Author Topic: What combination of changes would it take for you to prefer Roth over pretax?  (Read 3333 times)

ender

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I'm curious what change(s) people would need to see in the tax code in order for Roth to become preferred over pretax 401k/IRAs/etc for people aspiring for early retirement.

It seems like the benefits are impactful enough that it would require multiple changes in order to make them a better option - the subject comes up here often of "roth vs traditional?" and one of the often quoted reasons to do Roth is "what if..." scenarios.

To me, it would take multiple changes in order to make it better to do my Roth 401k vs pretax (other than my marginal tax rate dropping low enough during contribution years or phasing out of the deductible IRA range). And most of those changes would cripple most Americans.


mathjak107

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see my answer i posted to a  similar thread earlier .today

"   depending on your situation the roth will likely be the winner for many reasons and all have little to do with final tax brackets .

first off so much in retirement is income linked .  everything from getting ss taxed  to what you pay for medicare premiums are linked to your magi .

if you retire earlier then medicare age getting an aca subsidy is income linked .

you have no rmd's to deal with . rmd's can be a disaster when one spouse dies and the other has to file single tax wise .

once rmd's start if you reinvest that money  all gains and distributions are forever taxed .  roths are never taxed and remain tax free long after rmd's are taxed on gains .

but the biggest factor few look at are your average long term tax bracket .

most of us have careers that ramp up over decades to the higher brackets .    folks make the mistake of just looking at their final years and going in retirement we will be in a lower bracket tax wise . but that is wrong . it is your total career average that matters and roths can leave you with as much as 20%  more spendable income even if brackets stay the same .

it is only certain careers like doctors , lawyers , bankers , etc where you start out in the highest brackets that would not benefit as much from a roth .

now that i retired  i realize i made a big mistake shying away from roths  and now it t is not about whether taxes go up or not when you retire . it is all about the things linked to your income when you retire and how painful rmd's can become .

at this point conversions offer little help . . in fact convert to much and you can find your medicare premiums tripled .

se sold an asset 2 years before medicare and retiring . since medicare goes back 2 years to determine income we got a 300% increase

MustacheAndaHalf

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One early retirement approach suggests saving in pre-tax during the income years, and then converting to Roth during the early retirement years.  Essentially it's shifting pre-tax money to a lower tax year, and then letting it be taxed.  With that in mind, there isn't so much a preference as a role to play: pre-tax defers tax, and converting to Roth lets taxes be paid in a low tax bracket.

mathjak107

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providing you can convert enough without ruining a zero capital gains bracket you might need  to utilize or you can fill up the 15% bracket if rmd's will be at a higher rate .

but keep in mind , medicare goes back two years when you start medicare . convert over to roths and if you convert to much you can see a whopper of a premium increase .


there is nothing like doing roths when you are younger and first ramping up in income over the early decades .

ender

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providing you can convert enough without ruining a zero capital gains bracket you might need  to utilize or you can fill up the 15% bracket if rmd's will be at a higher rate .

but keep in mind , medicare goes back two years when you start medicare . convert over to roths and if you convert to much you can see a whopper of a premium increase .


there is nothing like doing roths when you are younger and first ramping up in income over the early decades .

... what? How old are you when you are you planning on retiring? 

mathjak107

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i am retired . i retired at 62 .  but keep in mind when doing roth conversions "early in retirement "  that once you hit 65  they go back 2 years to determine your income  for setting your medicare premium ..

if your magi with the roth conversions hit certain milestones you can pay a lot for premiums for every year you do a conversion that increases you beyond the thresholds.

we sold some commercial lease rights in 2014 before we retired and my wife who is older then me was not on medicare yet nor retired . she started medicare in 2015 . .

well for 2016 we got a notice our medicare premiums were being raised 300% because of the magi levels we hit in 2014 .

so if you have conversions to do , be careful how much you convert when it is added to your other income .

« Last Edit: July 23, 2016, 05:04:49 PM by mathjak107 »

ender

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... ok, you also realize that most people here are planning on retiring in their 40s, right?


mathjak107

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didn't we all  ,  ha ha ha  . i hoped to but on the way a funny thing happened . a wife and kids .

if you are planning that young why bother with conversions , unless your income is that  high , do a roth .   you still likely want to keep your magi as low as you  can regardless of age if you retire . you still may want aca subsidy's , medicaid  , etc .  depending on your time line they may get in the way .

having a zero capital gains bracket that is free and available to use and not filled with conversion money or taxable distributions  is another plus .


