New to investing, ETF question

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New to investing, ETF question

Postby Brantley » Mon Dec 03, 2012 2:27 am

Hi all,

Just joined the forum. I've been reading up on ETFs for the past few weeks, and I've decided to take the plunge. Just for some background info on myself, I am in my early 20's, have a steady 50k range job, rent an apartment with my girlfriend and I have no loans. I'm currently saving 10% in my company sponsored Roth 401k, which is being invested in a target fund.

I inherited a decent sum of money which is currently invested in a Roth IRA that is being handled by my family advisor. The IRA is diversified in American Funds, which my advisor is charging a 1.25% annual fee. I'd say I'm decently happy with the returns, but I'm not quite ready to handle that much money on my own yet.

For my Roth IRA, I'm required to take minimum distributions from the account. For these distributions, I'd like to reinvest them in a Roth IRA brokerage account through Vanguard which I will invest in ETFs. The plan as of now is to follow Rick Ferri's core four allocation with 90% in equities (54% VTI, 27% VXUS, 9% VNQ) and 10% in bonds (BND).

Questions:

Is a 90/10 allocation too aggressive? Also, would you suggest I split the bonds 50% BND and 50% VTIP? Any other suggestions or ideas?

Thanks!
~Brantley
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Re: New to investing, ETF question

Postby Johm221122 » Mon Dec 03, 2012 3:04 pm

Welcome to forum,
why Roth 401?
What are 401 choices?
Try this link
viewtopic.php?t=6212
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Re: New to investing, ETF question

Postby Brantley » Mon Dec 03, 2012 4:06 pm

I chose a Roth 401k because I feel I'll be in a higher tax bracket when I retire. I think it makes more sense for me to be in a Roth vs. a traditional 401k. My 401k is through Fidelity.

My options include:

DODGE & COX STOCK, FID BLUE CHIP GR K, FID FUND K, FID GROWTH CO K, SPTN 500 INDEX INST, VANG CAP OPPS ADM, VANG PRIMECAP CORE, FID LOW PRICED STK K, TRP NEW HORIZONS, VANG SM VAL IDX INST, AF EUROPAC GROWTH R5, AF NEW PERSPECT R5, FID DIVERSIFD INTL K, VANG REIT IDX INST, FID ASSET MGR 50%, VANGUARD TARGET 20xx, VANGUARD TARGET INC, FID MIP II CL 3, PIM TOTAL RT INST, VANG TOT BD MK IS PL, & VANG INFL PROT INST
~Brantley
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Re: New to investing, ETF question

Postby retiredjg » Mon Dec 03, 2012 4:40 pm

Welcome to the forum!

Brantley wrote:I chose a Roth 401k because I feel I'll be in a higher tax bracket when I retire.

A lot of people think this, but it is not really that common. Don't confuse your net worth or your wealth when you are older with your taxable income when you are older. In fact, your taxable income could be quite low even if you are quite wealthy.

If you are making about $50k and your contributions to your 401k are Roth, you are probably in the 25% tax bracket right now. So you are paying 25% to get that money into Roth 401k. But you quite likely would not be paying 25% to take money out of traditional 401k. Even if you are in the 25% marginal bracket in retirement all your money may not be coming at 25% because some of it might be filling the tax brackets that are lower than 25%.

If you know you'll have a pension in retirement, you can probably assume the pension will be filling some of the lower brackets. But if there is no pension, some parts of your 401k quite likely will be filling some of the lower bracket space (and therefore not being taxed at 25%). And even if you do pay 25% in later years, it breaks even with paying 25% now.

So why pay more now when you might pay less later?

If you put the money into traditional 401k, you might actually drop into the 15% tax bracket. And you'd have more money to save. I think you should give consideration to putting enough in traditional 401k to get yourself into the 15% bracket. Then put whatever else you can save into Roth IRA or Roth 401k.

I believe that all portfolios need at least 20% bonds, so in my opinion, 90/10 is not the best choice.

The easiest way to invest your money at this point is to simply use a Vanguard Target Retirement fund that has the stock to bond ratio you have picked. Ignore the date in the name. Put that fund in both your 401k and in your Roth IRA.

If you can move the Inherited Roth IRA to Vanguard, you can get much lower cost funds there. Again, just use the same target date fund. No need to worry about being ready to handle that much money - the target fund does all the work.
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Re: New to investing, ETF question

Postby retiredjg » Mon Dec 03, 2012 4:43 pm

P.S. Don't get hung up on ETFs. Once you have $10k in a fund, the cost for the mutual fund is usually the same as the cost for the ETF (at Vanguard). ETFs are a little tricker and require a little more work. If you like them, fine. But don't assume that ETFs are any better than mutual funds because they are not.
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Re: New to investing, ETF question

Postby Brantley » Mon Dec 03, 2012 8:36 pm

Even if you are in the 25% marginal bracket in retirement all your money may not be coming at 25% because some of it might be filling the tax brackets that are lower than 25%.
I don't see how this is relevant as my income is not initially taxed at a flat 25%, but rather progressively. This would only be true is I was annually withdrawing more than I put in. Since I have about another 40 years to invest, expect to live to maybe 100, and expect my portfolio to grow, I don't think this would be the case. Can you elaborate on this point?

If you put the money into traditional 401k, you might actually drop into the 15% tax bracket.
How much would I need to save for this to be the case? I make around $55k, less a personal exemption of $3,800, and to simplify things lets assume I take the standard deduction of $5,950. I'm left with taxable income of $45,250. To reach the 15% tax bracket I need to reduce my taxable income to $35,350, which would mean I'd need to put away $9,900 in a traditional 401K. That's putting away 18% of my salary. I'm not sure its worth me saving away that much, also considering my RMD for my inherited IRA will bump up my taxable income a bit as well.

I believe that all portfolios need at least 20% bonds, so in my opinion, 90/10 is not the best choice.
Any reason for this? I think I'm young enough and in a strong enough financial position where I can bear the risk.

If you can move the Inherited Roth IRA to Vanguard, you can get much lower cost funds there.
That's a good idea, but I think I'll leave it where it is for now.

But don't assume that ETFs are any better than mutual funds because they are not.
If they are cheaper and provide the same return, how are they not better for me as of now? I know they are a bit trickier (actively sold on the market, not as simple to purchase), but that shouldn't mean I should steer away from them.
~Brantley
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Re: New to investing, ETF question

Postby grabiner » Mon Dec 03, 2012 8:54 pm

Brantley wrote:
I believe that all portfolios need at least 20% bonds, so in my opinion, 90/10 is not the best choice.
Any reason for this? I think I'm young enough and in a strong enough financial position where I can bear the risk.


You can bear the risk financially, but can you bear it emotionally? What did you do with your investments in 2007-2009? A 90/10 portfolio lost more than half its value. If you had 80% stock in 2007 and still had 80% stock in 2009, then you know how you will react to that risk. Otherwise, I would recommend limiting your exposure to 80% stock until you have been through a bear market.

