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by **Chicago60** » Tue Jul 02, 2013 10:45 pm

My company ended its profit sharing plan last year (I rolled over the funds into my IRA after years of Back Door Roths), and no longer has any retirement accounts available. If I am in or near the highest income bracket, what options, if any, do I have to set aside money in a tax advantaged account? We already fully funded I-Bonds and with a substantial IRA account, adding non deductible money to the IRA does not make sense for me for the administrative hassle once I start withdrawing.

by **Electron** » Tue Jul 02, 2013 11:52 pm

You might want to consider taxable equity investments with a focus on tax efficiency. Many index funds have low turnover and there are also tax managed funds. There are tax breaks for qualified dividends and capital gains.

Since future tax rates are not known in advance, it may make sense to hedge and use both taxable and tax-deferred accounts. The same argument applies to Traditional IRAs and whether a Roth Conversion will ultimately pay off.

Municipal bonds could be considered on the fixed income side. If you are concerned about rising rates, individual bonds can be held to maturity.

One could also evaluate tax deferred variable annuities holding mutual funds.

by **grabiner** » Wed Jul 03, 2013 12:35 am

Chicago60 wrote:My company ended its profit sharing plan last year (I rolled over the funds into my IRA after years of Back Door Roths), and no longer has any retirement accounts available. If I am in or near the highest income bracket, what options, if any, do I have to set aside money in a tax advantaged account? We already fully funded I-Bonds and with a substantial IRA account, adding non deductible money to the IRA does not make sense for me for the administrative hassle once I start withdrawing.

If neither you nor your spouse is covered by an employer plan, you can both make deductible IRA contributions regardless of your income.

If you have more to invest than that, then it is probably best to buy stock index funds in your taxable account; they are not tax-advantaged in the same sense as IRAs, but they do produce low tax bills.

by **Bob's not my name** » Wed Jul 03, 2013 5:15 am

From your prior post it looks like your spouse could continue to do backdoor Roths without the complication of an existing pre-tax IRA. However, since you are in a high bracket and eligible for deductible TIRA contributions, that looks more attractive ($13,000/year given your ages). In Illinois it's also possible to do a state-deductible back door Roth (see viewtopic.php?f=10&t=86262 ), but I don't think that's attractive in the 35% federal bracket* -- you can enjoy the Illinois exemption on retirement income later.

*It's worse than that. Under the ATRA rules the 35% bracket is pretty narrow. You are subject to the 0.9% ACA tax on wages (not avoidable), the 3.8% ACA tax on investment income, the ATRA exemption phaseout (1% per dependent), the ATRA itemized deduction phaseout (1%), and possibly the 20% ATRA rate on LTCG and QD and the 39.6% rate on other income. The deductible TIRAs allow you to avoid about $6,000 in taxes.

by **Chicago60** » Wed Jul 03, 2013 10:51 am

Thanks, Bob (though I suppose that is not your name). Already did spouse's backdoor Roth. And I had to "undo" my backdoor Roth last year. Adding an after tax contribution of $6500 (which I did in January 2012) to an IRA that now has substantial assets in before tax contributions made no sense to me as noted above due to the administrative hassle once I start mandatory withdrawals. As for the other responses, I very much appreciate the time you took to post, but the posts did not answer the question.

by **Bob's not my name** » Wed Jul 03, 2013 11:01 am

Chicago60 wrote:As for the other responses, I very much appreciate the time you took to post, but the posts did not answer the question.

This didn't?

grabiner wrote:If neither you nor your spouse is covered by an employer plan, you can both make deductible IRA contributions regardless of your income.

by **Chicago60** » Wed Jul 03, 2013 11:05 am

I stand corrected....that portion of the reply did.

by **Bob's not my name** » Wed Jul 03, 2013 11:17 am

And in my post I'm pointing out that the backdoor Roth you already did for your wife is actually deductible. For federal purposes, that gets you nothing because you pay the tax at conversion, but thanks to Illinois tax law you made an immediate 5.3% return. In your bracket I wouldn't bother to convert, but that's your choice.

by **Electron** » Wed Jul 03, 2013 2:37 pm

Bob's not my name wrote:For federal purposes, that gets you nothing because you pay the tax at conversion, but thanks to Illinois tax law you made an immediate 5.3% return.

