The Power of Zero - Use Roth Exclusively bc Future Taxes will be much Higher?

[Radioherd88]

https://www.powerofzero.com/books I recently read the power of zero -The over arching story is pay taxes now and invest in roth accounts to take advantage of the historically low taxes we have until 2026 - and it is extremely likely taxes will be higher in the future because of the rising unsustainable national debt. As frugalites/mustachians, are we all on board with this message? Even as we plan for our post retirement income to be lower, it suggests tax rates could still end up being higher for lower brackets, and our plans to use tax deferred accounts now and pay less tax in the future will backfire....

Th reasoning is the unsustainable and unstoppable national debt and the whole argument is that the US has 2 choices - either default on it's debt, or scrap social security, medicare, and hike taxes way beyond today's levels to try and pay it off - none of those are great for the long term stability of any retirement assets surely? If the US defaults, stock prices would permanently crash no? Are we not all too casual about the elephant in the room that is how this national debt can bring it all crashing down?

[MDM]

What if income tax rates decrease but a Value Added Tax is introduced? ;)

[MustacheAndaHalf]

On wikipedia I see in FY2019, the U.S. government spent $4.5 trillion all year.  And with COVID-19... they spent at least half that amount last month.  I assume the cost of that behavior is eventual higher taxes.  In the WWII era U.S. taxes were far higher than today for the top brackets, so I'm guessing it looks something like that.

Since U.S. is the world's reserve currency, and has debts denominated in U.S. dollars (USD)... how does it default on it's own currency?  The U.S. can either default, or print USD to pay off debts.  Once dollars are printing wildly, inflation rears it's head... but that seems more likely than a default.

[terran]

What if income tax rates decrease but a Value Added Tax is introduced? ;)

This. Or a wealth tax? Or a payroll tax? Point is: nobody knows nothin'.

[Radioherd88]

What if income tax rates decrease but a Value Added Tax is introduced? ;)

This. Or a wealth tax? Or a payroll tax? Point is: nobody knows nothin'.

Correct, nobody knows nothin, but we are obviously making a decision here, and the logic for this is based on the current tax brackets being historically low (look at the past 100 years as an example, and the 70s and 80s https://taxfoundation.org/us-federal-individual-income-tax-rates-history-1913-2013-nominal-and-inflation-adjusted-brackets/ - sure seems like an educated bet to pay the tax now?

[Radioherd88]

On wikipedia I see in FY2019, the U.S. government spent $4.5 trillion all year.  And with COVID-19... they spent at least half that amount last month.  I assume the cost of that behavior is eventual higher taxes.  In the WWII era U.S. taxes were far higher than today for the top brackets, so I'm guessing it looks something like that.

Ok - so you are thinking you won't be impacted with the upper tax brackets, and happy to invest in tax deferred accounts atm?

Since U.S. is the world's reserve currency, and has debts denominated in U.S. dollars (USD)... how does it default on it's own currency?  The U.S. can either default, or print USD to pay off debts.  Once dollars are printing wildly, inflation rears it's head... but that seems more likely than a default.

Yeah, obviously i don't know what it looks like, it just seems ignorant to me to assume that it continues to be ignored without any repercussions for the taxpayer, so why not protect yourself from that chance?

[seattlecyclone]

On wikipedia I see in FY2019, the U.S. government spent $4.5 trillion all year.  And with COVID-19... they spent at least half that amount last month.  I assume the cost of that behavior is eventual higher taxes.  In the WWII era U.S. taxes were far higher than today for the top brackets, so I'm guessing it looks something like that.

Ok - so you are thinking you won't be impacted with the upper tax brackets, and happy to invest in tax deferred accounts atm?

Since U.S. is the world's reserve currency, and has debts denominated in U.S. dollars (USD)... how does it default on it's own currency?  The U.S. can either default, or print USD to pay off debts.  Once dollars are printing wildly, inflation rears it's head... but that seems more likely than a default.

Yeah, obviously i don't know what it looks like, it just seems ignorant to me to assume that it continues to be ignored without any repercussions for the taxpayer, so why not protect yourself from that chance?

