ROTH or Traditional? (High Income now and in Retirement)

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ROTH or Traditional? (High Income now and in Retirement)

Postby Dulocracy » Thu May 09, 2013 3:00 pm

Every time that I mention that I am in a high income bracket and contribute to my ROTH, I have people go on and on about how that is a bad idea, even if it has nothing to do with the forum. For that reason, I am going to settle this once and for all in my mind. I am going to explain my reasoning, and let people have at the arguments that convinced me ROTH is Right for me.

Emergency Fund: Check
Asset Allocation: Irrelevant for this question
Combined family income: 140,000/yr (100k for my salary, 40k for wife)
Current 401k accounts, combined: $45k
Current liquid accounts, combined: $30k (this is liquid as a business emergency fund and therefore cannot be touched… or the car loan would be gone).

Debt:
Auto Loan (pre-boglehead decision) 4.45% interest $6,900 paid off July 2014
Mortgage at 6.35% interest with a balance of $159,000 paid off in about 23 years – after talking with the credit union today, this may be refinanced despite being upside down to a 15 year mortgage at a lower rate.

Current Federal and State Tax rate: 35-38% depending on what my firm does this year. At odds with the number above? The firm made investments in previous years to allow it to grow (good business debt). The deduction was great then. Now, I cannot take a deduction again on the amount we paid the debt down, therefore, the IRS sees it as income (although it went to service debt and I do not have it). Think of it in the way of getting a computer on a credit card (Not what we did, but it simplifies it). If you buy the computer on credit card in 2012, you get the deduction at that time. The debt is a separate thing (a loan that also covers other expenses). Since you deducted the computer in 2012, you cannot also deduct it in 2013, when you pay the debt off. This creates ghost income. Because we paid almost all the debt last year, and will pay the rest this year, this should be the last year with this type of “ghost income.” My tax bracket will go down, but not a lot.

Business Income: I am 1/2 owner of a successful law firm with multiple attorneys. It will likely have a little extra profit this year. When I retire, this will be sold.
Life Insurance: I have $500,000 in term life insurance that my wife will get. It ends when I turn 46. I have $1,000,000 in life insurance paid for by the firm that ends when I turn (104? Something like that.) The proceeds will be invested to provide income at the point that she receives it.

Commercial Real Estate: I am 1/2 owner of a commercial property (the property for the business address). I receive nothing for this business now, but it will be paid off in 19 years. I will then receive income from the property. When I retire, this will potentially be sold. The current value of the property is $450,000, and it produces income of $7,000 a month. Again, I have a half interest in this property.

Residential Real Estate: While I do not own any now, I plan on buying some at the end of the year. I know that some people think of this as a hassle, but as an attorney, I know what it takes for an eviction process. I have handled these cases before. My goal is to own 10 - 20 properties by the time I retire. I have contacts that I believe will make this easier for me than for some (my grandfather and father both were primarily in this field).

Side business: Wife has a business that makes her $3k to $12k/year. Not overly relevant with the overall numbers, but I am trying to disclose everything.

Assuming that all goes to plan, I do not think I will be in a lower tax bracket when I retire. Rather, I anticipate being in a high tax bracket even when I no longer work. My wife is 9 years younger than I am, so she will continue to work after I retire. She is in at a company that should allow her to really grow. Even if the company goes under, I am confident in her ability to land a similar job (she just turned down such an offer from a recruiter). I may be wrong, but in planning, I want to look at what we anticipate will happen, so she would be making around 100k at that time (based in today’s dollars).

The question then becomes whether or not it is better to put money into a ROTH. I think of it as a hedge against increasing tax rates, as well as being able to stuff a little more into my retirement account, which is almost maxed out. I believe I can put 0.5% more into mine to max it out, but since you can only put into it in increments of 0.5%, I did not want to overfund it and kept the rate down. With anticipated increase in salary this year, I may not be able to make this correction. We will see at that time. For all intents and purposes, it is maxed out. My wife's has a little more room before it gets maxed out.

How is it stuffing more into the retirement? Well, by paying taxes now, the money at the end would be tax-free. Not paying taxes on it, it will be an actual value we receive, not an amount to be taxed. It is like making the dollars we set aside more valuable.

