Author Topic: Go Curry Cracker: Roth vs. Taxable  (Read 17513 times)

brooklynguy

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Go Curry Cracker: Roth vs. Taxable
« on: February 02, 2015, 12:35:49 PM »
Since I haven't seen it mentioned yet in the forum, Go Curry Cracker put out a great article on when (or if) it makes sense to utilize Roth accounts during the accumulation phase:

http://www.gocurrycracker.com/roth-sucks/

For the prototypical aspiring early retiree, the Traditional vs. Roth debate has been beaten to death and long been settled in favor of Traditional (so while this article does a good job of recapping that debate, it doesn't cover any new ground on that issue).

But the article (primarily in the addendum, and in the comments) puts a spotlight on the issues and considerations that often get overlooked in the Roth vs. Taxable comparison.

Many people assume that once all tax-deferred vehicles have been exhausted, it always makes sense to fill up any available Roth buckets (through the "front door" and/or one of the "back doors") before deploying funds to taxable investing, because you are using post-tax dollars in any event.  This article does an excellent job of making the case that the prototypical early retiree may come out ahead by forgoing all Roth options in favor of taxable investing (but make sure to read through the comments for all the nuanced views -- personally, as I stated in those comments, I believe the protection against changes in tax laws (and, when applicable, the state and local tax benefits) may still outweigh taxable investing's benefit of guaranteed penalty-free access to earnings).

Mississippi Mudstache

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #1 on: February 02, 2015, 02:17:18 PM »
Very timely, and absolutely correct. I contributed $5500 to a Roth IRA and rolled-over another $3120 into one last year, because I was expecting to have negative tax liability for 2014. A big bonus turned the tables on me, and I've calculated that the effective tax rate on my IRA money is >16%. Earlier today, I emailed my broker to see about re-categorizing those Roth dollars into a traditional account.

MrMoogle

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #2 on: February 02, 2015, 02:53:29 PM »
A very good read!

Quick summary:  After FIRE, there's little advantage having money in a Roth compared to a taxable account.  Most mustachians will have in the 15% bracket or lower, and therefore will pay 0% tax on qualified dividends and long term capital gains.  In a taxable account you'll have access to the contribution and earnings, while in a Roth you'd only have access to the contribution.  So there are little financial downsides having it in a taxable account.  You should still do traditional if you get the benefits.

I fell into the "I'm special this doesn't apply to me" thinking, but maybe I'm not as special as I think.  I'm an expat, under the FEIE limit, so I don't pay federal income taxes, so there's no benefit of a traditional 401k.  I've been maxing out my Roth 401k, then putting the rest into taxable, but maybe I need to rethink this...

The one possible example where this isn't as smart is the following scenario:  You make enough so that you won't be eligible for tIRA benefits, and therefore are in a higher bracket, so you'd be paying taxes on dividends and capital gains.  You have many years to FIRE (say due to SL), but want to invest the whole time (because those SL have a low interest rate).  This way, you'd have many years of paying taxes on capital gains and dividends.  But as you near FIRE, a taxable account might make sense.

And there are other non-financial benefits of Roth IRAs, such as inheritance advantages and law suit advantages.

Aphalite

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #3 on: February 02, 2015, 03:14:03 PM »
I think the point in the "pro" Roth camp is that you can't really predict how tax law will evolve for capital gains. Suppose the minimum capital gain rate is eventually raised from 0% to 5% or 10%, then Roth earnings obviously has an advantage over parking in a taxable account. The point is you just don't know, so why even take that chance if you can draw the principal tax free anyways?

seattlecyclone

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #4 on: February 02, 2015, 03:57:41 PM »
I think the point in the "pro" Roth camp is that you can't really predict how tax law will evolve for capital gains. Suppose the minimum capital gain rate is eventually raised from 0% to 5% or 10%, then Roth earnings obviously has an advantage over parking in a taxable account. The point is you just don't know, so why even take that chance if you can draw the principal tax free anyways?

This. For someone with an income in the 15% bracket, taxable accounts offer better access to your money than a Roth account and make you pay no more tax than a Roth account. But if the capital gains rate goes above 0%, the "no more tax than a Roth account" thing goes away, and you'll have to weigh easier access against higher taxes to see which is more important in your situation.

Daisy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #5 on: February 02, 2015, 09:27:58 PM »
Wouldn't having money in a Roth vs. taxable mean that any capital gains (say you are trading...gasp) would not affect your AGI or MAGI or whatever the acronym is...that could potentially take you over the 15% tax bracket, or take you out of the ACA subsidy range?

I also think having money in a Roth is still accessible before the age of 60. Any non-contribution earnings can be withdrawn from the Roth and you pay a 10% penalty, which is less than the capital gains tax rate of 15%. I just thought of this recently and thought it was an advantage to putting money in a Roth vs. taxable accounts.

Speaking as someone who barely contributed to Roth IRAs in the past, but recently started funneling money into a backdoor Roth and weighing the pros and cons...
« Last Edit: February 02, 2015, 09:52:04 PM by Daisy »

eyePod

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #6 on: February 03, 2015, 06:43:17 AM »
Eh, I hedge my bets and contribute to 401k and roth. Who know what the taxes are going to be when I'm taking money from the accounts?