Why not is that if you're wrong you'll have lost more money to tax than you could have otherwise. But again, it's all just guesswork. If all the personal and political factors you're aware of lead you to believe that your tax bracket will be higher in retirement than it is now, Roth is the way to go.

[Paul der Krake]

I signed up for this forum in 2012, about one month into my first job. Back then, people on this very forum were already arguing about how much higher taxes were inevitable and how Roth was the way to go.

These inevitable tax hikes were so inevitable that I've somehow managed to start, pursue, and end my career without seeing them. In fact, the opposite has happened, I have experienced a sharp tax decrease. I sure am glad I didn't listen.

Stop speculating. Take the tax laws as they are, not what you wish they were.

[Radioherd88]

On wikipedia I see in FY2019, the U.S. government spent $4.5 trillion all year.  And with COVID-19... they spent at least half that amount last month.  I assume the cost of that behavior is eventual higher taxes.  In the WWII era U.S. taxes were far higher than today for the top brackets, so I'm guessing it looks something like that.

Ok - so you are thinking you won't be impacted with the upper tax brackets, and happy to invest in tax deferred accounts atm?

Since U.S. is the world's reserve currency, and has debts denominated in U.S. dollars (USD)... how does it default on it's own currency?  The U.S. can either default, or print USD to pay off debts.  Once dollars are printing wildly, inflation rears it's head... but that seems more likely than a default.

Yeah, obviously i don't know what it looks like, it just seems ignorant to me to assume that it continues to be ignored without any repercussions for the taxpayer, so why not protect yourself from that chance?

Why not is that if you're wrong you'll have lost more money to tax than you could have otherwise. But again, it's all just guesswork. If all the personal and political factors you're aware of lead you to believe that your tax bracket will be higher in retirement than it is now, Roth is the way to go.

No roth for you then? The correct way to do it is likely to split contributions 50/50 between roth and traditional as you can then convert/withdraw from the subsequent account based on high or low taxes throughout retirement no?

[Radioherd88]

I signed up for this forum in 2012, about one month into my first job. Back then, people on this very forum were already arguing about how much higher taxes were inevitable and how Roth was the way to go.

These inevitable tax hikes were so inevitable that I've somehow managed to start, pursue, and end my career without seeing them. In fact, the opposite has happened, I have experienced a sharp tax decrease. I sure am glad I didn't listen.

Stop speculating. Take the tax laws as they are, not what you wish they were.

So you went traditional all your working life based on a hunch that this forum was talking garbage?

[MDM]

The correct way to do it is likely to split contributions 50/50 between roth and traditional as you can then convert/withdraw from the subsequent account based on high or low taxes throughout retirement no?

No.

The "correct" split will be known only in hindsight, but it's unlikely to be exactly 50/50.  Of course, if you do 50/50 then you won't be more than half wrong. ;)

One way to look at it: maximize the amount in traditional, subject to the constraint of never having to withdraw from traditional at a marginal tax rate above the break even tax rate for the contribution in question.  As noted, some guesswork needed.

See Traditional versus Roth - Bogleheads for more.

[MDM]

So you went traditional all your working life based on a hunch that this forum was talking garbage?

What specific garbage do you have in mind?

[rmorris50]

While none of us know nothing about future tax rates, for someone like who is 45 with a fat rollover IRA, maybe I should retire now into a lower tax bracket and not be afraid of the 10% penalty. Seems like I if wait to 59.5 to avoid the penalty, taxes rates could just up 10% and I'm back where I started. And yest I know I can do SEPPS now but it won't provide enough. And I have enough pension, deferred comp, Roth and SS to support my later years. I keep working because to avoid this 10% penalty, but maybe I shouldn't.

[MDM]

While none of us know nothing about future tax rates, for someone like who is 45 with a fat rollover IRA, maybe I should retire now into a lower tax bracket and not be afraid of the 10% penalty. Seems like I if wait to 59.5 to avoid the penalty, taxes rates could just up 10% and I'm back where I started. And yest I know I can do SEPPS now but it won't provide enough. And I have enough pension, deferred comp, Roth and SS to support my later years. I keep working because to avoid this 10% penalty, but maybe I shouldn't.