I followed that advice myself; I was 80% stock in 2000-2002, had no problem with the bear market, and have been 90% stock since 2004. And when my 90% became 86% in October 2008, I sold some bonds to buy more stock in order to keep that 90% stock allocation.
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Re: New to investing, ETF question

Postby retiredjg » Mon Dec 03, 2012 8:59 pm

Brantley wrote:
Even if you are in the 25% marginal bracket in retirement all your money may not be coming at 25% because some of it might be filling the tax brackets that are lower than 25%.
I don't see how this is relevant as my income is not initially taxed at a flat 25%, but rather progressively.

Yes, your income is taxed progressively. But the part that goes into the 401k is "off the top" - in your case, all in the 25% tax bracket.

Another way to look at it, if you put all the money into Roth 401k, all of that $17k is in the 25% bracket. But if you put all your 401k into traditional 401k, you are reducing your taxable income by $17k and saving $4,200 in taxes.

If you put the money into traditional 401k, you might actually drop into the 15% tax bracket.
How much would I need to save for this to be the case? I make around $55k, less a personal exemption of $3,800, and to simplify things lets assume I take the standard deduction of $5,950. I'm left with taxable income of $45,250. To reach the 15% tax bracket I need to reduce my taxable income to $35,350, which would mean I'd need to put away $9,900 in a traditional 401K. That's putting away 18% of my salary. I'm not sure its worth me saving away that much, also considering my RMD for my inherited IRA will bump up my taxable income a bit as well.

You are approaching this correctly. But there are more things that might reduce your taxable income. Let me ask someone who knows this area well to come comment.

Even if you don't drop into the 15% bracket, the argument is the same. There is no need to pay a straight 25% now when you could easily pay less than 25% later.

I believe that all portfolios need at least 20% bonds, so in my opinion, 90/10 is not the best choice.
Any reason for this? I think I'm young enough and in a strong enough financial position where I can bear the risk.

As you move from 20% bonds to 10% bonds, the risk increases faster than the return. Less bang for the buck. That's why.


But don't assume that ETFs are any better than mutual funds because they are not.
If they are cheaper and provide the same return, how are they not better for me as of now? I know they are a bit trickier (actively sold on the market, not as simple to purchase), but that shouldn't mean I should steer away from them.

I'm not trying to steer you away from them. But a lot of people think ETFs are somehow better than mutual funds. They aren't better at all. It's a myth. And they are more trouble and you do lose some pennies in the bid ask spread (or so I hear). If you like ETFs, that's fine. It just was not clear to me whether you had bought into the myth.

Using ETFs right now might save you a very small handful of dollars for a year or maybe two, but in the long run, they will cost the same as just using the Vanguard mutual funds.
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Re: New to investing, ETF question

Postby Brantley » Mon Dec 03, 2012 11:13 pm

The easiest way to invest your money at this point is to simply use a Vanguard Target Retirement fund that has the stock to bond ratio you have picked. Put that fund in both your 401k and in your Roth IRA
.

The Vanguard target fund I'm in has a 90% equities 10% bond allocation. I think I can stomach the ups and downs, and Vanguard seems to think that's the right allocation for someone my age.

But the part that goes into the 401k is "off the top" - in your case, all in the 25% tax bracket.

Isn't the contribution a percentage of after tax dollars? How is this off the top?
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Re: New to investing, ETF question

Postby DSInvestor » Mon Dec 03, 2012 11:35 pm

Brantley wrote:
The easiest way to invest your money at this point is to simply use a Vanguard Target Retirement fund that has the stock to bond ratio you have picked. Put that fund in both your 401k and in your Roth IRA
.

The Vanguard target fund I'm in has a 90% equities 10% bond allocation. I think I can stomach the ups and downs, and Vanguard seems to think that's the right allocation for someone my age.

But the part that goes into the 401k is "off the top" - in your case, all in the 25% tax bracket.

Isn't the contribution a percentage of after tax dollars? How is this off the top?


Traditional 401k contributions give you a tax benefit at the top of your income stack at your top marginal tax rate. When you start withdrawing from your Traditional 401k, those withdrawals (assuming no other income) will be taxed starting at 0% and slowly creep up the tax brackets. I made Traditional 401k contributions and received tax deductions in the 33% Fed and 6% state tax brackets. Now that I have stopped working I'm converting those traditional assets to Roth tax free every year to consume my 0%, 10% tax brackets. The current tax rules for Qualified Dividend Income and Long Term Capital Gains allow me to creep into 10% bracket and still pay zero tax. This is a no-brainer for my situation. The average tax rate that I'm paying on my withdrawals and conversions is much closer to 0% than 33%. Traditional 401k contributions were definitely the right way to go for me. If you will not have a pension to consume your 0% bracket you may be able to do something similar.

Roth 401k contributions do not offer any tax deduction but the deduction that you gave up was at the top of your income stack at your highest rates. If you gave up a deduction in the 25+% tax bracket and retire without a pension, you may find yourself in a lower tax bracket even if tax rates are higher in the future.
Last edited by DSInvestor on Mon Dec 03, 2012 11:49 pm, edited 1 time in total.
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Re: New to investing, ETF question

Postby Brantley » Mon Dec 03, 2012 11:48 pm

Traditional 401k contributions give you a tax benefit at the top of your income stack at your top marginal tax rate. When you start withdrawing from your Traditional 401k, those withdrawals (assuming no other income) will be taxed starting at 0% and slowly creep up the tax brackets. I made Traditional 401k contributions and received tax deductions in the 33% Fed and 6% state tax brackets. Now that I have stopped working I'm converting those traditional assets to Roth tax free every year to consume my 0%, 10% tax brackets. This is a no-brainer for my situation. If I needed the 401k money to meet expenses, a large portion of my withdrawals every year will be taxed at a rate far lower than the 33+% rate from when I made contributions. If you will not have a pension to consume your 0% bracket you may be able to do something similar.

Roth 401k contributions do not offer any tax deduction but the deduction that you gave up was at the top of your income stack at your highest rates.


So this goes back to the point of if you are in a higher tax bracket now than when you retire, a traditional 401K makes sense. For a traditional, income that you make when you're in a 33%+ bracket is only going to be taxed based on your income when you retire (distributions, pension, capital gains). But if you're in the same tax bracket when you're saving vs. when you retire there will be no difference for a Roth or Traditional. When I am later in life in a higher bracket such as yourself - it seems to make sense to start contributing to a Traditional IRA rather than a Roth, and keep my 401K in a Roth now? Can I at some point switch over future contributions to a traditional 401K rather than a Roth?
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Re: New to investing, ETF question

Postby DSInvestor » Tue Dec 04, 2012 12:45 am

The composition of income in retirement is important. Let's say you're single, retired and withdraw enough from Traditional IRA to break into the 25% tax bracket by $1 in 2011. What is the average tax rate for your 401k withdrawal?