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #7 on: February 03, 2015, 07:32:43 AM »
I think the point in the "pro" Roth camp is that you can't really predict how tax law will evolve for capital gains. Suppose the minimum capital gain rate is eventually raised from 0% to 5% or 10%, then Roth earnings obviously has an advantage over parking in a taxable account. The point is you just don't know, so why even take that chance if you can draw the principal tax free anyways?

That goes the other way too though. The Roth is such a fantastic tax shelter (especially for non-mustachian retirees) that there is speculation that congress might take it away in the future and/or start taxing it. Obama did after all propose to do exactly this with 529 accounts. Raising capital gains tax on the poorest half of the population I think is extremely unlikely. Taxing roth accounts which I'd bet are more a domain of the well-off I think is at least as likely.

We are in the 25% bracket, and with 20 years to retirement we'll pay a fair bit just in tax on yearly dividends alone in a taxable accounts so I think I'll continue to put in the (relatively low) max into our Roths. But I'm still not 100% sure it's the best thing to do.

brooklynguy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #8 on: February 03, 2015, 07:42:49 AM »
Wouldn't having money in a Roth vs. taxable mean that any capital gains (say you are trading...gasp) would not affect your AGI or MAGI or whatever the acronym is...that could potentially take you over the 15% tax bracket, or take you out of the ACA subsidy range?

If this is a concern, just do your trading in your traditional tax-deferred accounts (where you probably have a bigger pot of funds to play with anyway) or, if you're going to start a Roth conversion pipeline, inside your Roth account once you've started funded it with the pipeline.

I also think having money in a Roth is still accessible before the age of 60. Any non-contribution earnings can be withdrawn from the Roth and you pay a 10% penalty, which is less than the capital gains tax rate of 15%. I just thought of this recently and thought it was an advantage to putting money in a Roth vs. taxable accounts.

Earnings pulled out early from the Roth are subject to both tax and the penalty.

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #9 on: February 03, 2015, 07:53:13 AM »
Hi brooklynguy, thanks for sharing that post and for the great discussion in the comments

It's a lot of fun figuring out how best to optimize everything, and always enjoyable to debate the options with knowledgeable people such as yourself

Another reader sent me this today, it looks like some efforts might be made to close the back door
http://www.msn.com/en-us/money/taxes/obama-budget-would-prohibit-backdoor-roth-iras/ar-AA8UuI3

brooklynguy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #10 on: February 03, 2015, 07:54:41 AM »
That goes the other way too though. The Roth is such a fantastic tax shelter (especially for non-mustachian retirees) that there is speculation that congress might take it away in the future and/or start taxing it. Obama did after all propose to do exactly this with 529 accounts. Raising capital gains tax on the poorest half of the population I think is extremely unlikely. Taxing roth accounts which I'd bet are more a domain of the well-off I think is at least as likely.

Go Curry Cracker raised this point in response to my comment on the blog, but I think the chances of Congress effectively reneging on the bargain being struck with today's Roth account-holders are vastly outweighed by the likelihood of changes to the tax code that remove the 0% rate for long term gains and dividends or otherwise upset the incentives promoting leisure over labor.  That said, while direct taxation of Roth withdrawals seems extremely unlikely, there are backdoor methods of accomplishing the same thing that, in my view, have more potential for actually happening (for example, imposing an across-the-board value-added-tax, or start counting Roth balances against eligibility for Medicare or Social Security).

All told, I view the Roth's likely protection against changes in tax law and its state and local tax benefits (as a NYC resident) as outweighing the restrictions on access to earnings, so I fund my Roth (through the mega backdoor) to the fullest extent possible.  But I also have enough leftover for significant taxable investing.  Since we won't know for sure which approach is optimal until the future has arrived and we have the benefit of hindsight, I like the idea of hedging my bets and diversifying between Roth and taxable (after exhausting all traditional tax-deferred options).

Aphalite

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #11 on: February 03, 2015, 08:25:11 AM »
I think the point in the "pro" Roth camp is that you can't really predict how tax law will evolve for capital gains. Suppose the minimum capital gain rate is eventually raised from 0% to 5% or 10%, then Roth earnings obviously has an advantage over parking in a taxable account. The point is you just don't know, so why even take that chance if you can draw the principal tax free anyways?

That goes the other way too though. The Roth is such a fantastic tax shelter (especially for non-mustachian retirees) that there is speculation that congress might take it away in the future and/or start taxing it. Obama did after all propose to do exactly this with 529 accounts. Raising capital gains tax on the poorest half of the population I think is extremely unlikely. Taxing roth accounts which I'd bet are more a domain of the well-off I think is at least as likely.

We are in the 25% bracket, and with 20 years to retirement we'll pay a fair bit just in tax on yearly dividends alone in a taxable accounts so I think I'll continue to put in the (relatively low) max into our Roths. But I'm still not 100% sure it's the best thing to do.

