage? The best I can see is concern over potential tax law changes. However, those are unlikely to be aimed at people in lower tax brackets.

Morning Glory

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #1 on: April 26, 2021, 12:41:38 PM »
Option C: If your taxable income is that low, then going traditional instead of Roth for the IRA might get you into saver's credit territory. Then you can use the additional tax savings to fund a taxable account!!!

DadJokes

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #2 on: April 26, 2021, 12:45:53 PM »
Option C: If your taxable income is that low, then going traditional instead of Roth for the IRA might get you into saver's credit territory. Then you can use the additional tax savings to fund a taxable account!!!

We already have the Saver's Credit. It's something we consider as well.

Edit: In 2020, we were about $4k below the 10% credit threshold, so we aren't going to reach the 20% mark. The Saver's Credit is one more reason I'm ruling out option three out of what I listed.
« Last Edit: April 26, 2021, 12:59:23 PM by DadJokes »

terran

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #3 on: April 26, 2021, 02:48:14 PM »
I wouldn't, but I don't have a mortgage I want to pay off (although we might buy at some point in retirement at which point we'll need to decide how to fund that -- who knows). Remember that Roth contributions can always be withdrawn tax and penalty free.

If you income is always low enough that you don't pay tax on qualified dividends then the advantages of Roth over traditional are 1) no tax on non-qualified dividends, 2) no state tax on qualified dividends or capital gains and 3) withdraw as much of your contributions anytime and as much of your gains once you're 59.5 as you want without any tax considerations (don't need to stay within a certain bracket). Also remember that even if you don't pay tax on your capital gains they can still reduce ACA subsidies. 

MustacheAndaHalf

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #4 on: April 28, 2021, 08:19:46 AM »
If you're married filing jointly (the "we" you mention), then you have $24k of standard deduction and up to $80k above that before leaving the 12% bracket.  I think if you make under $100k, you are in the 12% tax bracket.

When you mention the savers credit, does that mean you rely on various tax deductions to get your income into a certain range?  If so, there's probably too many pieces for me to unravel.

But assuming you're under $100k regardless of 401(k) & HSA, then you might favor paying tax now.  Always contribute up to the match in the 401(k), of course.  But maybe you could shift some of the contributions towards a taxable investment account?  If you don't use up the HSA each year - you're investing for the future ... maybe that could be another place to shift some pre-tax income into after-tax accounts.

I think you're going to have to pick somewhere to get less of your investment dollars, and I'd look at the HSA and 401(k) above the match as possible places - again, assuming you're in the 12% bracket, and want to lock that in now.

Morning Glory

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #5 on: April 28, 2021, 09:12:51 AM »
What is your state income tax rate and are you planning to move to a different state when you retire?

yachi

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #6 on: April 28, 2021, 10:02:26 AM »
If my taxable income is low enough, what actual reason is there to prioritize the Roth over a taxable brokerage? The best I can see is concern over potential tax law changes. However, those are unlikely to be aimed at people in lower tax brackets.

1.  The IRA has creditor protections being a retirement account.
2.  The IRA, as a retirement account count less towards college contributions if filling out the FAFSA.
3.  If you make the Roth contribution, you can change your mind and take out your contribution and put it in a taxable brokerage.  If  you keep it all in a taxable brokerage, you can't change your mind and put it in a Roth IRA - you're limited to 6k per year.
4.  All those yearly dividends get taxed each year in the taxable brokerage, stock sales to rebalance get taxed in a brokerage, not in an IRA.
5.  Sort of part of 4, but it deserves it's own mention.  If you make massive gains with stock options, you can sell them and buy a longer date without tax in an IRA.  In a taxable account, you'll pay taxes on the massive gains.

robartsd

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #7 on: April 28, 2021, 10:16:22 AM »
Edit: In 2020, we were about $4k below the 10% credit threshold, so we aren't going to reach the 20% mark. The Saver's Credit is one more reason I'm ruling out option three out of what I listed.
Assuming you have plenty of tax advantaged space, you could cycle the Saver's tax credit. My spending is closer to the 20% threshold than yours and I don't have a desire to pile up taxable/Roth IRA as a mortgage payoff fund, so it's not as difficult for me as it would be for you. When I noticed that my spending was within striking distance of the 20% threshold, I thought about what it might take to hit it. Then I realized that the 50% threshold wasn't that far from the 20% threshold. My current strategy involves building up taxable savings while targeting the 10% credit some years and partially living off taxable savings while targeting the 50% credit in other years. Motivation for decreasing spending is to increase the ratio of 50% credit years to 10% credit years.

If my taxable income is low enough, what actual reason is there to prioritize the Roth over a taxable brokerage? The best I can see is concern over potential tax law changes. However, those are unlikely to be aimed at people in lower tax brackets.