Your thoughts?

Edited to correct a grammatical error.
Last edited by Dulocracy on Thu May 09, 2013 3:37 pm, edited 1 time in total.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby MnD » Thu May 09, 2013 3:08 pm

Dulocracy wrote:For all intensive purposes, it is maxed out.


I believe the correct phrase is "For all in tents and porpoises"
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby serbeer » Thu May 09, 2013 3:36 pm

http://thefinancebuff.com/case-against-roth-401k.html
talks about 401K but the same argument applicable to IRA.

I put money into traditional 401K (bird in hand) and backdoor non-deductible IRA into Roth.
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby letsgobobby » Thu May 09, 2013 3:39 pm

Is the current $140k annual income inclusive of all the side businesses, wife's income, etc?
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby MnD » Thu May 09, 2013 3:46 pm

For your situation that sounds like a reasonable move.
We are both making the maximum traditional 401-K contributions as 100% of them garner a 28% federal deduction and we expect the withdrawals to be taxed mostly at 25%, with a small portion topping up the 15% bracket. if I had extra earned income just "piling up" I'd consider adding backdoor Roths, but with two in college that is not the case.
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby Dulocracy » Thu May 09, 2013 3:52 pm

letsgobobby wrote:Is the current $140k annual income inclusive of all the side businesses, wife's income, etc?


Sorry, no. That is salary only. Other than the wife's side business and a few dividends that come through on the $30k business emergency fund, the rest is ghost income (income I do not actually touch, but shows up on paper- like the payoff of the debt or the payment on the mortgage of the commercial property that reduces balance).

serbeer wrote:http://thefinancebuff.com/case-against-roth-401k.html
talks about 401K but the same argument applicable to IRA.

I put money into traditional 401K (bird in hand) and backdoor non-deductible IRA into Roth.


I have read many articles like that one. I think that particular article is well written and well considered, but:

I do not plan on being divorced.
I do not plan on leaving my job (as half owner of the business, if it goes under, I am in real trouble anyway). I can see the finances and know it to be extremely stable, so I will plan for it to remain so.
I do not plan on moving to a different state in retirement.
If I take early retirement, it will be because of the amount of income I have coming in, but I (at least for now) would not retire if I could, because I love what I do).
I believe I will be making more in retirement than I am now, and therefore will likely be in a top tax bracket.

That is why I have a problem with this question... most people give reasons that do not apply in my situation in their analysis. I do plan on paying more in taxes during retirement than I do now (if my financial plan remains intact). That is what I am planning for. If I am wrong, then I made the wrong play. What I am trying to determine is whether or not this play is the right play if I am correct.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby MN Finance » Thu May 09, 2013 4:03 pm

I don't know that "high" income is 35% state and fed combined, so I can't imagine that there would be a ton of people advocating against the Roth. I mean it's a lot higher than some, but it's certainly not the top bracket. You make a lot of assumptions about future net worth in stating your case. Should those actually come to pass, and should we make a leap that generally taxes will be higher in the future, seems appropriate for a Roth now.
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby alisa4804 » Thu May 09, 2013 4:14 pm

I have similar questions on Roths vs. traditional IRAs, so will watch for more discussion and thoughtful advice. One thing I noticed is that since you're already talking to a credit union to refinance your home to a 15 year mortgage, might be worth it to refinance the car loan at the credit union also. We did; got a lower interest rate for the final year of car payments and it was painless/no fees. Plus I'd rather have my interest supporting a credit union than the traditional bank. Good luck!
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby letsgobobby » Thu May 09, 2013 4:35 pm

personally I think you're presuming too much about future income/assets. I would assume there are ways for you to sell your businesses in chunks, during early or partial retirement, to mitigate the income and tax gains.

I don't like choosing Roth over traditional unless it's a slam dunk case, because the decision is irrevocable. A slam dunk case would be a medical resident. I don't think your case is slam dunk, so I wouldn't do it.
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby Quickfoot » Thu May 09, 2013 4:38 pm

I am in almost exactly the same income situation and contribute to both traditional 401K and Roth IRAs. I like having a mix of pre and post tax investments and will continue to invest in Roth even as our income continues to climb.
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Re: ROTH or Traditional IRA?