Obama's proposal is for NEW 529 accounts. If any politician wanted to take on the task of taxing CURRENT Roth accounts, good luck to them

brooklynguy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #12 on: February 03, 2015, 09:11:50 AM »
Hi brooklynguy, thanks for sharing that post and for the great discussion in the comments

It's a lot of fun figuring out how best to optimize everything, and always enjoyable to debate the options with knowledgeable people such as yourself

Another reader sent me this today, it looks like some efforts might be made to close the back door
http://www.msn.com/en-us/money/taxes/obama-budget-would-prohibit-backdoor-roth-iras/ar-AA8UuI3

Jeremy, thanks for the link.  I think the ever-changing tax landscape itself highlights the value of taxable investing.  I wouldn't give up the bird in the hand of the upfront tax deductions provided by traditional tax-deferred vehicles, but after exhausting those I would not be entirely comfortable with 100% of my assets residing in tax-advantaged accounts.  I'm lucky enough to be able to fill up all available tax-advantaged buckets and still have surplus for taxable investing, but I probably wouldn't be exhausting my Roth options at the expense of all taxable investing even if my best educated guesstimates predicted that that was the optimal strategy.  I take comfort in having a portion of my portfolio in taxable accounts, where no financial gymnastics are required to access the money and (unlike for tax-advantaged accounts) it is close to impossible to conceive of a scenario where access to funds becomes restricted as a result of legislative changes.

Daisy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #13 on: February 03, 2015, 08:04:53 PM »
Wouldn't having money in a Roth vs. taxable mean that any capital gains (say you are trading...gasp) would not affect your AGI or MAGI or whatever the acronym is...that could potentially take you over the 15% tax bracket, or take you out of the ACA subsidy range?

If this is a concern, just do your trading in your traditional tax-deferred accounts (where you probably have a bigger pot of funds to play with anyway) or, if you're going to start a Roth conversion pipeline, inside your Roth account once you've started funded it with the pipeline.

I also think having money in a Roth is still accessible before the age of 60. Any non-contribution earnings can be withdrawn from the Roth and you pay a 10% penalty, which is less than the capital gains tax rate of 15%. I just thought of this recently and thought it was an advantage to putting money in a Roth vs. taxable accounts.

Earnings pulled out early from the Roth are subject to both tax and the penalty.

I didn't know that. Crap. It did sound too good to be true to bypass the 15% capital gains tax. Oh well...luckily I do have quite a bit in my taxable accounts as I shunned the Roth IRA for a long time.

I had a small Roth IRA from some contributions in the past. I also just started using the after-tax part of my 401k to further fund the Roth. And I plan to do the Roth conversion pipeline after FIREing.

I think between my taxable accounts and the Roth conversion contributions, I should be able to make it to age 60 without accessing any Roth earnings.

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #14 on: February 03, 2015, 08:51:14 PM »
I just read this article last night.  I was wondering if Taxable is the better choice if you are not going to be a 30's or 40's early retiree.  Let's say you are a 50's early retiree.  Would Taxable still be optimal, or since you are so close to being able to draw the funds anyway, would the Roth be a better choice?

Daisy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #15 on: February 03, 2015, 09:00:37 PM »
I just read this article last night.  I was wondering if Taxable is the better choice if you are not going to be a 30's or 40's early retiree.  Let's say you are a 50's early retiree.  Would Taxable still be optimal, or since you are so close to being able to draw the funds anyway, would the Roth be a better choice?

I think the closer you are to 60, the better the Roth is. After 60, the Roth and the taxable accounts are somewhat equivalent...or rather the Roth is better because you will never pay capital gains, early withdrawal penalties, or any other tax. Also, any capital gains made in a Roth will not affect AGI or MAGI, which helps with ACA and possibly not having your Social Security income taxed.

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #16 on: February 04, 2015, 08:48:31 PM »
A very good read!
...

The one possible example where this isn't as smart is the following scenario:  You make enough so that you won't be eligible for tIRA benefits, and therefore are in a higher bracket, so you'd be paying taxes on dividends and capital gains.  You have many years to FIRE (say due to SL), but want to invest the whole time (because those SL have a low interest rate).  This way, you'd have many years of paying taxes on capital gains and dividends.  But as you near FIRE, a taxable account might make sense.

And there are other non-financial benefits of Roth IRAs, such as inheritance advantages and law suit advantages.

This is exactly where I am. My marginal tax rate is 28%, and my state marginal rate is 9.6%. I have a substantial amount of low-interest student loan debt and can realistically FIRE in about 10-12 years. My MAGI puts me over the limit for taking the tIRA tax deduction. If I invest in a taxable account right now, I will be paying taxes on those dividends and mutual fund capital gains. My income this year will likely phase out my eligibility for contributing to a Roth, so I would have to pursue the backdoor option.

I would perhaps think that anyone whose income is high enough to need to pursue a backdoor Roth strategy would be better off doing that first before investing in taxable accounts, unless FIRE is imminent.
« Last Edit: February 04, 2015, 08:57:53 PM by marblejane »

brooklynguy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #17 on: February 05, 2015, 07:11:44 AM »
I would perhaps think that anyone whose income is high enough to need to pursue a backdoor Roth strategy would be better off doing that first before investing in taxable accounts, unless FIRE is imminent.

Run the numbers for your own situation, but for most people this will be a relatively small issue as long as they are using tax-efficient investments that don't throw off much in the way of dividends or capital gains (like the Vanguard Total Stock Market Index Fund).

I would say the opposite is true and the issue gets bigger as you get closer to FIRE, because then you will have accumulated substantial balances and even small dividend yields start to become meaningful dollar amounts in the absolute sense.