Thanks for the excellent research on the backdoor Roth conversions for each state. The 5.3% return is a nice extra but I believe it also comes with additional tax obligation in the future.

Chicago60 - The variable annuity that I mentioned is a tax advantaged account. Expenses can be quite low. Here is one example.

https://investor.vanguard.com/what-we-o ... retirement

Lastly, it is worth thinking about RMDs after age 70.5. The withdrawal percentage rises every year, and depending on the return in the account the taxable withdrawals can increase in dollar amount for many years before declining.

The RMD percentage starts out at 3.65% and hits 5.35% at age 80. The percentage is 8.77% at age 90 and it eventually levels off at 52.63%. Those with one or more accounts subject to RMDs can wind up with significant withdrawals and taxes to be paid for many years. It is all ordinary income and may push one into a relatively high tax bracket.

by **Bob's not my name** » Wed Jul 03, 2013 2:42 pm

Electron wrote:The 5.3% return is a nice extra but I believe it also comes with additional tax obligation in the future.

How so?

by **Bob's not my name** » Wed Jul 03, 2013 2:44 pm

Electron wrote:The percentage is 8.77% at age 90.

A lot of people at that age are in assisted living, the cost of which is deductible, placing them in the 0% bracket even if they have a six figure income. I managed the finances of a wealthy elderly person who had enough headroom in the 0% bracket to convert all IRAs to Roth at that tax rate. Zero is a low rate. The Roth IRA was then inherited.

As is discussed often here, early retirement (<70 today, perhaps <75 in the near future) is also a great opportunity to convert to Roth at a low tax rate.

Retirees are generally in very low brackets.

by **Electron** » Wed Jul 03, 2013 3:23 pm

Bob's not my name wrote:

Electron wrote:The 5.3% return is a nice extra but I believe it also comes with additional tax obligation in the future.

How so?

I assumed that a deductible IRA contribution for purposes of the state tax affects the IRA basis for the state and future taxation. Maybe that is incorrect.

In California there are some interesting complications for IRAs. One has to keep track of 1982-86 basis as that is withdrawn first before any state taxes are paid on withdrawals. IRA basis may also be different for the purposes of Federal and California income taxes.

by **Bob's not my name** » Wed Jul 03, 2013 3:30 pm

No, the state taxes neither withdrawal nor conversion. If you contribute to a TIRA, convert it to a Roth IRA, and later withdraw from the Roth, Illinois taxes none of those transactions. If instead you contribute directly to a Roth IRA, you are taxed on that transaction.

by **Chicago60** » Wed Jul 03, 2013 4:53 pm

Thanks for those thoughts.

by **grabiner** » Wed Jul 03, 2013 9:25 pm

Electron wrote:

Bob's not my name wrote:

Electron wrote:The 5.3% return is a nice extra but I believe it also comes with additional tax obligation in the future.

How so?

I assumed that a deductible IRA contribution for purposes of the state tax affects the IRA basis for the state and future taxation. Maybe that is incorrect.

In California there are some interesting complications for IRAs. One has to keep track of 1982-86 basis as that is withdrawn first before any state taxes are paid on withdrawals. IRA basis may also be different for the purposes of Federal and California income taxes.

Other states also have odd rules; check with your state tax bureau. For example, NJ does not allow a deduction for IRA contributions, so all IRAs (except rollovers from deductible 401(k)s) are treated as non-deductible for NJ tax purposes. This makes Roth IRAs more attractive in NJ, particularly if you might retire in another state and thus get no benefit from the NJ basis.

by **Kalo** » Thu Jul 04, 2013 2:31 pm

Can I get suggestions on making this analysis more robust or just tell me what's wrong with it?

