I'm a firm believer in the idea that tax deferred investments are the better choice for anyone who expects to be in the same or lower tax bracket in retirement as compared to during their working years. However, my wife and I are in a low bracket (15%) and are able to contribute large amounts to tax deferred account both in terms of our ability to save and the accounts we have access to (solo 401k, 403b, 457, t.IRAs, sometimes an HSA), so it seems conceivable that we could over contribute such that we end up in a higher bracket (25%) in retirement, so I'm trying to figure out at what point that would be.
Assumptions (not our actual situation, but the idea is the same)
>Current tax deferred balance: $200k
>Average real rate of return (after inflation): 5%
>Current age: 30
>Age at retirement: 45
>Age at last withdrawal (death): 95
For the purposes on these calculations I will also assume that the current tax brackets remain the same when adjusted for inflation, which will allow us to make all calculations based on today's dollars. This means $20,800 of income will be taxed at 0% (standard deduction plus two personal exemptions), the 10% bracket tops out at $39,450 ($20,800 + $18,650 taxable income), and the 15% bracket tops out at $96,700 ($20,800 + $75,900 taxable income).
This means to make sure I fill all of the the lower bracket(s) in retirement I want to have withdrawals of $39,450/year, and if I don't want to go into a higher bracket in retirement I want to have withdrawals below $96,700/year. Remember that I'm using a real rate of return, so while these numbers will actually be higher, if the tax code stays the same, this is what they'll be in inflation adjusted terms.
So using the assumed 5% real return, 60 years of withdrawals (death at 95, retire at 45), a minimum annual payment of $39,450 and maximum annual payment of $96,700, the present value formula tells me I want a balance at retirement between $720,196.26 and $1,765,347.99 in tax deferred accounts.
Now, based on those same assumptions, the resulting min/max balances, 15 years of savings (current age of 30, retire at 45), and current tax deferred balances of $200k, the payment formula tells me I need to save between $14,107.08/year and $62,541.81/year to tax deferred accounts.
Things that would change these results:
>Rate of return: a higher return would make the required savings lower
>Age at retirement and current age: a higher retirement age or lower current age would make the required savings lower (more time to save and/or less time to spend)
>Age at last withdrawal (death): A lower age of death would mean lower required savings (less time to spend), although it doesn't make as big a difference as changing the current or retirement age.
>State taxes: the possibility of moving to a no income tax state would encourage trying to max out the 15% bracket in retirement as staying in the 10% would only save 5% (likely to be made up for by the state tax savings while working), but it would not encourage going into the 25% bracket in retirement since that would cost and additional 10% (unlikely to be made up for by the state tax savings while working).
> Social security or other income: the possibility of other income at some point in retirement would suggest that it might be best to leave some room in the 15% bracket for that income. I view this as icing on the cake and if I have the "misfortune" to get some extra income that pushes me into the 25% bracket, so be it.
> Current tax credits: before now we've been favoring tax deferred because it has kept us within income limits for the savers tax credit resulting on a larger marginal tax rate savings by prioritizing tax deferred. Soon we won't be able to stay under these limits no matter what we do.
> Subsidies: If you think you might get income tested subsidies (like the current healthcare subsidies) then you might want to try to keep your retirement income lower
> Significant capital gains: if you expect to have taxable investments with significant capital gains you might want to leave some room in the 15% bracket so you can harvest those gains tax free.
> Death of a spouse: This would lower the tax brackets of the surviving spouse, so this would be a reason to try to keep tax deferred balances lower.
So what do you think? Are my assumptions and calculations sound? Would you forgo tax deferred investments (by switching to Roth) if it looked like you were going to push yourself into a higher bracket in retirement, or do you think all of this has too many unknowns, so better to just keep maxing out tax deferred?