DeepEllumStache

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #18 on: February 05, 2015, 09:51:56 AM »
Hi brooklynguy, thanks for sharing that post and for the great discussion in the comments

It's a lot of fun figuring out how best to optimize everything, and always enjoyable to debate the options with knowledgeable people such as yourself

Another reader sent me this today, it looks like some efforts might be made to close the back door
http://www.msn.com/en-us/money/taxes/obama-budget-would-prohibit-backdoor-roth-iras/ar-AA8UuI3

Noooooo!  Not the mega backdoor roth!

seattlecyclone

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #19 on: February 05, 2015, 10:20:20 AM »
Hi brooklynguy, thanks for sharing that post and for the great discussion in the comments

It's a lot of fun figuring out how best to optimize everything, and always enjoyable to debate the options with knowledgeable people such as yourself

Another reader sent me this today, it looks like some efforts might be made to close the back door
http://www.msn.com/en-us/money/taxes/obama-budget-would-prohibit-backdoor-roth-iras/ar-AA8UuI3

Noooooo!  Not the mega backdoor roth!

I'm not too worried about it in the short term. The Republicans in Congress are very unlikely to pass anything that they perceive as a tax increase. So we can probably count on both types of backdoor Roth surviving at least through 2016. After that it all depends on what happens in the next election.

DeepEllumStache

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #20 on: February 05, 2015, 11:41:32 AM »
Hi brooklynguy, thanks for sharing that post and for the great discussion in the comments

It's a lot of fun figuring out how best to optimize everything, and always enjoyable to debate the options with knowledgeable people such as yourself

Another reader sent me this today, it looks like some efforts might be made to close the back door
http://www.msn.com/en-us/money/taxes/obama-budget-would-prohibit-backdoor-roth-iras/ar-AA8UuI3

Noooooo!  Not the mega backdoor roth!

I'm not too worried about it in the short term. The Republicans in Congress are very unlikely to pass anything that they perceive as a tax increase. So we can probably count on both types of backdoor Roth surviving at least through 2016. After that it all depends on what happens in the next election.

How soon do you think Congress would shoot that piece down?

seattlecyclone

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #21 on: February 05, 2015, 12:05:20 PM »
The don't need to take any action to "shoot it down." The President's budget proposal is just that...a proposal. Congress has no obligation to enact any part of it into law, or even take a vote on it. As I said, I find it unlikely that the Republicans will vote for changes in the tax code that reduce the amount that higher-income people can save in tax-advantaged accounts.

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #22 on: February 05, 2015, 12:14:01 PM »
Hi brooklynguy, thanks for sharing that post and for the great discussion in the comments

It's a lot of fun figuring out how best to optimize everything, and always enjoyable to debate the options with knowledgeable people such as yourself

Another reader sent me this today, it looks like some efforts might be made to close the back door
http://www.msn.com/en-us/money/taxes/obama-budget-would-prohibit-backdoor-roth-iras/ar-AA8UuI3

Noooooo!  Not the mega backdoor roth!

I'm not too worried about it in the short term. The Republicans in Congress are very unlikely to pass anything that they perceive as a tax increase. So we can probably count on both types of backdoor Roth surviving at least through 2016. After that it all depends on what happens in the next election.

Dey comin' fo you chedda', hold onto your briches!

This will make me very happy indeed if it works out this way. I am less concerned after that time.
« Last Edit: February 05, 2015, 12:17:58 PM by WYOGO »

Gone Fishing

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #23 on: February 05, 2015, 02:01:02 PM »
Always enjoy Jeremy's blog posts. 

Here are my thoughts on Roth vs Taxable:

If the saver in question is having to make this decision, their income has eclipsed the deductible tIRA limits.  If they are mustachian type savers with this level of income they should have plenty to fund BOTH a ROTH and build a taxable portfolio sufficient to offer much of the loss harvesting benefits Jeremy points out.  Funding the ROTH will also help avoid some of the 15% dividend tax someone at this income level will likely pay in the years leading up to ER.       

teen persuasion

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #24 on: February 05, 2015, 07:13:20 PM »
Always enjoy Jeremy's blog posts. 

Here are my thoughts on Roth vs Taxable:

If the saver in question is having to make this decision, their income has eclipsed the deductible tIRA limits.  If they are mustachian type savers with this level of income they should have plenty to fund BOTH a ROTH and build a taxable portfolio sufficient to offer much of the loss harvesting benefits Jeremy points out.  Funding the ROTH will also help avoid some of the 15% dividend tax someone at this income level will likely pay in the years leading up to ER.     

Not necessarily.  The saver in question could instead owe no tax, making tIRA contributions pointless.  After 401k contributions, HSA, and standard deduction plus exemptions our taxable income is zero.  Then we have several refundable credits (and state matches on those), so I use the refunds to fund Roths for both of us.

Jeremy does make good points, but we are also looking at FAFSA rules and EITC rules, both of which discourage taxable accounts.  FAFSA may include taxable in calculations, and taxable income above $3350 can disqualify you from EITC.  He hasn't included those in his analysis presumably because it isn't on his radar (yet).

Gone Fishing

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #25 on: February 05, 2015, 07:30:54 PM »
Always enjoy Jeremy's blog posts. 