I realize I am not taking inflation into account (although arguably neither does the government when it sets tax brackets, except maybe in the long run as they adjust the tables?). My investment earnings assumption is 10%. If inflation was 3% over the same period, I'm thinking the analysis would still hold? Not sure of that.

Also, I held the total contribution made between the two scenarios at 10K per year. I can anticipate the argument that the Traditional investment could have been higher by the amount of the taxes paid in the Roth scenario. I guess I'm assuming the person is able to fully fund all accounts to maximum value for both scenarios.

Sorry if I'm starting a rehash but it seems like every time the subject of Roth Vs Traditional comes up, it's offered as a given that if your tax bracket is the same at contribution time and withdrawal time, then it will be a wash. So I made this spreadsheet to help me see this in black and white.

Assumptions:
Inflation: 0% assumed (not taking it into account in this first pass).
Rate of Return: 10%
Tax Rate: 25%

Doesn't the Roth scenario look like a better deal?

Kalo

by **livesoft** » Thu Jul 04, 2013 2:34 pm

First thing I see is that "withdrew all" in the last year does not make sense in the real world. Instead, why not put "Withdrew $30,000 a year tax-free for next 35 years"? After all, 20 years from now the standard deduction will probably creep up to $30,000 a year.

Another thing, if you have $12,500 to use, Roth is $10,000 to Roth and $2.5K to taxes, but traditional is $12,500 to IRA and $0 to taxes.

by **Kalo** » Thu Jul 04, 2013 2:39 pm

Good point, livesoft. I hadn't thought of that. I was just thinking it didn't matter as long as I held my tax rate at 25%, but I see what you mean. Doesn't effective tax rate already take into account standard deduction? I do see what you mean though if the standard deduction grew enough.

Of course my values were not chosen to account for this. As contributions increase and more time is added, couldn't my payouts grow also to a point where the standard deduction would not be such a large influence?

by **Kalo** » Thu Jul 04, 2013 2:42 pm

livesoft wrote:First thing I see is that "withdrew all" in the last year does not make sense in the real world. Instead, why not put "Withdrew $30,000 a year tax-free for next 35 years"? After all, 20 years from now the standard deduction will probably creep up to $30,000 a year.

Another thing, if you have $12,500 to use, Roth is $10,000 to Roth and $2.5K to taxes, but traditional is $12,500 to IRA and $0 to taxes.

I was assuming the person can fund all accounts to the maximum allowed, as stated. I just stopped at 10K for convenience. (Assume 10k is max allowed, including 401K and IRA, if you will.)

I did show $0 to taxes for the traditional. Am only trying to view the tax effect. Arguably that 2.5K paid to taxes could be invested in a taxable account in the Traditional scenario.

by **furwut** » Thu Jul 04, 2013 2:48 pm

livesoft wrote:Another thing, if you have $12,500 to use, Roth is $10,000 to Roth and $2.5K to taxes, but traditional is $12,500 to IRA and $0 to taxes.

That's it. OP is comparing apples to oranges by saving more in the Roth since 10000 post-tax beats 10000 pre-tax. If OP reruns the calculation using $7500 for the Roth contribution you will see it is a wash.

by **livesoft** » Thu Jul 04, 2013 2:54 pm

Kalo wrote:As contributions increase and more time is added, couldn't my payouts grow also to a point where the standard deduction would not be such a large influence?

No. It will always have a large influence even if all the withdrawal is not tax-free because it is larger than the standard deduction (or one's itemized deductions).

by **furwut** » Thu Jul 04, 2013 2:56 pm

The Finance Buff has some great posts on Roth versus Traditional:

The Case Against Roth 401(k)

by **Kalo** » Thu Jul 04, 2013 3:09 pm

furwut wrote:The Finance Buff has some great posts on Roth versus Traditional:

The Case Against Roth 401(k)

Thanks for that link, furwut. That was very informative and had a lot of info I had not thought about. I was forgetting totally about the marginal tax rates (was using a constant effective rate). Plus I learned a lot of other things to consider.