1.  The IRA has creditor protections being a retirement account.
2.  The IRA, as a retirement account count less towards college contributions if filling out the FAFSA.
3.  If you make the Roth contribution, you can change your mind and take out your contribution and put it in a taxable brokerage.  If  you keep it all in a taxable brokerage, you can't change your mind and put it in a Roth IRA - you're limited to 6k per year.
4.  All those yearly dividends get taxed each year in the taxable brokerage, stock sales to rebalance get taxed in a brokerage, not in an IRA.
5.  Sort of part of 4, but it deserves it's own mention.  If you make massive gains with stock options, you can sell them and buy a longer date without tax in an IRA.  In a taxable account, you'll pay taxes on the massive gains.
Those are good reasons, though OP stated that he is in 0% LTCG territory so not all these currently apply. Personally, I'd stick with Roth as I trust tax free Roth withdraws continuing over 0% LTCG rate continuing. OP plan to reset cost basis regularly only partially mitigates potential for increase in the LTCG rate in the future.

Morning Glory

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #8 on: April 28, 2021, 11:15:36 AM »
How does your state treat capital gains? Some states treat them just like earned income.

DadJokes

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #9 on: April 28, 2021, 12:57:19 PM »
How does your state treat capital gains? Some states treat them just like earned income.

Beginning in 2021 (hey, that's this year!), there is no tax on capital gains.

If my taxable income is low enough, what actual reason is there to prioritize the Roth over a taxable brokerage? The best I can see is concern over potential tax law changes. However, those are unlikely to be aimed at people in lower tax brackets.

1.  The IRA has creditor protections being a retirement account.
2.  The IRA, as a retirement account count less towards college contributions if filling out the FAFSA.
3.  If you make the Roth contribution, you can change your mind and take out your contribution and put it in a taxable brokerage.  If  you keep it all in a taxable brokerage, you can't change your mind and put it in a Roth IRA - you're limited to 6k per year.
4.  All those yearly dividends get taxed each year in the taxable brokerage, stock sales to rebalance get taxed in a brokerage, not in an IRA.
5.  Sort of part of 4, but it deserves it's own mention.  If you make massive gains with stock options, you can sell them and buy a longer date without tax in an IRA.  In a taxable account, you'll pay taxes on the massive gains.

1. I guess if we got sued, that could be a concern, but I'm not too worried about that.
2. We plan to retire and pay off the house by the time our child is 15. Not having a mortgage payment will actually make getting FAFSA/ACA benefits much easier.
3. True, but we could also live off of the taxable brokerage and max out a couple Roth 401(k)s if we decide that.
4. We're well below the income threshold for capital gains tax, and we'll use tax gain harvesting to ensure that we never do get to that point.
5. We don't do stock options.

Sure, laws could change things. I find it unlikely that lower tax brackets will be targeted, but we'll adjust if that happens.

I know that most of this is incredibly specific to my situation, but I haven't really seen anything to suggest that the benefits of a Roth are better than the flexibility offered by a taxable brokerage for us.

robartsd

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #10 on: April 28, 2021, 03:25:04 PM »
2. We plan to retire and pay off the house by the time our child is 15. Not having a mortgage payment will actually make getting FAFSA/ACA benefits much easier.
I suppose a paid off primary residence is even better than retirement account at hiding assets from FAFSA (assuming the opportunity cost isn't a problem).

3. True, but we could also live off of the taxable brokerage and max out a couple Roth 401(k)s if we decide that.
Only if you still have earned income.

Sure, laws could change things. I find it unlikely that lower tax brackets will be targeted, but we'll adjust if that happens.
I agree that neither are likely to change, but I'm more confident that Roth will not change than that capital gains will not change.

Either way getting this wrong will only lead to a minor Mustachian People Problem.

MDM

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #11 on: April 28, 2021, 10:47:10 PM »
Roth is almost certain to be better than taxable.  E.g.,
 - if you are forced to withdraw Roth earnings before age 59.5, you will have more pressing problems than Roth vs. taxable
 - Roth withdrawals do not affect the taxability of social security benefits, but interest/dividends/capital gains do

Whether traditional is better than Roth is a different question....

DadJokes

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #12 on: April 29, 2021, 06:01:40 AM »
- if you are forced to withdraw Roth earnings before age 59.5, you will have more pressing problems than Roth vs. taxable

What does that have to do with anything?

Quote
- Roth withdrawals do not affect the taxability of social security benefits, but interest/dividends/capital gains do

The entire purpose of the account is to pay off our mortgage. It'll be gone long before we reach the age to draw social security.