No 10% penalty if you convert from traditional to Roth, while using deferred comp (assuming this is a NQDC plan) for living expenses.

[rmorris50]

I turn 46 in June. Can't touch DC until 55 :-(

[Paul der Krake]

I signed up for this forum in 2012, about one month into my first job. Back then, people on this very forum were already arguing about how much higher taxes were inevitable and how Roth was the way to go.

These inevitable tax hikes were so inevitable that I've somehow managed to start, pursue, and end my career without seeing them. In fact, the opposite has happened, I have experienced a sharp tax decrease. I sure am glad I didn't listen.

Stop speculating. Take the tax laws as they are, not what you wish they were.

So you went traditional all your working life based on a hunch that this forum was talking garbage?

"Talking garbage" is too strong a statement. I saw no conclusive evidence that Roth was the better choice. As a result, I chose to take the tax savings that were immediately available to me, as opposed to maybe tax savings in the future. As luck would have it, my income grew considerably in the last couple of years, which allowed me to put some money in Roth too. But only after maxing out the available pre-tax space.

I see no evidence that things are different in 2020, the proverbial marshmallow is still hypothetical, so I urge others to think carefully before making a decision.

[ctuser1]

Aren't a majority of Mustachians maxing out their tax advantages space?

I get the vibe that most are white collar professionals earning enough that they would be able to do it if they live frugally. If so, how much Roth you can do may be externally constrained for you. $19.5k in traditional vs. 6.5k roth.

I guess if you do have Roth 401k then you can dial the ratio back and forth. But they don't seem to be particularly common (I have only had them offered at one employer - my current one - out of 6 different employers that I or DW have worked at).

My point is, for most people on this forum, the choice between Roth and 401k/Traditional may not be meaningful.

Or, am I missing something?

[Paul der Krake]

I guess if you do have Roth 401k then you can dial the ratio back and forth. But they don't seem to be particularly common (I have only had them offered at one employer - my current one - out of 6 different employers that I or DW have worked at).

Looks like your household has been unlucky with employers. They're quite common, and getting more popular.

From CNBC:

Adding a Roth 401(k) option has gotten trendy in recent years.

Seven in 10 employers now offer a Roth option within their 401(k), up from 54 percent in 2014, per a survey of large and midsize companies conducted by global advisory firm Willis Towers Watson. It’s prevalent even among smaller plans, of which roughly 6 in 10 allowed after-tax Roth contributions during 2016, according to the Plan Sponsor Council of America’s annual survey of profit-sharing and 401(k) plans.

Whether to Roth it up when it comes to IRAs is a much less interesting question. Not only, as you pointed out, the limits are much lower, but the incentives are much more clearly defined by the law as to who gets to contribute to what. If you have a retirement plan at work and make more than a certain amount, the tIRA deduction is simply disallowed. That forces a lot of people to Roth whether they like it or not.

[nereo]

I signed up for this forum in 2012, about one month into my first job. Back then, people on this very forum were already arguing about how much higher taxes were inevitable and how Roth was the way to go.

These inevitable tax hikes were so inevitable that I've somehow managed to start, pursue, and end my career without seeing them. In fact, the opposite has happened, I have experienced a sharp tax decrease. I sure am glad I didn't listen.

Stop speculating. Take the tax laws as they are, not what you wish they were.

I had a similar thought as you Paul. 
Just as statements like “we wont’ ever see returns like we have before because of XYZ” have turned out to be false decade after decade, the assumption that tax rates in the future will inevitably be higher has also turned out to be incorrect.

At some point (maybe now!) one or both of these things might change.  Or maybe they won’t.

Another idea/fear that gets passed around but hasn’t been mentioned here yet is the possibility that Roth funds will be taxed in the future.  A congressional law put them into place, and another one can alter those funds. FWIW I think it is unlikely, but if the US suddenly feels the need to generate more revenue those trillions of savings sitting in tax-free accounts might look pretty tempting to a populist driven lawmaker.