:happy

Kalo

by **Epsilon Delta** » Thu Jul 04, 2013 3:13 pm

You are comparing the values of payments in different years, without correcting for the time value.
Would you rather pay $2,500 today or $2,500 in 20 years?
Would you rather pay $2,500 today or $17,652 in 20 years?

by **Kalo** » Thu Jul 04, 2013 4:18 pm

Epsilon Delta wrote:You are comparing the values of payments in different years, without correcting for the time value.
Would you rather pay $2,500 today or $2,500 in 20 years?
Would you rather pay $2,500 today or $17,652 in 20 years?

I did say I did not take inflation into account (a weakness in my numbers). As for the other components of the time value of money, I only showed the difference in nominal dollars paid, true. I feel intuitively that inflation is the piece that matters since the investment balances grew over the years but I might be wrong on that.

In addition to the link given by furwut above, here is another one by the same author that takes into account maxing out all retirement accounts.

http://thefinancebuff.com/roth-401k-for ... e-max.html

I'm not sure either of the links really tries to account for a potentially higher tax rate on all tax payers in the future, even though it does a good job showing how each additional dollar earned has a different tax rate.

And there is also a ton of great information in both articles. Lots of stuff I did not think about or take into account in my OP spreadsheet.

There is a difference when you are maxing out all retirement accounts, as you will see in the above link. I think it defends (my takeaway) putting some dollars into a Roth 401K if you are maxing out all account types, but it's still complicated to know how much to put in the Roth 401K vs the Traditional 401K.

Kalo

by **livesoft** » Thu Jul 04, 2013 4:29 pm

If one is maxing out all retirement accounts, let's say that is traditional 401(k), Roth IRA, and HSA, then a question is whether to put additional money into a taxable account or use the money to replace some of one's tradtional 401(k) contributions with a Roth 401(k) contributions. Not readily apparent is how a taxable account with its tax advantages (tax-loss harvesting, long-term cap gains tax rate as low as 0%) can really help with converting tax-deferred (traditional IRA, traditional 401(k)) to tax-free (Roth IRA) at a very low tax rate ... as low as 0%.

I don't believe this analysis is shown in tfb's well-reasoned blog articles and spreadsheet. Of course, not many people will be able to do that, but if you are one of those folks, a Roth 401(k) makes even less sense, because one can convert from traditional to Roth at a much lower tax rate than one can contribute to a Roth. So for us, it's traditional 401(k)s to the max ($46,000 a year) and Roth IRAs to the max if allowed ($13,000 a year) if we can afford it.

by **Bob's not my name** » Thu Jul 04, 2013 5:08 pm

Kalo wrote:it seems like every time the subject of Roth Vs Traditional comes up, it's offered as a given that if your tax bracket is the same at contribution time and withdrawal time, then it will be a wash. So I made this spreadsheet to help me see this in black and white.

Why use a spreadsheet when simple equations prove the "given"? If T is tax rate, G is growth (e.g., 10X), and M is the starting gross income consumed to make the contribution:

Roth(final) = M * (1 - T) * G
Traditional(final) = M * G * (1 - T)

Obviously the result is the same. Only in the saturated case (all accounts maxed in both scenarios) do you need to complicate the choice.

The assumption of tax bracket being the same when working and in retirement is a terrible assumption, of course, because retirees make less money and get more federal and state tax breaks -- the list is extensive, but includes the munificent 0% rate on LTCG and QD, the deductibility of assisted living expenses (putting even multi-millionaires in the 0% bracket), and many states' exemptions of retirement income.

by **Bob's not my name** » Thu Jul 04, 2013 5:16 pm

livesoft wrote:Another thing, if you have $12,500 to use, Roth is $10,000 to Roth and $2.5K to taxes, but traditional is $12,500 to IRA and $0 to taxes.

Roth would be $9,375.

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