Over at Bogleheads we came across the following discussion: help with basic tax strategy
help with basic tax strategy
by TylerDavis » Tue Feb 04, 2014 3:35 pm
I have a company 401k to which I contribute 6% of my gross income. Company matches 100% up to 4%.
I also have 529 accounts for my kids.
Given a fixed savings rate, salary below the max limits, can someone give me a basic strategy rundown for tax advantages of the various account types?
I have read through this:
http://en.wikipedia.org/wiki/Comparison_of_401(k)_and_IRA_accounts
but still a little foggy.
I understand 401k is invested pre-tax, then withdrawals are taxed at the going rate at the time.
529 is invested post-tax, contributions are state-deductible but not federal deductible. Withdrawals for education expenses are tax-free.
I have read and heard of Roth 401k, Roth IRA and traditional IRA, but I'm not sure I understand when those are a good option. I gather that Roth401k and 529 have same tax structure (minus 529 state advantage), main difference is the purpose for education vs retirement.
Isn't it a reasonable assumption that my tax bracket in retirement will be very low (zero salary income) compared to current tax bracket? So why would you want to pay taxes up front, as in an IRA?
Is an IRA only necessary once I exceed the $17,500 yearly contribution for the 401k?
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Re: help with basic tax strategy
by House Blend » Tue Feb 04, 2014 4:25 pm
TylerDavis wrote:basic strategy rundown for tax advantages of the various account types?
I have read through this:
I have read and heard of Roth 401k, Roth IRA and traditional IRA, but I'm not sure I understand when those are a good option. I gather that Roth401k and 529 have same tax structure (minus 529 state advantage), main difference is the purpose for education vs retirement.
Have you read the wiki on Traditional vs. Roth?
Isn't it a reasonable assumption that my tax bracket in retirement will be very low (zero salary income) compared to current tax bracket? So why would you want to pay taxes up front, as in an IRA?
Low, yes. Generally you wouldn't want to pay taxes in advance. Main danger, which doesn't affect everyone to the same degree, is that you have to take Required Minimum Distributions (RMDs) from your tax-deferred accounts. If they are big enough, you could pay taxes at the same or a higher rate. (Generally a problem only if you are a workaholic with a high savings rate, or have a pension on top.) Also, the quirky way that SS income gets taxed means that you could be in what looks like the 15% Federal bracket, but have your RMDs taxed at a marginal rate of 27.75%.
But yes, for many Bogleheads, especially ubersaving, early-retiring, LBYM, pension-free, Roth-convert-later Bogleheads, tax-deferred retirement savings in a 401k or IRA are a better deal than their Roth counterparts.
Is an IRA only necessary once I exceed the $17,500 yearly contribution for the 401k?
If your 401k doesn't offer low-cost funds covering every asset class you need, you might want to use an IRA for those asset classes even before you max out the 401k.
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Re: help with basic tax strategy
by BolderBoy » Tue Feb 04, 2014 4:31 pm
TylerDavis wrote:Isn't it a reasonable assumption that my tax bracket in retirement will be very low (zero salary income) compared to current tax bracket? So why would you want to pay taxes up front, as in an IRA?
Is an IRA only necessary once I exceed the $17,500 yearly contribution for the 401k?
You have some more reading to do. There is a different between a Roth IRA and a Traditional IRA and they are both different than a 401k. I don't have kids so know nothing about 529s.
In general, your in-retirement tax rate MIGHT be lower than your present tax rate - tough to know. But you need to plan NOW for your assumption THEN and it may be safe to say your in-retirement tax rate will be lower (or equal.)
In prep for that day, you should max out your workplace 401k plan then, max out either tIRAs or rIRAs for you and your wife. Whether to use rIRA or tIRA now depends upon your income now. If high income and can benefit from the tax deduction, use tIRA. If low income and can afford it, use rIRA.
But more reading will help you decide. This website has a wiki with lots of answers to your questions.
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Re: help with basic tax strategy
by Kevin M » Tue Feb 04, 2014 4:34 pm
House Blend covered it well, but to expand on the last point, some 401k plans offer only high-cost, actively-managed funds. In that case favoring IRA contributions could make sense after you maximize your employer match.
If your income is below the limit for getting a full deduction on traditional IRA contributions, then for non-matched contributions the tIRA has the same tax benefits as a traditional 401k.
If above that limit, then a Roth IRA may make sense, but as you say, if your effective tax rate in retirement is much lower than your marginal tax rate now, then contributing more to the traditional 401k could still make sense, even with no inexpensive index fund choices.
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Re: help with basic tax strategy
by sunnyday » Tue Feb 04, 2014 4:49 pm
I don't want to add confusion, but it's usually recommended that you fund your retirement accounts fully before funding a 529.http://www.forbes.com/2010/03/16/colleg ... first.html
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