Here are my thoughts on Roth vs Taxable:

If the saver in question is having to make this decision, their income has eclipsed the deductible tIRA limits.  If they are mustachian type savers with this level of income they should have plenty to fund BOTH a ROTH and build a taxable portfolio sufficient to offer much of the loss harvesting benefits Jeremy points out.  Funding the ROTH will also help avoid some of the 15% dividend tax someone at this income level will likely pay in the years leading up to ER.     

Not necessarily.  The saver in question could instead owe no tax, making tIRA contributions pointless.  After 401k contributions, HSA, and standard deduction plus exemptions our taxable income is zero.  Then we have several refundable credits (and state matches on those), so I use the refunds to fund Roths for both of us.

Jeremy does make good points, but we are also looking at FAFSA rules and EITC rules, both of which discourage taxable accounts.  FAFSA may include taxable in calculations, and taxable income above $3350 can disqualify you from EITC.  He hasn't included those in his analysis presumably because it isn't on his radar (yet).

If you owe no tax, loss harvesting, Jeremy's primary benefit of a taxable account, would be null anyway.

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #26 on: February 06, 2015, 12:16:59 AM »
Always enjoy Jeremy's blog posts. 

Here are my thoughts on Roth vs Taxable:

If the saver in question is having to make this decision, their income has eclipsed the deductible tIRA limits.  If they are mustachian type savers with this level of income they should have plenty to fund BOTH a ROTH and build a taxable portfolio sufficient to offer much of the loss harvesting benefits Jeremy points out.  Funding the ROTH will also help avoid some of the 15% dividend tax someone at this income level will likely pay in the years leading up to ER.     

Not necessarily.  The saver in question could instead owe no tax, making tIRA contributions pointless.  After 401k contributions, HSA, and standard deduction plus exemptions our taxable income is zero.  Then we have several refundable credits (and state matches on those), so I use the refunds to fund Roths for both of us.

Jeremy does make good points, but we are also looking at FAFSA rules and EITC rules, both of which discourage taxable accounts.  FAFSA may include taxable in calculations, and taxable income above $3350 can disqualify you from EITC.  He hasn't included those in his analysis presumably because it isn't on his radar (yet).

If you owe no tax, loss harvesting, Jeremy's primary benefit of a taxable account, would be null anyway.


Hi So Close, good discussion

I view the loss harvesting as more of a secondary benefit, although a nice one.  The primary benefit is unrestricted access to earnings. 

Tax loss harvesting can still be of benefit with no tax liability.  I can use it to increase my basis in another stock (sell stock A for a loss, harvest a gain in stock B of equal value) and I believe (but need to research further) use some of that loss to increase the speed at which we are doing Roth IRA Conversions at the 0% tax rate ($3k limit maybe?)  This might be of use in the race against the RMD as we try to get all of our funds out of the 401k/IRA before Age 70.5.  I think we may have to use every weapon in our arsenal to do so


I agree that the ROTH can be used to reduce taxes during the working years, and this is mostly a choice of whether to have both types of accounts, not an either/or decision

Assuming an asset like VTI / VTSAX and a 2% dividend, you might reduce the tax load on those funds by 0.3% of assets (15% tax on 2% yield)  (You can also add state tax as a load, as well as potential reductions in ACA credits)

On a $5500 contribution, this is $16.50 in year one.  I would just pay that out of work income.  It will grow when projecting out one or two decades, and this will need to be weighed against having no access to dividends for the decades that follow.



teen persuasion is right, FAFSA hasn't been on our radar.  And also Roths are ideal for that situation, already with 0 tax load

I don't see a situation where we ever qualify for the EITC.  I also don't really like the idea of receiving subsidies for things when we don't need them

If the $'s available for student grants and aid in a given year is fixed, and we can pay full price for tuition without breaking a sweat but can legally hide assets and thus qualify, should we take the free money that would have otherwise gone to somebody that truly needed it?

Now I suppose I could argue that it is just a refund on taxes paid in previous years...



kiblebuka

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #27 on: February 07, 2015, 06:51:33 AM »
Every time I read one of these articles, I end up understanding IRAs less...

Tabaxus

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #28 on: February 07, 2015, 01:32:56 PM »
Hi brooklynguy, thanks for sharing that post and for the great discussion in the comments

It's a lot of fun figuring out how best to optimize everything, and always enjoyable to debate the options with knowledgeable people such as yourself

Another reader sent me this today, it looks like some efforts might be made to close the back door
http://www.msn.com/en-us/money/taxes/obama-budget-would-prohibit-backdoor-roth-iras/ar-AA8UuI3

Noooooo!  Not the mega backdoor roth!

I'm not too worried about it in the short term. The Republicans in Congress are very unlikely to pass anything that they perceive as a tax increase. So we can probably count on both types of backdoor Roth surviving at least through 2016. After that it all depends on what happens in the next election.

