Max out my Roth 401(k) or open taxable investment?

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Topic Author
coolguy954
Posts: 121
Joined: Fri Mar 08, 2013 5:47 am

Max out my Roth 401(k) or open taxable investment?

Post by coolguy954 »

Info:
26 year old
salary 110k
Plans to retire before 60 :sharebeer ...60 WILL be the max

I am currently using my company's Roth 401k. They match up to 6% but in PRE TAX form. So I would have a near 50-50 split in pre and post tax money in my 401k :mrgreen: . However, I feel that I should only put in the match amount in my 401k and put the remainder into a taxable account. Here is why

1) Based on my age and salary with being a booglehead so young..I might be able to retire at 50 :) So the taxable account would be my income until then (tax rate will be only at capitals gains tax)
2) I would be able to liquidate much need cash if my e-fund can't handle the blow

Downsides:
1) My 401k is the best I have ever seen. Everything fund is a SSGA index fund of some sorts with 0.03-0.6%(not a typo) fees
2) 401k as obvious are the best tax deferred investments

Please do not try to persuade to put all my money into a traditional 401k. I crunch the math and if I max out my 401k and with the company match, it will force me to retire at the 31 or 33% tax bracket (depends on how much my future wife makes)
RMD at age 70 1/2 would be 150k :oops:
FatCat
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Re: Max out my Roth 401(k) or open taxable investment?

Post by FatCat »

If you're saving for retirement you should maximize contributions to your tax-advantaged accounts before your taxable accounts. With the Roth 401k (and especially with a good one) you really don't have any good reason to not max it out. Contributions to Roth accounts can be withdrawn without tax or penalty at any time. You should fill up your Roth 401k and probably a Roth IRA before contributing to your taxable account... it doesn't make sense to leave tax advantages on the table if you don't have to.
Topic Author
coolguy954
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Re: Max out my Roth 401(k) or open taxable investment?

Post by coolguy954 »

FatCat wrote:If you're saving for retirement you should maximize contributions to your tax-advantaged accounts before your taxable accounts. With the Roth 401k (and especially with a good one) you really don't have any good reason to not max it out. Contributions to Roth accounts can be withdrawn without tax or penalty at any time. You should fill up your Roth 401k and probably a Roth IRA before contributing to your taxable account... it doesn't make sense to leave tax advantages on the table if you don't have to.
I guess I was reading about roth 401k wrong...Never knew I can pull out my contributions in a Roth 401k like a Roth IRA..then I think I would be fine in maxing out my Roth 401k then
kerplunk
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Re: Max out my Roth 401(k) or open taxable investment?

Post by kerplunk »

I am 27 years old... and envious of your financial situation.

Max out the 401(k).

Maxing out your 401(k) every year until age 60 (34 years from now) and you could see $3 million... let that ride a couple more years until age 65 and you could add another $1 million or $2 million on top of that, depending on your asset allocation and chosen funds.

Enjoy.
letsgobobby
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Re: Max out my Roth 401(k) or open taxable investment?

Post by letsgobobby »

Why in the world would you choose a Roth 401k over traditional at your current tax rate?
mnvalue
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Re: Max out my Roth 401(k) or open taxable investment?

Post by mnvalue »

If you max your Roth 401k, that's 17.5k and a match of 6.6k. That's still biased quite a bit in favor of Roth even if you don't do a Roth IRA (which you probably can and thus should).

I'm in a similar situation. I'm 28, making roughly the same as you, able to save lots. I was doing all Roth (401k + IRA) for a while, so I have some pretty decent Roth balances already. I got married, but together we (at least temporarily) have not been able to max out all of the 401k space. So last year, we switched to pre-tax after I posted here. That gets us a big tax break now, allowing us to get closer to maxing out. We may max out both 401ks this year. So if there's more to be saved, then we have the choice to either start doing some level of Roth contributions or max out pre-tax and put any excess in taxable. I'm leaning towards the traditional + taxable option, based on the idea that 15-25% tax later (on the traditional) is better than 25% now (on the Roth) or 25% equivalent now spread over time (the rule of thumb for taxable early in your career on the tax-adjusted allocation wiki page).

I share your concern about how to deal with early retirement should that be possible and desirable for me when (and if, I suppose) I get there. I'm not sure what the right 401k split is, but I doubt it's 100% either way. If you find any good advice on how to actually estimate a correct split, I'd love to hear about it. I know that these sort of estimations aren't perfect, but it's hard for it to be worse than just picking one or the other.
Topic Author
coolguy954
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Joined: Fri Mar 08, 2013 5:47 am

Re: Max out my Roth 401(k) or open taxable investment?

Post by coolguy954 »

kerplunk wrote:I am 27 years old... and envious of your financial situation.

Max out the 401(k).