Postby Taylor Larimore » Thu May 09, 2013 4:38 pm

Your thoughts?

Dulocracy:

You may be "overthinking" something that does not have a knowable answer. In any event, either type IRA should be significantly better than a taxable account.

You may find this Morningstar calculator helpful:

http://screen.morningstar.com/IRA/IRACalculator.html

Best wishes.
Taylor
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby greg24 » Thu May 09, 2013 5:14 pm

Dulocracy wrote:I do not plan on being divorced.
I do not plan on leaving my job (as half owner of the business, if it goes under, I am in real trouble anyway). I can see the finances and know it to be extremely stable, so I will plan for it to remain so.
I do not plan on moving to a different state in retirement.


Most people don't plan those things, but life sometimes gets in the way.
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby Dulocracy » Thu May 09, 2013 6:16 pm

greg24 wrote:
Most people don't plan those things, but life sometimes gets in the way.


True, as I well know as an attorney. That being said, I have a strategy- a plan. I have goals that seem attainable. If I am going to plan, I can plan based on what I think will happen or based on what I do not think will happen. I choose to plan based on what I believe will happen, based on an overall understanding of my circumstance. When we ask for advice on these boards about what to do in the future, a certain level of assumption is required for success. If I say, "Presume A, B, and C. What do I do?", then an answer can be given. That is why so many facts are asked of people posting. So, based on current information, I believe the forgoing statements about my future to be true. Presuming those situations, what is the best course of action now? :beer


letsgobobby wrote:personally I think you're presuming too much about future income/assets. I would assume there are ways for you to sell your businesses in chunks, during early or partial retirement, to mitigate the income and tax gains.

I don't like choosing Roth over traditional unless it's a slam dunk case, because the decision is irrevocable.


I am presuming about the future, but I think I addressed that enough in the previous statement. As the business is a law firm, it is all in or all out. It cannot be sold in parts with the firm structure and agreements. This is good in a lot of ways (except the very valid drawbacks you mentioned). :(

In my case, either decision is likely irrevocable. Unless something horrible happens, I, as the founding partner, will be at the firm until I retire. If something does go wrong, I am in bankruptcy anyway. None of this will matter. I really do not want to go that route. I must make my decisions presuming that the firm will not fail and that I will maintain the controlling interest (which only I can remove from me). Again, knowing the firm's financials, while not impossible, I would be very surprised if the firm went under. This means no matter the decision: for me it is final. My question for you, then, would be whether or not ROTH or traditional is better if my above presumed statements are true.

MN Finance wrote:I don't know that "high" income is 35% state and fed combined, so I can't imagine that there would be a ton of people advocating against the Roth. I mean it's a lot higher than some, but it's certainly not the top bracket. You make a lot of assumptions about future net worth in stating your case. Should those actually come to pass, and should we make a leap that generally taxes will be higher in the future, seems appropriate for a Roth now.


Point taken about high income. Agreed that I make assumptions about the future, but in order to make a choice, I have to assume something. Even the "your tax rate is lower in retirement" statement often used is an assumption. Of course, if I am wrong, I obviously messed up. Presuming the strategy that I have taken comes to pass, I need to take a course of action. I appreciate your input based on those assumptions. :happy

Taylor Larimore wrote:
Your thoughts?

Dulocracy:

You may be "overthinking" something that does not have a knowable answer. In any event, either type IRA should be significantly better than a taxable account.

You may find this Morningstar calculator helpful:

http://screen.morningstar.com/IRA/IRACalculator.html

Best wishes.
Taylor


Thank you for the resource. I am often accused of overthinking; It is what I do best. Agreed that either is better than taxable.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.
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Re: ROTH or Traditional? (High Income now and in Retirement)

Postby letsgobobby » Thu May 09, 2013 6:47 pm

I still say 25%+ federal in addition to state tax of whatever percent is not a tax I want to pay now, voluntarily. The higher you are the less I want to pay it.

Remember you can always convert later. You can't unconvert twenty years down the road if you see your tax bracket is going to be dropping.
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