« Last Edit: July 23, 2016, 05:39:48 PM by mathjak107 »

sparkytheop

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I'm not sure (I've always done a traditional and just opened a Roth this year, only partially funding it), but my son is 18, likely won't pay any taxes this year and very minimal next year, so I'm having him put $1k to $2k into it, then $10/week after that.  With him starting at 18, he can put just a little away and have a big payoff later.  As he gets older and makes more money, he can open a traditional as well, taking advantage of both.

ender

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didn't we all  ,  ha ha ha  . i hoped to but on the way a funny thing happened . a wife and kids .

if you are planning that young why bother with conversions , unless your income is that  high , do a roth .   you still likely want to keep your magi as low as you  can regardless of age if you retire . you still may want aca subsidy's , medicaid  , etc .  depending on your time line they may get in the way .

having a zero capital gains bracket that is free and available to use and not filled with conversion money or taxable distributions  is another plus .

Pretty much this entire forum is either planning or has retired early.

I'm not sure if you realize this.

mathjak107

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which is why i said conversions can be a poor idea . it may be to late for that  unless you can fill up any unused space in the 15% bracket if you will be in the 25% range with rmd's and ss  when it kicks in .

matchewed

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which is why i said conversions can be a poor idea . it may be to late for that  unless you can fill up any unused space in the 15% bracket if you will be in the 25% range with rmd's and ss  when it kicks in .

His point is that you seem to be missing the crux of this forum. This forum is geared towards young people actually retiring early, not just dreaming.

Conversions are a great idea when you saved the money tax free while you were in a higher bracket and then you convert the money while you are in a lower bracket. The idea is to have that five year gap covered so you can keep your "income" artificially low therefore you are in a very low tax bracket.

matchewed

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I think the changes would be focused mainly on how conversions are treated. If the gov ever did something to change how things are now it would just have to be a reevaluation of the plan. Pre-tax savings is killer though, it's very tough to upset that apple cart in my mind.

mathjak107

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which is why i said conversions can be a poor idea . it may be to late for that  unless you can fill up any unused space in the 15% bracket if you will be in the 25% range with rmd's and ss  when it kicks in .

His point is that you seem to be missing the crux of this forum. This forum is geared towards young people actually retiring early, not just dreaming.

Conversions are a great idea when you saved the money tax free while you were in a higher bracket and then you convert the money while you are in a lower bracket. The idea is to have that five year gap covered so you can keep your "income" artificially low therefore you are in a very low tax bracket.

which is what i said , if you can fill up the 15% bracket when that income may eventually be in the 25% bracket then it is worth it . that has no bearing on what age you retire . it is just simple math at any age

ender

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which is why i said conversions can be a poor idea . it may be to late for that  unless you can fill up any unused space in the 15% bracket if you will be in the 25% range with rmd's and ss  when it kicks in .

His point is that you seem to be missing the crux of this forum. This forum is geared towards young people actually retiring early, not just dreaming.

Conversions are a great idea when you saved the money tax free while you were in a higher bracket and then you convert the money while you are in a lower bracket. The idea is to have that five year gap covered so you can keep your "income" artificially low therefore you are in a very low tax bracket.

which is what i said , if you can fill up the 15% bracket when that income may eventually be in the 25% bracket then it is worth it . that has no bearing on what age you retire . it is just simple math at any age

That's not true at all.

Someone retiring at 65 with $1M in an IRA has a lot more concern with RMDs and "too much traditional" than someone at 40. The person at 40 has 20+ years to convert it to Roth, for free.

If the person retiring at age 40 ends up with so much leftover after the "free" Roth conversions during their 40s and 50s that RMDs end up a factor, well, it basically means they "won" completely. They ended up with way too much money.

I plan to either:

  • Pay minimal income taxes on all my pretax money or
  • end up with way too much in my 60s/70s

Either option is fine. Only the second is available to a more traditional retiree.

seattlecyclone

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Back to the original question, there would have to be some pretty extensive changes for me to believe Roth contributions are better than traditional contributions in my situation.

Based on the difference between my current tax bracket and expected retirement tax bracket, you could make withdrawals of Roth conversions subject to early withdrawal taxes even after five years, eliminate the SEPP option entirely, even double the early withdrawal tax to 20%, and traditional contributions would still probably come out ahead.

If I have a favorable sequence of returns, it's likely that I won't even need to use my IRA money until after age 60; the taxable accounts have a decent chance of lasting until then. If that happens I will just be using Roth conversions as a way of smoothing out my taxable income and avoiding huge RMDs later in life.

ender

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Back to the original question, there would have to be some pretty extensive changes for me to believe Roth contributions are better than traditional contributions in my situation.

Based on the difference between my current tax bracket and expected retirement tax bracket, you could make withdrawals of Roth conversions subject to early withdrawal taxes even after five years, eliminate the SEPP option entirely, even double the early withdrawal tax to 20%, and traditional contributions would still probably come out ahead.

If I have a favorable sequence of returns, it's likely that I won't even need to use my IRA money until after age 60; the taxable accounts have a decent chance of lasting until then. If that happens I will just be using Roth conversions as a way of smoothing out my taxable income and avoiding huge RMDs later in life.

This brings up a good point - if you're saving in taxable accounts, the factors making trad > Roth are even stronger.