Maxing out your 401(k) every year until age 60 (34 years from now) and you could see $3 million... let that ride a couple more years until age 65 and you could add another $1 million or $2 million on top of that, depending on your asset allocation and chosen funds.

Enjoy.
My plan was to live off my roth IRA (retire date 60) (by the time I am 60 it should be close to 700-800k in it) until age 70 1/2 when I am forced to start taking my 401k

letsgobobby wrote:Why in the world would you choose a Roth 401k over traditional at your current tax rate?
because If i switched and use pre tax money I would bump my percentage to 10%. I use a calculator and add my 10% with my company 6% match and my RMD at 70 1/2 would be 150k of taxed money (thus putting me in a higher bracket when I retire) Thats not even considering any raises I would get

mnvalue wrote:If you max your Roth 401k, that's 17.5k and a match of 6.6k. That's still biased quite a bit in favor of Roth even if you don't do a Roth IRA (which you probably can and thus should).

I'm in a similar situation. I'm 28, making roughly the same as you, able to save lots. I was doing all Roth (401k + IRA) for a while, so I have some pretty decent Roth balances already. I got married, but together we (at least temporarily) have not been able to max out all of the 401k space. So last year, we switched to pre-tax after I posted here. That gets us a big tax break now, allowing us to get closer to maxing out. We may max out both 401ks this year. So if there's more to be saved, then we have the choice to either start doing some level of Roth contributions or max out pre-tax and put any excess in taxable. I'm leaning towards the traditional + taxable option, based on the idea that 15-25% tax later (on the traditional) is better than 25% now (on the Roth) or 25% equivalent now spread over time (the rule of thumb for taxable early in your career on the tax-adjusted allocation wiki page).

I share your concern about how to deal with early retirement should that be possible and desirable for me when (and if, I suppose) I get there. I'm not sure what the right 401k split is, but I doubt it's 100% either way. If you find any good advice on how to actually estimate a correct split, I'd love to hear about it. I know that these sort of estimations aren't perfect, but it's hard for it to be worse than just picking one or the other.
I just got this job so my current balance with this job and adding my old job and roth is 85% Pre TAX 15% Roth accounts So I got a while before it would get close to my minimum goal (50-50) . Again as I replied earlier I am thinking about using my roth IRA until I am forced to use my 401k account when retire early.
livesoft
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Joined: Thu Mar 01, 2007 7:00 pm

Re: Max out my Roth 401(k) or open taxable investment?

Post by livesoft »

Did you know that 401(k)s are different from IRAs in that with a 401(k) one can start withdrawals without penalty in the year one is age 55 or older if one separates from service then?

Here are some links to read: http://bit.ly/1emIkmf

I would max out traditional 401(k), max out Roth IRA, and then contribute to tax-efficient investing in a taxable account. You have many years to go and you will change your mind about what you want to spend your money on several times before retirement. You will like the fact that you have money in that taxable account to do what you wish.
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Laura
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Re: Max out my Roth 401(k) or open taxable investment?

Post by Laura »

I am not sure you are calculating your RMD correctly or thinking about the lower income years between the end of work and starting your RMDs. Many people here use those years to do roth conversions with some of the money so you put it in pre-tax today saving your very high tax rate now and then do the conversions in the years when your income is lower. You will probably save money that way since you are in a high tax bracket today. Most people are in a lower tax bracket in retirement so for those people using pre-tax makes a lot more sense. Perhaps you are one of the people who will remain in the high tax bracket forever. If that is the case and you do the math your decision of roth vs traditional is a wash.

Are you using a roth IRA? Even if you do not qualify you can make non-deductible IRA contributions (if you have no other traditional IRA accounts) then you can convert that to a roth. I would suggest considering the pre-tax 401k and using a roth as well.

I don't believe it is correct that you can make withdrawals of your contributions from the roth 401k like you can a normal roth. However, in your plan you have left your employer for early retirement which means you can roll the roth 401k money into a roth IRA then you can make withdrawals. I am not an expert on withdrawal rules so this could be wrong but the IRS says in their FAQ on designated roths :
Since I make designated Roth contributions from after-tax income, can I make tax-free withdrawals from my designated Roth account at any time?

No, the same restrictions on withdrawals that apply to pre-tax elective contributions also apply to designated Roth contributions. If your plan permits distributions from accounts because of hardship, you may choose to receive a hardship distribution from your designated Roth account. The hardship distribution will consist of a pro-rata share of earnings and basis and the earnings portion will be included in gross income unless you have had the designated Roth account for 5 years and are either disabled or over age 59 ½.
I would not invest in a taxable account until I had maximized all tax advantaged accounts. If you haven't looked into SEPP (substantially equal period payment) withdrawal rules from your IRA then you should take a look. It is a way for you to cover the gap between early retirement and full retirement age.