Link to 1040 tax table:
http://www.irs.gov/pub/irs-pdf/i1040tt.pdf
Link to Fairmark Reference page showing std deduction and exemptions:
http://fairmark.com/reference/index.htm

For 2011, 25% bracket started at taxable income $34,500 and the Fed tax for $34,500 taxable income is $4,750. Let's add the std deduction and 1 exemption to taxable income to get AGI.
AGI = 34,500 + 5800 + 3700 = $44,000

In the absence of other income, a single person can withdraw $44,000 from Traditional 401k in 2011 and pay only $4750 in Fed Tax. The average tax rate for this withdrawal is 10.7% but the retiree is in the 25% bracket. I think it is important to consider the average tax that you will pay for your 401k withdrawals.

The average tax for 44K of withdrawal would be much higher if the retiree had a pension of 50K. In such a case, every dollar of 401k withdrawal will be taxed at 25% or higher.

You can always elect to change future contributions to Traditional 401k or Roth 401k or you can contribute both Traditional and Roth. The sum of your employee salary deferrals cannot exceed the 17K max for 2012.

Roth 401k contributions that you have already made are irrevocable.

Traditional 401k contributions are pre-tax assets in your 401k and there are several ways to change them to Roth:
1) Your 401k may offer the option for in-plan Roth conversion. Any pre-tax assets converted to Roth is taxable and will add to your income.
2) If you leave your job, you can rollover your 401k to an IRA and convert any amount to Roth IRA that you wish.
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Re: New to investing, ETF question

Postby Bob's not my name » Tue Dec 04, 2012 5:38 am

You're resisting some good advice here from people who really understand this stuff. Here are a few things you are saying that don't make sense:
Brantley wrote:I inherited a decent sum of money which is currently invested in a Roth IRA that is being handled by my family advisor. The IRA is diversified in American Funds, which my advisor is charging a 1.25% annual fee. I'd say I'm decently happy with the returns, but I'm not quite ready to handle that much money on my own yet.
You're obviously a sharp guy. Here's a math exercise: Part of your diversified portfolio must be in bonds that are currently yielding less than 2%. You are paying American Funds an expense ratio of about, what, 0.75%? You are paying the advisor 1.25%. What's left over for you? Who's getting rich fastest: you, the advisor, or American Funds?
Brantley wrote:I'm currently saving 10% in my company sponsored Roth 401k.
That's putting away 18% of my salary. I'm not sure its worth me saving away that much.
You're currently saving $5,500 in the 401k and you're also proposing saving the inherited Roth IRA RMD in a new Roth IRA. How much is the RMD? It's not clear to me you need to save more than you're already proposing to stay underneath the 28% bracket (remember that under current law the 25% bracket goes to 28% next year). First of all, to make a $5,500 Roth 401k contribution you are using $7,640 of gross salary and paying $2,140 of federal income tax on it. Maybe you live in a no-tax state, but I'll assume you have a state tax of 6%, which is about the median. That means you're using $8,330 of gross salary and paying $2,833 of tax on it to make your Roth contribution. Let's look at your numbers for 2013, assuming you save nothing more in your 401k, but switch to deductible contributions:

$55,000 gross salary
- $2,000 pre-tax health, dental, and disability insurance premiums withheld from your pay (I'm assuming you have employer-provided insurance)
- $8,330 traditional 401k contribution
------------------
$44,670 Adjusted Gross Income
- $3,900 personal exemption (it goes up a little every year)
- $6,100 standard deduction (this is a guess at what it will be next year)
-----------
$34,670 taxable income

How about that! You can get under the 28% bracket without saving another dime! This year's $35,350 threshold will also go up next year, so you probably have more than $1,000 of headroom in the 15% bracket without saving a dime more than you're saving now. If you can then make Roth IRA contributions in the 15% bracket, you won't get much argument here ... unless you live in Illinois, Kentucky, or Oklahoma, which exempt traditional IRA contributions and withdrawals regardless of age, or if in the next fifty years you are ever disabled, laid off, die young leaving dependents, or retire early, or unless you might return to school full time, or unless you are currently in a high tax state but may move to a low tax state.
my RMD for my inherited IRA will bump up my taxable income a bit as well.
You said it is a Roth IRA, so this can't be true. Roth distributions are tax-free because the deceased person paid the taxes for you.
Brantley wrote:Can I at some point switch over future contributions to a traditional 401K rather than a Roth?
Yes, but you have it backwards. It's generally better to accumulate some pre-tax savings before starting Roth. In your case, you have massive Roth savings and very little traditional. If you have some of both you have a fully functioning time machine. Read these two articles on how you can travel through time. They will also be a good exercise for you on thinking about the taxation of your savings:

http://thefinancebuff.com/how-to-build- ... art-1.html

http://thefinancebuff.com/how-to-build- ... art-2.html

And here's an article on why pre-tax savings should be the priority for a young person:

http://thefinancebuff.com/your-traditio ... -fund.html
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Re: New to investing, ETF question

Postby retiredjg » Tue Dec 04, 2012 10:43 am

Brantley wrote:So this goes back to the point of if you are in a higher tax bracket now than when you retire, a traditional 401K makes sense.

Correct.

For a traditional, income that you make when you're in a 33%+ bracket is only going to be taxed based on your income when you retire (distributions, pension, capital gains).

Correct.


But if you're in the same tax bracket when you're saving vs. when you retire there will be no difference for a Roth or Traditional.

Correct.


When I am later in life in a higher bracket such as yourself - it seems to make sense to start contributing to a Traditional IRA rather than a Roth, and keep my 401K in a Roth now?

This is where you are going off track. It is starting in the 25% tax bracket, not a higher bracket, that you should be using traditional.


Can I at some point switch over future contributions to a traditional 401K rather than a Roth?

Sure. But you should be switching now, not later.
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 4:45 pm

Who's getting rich fastest: you, the advisor, or American Funds?
I know I'm probably losing out on the fees, but I'd rather have him handle it for now. Once I get a better grip on investments I'll be ready to invest it on my own.

How much is the RMD?
Around $1,500

(remember that under current law the 25% bracket goes to 28% next year)
Good point, but I doubt we'll be going over the fiscal cliff.

First of all, to make a $5,500 Roth 401k contribution you are using $7,640 of gross salary and paying $2,140 of federal income tax on it.
That's a great point and I didn't even realize when I made a 10% election, its 10% after tax dollars. I live in Massachusetts, and I'd prefer to be putting away 10% pre-tax. My total taxes on my contribution should be 35.33% (4.2 SS, 1.45 medicare, 4.68 state, and 25 fed). Does that mean I should be putting away 6.5% or 3,556.85 which would be comparable to saving 10% in a traditional 401K?