This could very easily be shut down by executive action.  The IRS hasn't invoked the step transaction doctrine against the backdoor Roth.  Most tax professionals aren't entirely sure why, other than the fact that the IRS is typically a little leery about using step transaction doctrine against things that a lot of people have done for a fair amount of time.  But Treasury could put out a regulation--or the IRS could put out a notice of proposed rulemaking--that could easily shut down the backdoor without Congressional involvement.  Litigating against the validity of such a position would be risky, expensive, time consuming, and probably not worth it for most people.

xenon5

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #29 on: February 08, 2015, 12:30:37 AM »
Hi brooklynguy, thanks for sharing that post and for the great discussion in the comments

It's a lot of fun figuring out how best to optimize everything, and always enjoyable to debate the options with knowledgeable people such as yourself

Another reader sent me this today, it looks like some efforts might be made to close the back door
http://www.msn.com/en-us/money/taxes/obama-budget-would-prohibit-backdoor-roth-iras/ar-AA8UuI3

Noooooo!  Not the mega backdoor roth!

I'm not too worried about it in the short term. The Republicans in Congress are very unlikely to pass anything that they perceive as a tax increase. So we can probably count on both types of backdoor Roth surviving at least through 2016. After that it all depends on what happens in the next election.

This could very easily be shut down by executive action.  The IRS hasn't invoked the step transaction doctrine against the backdoor Roth.  Most tax professionals aren't entirely sure why, other than the fact that the IRS is typically a little leery about using step transaction doctrine against things that a lot of people have done for a fair amount of time.  But Treasury could put out a regulation--or the IRS could put out a notice of proposed rulemaking--that could easily shut down the backdoor without Congressional involvement.  Litigating against the validity of such a position would be risky, expensive, time consuming, and probably not worth it for most people.

Also I think there's 2 different roth stretegies called "back door" which might be causing confusion - The first is people with high earned incomes using a tIRA to fund a roth IRA while working.  This the one the proposed legislation would affect.

The "mega" back door is converting traditional retirement funds in 401ks or tIRAs into roths AFTER retiring, in order to avoid ever paying income tax on these savings, or paying very little, and access them ealier.  There's a risk this loophole could be closed some day but it's not part of Obama's proposal.  I'd argue this is also a bigger threat than the first point since it would tie up much larger 401k balances.
« Last Edit: February 08, 2015, 12:36:28 AM by xenon5 »

shuffler

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #30 on: February 08, 2015, 01:00:49 AM »
The "mega" back door is converting traditional retirement funds in 401ks or tIRAs into roths AFTER retiring, in order to avoid ever paying income tax on these savings, or paying very little, and access them ealier.
No.  That's a Roth Conversion Ladder.

The "mega backdoor Roth", apart from having a dumb name, is just the 401k analog of doing a "backdoor Roth" with an IRA.
You make after-tax contributions to your 401k (if your plan allows it), and then withdraw/convert those funds (if your plan allows it) into either a Roth IRA or a Roth account within your 401k.

xenon5

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #31 on: February 08, 2015, 01:08:42 AM »
The "mega" back door is converting traditional retirement funds in 401ks or tIRAs into roths AFTER retiring, in order to avoid ever paying income tax on these savings, or paying very little, and access them ealier.
No.  That's a Roth Conversion Ladder.

The "mega backdoor Roth", apart from having a dumb name, is just the 401k analog of doing a "backdoor Roth" with an IRA.
You make after-tax contributions to your 401k (if your plan allows it), and then withdraw/convert those funds (if your plan allows it) into either a Roth IRA or a Roth account within your 401k.

That didn't even occur to me, as my plan doesn't allow this.  There are too many Roth strategies with similar names!

MrMoogle

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #32 on: February 08, 2015, 01:55:22 AM »
The "mega" back door is converting traditional retirement funds in 401ks or tIRAs into roths AFTER retiring, in order to avoid ever paying income tax on these savings, or paying very little, and access them ealier.
No.  That's a Roth Conversion Ladder.

The "mega backdoor Roth", apart from having a dumb name, is just the 401k analog of doing a "backdoor Roth" with an IRA.
You make after-tax contributions to your 401k (if your plan allows it), and then withdraw/convert those funds (if your plan allows it) into either a Roth IRA or a Roth account within your 401k.

It's Mega because it increases your 401k limit to $53k (traditional + Roth + company match + this backdoor).  Both ways are non-direct paths to getting money into a Roth, hence the "backdoor Roth" part.  The normal uses an after-tax IRA, the Mega uses an after-tax 401k, if your plan allows it (less than half do).  And both ways would be shut down by Obama's proposal (if it gets passed). 

ender

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #33 on: February 08, 2015, 10:45:41 AM »
Man I go back and forth on this.

I just filed taxes -- and did not recharacterize my 2014 IRA into a T-IRA -- though I have about an 18% marginal rate on that money. I spent a ton of time pondering this decision... I also put the max into my HSA and t-401k so I have a mix.

I think for 2015 we might do traditional IRA's for both myself and my wife as we hope in the next few years to have children and it's very likely my marginal rate will go to nearly 0% at that point.

I go back and forth on Roth/traditional/taxable. For me the $1000 or so I "spent" I spent to lock in tax-free earnings/appreciation on that $5500 until I use the money, conceivably in 20 years. As much as it might be suboptimal currently, I have some level of uncertainty regarding:

  • Future long-term capital gains/dividend tax rates
  • Future marginal rates
  • My future income
  • Overall governmental policies

putting money into a Roth account in my opinion is just a form of insurance (an expensive insurance at that).