Or the US might do away with income tax entirely in favor of a flat-tax, sales-tax, larger corporate taxes etc. 

From a mustachian-perspective, there’s not much revenue (relatively speaking) to be gained from increasing the taxes paid by the bottom third of households, which is about where you are if you spend under $40k/year. Yet there’s a lot of votes there, so there’s some political pressure not to raise taxes on those households.

[DadJokes]

Show me the politician who is willing to raise taxes on households making under $150k per year (MFJ), and I'll show you a politician who isn't getting re-elected. There might be a few exceptions, but not enough that it's going to happen.

As things stand, we invest about 80% in traditional accounts and 20% in a Roth IRA, and most of that is while we are in a 12% marginal tax bracket.

[Alternatepriorities]

My own thoughts (and therefore strategy) has been in line with Nereo and Paul der Krake on this. There are too many ways money in Roth IRAs can still be "taxed" (VAT and creating inflation come to mind) for me to gamble heavily on paying taxes now. So, under the current tax code DW and I aim to limit our taxes to the 12% bracket. Anything that would be taxed above that goes into a tax deferred plan. Below 12% it's less certain if we're better off deferring taxes and since we spend only about 1/2 of the 12% bracket there is significant investing there. In the early days I would max out the Roth first at this rate and then put the rest into tax deferred accounts. As we close in of FI(RE?) I've realized there are advantages to putting more of it into taxable investments and have moved our allocation accordingly. 

[Alternatepriorities]

On wikipedia I see in FY2019, the U.S. government spent $4.5 trillion all year.  And with COVID-19... they spent at least half that amount last month.  I assume the cost of that behavior is eventual higher taxes.  In the WWII era U.S. taxes were far higher than today for the top brackets, so I'm guessing it looks something like that.

Since U.S. is the world's reserve currency, and has debts denominated in U.S. dollars (USD)... how does it default on it's own currency?  The U.S. can either default, or print USD to pay off debts.  Once dollars are printing wildly, inflation rears it's head... but that seems more likely than a default.

It seems pretty clear to me that this is the plan. I don't know if they can print 20 trillion without creating inflation, but given the current risk of deflation, now is probably as good of time as any to try.

[Paul der Krake]

As things stand, we invest about 80% in traditional accounts and 20% in a Roth IRA, and most of that is while we are in a 12% marginal tax bracket.

But would you still be in the 12% bracket if you suddenly went all Roth? It seems rather difficult, for most people, to max two Roth 401(k)s while remaining there. Do you have lots of children or rock bottom living expenses?

[DadJokes]

As things stand, we invest about 80% in traditional accounts and 20% in a Roth IRA, and most of that is while we are in a 12% marginal tax bracket.

But would you still be in the 12% bracket if you suddenly went all Roth? It seems rather difficult, for most people, to max two Roth 401(k)s while remaining there. Do you have lots of children or rock bottom living expenses?

No, that's why I said that most of our contributions occurred while in the 12% bracket, rather than all of them.

[Paul der Krake]

As things stand, we invest about 80% in traditional accounts and 20% in a Roth IRA, and most of that is while we are in a 12% marginal tax bracket.

But would you still be in the 12% bracket if you suddenly went all Roth? It seems rather difficult, for most people, to max two Roth 401(k)s while remaining there. Do you have lots of children or rock bottom living expenses?

No, that's why I said that most of our contributions occurred while in the 12% bracket, rather than all of them.

Ha, should have read more carefully. My bad.

[seattlecyclone]

Yeah, obviously i don't know what it looks like, it just seems ignorant to me to assume that it continues to be ignored without any repercussions for the taxpayer, so why not protect yourself from that chance?

Why not is that if you're wrong you'll have lost more money to tax than you could have otherwise. But again, it's all just guesswork. If all the personal and political factors you're aware of lead you to believe that your tax bracket will be higher in retirement than it is now, Roth is the way to go.