$55,000 gross salary
- $2,000 pre-tax health, dental, and disability insurance premiums withheld from your pay (I'm assuming you have employer-provided insurance)
- $8,330 traditional 401k contribution
------------------
$44,670 Adjusted Gross Income
- $3,900 personal exemption (it goes up a little every year)
- $6,100 standard deduction (this is a guess at what it will be next year)
-----------
$34,670 taxable income

I'm still on my parent's insurance so that deduction won't apply. That mean's I need to save $9,650, or 17% of my salary to drop down to the 15% bracket. That's more than I'd like to put away.

You said it is a Roth IRA, so this can't be true. Roth distributions are tax-free because the deceased person paid the taxes for you.
Forgot to mention this, but it was rolled over from a traditional 401k. Withdrawals are currently being taxed, but I'm not sure if I'm getting them back on my taxes as I have my accountant prepare my returns. I'll have to look into that one.

If you have some of both you have a fully functioning time machine. Read these two articles on how you can travel through time. They will also be a good exercise for you on thinking about the taxation of your savings:

And here's an article on why pre-tax savings should be the priority for a young person:
I read the three articles you wrote. While they make some good points, they don't seem to be relevant to my situation.

Thanks for the help.
~Brantley
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 4:48 pm

It is starting in the 25% tax bracket, not a higher bracket, that you should be using traditional.
Why now? Do you really only need $35k a year when you retire? I'm not sure what a possibly retire scenario would be for myself. I'd say I most likely will not have a pension.
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Re: New to investing, ETF question

Postby DSInvestor » Tue Dec 04, 2012 5:01 pm

Let's say you're retired now and withdrawing from Traditional 401k. There is no other income. You're age 60 married taking the standard deduction and 2 exemptions. Let's run through some Fed tax numbers for various levels of withdrawal.

20K withdrawal Fed Tax = $51, average tax rate = 0.2%
40K withdrawal, Fed Tax= $2,209, average tax = 5.5%
60K withdrawal, Fed tax= $5, 209, Marginal tax rate = 15%, average tax rate = 8.6%
80K withdrawal, Fed tax = $8,209, Marginal tax rate= 15%, average tax rate = 10.2%
100K withdrawal, Fed Tax = $12,191, Marginal Tax rate = 25%, average tax rate = 12.1%
200K withdrawal, Fed Tax = $38,319, Marginal Tax rate = 28%, average tax rate = 19.1%

In the absence of other income like a pension, you can make very large Traditional 401k contributions and not pay much taxes in our progressive tax system. In this scenario, the Fed tax on 100K was 12K. The tax for 200K was 38K meaning that the tax on the second 100K was 26K which makes sense because that second 100K fell into the 25% and 28% brackets.

If you won't have a pension, the case for Traditional contributions now is strong if you're currently in 25% Fed.
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Re: New to investing, ETF question

Postby Bob's not my name » Tue Dec 04, 2012 5:06 pm

It sounds like your Inherited IRA is a Traditional IRA, not a Roth IRA. This is a significant point of confusion you need to clear up to get good advice.

Traditional 401k contributions don't escape SS and Medicare tax.

Massachusetts tax is 5.3% on ordinary income.

In Massachusetts traditional IRA contributions are taxed, unlike most states, whereas traditional 401k contributions are not. So all pre-tax savings should be in your 401k -- this doesn't conflict with what you were planning anyway; I'm just letting you know your state's tax code is odd when it comes to TIRAs.

If you think the articles don't apply to you you need to read them again. You are throwing away a lot of money in taxes. Thought exercise: if you think it's so wonderful to pay 30% tax on your savings, why don't you withdraw more than the RMD from your Inherited IRA, give 30% to the government, and put the remainder in a Roth IRA?

Good job milking the ACA for free insurance.
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 5:38 pm

It sounds like your Inherited IRA is a Traditional IRA, not a Roth IRA. This is a significant point of confusion you need to clear up to get good advice.
It looks like my IRA is an 'inherited' IRA rather than a traditional/Roth.

Massachusetts tax is 5.3% on ordinary income.
Looking at my paycheck, my income is being taxed at 4.68%, and this website http://www.suburbancomputer.com/tips_calculator.php calculated the same amount. What do you think the discrepancy is due to?

In Massachusetts traditional IRA contributions are taxed, unlike most states, whereas traditional 401k contributions are not. So all pre-tax savings should be in your 401k
Would that mean it would make more sense to put my RMDs in a Roth since they will be taxed if I put them in a traditional?

If you think the articles don't apply to you you need to read them again. You are throwing away a lot of money in taxes.
I'll take another look through them tonight when I get home from work.
~Brantley
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 5:47 pm

DSInvestor wrote:Let's say you're retired now and withdrawing from Traditional 401k. There is no other income. You're age 60 married taking the standard deduction and 2 exemptions. Let's run through some Fed tax numbers for various levels of withdrawal.

20K withdrawal Fed Tax = $51, average tax rate = 0.2%
40K withdrawal, Fed Tax= $2,209, average tax = 5.5%
60K withdrawal, Fed tax= $5, 209, Marginal tax rate = 15%, average tax rate = 8.6%
80K withdrawal, Fed tax = $8,209, Marginal tax rate= 15%, average tax rate = 10.2%
100K withdrawal, Fed Tax = $12,191, Marginal Tax rate = 25%, average tax rate = 12.1%
200K withdrawal, Fed Tax = $38,319, Marginal Tax rate = 28%, average tax rate = 19.1%

In the absence of other income like a pension, you can make very large Traditional 401k contributions and not pay much taxes in our progressive tax system. In this scenario, the Fed tax on 100K was 12K. The tax for 200K was 38K meaning that the tax on the second 100K was 26K which makes sense because that second 100K fell into the 25% and 28% brackets.

If you won't have a pension, the case for Traditional contributions now is strong if you're currently in 25% Fed.


That is a good point. When I'm married filing jointly the brackets will be much higher. As of current brackets, I'll hit the 25% bracket by $70,700. I imagine I'll need at least that much to retire. Thanks for info. Any other points I should be considering? I just spoke with my financial advisor would handles my IRA, and he recommended I open a Roth 401k due to the RMD age limits and reducing the risk that tax rates go up. Any validity to those points?
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Re: New to investing, ETF question

Postby retiredjg » Tue Dec 04, 2012 6:19 pm

Brantley wrote:
It is starting in the 25% tax bracket, not a higher bracket, that you should be using traditional.
Why now? Do you really only need $35k a year when you retire? I'm not sure what a possibly retire scenario would be for myself. I'd say I most likely will not have a pension.

No. That is not what it means.