Jeremy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #34 on: February 28, 2015, 01:56:55 AM »

Tax loss harvesting can still be of benefit with no tax liability.  I can use it to increase my basis in another stock (sell stock A for a loss, harvest a gain in stock B of equal value) and I believe (but need to research further) use some of that loss to increase the speed at which we are doing Roth IRA Conversions at the 0% tax rate ($3k limit maybe?)  This might be of use in the race against the RMD as we try to get all of our funds out of the 401k/IRA before Age 70.5.  I think we may have to use every weapon in our arsenal to do so


Following up on this comment.  I finished the analysis of whether we can get all of our 401k funds into a Roth IRA before the RMD starts via the world's longest Roth IRA Conversion Ladder, all while paying 0% tax

Conclusion:  Yes

http://www.gocurrycracker.com/gcc-vs-rmd/

ender

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #35 on: February 28, 2015, 06:05:08 AM »

Tax loss harvesting can still be of benefit with no tax liability.  I can use it to increase my basis in another stock (sell stock A for a loss, harvest a gain in stock B of equal value) and I believe (but need to research further) use some of that loss to increase the speed at which we are doing Roth IRA Conversions at the 0% tax rate ($3k limit maybe?)  This might be of use in the race against the RMD as we try to get all of our funds out of the 401k/IRA before Age 70.5.  I think we may have to use every weapon in our arsenal to do so


Following up on this comment.  I finished the analysis of whether we can get all of our 401k funds into a Roth IRA before the RMD starts via the world's longest Roth IRA Conversion Ladder, all while paying 0% tax

Conclusion:  Yes

http://www.gocurrycracker.com/gcc-vs-rmd/

I am really optimistic and hopeful the rollover policies don't change in the time between now and when I could use them.

They are so wonderful for people who want and can ER!

Gin1984

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #36 on: February 28, 2015, 07:10:44 AM »
But Jeremy did agree "re: mQ1
Children, increased exemptions at old age, etc… agreed this will move the 0% tax threshold around. In general, if a family is paying a very low tax rate (e.g. 0%) then take advantage of a Roth now. I think I mentioned something similar in the conclusions".  We put money in our 403b/HSA until we are in the 10% bracket, then the child tax credit, savers credit and EITC pull us down to 0.  We then put a small amount (a few hundred dollars) into the Roth.  It is not much but unlike many here we don't have a high income.

nanu

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #37 on: February 28, 2015, 07:46:42 AM »
posting to follow (though I think this particular dead horse has been beaten plenty by now)

Indexer

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #38 on: February 28, 2015, 11:50:34 AM »
For clarification:

Backdoor Roth: 
Contribute after tax money to tradIRA without taking a deduction and then immediately convert it to a Roth with no tax liability. 
Useful way for high income earners to put money in a Roth.
If you have other money in pre-tax IRAs it can make backdoor roths very complicated and end up causing a tax nightmare.  So if you plan on doing this in the future it is good to always roll pre tax employer plans into new plans so you don't have traditional IRAs floating around.
The backdoor roth is a tax loophole.  Congress didn't intend for it to happen.  In 2010 they wanted additional 'current' tax revenue so they allowed people to convert existing IRAs to Roth IRAs regardless of income(there use to be a phase out) so future tax revenue became current tax revenue.  CPAs and CFPs quickly noticed you could use this to pump funds into Roth IRAs regardless of income.
I would be surprised if it eventually doesn't get closed.  It might be around for awhile, but I doubt it will be around 10+ years from now.  The democrats didn't bother it the last time they had a majority because they were the ones who wanted all that 'current' year tax revenue.

Mega Backdoor:
You can put after tax money into a 401k above the normal pre-tax limits.  Most people never take advantage of it.  When you roll the plan into an IRA there had been a TON of confusion on what you were suppose to do with the money.  The IRS never said anything. Some people thought you could roll it into a Roth, but most CPAs advised against that so most people either just took the money out and put it in a taxable account or filled out all the extra tax forms to keep it in a traditional IRA as after tax money.  The IRS just recently(late last year) said you could put that money in a Roth.  This was a huge surprise to the personal income tax and financial planning industries.  "Wait you can do what????" 
The benefit is obvious and helps people pump crazy amounts of money into Roths.  In this case the IRS opened the door by just choosing how to interpret their own rules.  I don't think Congress had any say and I highly doubt congress will let this fly forever.    The biggest problem I see with this is that 401ks aren't exactly liquid... you normally have to leave your job in order to roll them over and it could take over a month to complete the rollover.  So if someone did pump tons of after tax money into their 401k, and then Congress decided to close the loophole your options are quit your job today or lose the benefit on all those funds.

Roth conversion ladder:
If you convert money from pre-tax to Roth you can't touch it for 5 years, but after 5 years the amount you converted counts as 'contributions' in the roth which you can take out whenever you want.  Say you have enough to FIRE in pretax funds and at least 125k in taxable funds and you want to retire early.   You live off the 125k+ and each year you convert what you will need in 5 years from the pretax funds into a Roth.  So years 1-5 you take 25k out of taxable to live on, and you convert only 25k to Roth keeping yourself in a low tax bracket.  In year 5 you have 25k in Roth 'contributions' you can live off of, and then you convert another 25k to Roth.  Repeat forever. 
I see no reason Congress or the IRS would care.  They are getting their tax revenue.  You are skirting the 59 1/2 rule, but since you always have to plan it 5 years in advance only someone who was retiring early would actually bother to do it.  The 59 1/2 rule is primarily there to prevent people from taking the money out for stupid/non-retirement reasons(buying a porsche).  401ks and tax deferred annuities have rules to skirt the 59 1/2 rule for people retiring early and the IRS nor Congress have ever cared to touch those.