MDM

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #13 on: April 29, 2021, 06:23:07 AM »
- if you are forced to withdraw Roth earnings before age 59.5, you will have more pressing problems than Roth vs. taxable
What does that have to do with anything?
Quote
- Roth withdrawals do not affect the taxability of social security benefits, but interest/dividends/capital gains do
The entire purpose of the account is to pay off our mortgage. It'll be gone long before we reach the age to draw social security.
If you have considered how your expenses will be paid through age 90 or so, then you are all set.

djadziadax

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #14 on: May 07, 2021, 11:55:42 AM »
Roth is always better as others have said, because you are sure you wont be paying taxes on in the future, AND you can invest in the same assets you would invest in the taxable.

You already have 35K, you can put another 70K in it (6K this year, but will increase in future years). So you will have 100K to withdraw tax and penalty free and still have a lot of money in the Roth to continue to grow tax free.

You do not know what your financial situation would be in 10 year (I assume you have that long to accumulate). You may have enough income by then (10 years is a lot of time) that you would have to pay taxes on cap gains if you sell off enough assets to generate 200K even if the tax law stays the same. Unless you count on not having any income that one year and sell off enough of your portfolio to pay off the mortgage AND live for a year.

You do not have that much in your non-taxable accounts to start diverting money to taxable at this point in your accumulation phase.

ixtap

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #15 on: May 07, 2021, 11:58:51 AM »
Do you have reason to believe that your income will not increase between now and age 45?

Morning Glory

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #16 on: May 07, 2021, 12:04:55 PM »
Roth is not always better. Traditional is usually better than Roth (provided that your income isn't too high for the IRA deduction), even if you completely ignore the Saver's credit.  The only situation I can think of in which Roth might be better is if you currently live someplace with no state income taxes and you want to move to New York or California when you retire. 

https://www.madfientist.com/traditional-ira-vs-roth-ira/

EvenSteven

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #17 on: May 07, 2021, 12:30:39 PM »
Roth is not always better. Traditional is usually better than Roth (provided that your income isn't too high for the IRA deduction), even if you completely ignore the Saver's credit.  The only situation I can think of in which Roth might be better is if you currently live someplace with no state income taxes and you want to move to New York or California when you retire. 

https://www.madfientist.com/traditional-ira-vs-roth-ira/

A few other situations where Roth might be better:

1) You get a windfall later in life (like maybe an inherited traditional IRA) that makes your income when withdrawing from your IRA higher than when you were contributing.

2) You have a high savings rate and work longer than you need to, either because you like your job or because you value having a low withdrawal rate, such that your RMDs end up putting you at a higher tax rate when withdrawing than when you were contributing.

3) You have a substantial pension and social security (and maybe even the death of a spouse changing your tax filing situation) such that your RMDs end up putting you at a higher tax rate when withdrawing than when you were contributing.

I think #2 is probably not applicable to the OP, but #'s 1 and 2 might be.

DadJokes

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #18 on: May 07, 2021, 12:56:19 PM »
Do you have reason to believe that your income will not increase between now and age 45?

Yes. My wife is a teacher, and I am a state government employee. Our wage increases are fairly predictable.

DadJokes

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #19 on: May 07, 2021, 01:41:27 PM »
Roth is always better as others have said, because you are sure you wont be paying taxes on in the future, AND you can invest in the same assets you would invest in the taxable.

You already have 35K, you can put another 70K in it (6K this year, but will increase in future years). So you will have 100K to withdraw tax and penalty free and still have a lot of money in the Roth to continue to grow tax free.

You do not know what your financial situation would be in 10 year (I assume you have that long to accumulate). You may have enough income by then (10 years is a lot of time) that you would have to pay taxes on cap gains if you sell off enough assets to generate 200K even if the tax law stays the same. Unless you count on not having any income that one year and sell off enough of your portfolio to pay off the mortgage AND live for a year.

You do not have that much in your non-taxable accounts to start diverting money to taxable at this point in your accumulation phase.

I'd say that I have 90% certainty that I won't be paying taxes, plus I'd have the added flexibility (i.e. paying my home off before retiring) if I start prioritizing taxable over Roth. I'll take that added flexibility over the additional 10% certainty.

Roth being better because of conventional wisdom isn't really a good enough reason to do something. I've done the math (I am a CPA, after all), and so far no one has presented anything new that I had not previously considered that was significant enough to dissuade me. The only thing anyone said that I hadn't previously considered was @yachi regarding protection from creditors/lawsuits.

Kem

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Re: For future flexibility, should I prioritize a taxable brokerage?
« Reply #20 on: May 07, 2021, 03:36:05 PM »
@DadJokes - I've been down this path myself

Once I hit CoastFi (Highly certain that retirement funds will full fund retirement at retirement age) I stopped emphasizing channels such as the ROTH to instead concentrate on my Taxable Brokerage.

Today, 1.1M would fund FI including mortgage debt - 745K covers FI with no mortgage - 980K covers FI & Mortgage payoff.

I'm accelerating my Taxable until I have the mortgage balance and enough cash cushion to get me through full retirement age following a SWR.

I give up legal protection....