Just for the sake of discussion, assume no changes in tax law. Most people retire in either the 15% tax bracket or the 25% tax bracket. Not so many fall outside that range, but some do. (Some even fall into a lower bracket). At this point, there is no reason to believe you will be one of them. So let's assume you will be one of the "most" people who retire in the 15% or 25% tax brackets.

    -If you retire in the 15% tax bracket, you could pay 15% taxes later as compared to 25% today. This leaves more money for you.

    -If you retire in the 25% tax bracket, you could pay 25% later as compared to 25% today. No gain, no loss, everything is equal.
So if you are most likely to pay less later or the same later, why pay it today? Why not wait? If you postpone the taxes, there's a very large chance you won't end up paying more and there's at least a good chance you will pay less. If you pay the tax now, you eliminate the possibility that you might pay less later. There's probably no penalty for waiting. Doesn't it seem like a no-brainer to wait?

But wait....above I said "If you retire in the 15% tax bracket, you could pay 15% taxes later as compared to 25% today"? The truth is that you probably won't actually pay the full 15% later because some of that money is going to be filling up the lower tax brackets. So some of it will not be taxed at 15% but at some lower rate.

Now, obviously, we know tax law is going to change. Taxes will certainly go up and go down, maybe several times, before you retire. We have no way of predicting what is going to happen. But it still seems likely that you are still going to fall into the cohort of people who have less taxable income in retirement than they have while working. It still seems likely that we will still have a tiered system (where some of your money is taxed at one rate, some at another, etc.) Even with those likely scenarios, since we can't predict the future, it doesn't it seem smart to save money while you can?

I'm not saying not to put any money into Roth at some point. There will come a time when your choice of where to invest the next dollar won't be traditional vs Roth. The choice will be Roth vs taxable. At that point, the obvious choice is Roth. Eventually, you will have both traditional money and Roth money in your portfolio. And that will be a good thing. :D
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Re: New to investing, ETF question

Postby retiredjg » Tue Dec 04, 2012 6:29 pm

Brantley wrote: Would that mean it would make more sense to put my RMDs in a Roth since they will be taxed if I put them in a traditional?

Maybe. Maybe not. If you put the RMDs into Roth, they will be taxed federally and state. If you put the RMD in traditional, you will only pay state tax. This might be a question that you can only answer by knowing how much total you are saving a year.

If you think the articles don't apply to you you need to read them again. You are throwing away a lot of money in taxes.

I'll take another look through them tonight when I get home from work.

We know this can be a tough concept to get. Read the articles again. Learn more about how taxes are paid. But you might just have to put all this on the back burner until, all of a sudden, you "get it". Until that time, you might be wise to follow the advice of people who have already "gotten it". :wink:

If you simply can't believe it, go in search of articles that suggest you should use Roth 401k. I doubt you will find many.

Here's one more to add to your reading list.

http://money.cnn.com/2011/07/14/pf/expe ... t=My+Yahoo

And here's an article that does encourage Roth (TSP, like a 401k), but that is specifically for people who will have a pension. Maybe that will help it make more sense to you.

http://thefinancebuff.com/most-tsp-part ... h-tsp.html
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Re: New to investing, ETF question

Postby retiredjg » Tue Dec 04, 2012 6:35 pm

Just one last point.

Brantley wrote: That mean's I need to save $9,650, or 17% of my salary to drop down to the 15% bracket. That's more than I'd like to put away.

It is not important at all whether you can drop down into the 15% bracket. Just forget that part.

Do you realize that saving $9,650 pre tax is the same as saving $7,237 after tax?
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 6:55 pm

Do you realize that saving $9,650 pre tax is the same as saving $7,237 after tax?
Yes. What's your point?
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Re: New to investing, ETF question

Postby DSInvestor » Tue Dec 04, 2012 7:10 pm

Brantley wrote:I just spoke with my financial advisor would handles my IRA, and he recommended I open a Roth 401k due to the RMD age limits and reducing the risk that tax rates go up. Any validity to those points?
Roth 401k and Traditional 401k are both subject to RMD. Upon separation from service, I believe you can rollover Roth 401k assets to Roth IRA to avoid RMD on the Roth 401k assets.

By making Roth 401k contributions, you give up the tax deduction offered by Traditional 401k contributions. You're pre-paying the tax in return for no taxation later. This is a way to protect yourself from higher tax rates in the future. Don't forget that depending on your tax situation, it may be possible to withdraw a good chunk from Traditional IRA at 0% tax rate and other low tax rates. Unless there is a drastic overhaul of the tax system, deductions, exemptions and tax credits will continue to offer a sizeable 0% tax bracket. Withdrawals from Traditional IRA may be taxable but the tax rate can be 0%.

Here's something else to consider. Early in your career, income may not be sufficient to fund all priorities - emergency fund, saving for car, house, student loan repayment, accelerated mortgage payments, Roth IRA etc. If you contribute 17K to Traditional 401k and receive full tax deduction at 25% tax rate, your take home pay will be $4250/yr higher than if you contributed 17K to Roth 401k. This extra $4000 may help fund these other priorities. It is a significant amount every year. If you are subject to state income tax, the tax deduction will be even more valuable.

If you contribute to Traditional 401k and Roth IRA, you have the benefit of tax diversification to give you more control of tax liability in retirement. Withdraw some for Traditional taxed at low brackets and a little from Roth IRA tax free.
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 7:12 pm

If you simply can't believe it, go in search of articles that suggest you should use Roth 401k. I doubt you will find many.
Most of the articles I'm finding aren't advocating to use a traditional either. They seem to mostly focus on predicting if your retirement tax rate will be higher or lower than your current, and they say to diversify between Roth and Traditional if you're unsure. Any other articles with new information I can dig into'?
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 7:21 pm

I believe you can rollover Roth 401k assets to Roth IRA to avoid RMD on the Roth 401k assets.
Yes that is correct.

Here's something else to consider. Early in your career income may not be sufficient to fund all priorities - emergency fund
-well on my way towards one
saving for car
own one
student loan repayment
Have none
If you contribute 17K to Traditional 401k and receive tax deduction at 25% tax rate, your take home pay will be $4250/yr higher than if you contributed 17K to Roth 401k.
Where did the 17k come from? That's 31% of my paycheck.
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Re: New to investing, ETF question

Postby DSInvestor » Tue Dec 04, 2012 7:43 pm

Brantley wrote:Where did the 17k come from? That's 31% of my paycheck.


That's the max employee contribution allowed for 401(k) for 2012. Some employers allow up to 100% of salary to be contributed to 401k. I had a goal of retiring early so I maxed out 401k early in my career. I maxed out Traditional 401k, Roth IRA and invested in taxable too. FWIW, I saved 50% of my gross income.