No roth for you then? The correct way to do it is likely to split contributions 50/50 between roth and traditional as you can then convert/withdraw from the subsequent account based on high or low taxes throughout retirement no?

I have some Roth, but that's mostly from the mega backdoor Roth (where pre-tax wasn't an option) and in IRAs (ditto due to income limitations). The math is simple: when you have a choice about when to recognize income, choose the year your marginal tax rate is lowest. If you think that's now, go Roth. If you think that's later, go traditional.

Now, I do think it's important to note that the ACA adds about 10-18% on to your base tax bracket in retirement if you purchase a subsidized plan from the exchange, so even if you do think the laws won't change it's not quite as simple as a straight comparison of your current taxable income to your expected taxable income in retirement.

[Wolfpack Mustachian]

If you make above a certain amount and plan on living under another amount, I can't fathom how odds would be in your favor to do Roth before maxing out all tax advantaged accounts. Let's say you bring in 150K as a family and live off of 40K. The tax rate would not only have to go up, but it would have to go up enough that the percentage rate on 40K in the future is greater than the percentage rate on 150K now. I mean, could it happen - sure. However, I'd default to the reality most mustachian people on this board are in - higher income, lower expenses. The Roth route before 401K maxing is much more applicable to standard people - expecting to spend in retirement much closer to what they're earning in their careers.

[MustacheAndaHalf]

When there's a tie in the decision between Traditional and Roth, I prefer Roth owing to the reduced uncertainty.  I know my tax rate now, and won't know my tax rate at a vague future date.

I also wanted to mention the Roth ladder as a way to give both sides of the Roth / Traditional debate their due.  You can contribute to the Traditional while working (tax deduction in higher tax bracket), and upon early retirement, start converting Traditional to Roth (paying tax in a lower tax bracket).

[Radioherd88]

So you went traditional all your working life based on a hunch that this forum was talking garbage?

What specific garbage do you have in mind?

Was paraphrasing the user i was quoting - that's what he was suggesting

[Radioherd88]

I had a similar thought as you Paul. 
Just as statements like “we wont’ ever see returns like we have before because of XYZ” have turned out to be false decade after decade, the assumption that tax rates in the future will inevitably be higher has also turned out to be incorrect.

At some point (maybe now!) one or both of these things might change.  Or maybe they won’t.

Another idea/fear that gets passed around but hasn’t been mentioned here yet is the possibility that Roth funds will be taxed in the future.  A congressional law put them into place, and another one can alter those funds. FWIW I think it is unlikely, but if the US suddenly feels the need to generate more revenue those trillions of savings sitting in tax-free accounts might look pretty tempting to a populist driven lawmaker.

Or the US might do away with income tax entirely in favor of a flat-tax, sales-tax, larger corporate taxes etc. 

From a mustachian-perspective, there’s not much revenue (relatively speaking) to be gained from increasing the taxes paid by the bottom third of households, which is about where you are if you spend under $40k/year. Yet there’s a lot of votes there, so there’s some political pressure not to raise taxes on those households.

Yes good points against those of us living frugally to be concerned - the argument for higher taxes certainly seems less powerful if you have half/3rd the income you used to at accumulation stage...

[Radioherd88]

I signed up for this forum in 2012, about one month into my first job. Back then, people on this very forum were already arguing about how much higher taxes were inevitable and how Roth was the way to go.

These inevitable tax hikes were so inevitable that I've somehow managed to start, pursue, and end my career without seeing them. In fact, the opposite has happened, I have experienced a sharp tax decrease. I sure am glad I didn't listen.

Stop speculating. Take the tax laws as they are, not what you wish they were.

So you went traditional all your working life based on a hunch that this forum was talking garbage?

"Talking garbage" is too strong a statement. I saw no conclusive evidence that Roth was the better choice. As a result, I chose to take the tax savings that were immediately available to me, as opposed to maybe tax savings in the future. As luck would have it, my income grew considerably in the last couple of years, which allowed me to put some money in Roth too. But only after maxing out the available pre-tax space.