« Last Edit: February 28, 2015, 11:55:48 AM by Indexer »

MidWestLove

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #39 on: February 28, 2015, 02:00:14 PM »
"The Roth is such a fantastic tax shelter (especially for non-mustachian retirees) that there is speculation that congress might take it away in the future and/or start taxing it"

I am of the opinion that in my lifetime/timeline (~30 years) it is near certain to happen, and it will happen as it usually does under the guise of 'fixing loopholes' with most likely scenario is that your roth distributions would still be income tax free but will be accounted for purposes of government benefits like social security or ACA benefits. this way Congress can pretend that it kept the word (you paid no income taxes) while in reality taxing you. this happens left and right already (muni bonds are supposed to be non taxable except they "account" within AMT calculations, social security was supposed to be non taxable and that was 'fixed' as well).  Whether it would happen under a guise of campaign for 'fairness' (look at these rich people with 6 digit accounts abusing the system intended to help poor while grandma suffers) or equality (all IRAs are IRAs, you can withdraw without tax but we will account for it in our calculations for government benefits, it is only 'fair'), both are easy to drum up support for and get politicians to act , not to mention them seeing large pots of money they can get their hands on while constantly running major deficits...


« Last Edit: February 28, 2015, 02:04:54 PM by MidWestLove »

Daisy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #40 on: February 28, 2015, 05:55:14 PM »

Tax loss harvesting can still be of benefit with no tax liability.  I can use it to increase my basis in another stock (sell stock A for a loss, harvest a gain in stock B of equal value) and I believe (but need to research further) use some of that loss to increase the speed at which we are doing Roth IRA Conversions at the 0% tax rate ($3k limit maybe?)  This might be of use in the race against the RMD as we try to get all of our funds out of the 401k/IRA before Age 70.5.  I think we may have to use every weapon in our arsenal to do so

Following up on this comment.  I finished the analysis of whether we can get all of our 401k funds into a Roth IRA before the RMD starts via the world's longest Roth IRA Conversion Ladder, all while paying 0% tax

Conclusion:  Yes

http://www.gocurrycracker.com/gcc-vs-rmd/

Great post!

I'll be playing quite an optimizing game once I FIRE and start drawing on the stash. I plan to FIRE sometime this or next year and start the Roth conversion at about the age of 47 or 48 (depends on when I get severance pay).

So until I draw on Social Security at the age of 62 I will try to get as much converted to a Roth as I can and keep me in the 15% tax bracket. I figured that would allow me to get as much into the Roth as possible, even though I'd be paying about $3-4k per year for income tax. Your post is giving me second thoughts on this and I need to analyze further.

However, if I reduce the amount I convert to Roth every year, then I may lose ACA subsidies and be forced onto Medicaid if the income is too low. Also, once I reach 62, then my Social Security income may get taxed if I am taking too much out of the traditional IRA and converting to Roth. So that's another reason why I thought it would be OK to be in the 15% tax bracket from 47-62.

I suppose still having some money in the traditional IRA at the age of 70.5 isn't too bad, if the RMD is still pretty close to the amount you'd want to take out of the traditional IRA anyways. Is there really a need to get the traditional IRA down to 0 by 70.5?
« Last Edit: February 28, 2015, 07:41:44 PM by Daisy »

Jeremy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #41 on: February 28, 2015, 09:00:26 PM »
Is there really a need to get the traditional IRA down to 0 by 70.5?

No, there is no need

It is just a question of when the RMD starts to push withdrawals higher than you would have done anyway, resulting in higher taxes

For some people, that will never happen.  For others with large Traditional accounts, it could happen as early as Age 70.5

If one were living exclusively on withdrawals from a Traditional account, the RMD wouldn't push withdrawals above a 4-5% withdrawal rate until Age 80, after which the rate starts to increase quickly (8% at age 90, 15% at age 100)


Daisy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #42 on: March 18, 2015, 06:04:30 PM »
OK. If I have such a large amount of money still left in my traditional IRA by the time I turn 80 or 90, then that means my FIRE was a huge success. I'm not too worried about RMDs at that age, although I will do whatever I can to transfer traditional to Roth before then.

ender

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #43 on: March 18, 2015, 06:34:42 PM »
It's also likely the age for RMDs will be higher by the time many of us get to that age.

Jeremy

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Re: Go Curry Cracker: Roth vs. Taxable
« Reply #44 on: March 18, 2015, 11:53:28 PM »
OK. If I have such a large amount of money still left in my traditional IRA by the time I turn 80 or 90, then that means my FIRE was a huge success. I'm not too worried about RMDs at that age, although I will do whatever I can to transfer traditional to Roth before then.

I completely agree.  Here is some extra cash Uncle Sam, thanks for making it easier to win at life

It's also likely the age for RMDs will be higher by the time many of us get to that age.

This is definitely possible, since it is supposed to be based on life expectancy. 

The cynic in me assumes the IRS won't be in any rush to move the tax burden into the future