You indicated in your OP that you're contributing 10% (5K?) to Roth 401k. If you contributed 5K to Traditional 401k, your take home pay may increase by $1250 assuming 25% Fed tax bracket. If you switch to Traditional contributions, you'd be able to contribute $6,250 and still have the same take home pay. Is there an employer match and are you contributing enough to get the max match? If you're not contributing enough to get the max match, switching to Traditional may increase your match. This would be a no-brainer.
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Re: New to investing, ETF question

Postby Bob's not my name » Tue Dec 04, 2012 8:00 pm

Brantley wrote:It looks like my IRA is an 'inherited' IRA rather than a traditional/Roth. Inherited IRAs are either traditional or Roth. Your inherited IRA is traditional. It is not a Roth IRA. I'm telling you this for free. That jackass advisor is charging you for ... what?
Brantley wrote:Looking at my paycheck, my income is being taxed at 4.68%, and this website http://www.suburbancomputer.com/tips_calculator.php calculated the same amount. What do you think the discrepancy is due to? There's a difference between withholding rate and your marginal tax rate. Your employer (following guidelines) is assuming that you'll have certain exemptions and deductions against Massachusetts income, so it withholds at the average rate of 4.68%. But your marginal rate on your top slice of income is 5.3%. Just Google "Massachusetts income tax brackets 2012" and you'll see that Massachusetts has a flat income tax with only one bracket, 5.3%. Your first $6,000 or so is taxed at 0%, but everything else is taxed at 5.3%.
Bob's not my name wrote:In Massachusetts traditional IRA contributions are taxed, unlike most states, whereas traditional 401k contributions are not. So all pre-tax savings should be in your 401k
Would that mean it would make more sense to put my RMDs in a Roth since they will be taxed if I put them in a traditional? They'll be taxed either way. You shouldn't think of your RMDs as some sort of magical unicorn. They're just another (small) element of your income. A $1,500 RMD is indistinguishable from a $1,500 bonus. In addition, you are getting thoroughly confused by our wonderful tax code. Your RMDs are taxed as they exit the inherited IRA. You can't change that. Forget about it. Just think about this: "If I have $1,500 of taxable income, regardless of where it comes from, do I want to put it in a Roth and also pay $500 of taxes, or do I want to put it in my traditional 401k and get a tax deduction, which reduces my total taxable income by $1,500 and saves me $500 in taxes?"
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 8:43 pm

That jackass advisor is charging you for ... what?
That's a little aggressive.

They'll be taxed either way. You shouldn't think of your RMDs as some sort of magical unicorn. They're just another (small) element of your income. A $1,500 RMD is indistinguishable from a $1,500 bonus
I'm aware of that.

"If I have $1,500 of taxable income, regardless of where it comes from, do I want to put it in a Roth and also pay $500 of taxes, or do I want to put it in my traditional 401k and get a tax deduction, which reduces my total taxable income by $1,500 and saves me $500 in taxes?"
Which is actually my original question.
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Re: New to investing, ETF question

Postby retiredjg » Tue Dec 04, 2012 8:45 pm

Brantley wrote:
If you simply can't believe it, go in search of articles that suggest you should use Roth 401k. I doubt you will find many.

Most of the articles I'm finding aren't advocating to use a traditional either. They seem to mostly focus on predicting if your retirement tax rate will be higher or lower than your current....

Yes, that is true. The problem is not in the theory. The theory is correct.

The problem is that most people have NO IDEA how to predict their future taxable income and most people approach it completely wrong. Most people assume if they have a lot of money saved then they will have a high tax rate. In short, most people confuse wealth with high taxes.

Do not confuse wealth with taxable income. They are not the same. In fact, a very wealthy person can have a very low taxable income and therefore be in a very low tax bracket (or tax rate as is evidenced by people like Mitt Romney who is probably in a high tax bracket, but whose income was mostly taxed at lower capital gains rates).


...and they say to diversify between Roth and Traditional if you're unsure.

I don't think anyone here would disagree with that. However, in spite of what you think, that is not the question under discussion.


Any other articles with new information I can dig into'?

I don't think new information is going to help. :D I think you don't understand taxes and you can't yet figure it out because of that.
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Re: New to investing, ETF question

Postby retiredjg » Tue Dec 04, 2012 8:49 pm

Brantley wrote:
Do you realize that saving $9,650 pre tax is the same as saving $7,237 after tax?

Yes. What's your point?

Well, I don't know what you plan to save each year, but saving more pre-tax could be the exact same thing as saving less post tax. You said you didn't want to or couldn't save that much. I'm trying to point it it might not be any different from what you are already planning to save.

Either way, the goal is not to get into the 15% tax bracket. That would just be icing on the cake, but it is certainly not an important issue.
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 8:56 pm

Any other articles with new information I can dig into'?

I don't think new information is going to help. :D I think you don't understand taxes and you can't yet figure it out because of that.
Who said I'm illiterate? Give me some useful info and ill read it
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 9:05 pm

Mitt Romney who is probably in a high tax bracket, but whose income was mostly taxed at lower capital gains rates
Mitt is in a financial position that most people cannot take advantage of due to the carried interest loophole. That's not a fair comparison.

I don't think anyone here would disagree with that. However, in spite of what you think, that is not the question under discussion.
Why isn't that under discussion? What conversation are you a part of?
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 9:20 pm

If you think the articles don't apply to you you need to read them again. You are throwing away a lot of money in taxes.

I'll take another look through them tonight when I get home from work.

We know this can be a tough concept to get. Read the articles again. Learn more about how taxes are paid.


I took a look through the articles Bob's not my name posted again. Did you post the right articles? None of these situations seem to apply to me? I don't get it? They all point to very specific situations, none of which I'm in.
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Re: New to investing, ETF question

Postby retiredjg » Tue Dec 04, 2012 9:44 pm

Brantley wrote:
Any other articles with new information I can dig into'?

I don't think new information is going to help. :D I think you don't understand taxes and you can't yet figure it out because of that.

Who said I'm illiterate? Give me some useful info and ill read it

I don't think anyone said that you are illiterate. I know I didn't.

The useful information is in all the links that people have posted for you and in all the responses people have taken the time to post.

Maybe if you would stop trying to defend your position and open your mind other ways of seeing things, what people are saying here might start to make sense.

Please remember that you are the one who asked for advice in the first place. People have given advice. You don't like. You don't believe it. Or maybe you just don't want to believe it.

Either way, nobody here has anything to gain from giving you bad advice. People are telling you what they actually believe. In fact, people have gone to a lot of trouble to offer you answers that they believe are the right answers.