I see no evidence that things are different in 2020, the proverbial marshmallow is still hypothetical, so I urge others to think carefully before making a decision.

Fair enough - hard to tell the tone of text sometimes -

For the record i have all my funds in traditional atm - maxed out 401k/403b and 457b - this book has just made me question this a bit and consider moving some to roth instead (i have some i can roth and stay at 12% tax bracket for example)

[Radioherd88]

If you make above a certain amount and plan on living under another amount, I can't fathom how odds would be in your favor to do Roth before maxing out all tax advantaged accounts. Let's say you bring in 150K as a family and live off of 40K. The tax rate would not only have to go up, but it would have to go up enough that the percentage rate on 40K in the future is greater than the percentage rate on 150K now. I mean, could it happen - sure. However, I'd default to the reality most mustachian people on this board are in - higher income, lower expenses. The Roth route before 401K maxing is much more applicable to standard people - expecting to spend in retirement much closer to what they're earning in their careers.

Agree - that is the part that "the power of zero" book is missing - we are not ordinary high lifestyle retirees....

[LightStache]

I'm 100% tax deferred in the 24% Federal and 9.3% State brackets. I plan to be in the same federal bracket in retirement as I execute a Roth ladder over 24 years (hence my FatFI handle), and that bracket will presumably revert back to 28% in 2026. I'll also have the option of timing those conversions if I want to be in a lower bracket, while I don't have the option to time my income now. So there's a possibility I'll end up paying higher taxes in retirement (28% + 9.3% = 37.3%), but I could also make lifestyle choices to reduce that to 15% by moving to a lower cost area without state income tax on retirement withdrawals. Because of that option to move and time withdrawals, I'm 100% deferred now.

Even if income tax is raised, I assume it will remain relatively low for lower earners, and so I'll just adapt my lifestyle as the laws change.

[Radioherd88]

I'm 100% tax deferred in the 24% Federal and 9.3% State brackets. I plan to be in the same federal bracket in retirement as I execute a Roth ladder over 24 years (hence my FatFI handle), and that bracket will presumably revert back to 28% in 2026. I'll also have the option of timing those conversions if I want to be in a lower bracket, while I don't have the option to time my income now. So there's a possibility I'll end up paying higher taxes in retirement (28% + 9.3% = 37.3%), but I could also make lifestyle choices to reduce that to 15% by moving to a lower cost area without state income tax on retirement withdrawals. Because of that option to move and time withdrawals, I'm 100% deferred now.

Even if income tax is raised, I assume it will remain relatively low for lower earners, and so I'll just adapt my lifestyle as the laws change.

Yes - tax deferred now certainly keeps the decision over when to pay the tax in our hands, and that appeals to me too. I have decided to adjust a portion to Roth and pay tax now for he portion that is 12% federal, as it might be useful at some point to have that, but i'm still mostly traditional and planning to ladder for the most part.

[LightStache]

I'm 100% tax deferred in the 24% Federal and 9.3% State brackets. I plan to be in the same federal bracket in retirement as I execute a Roth ladder over 24 years (hence my FatFI handle), and that bracket will presumably revert back to 28% in 2026. I'll also have the option of timing those conversions if I want to be in a lower bracket, while I don't have the option to time my income now. So there's a possibility I'll end up paying higher taxes in retirement (28% + 9.3% = 37.3%), but I could also make lifestyle choices to reduce that to 15% by moving to a lower cost area without state income tax on retirement withdrawals. Because of that option to move and time withdrawals, I'm 100% deferred now.

Even if income tax is raised, I assume it will remain relatively low for lower earners, and so I'll just adapt my lifestyle as the laws change.

Yes - tax deferred now certainly keeps the decision over when to pay the tax in our hands, and that appeals to me too. I have decided to adjust a portion to Roth and pay tax now for he portion that is 12% federal, as it might be useful at some point to have that, but i'm still mostly traditional and planning to ladder for the most part.

That's a smart way to go -- it's such a big jump from 12% to 22%. I've been tempted to diversify into Roth over the years to provide some flex in retirement but never could pull the trigger.