Do your own thinking. But please don't be so rude as to accuse anyone here of suggesting that you are illiterate. Nobody has done that.
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Re: New to investing, ETF question

Postby Brantley » Tue Dec 04, 2012 9:48 pm

Ok thanks everyone. This doesn't seem like the right place for me to be.
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Re: New to investing, ETF question

Postby BuckyBadger » Tue Dec 04, 2012 9:51 pm

Bogleheads will really make you think for yourself and look at things from both sides of the situation. That's what makes it great, in my opinion, but it might not be for everyone.
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Re: New to investing, ETF question

Postby retiredjg » Tue Dec 04, 2012 9:51 pm

Brantley wrote:
Mitt Romney who is probably in a high tax bracket, but whose income was mostly taxed at lower capital gains rates
Mitt is in a financial position that most people cannot take advantage of due to the carried interest loophole. That's not a fair comparison.

It wasn't a comparison.

It was simply an example. An example of a person in a high tax bracket who has a low tax rate. The point was tax bracket vs tax rate. It had nothing to do with Mitt Romney other than bringing in a name and a real life situation that you might recognize.

Why isn't that under discussion? What conversation are you a part of?

I did discuss it. Above.
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Re: New to investing, ETF question

Postby Brantley » Thu Dec 06, 2012 8:21 pm

I got a few other questions if you guys would mind giving me another shot at this.

Does the fact that you won't be paying taxes on the earnings on a Roth counteract some of the tax advantages you'd receive in a traditional?

How does social security work? When I retire, will I receive SS regardless of my income (phase out/income test etc.)? Is it taxable? Will this fill my lower tax brackets?

I see the many advantages of the traditional 401k, but I also see the advantages of the Roth. If the tax brackets didn't change and things are exactly how we predict them when I retire, I'd say put everything in a Traditional. But realistically, I'm not sure what's going to happen. Here's my plan, let me know what you think. By the time I retire, I'd like to move towards an equal Roth/Traditional balance (while I can still contribute to them). Since my inherited IRA is a traditional IRA, I already have a fair amount of that covered. What I'll do is put my RMDs into a Roth IRA. I'll split up my 401k contributions so 5% will be pretax, and 4% will be Roth. That seems like a safe split, and a good start.

Also, what do you guys think of the traditional 80/20 split of the core four Vanguard ETFs? Should it be pure 20% BND, or should I have any of that % be cash, or inflation protected fund such as VTIP?

Thanks again
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Re: New to investing, ETF question

Postby Bob's not my name » Thu Dec 06, 2012 8:47 pm

Brantley wrote:Does the fact that you won't be paying taxes on the earnings on a Roth counteract some of the tax advantages you'd receive in a traditional?
No. Maybe you've already grasped this, but the comparison is mathematically simple. If G is an amount of gross income and T is your tax rate and your investments grow by a factor of 10 before you retire:

TIRA = G * 10 * (1-T)
Roth = G * (1 - T) * 10

You can see that these two equations are identical, since the order doesn't matter in multiplication. So neither is preferred based on the simple math. As you already understand, T (your tax rate) may change, which makes the equations unequal. There are many secondary considerations, too. One of the articles you felt doesn't apply to you argues that a young person like you should favor traditional, because the future is uncertain so don't voluntarily pay taxes when you might be spared them later in the event of job loss, illness, or disability. The time machine articles argue that you should adjust your Roth/traditional preference as your life situation (and hence tax rate) changes.

Anyway, you've figured out a reasonable compromise for the present.

Brantley wrote:How does social security work? When I retire, will I receive SS regardless of my income (phase out/income test etc.)? Is it taxable? Will this fill my lower tax brackets?
You can read the wiki article that explains current law. Basically, 85% of your SS income is taxable. You should expect this to change over the next half century.
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Re: New to investing, ETF question

Postby Brantley » Thu Dec 06, 2012 9:08 pm

Thanks for the response

because the future is uncertain so don't voluntarily pay taxes when you might be spared them later in the event of job loss, illness, or disability.
If I were to run into a situation such as this, your ideas make sense. But, these seem more like secondary considerations, or basically a back up plan. I think the fact that you most likely will retire in the same or lower tax bracket, and those earnings would be partially taxed at the 0 and 15% bracket presents a stronger argument for TIRA rather than Roth. Your articles brought up great ideas, they just seemed too specific to help me grasp the bigger picture.

You can read the wiki article that explains current law.
Will do
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Re: New to investing, ETF question

Postby retiredjg » Thu Dec 06, 2012 9:24 pm

Brantley wrote:Does the fact that you won't be paying taxes on the earnings on a Roth counteract some of the tax advantages you'd receive in a traditional?

No. Not-bob covered this part so I won't comment further.

How does social security work? When I retire, will I receive SS regardless of my income (phase out/income test etc.)? Is it taxable? Will this fill my lower tax brackets?

Yes. You'll get your SS regardless of your income (assuming you have qualified by paying into SS the required number of quarters). Unless you never bother to apply for it. Some people who don't need it don't apply for it, but they could if they chose to.

Yes, SS is taxable for most folks. The amount that is taxable depends on your other income. If you make little other income, less of your SS is taxable. If your other income is higher, more of your SS is taxable. Right now up to 85% of your SS is taxable and 15% is not taxed.

Yes, your SS will fill part or all of the lower brackets. The amount will depend on how much you pay in and how many years you pay into the plan.

But there may be years after you retire, but before you start taking your SS. These are your ideal years to convert traditional IRA to Roth IRA - the years when you have a very low taxable income. You might be able to convert some at very low tax rates.

Got an interruption. I might have time later for your other questions.
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Re: New to investing, ETF question

Postby retiredjg » Fri Dec 07, 2012 11:51 am

Brantley wrote:Here's my plan, let me know what you think. By the time I retire, I'd like to move towards an equal Roth/Traditional balance (while I can still contribute to them). Since my inherited IRA is a traditional IRA, I already have a fair amount of that covered.

Is your inherited IRA really that big?

What I'll do is put my RMDs into a Roth IRA. I'll split up my 401k contributions so 5% will be pretax, and 4% will be Roth. That seems like a safe split, and a good start.

I don't have a problem with the idea of the RMDs going into Roth IRA. But your 401k contributions really should go to traditional, not Roth. Again, why pay taxes at 25% now when you could pay taxes at a lower rate later? Besides, there are other ways to get money into Roth status.

    1) At some point, you should be able to fill up both a 401k plan and an IRA. At that point, you can use Roth IRA.

    2) You are allowed to convert tIRA to Roth IRA simply by paying the tax due. Over your career, you may have occasional years of low income (laid off, traveling, disability, etc.). If so, you might drop into the 15% bracket. At that time, convert $5k or so to Roth at 15% instead of 25%.

    3) You may have years of low income after retirement and before taking SS. You will probably drop into some bracket lower than 25%. That's a good time to convert tIRA to Roth IRA at some lower rate than 25%.
Your goal to have both traditional money and Roth money is a good one. But there really is no need for that to be half and half by the time you retire.

Also, what do you guys think of the traditional 80/20 split of the core four Vanguard ETFs? Should it be pure 20% BND, or should I have any of that % be cash, or inflation protected fund such as VTIP?

This is personal preference. Many people believe that your income is a protection against inflation, making TIPS unnecessary for someone your age. Others like the idea of having TIPS all along. Just suit yourself.
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Re: New to investing, ETF question

Postby Brantley » Fri Dec 07, 2012 1:49 pm

But your 401k contributions really should go to traditional, not Roth. Again, why pay taxes at 25% now when you could pay taxes at a lower rate later?
Ok, that's fair. I'm going to have a chat with my advisor soon. I'll let you know how that goes.

Back to the 80/20 split. Taking a look at the Vanguard Target Retirement funds - they have a 90/10 split for my age. You had recommended that I roll my inherited IRA into one of these funds that has such a split, but are also telling me at the same time I should be using a less aggressive split (80/20) for my 401K. My advisor currently has me at a 90/10 split, and so do the professionals at Vanguard. Why do you disagree with them?
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Re: New to investing, ETF question

Postby Brantley » Fri Dec 07, 2012 4:44 pm

I just thought of this. Am I allowed to transfer a RMD from an inherited traditional IRA to a Roth IRA? I was reading through the IRS guidance and it wasn't very clear on this subject.
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Re: New to investing, ETF question

Postby DSInvestor » Fri Dec 07, 2012 6:21 pm

Brantley wrote:I just thought of this. Am I allowed to transfer a RMD from an inherited traditional IRA to a Roth IRA? I was reading through the IRS guidance and it wasn't very clear on this subject.
Terminology is important. I'm not sure what you mean by transfer from the Inherited IRA to your Roth IRA. I you mean a Roth conversion from Inherited IRA to your Roth IRA, NO. If you mean, use the money from the RMD to contribute to your Roth IRA, YES.

After your RMD, you will have cash. Use the cash to contribute to Roth IRA. As long as you have earned income and your income is under the phase out range, you're good to go for Roth IRA contributions.

If the inherited IRA is managed by an advisor who charges 1.25%, you should take the RMD cash and invest it somewhere else for far lower cost. If you add the expense ratio of the American funds, you may be paying over 2% which is very very costly and a significant drag on your returns.

A Vanguard IRA would not have fees like that. If you're investing entirely in tax advantaged accounts 401k/IRA, you can consider something simple like a Vanguard LifeStrategy fund or Target Retirement fund that matches your desired asset allocation. You're using a target fund in your 401k, so it may make sense to use a target fund in your Roth IRA. OTOH, if your target fund in the 401k is very high cost, it may make sense to find the lowest cost options in the 401k and use your other accounts to fill in the gaps using separate funds or ETFs.

To help you compare costs, Vanguard's Target and LifeStrategy funds have expense ratios of ~0.17% and no advisor management fee.
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Re: New to investing, ETF question

Postby Bob's not my name » Fri Dec 07, 2012 6:33 pm

retiredjg wrote:2) You are allowed to convert tIRA to Roth IRA simply by paying the tax due. Over your career, you may have occasional years of low income (laid off, traveling, disability, etc.). If so, you might drop into the 15% bracket. At that time, convert $5k or so to Roth at 15% instead of 25%.
Since Brantley is a MA taxpayer with an inherited TIRA, I'd just like to clarify a couple of points that may lead to confusion:
1. Unlike almost every other state, MA taxes TIRA contributions. This makes TIRA contributions less attractive than traditional 401k contributions, which are exempt from MA tax.
2. You can't convert an inherited TIRA to Roth.
3. Therefore, the conversion opportunity -- which is an important point -- will probably refer to a 401k that you roll over to a TIRA upon leaving that employer. This could be converted to Roth when the tax rate is attractive.

In my view, the priorities of a MA taxpayer with a 30% marginal rate (federal + state) should be traditional 401k at least until he drops out of the 25% federal bracket, and then maybe Roth IRA. I don't really see the Roth IRA as attractive even in the 15% federal bracket, because you still have a total marginal rate of 20%, but it is at least a debatable point.
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Re: New to investing, ETF question

Postby DSInvestor » Fri Dec 07, 2012 6:53 pm

Brantley wrote:I inherited a decent sum of money which is currently invested in a Roth IRA that is being handled by my family advisor. The IRA is diversified in American Funds, which my advisor is charging a 1.25% annual fee.


If you add the 1.25% advisor fee to the underlying mutual fund expense ratio, you may be paying over 2% in expenses.

See Tyranny of Compounding Costs from PBS Frontline's Can You Afford to Retire?
http://www.pbs.org/wgbh/pages/frontline ... ranny.html

Interview with John Bogle for the above show:
http://www.pbs.org/wgbh/pages/frontline ... bogle.html
John Bogle wrote:So if I do your average, what percentage of my net growth is going to fees in a 401(k) plan?

Well, it's awesome. Let me give you a little longer-term example. The example I use in my book is an individual who is 20 years old today starting to accumulate for retirement. That person has about 45 years to go before retirement -- 20 to 65 -- and then, if you believe the actuarial tables, another 20 years to go before death mercifully brings his or her life to a close. So that's 65 years of investing. If you invest $1,000 at the beginning of that time and earn 8 percent, that $1,000 will grow in that 65-year period to around $140,000.

Now, the financial system -- the mutual fund system in this case -- will take about two and a half percentage points out of that return, so you will have a gross return of 8 percent, a net return of 5.5 percent, and your $1,000 will grow to approximately $30,000. One hundred ten thousand dollars goes to the financial system and $30,000 to you, the investor. Think about that. That means the financial system put up zero percent of the capital and took zero percent of the risk and got almost 80 percent of the return, and you, the investor in this long time period, an investment lifetime, put up 100 percent of the capital, took 100 percent of the risk, and got only a little bit over 20 percent of the return. That is a financial system that is failing investors because of those costs of financial advice and brokerage, some hidden, some out in plain sight, that investors face today. So the system has to be fixed.
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Re: New to investing, ETF question

Postby Brantley » Fri Dec 07, 2012 8:27 pm

Ok. Its clear I'm getting hammered on fees with the inherited IRA. I just realized what I said earlier regarding the inherited IRA funds was a mistake. They are currently in Delaware Optimum funds. When I was discussing with my advisor he was advising me to put my RMDs in American funds (that's where the confusion was). I repeat as said earlier, I will move them out soon once I feel comfortable doing so.

Quick question. I started work in September. Since I'll be in the 15% bracket - should I take out more than the RMD ($5000 total) as it will be taxed at 15%?

In regards to how I'll diversify the Roth IRA - I most likely will invest in Vanguard ETFs right now with a similar allocation to the target retirement funds. I want to try out making some of my own decisions and get a better understanding of investing rather than just using a target fund. Or, I might just throw it in the target fund for simplicity. We'll see.

Thanks for the links and videos. Good stuff
~Brantley
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