Laura
The views presented are my own and not necessarily those of the Department of State or the U.S. Government.
letsgobobby
Posts: 12073
Joined: Fri Sep 18, 2009 1:10 am

Re: Max out my Roth 401(k) or open taxable investment?

Post by letsgobobby »

coolguy954 wrote:
kerplunk wrote:I am 27 years old... and envious of your financial situation.

Max out the 401(k).

Maxing out your 401(k) every year until age 60 (34 years from now) and you could see $3 million... let that ride a couple more years until age 65 and you could add another $1 million or $2 million on top of that, depending on your asset allocation and chosen funds.

Enjoy.
My plan was to live off my roth IRA (retire date 60) (by the time I am 60 it should be close to 700-800k in it) until age 70 1/2 when I am forced to start taking my 401k

letsgobobby wrote:Why in the world would you choose a Roth 401k over traditional at your current tax rate?
because If i switched and use pre tax money I would bump my percentage to 10%. I use a calculator and add my 10% with my company 6% match and my RMD at 70 1/2 would be 150k of taxed money (thus putting me in a higher bracket when I retire) Thats not even considering any raises I would get

mnvalue wrote:If you max your Roth 401k, that's 17.5k and a match of 6.6k. That's still biased quite a bit in favor of Roth even if you don't do a Roth IRA (which you probably can and thus should).

I'm in a similar situation. I'm 28, making roughly the same as you, able to save lots. I was doing all Roth (401k + IRA) for a while, so I have some pretty decent Roth balances already. I got married, but together we (at least temporarily) have not been able to max out all of the 401k space. So last year, we switched to pre-tax after I posted here. That gets us a big tax break now, allowing us to get closer to maxing out. We may max out both 401ks this year. So if there's more to be saved, then we have the choice to either start doing some level of Roth contributions or max out pre-tax and put any excess in taxable. I'm leaning towards the traditional + taxable option, based on the idea that 15-25% tax later (on the traditional) is better than 25% now (on the Roth) or 25% equivalent now spread over time (the rule of thumb for taxable early in your career on the tax-adjusted allocation wiki page).

I share your concern about how to deal with early retirement should that be possible and desirable for me when (and if, I suppose) I get there. I'm not sure what the right 401k split is, but I doubt it's 100% either way. If you find any good advice on how to actually estimate a correct split, I'd love to hear about it. I know that these sort of estimations aren't perfect, but it's hard for it to be worse than just picking one or the other.
I just got this job so my current balance with this job and adding my old job and roth is 85% Pre TAX 15% Roth accounts So I got a while before it would get close to my minimum goal (50-50) . Again as I replied earlier I am thinking about using my roth IRA until I am forced to use my 401k account when retire early.
are you ignoring inflation?
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jimb_fromATL
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Re: Max out my Roth 401(k) or open taxable investment?

Post by jimb_fromATL »

Please do not try to persuade to put all my money into a traditional 401k. I crunch the math and if I max out my 401k and with the company match, it will force me to retire at the 31 or 33% tax bracket (depends on how much my future wife makes)
I think you may not be crunching quite enough numbers, or not looking at them closely enough.

Along with what others have posted, here are some more points to ponder:

I don't see any mention of a pension. Do you have a vested pension, or will you be living entirely on your savings and investments until you reach social security age?

Are you considering the possibility of very high costs for healthcare and health insurance -- especially between your early retirement and Medicare age? Healthcare costs have been going up a lot faster than inflation, and there's no reason to think it's going to change any time soon.

Others have mentioned that you can wihdraw from a 401(k) earlier without penalty if you retire earlier. So that's another reason for maxing your 401(k) first.

But perhaps the biggest misunderstanding is about your highest bracket now, and on your RMDs. A lot of folks including many writers and talk show hosts seem to overlook that you don’t pay your marginal bracket on all of your income. Your marginal rate is your highest bracket and rate you pay on every extra dollar of income -- not on all of your income.

You get to defer taxes now in your highest (marginal) bracket when you contribute to your tax-deferred 401(k). Conversely you guarantee to pay taxes in your highest bracket now if you contribute to a Roth. But because of the standard deduction, personal exemption(s) and graduated steps of lower percentages of taxes in the lower brackets, which all go up with inflation, you don’t pay your marginal rate on all your income now, and you won’t after retirement -- unless you have a very large pension or other income before any withdrawals from your retirement accounts.

Don't overlook that because the tax bracket steps go up with inflation, your RMDs will be in the inflation adjusted tax brackets too ... not set by today's numbers.

There's even more reason to contribute to tax-deferred plans to the max if you live in GA or any other state where you can defer state income tax for your retirement contributions now, but might live in GA or some other state where some or all retirement income is exempt, or else there is no state income tax.

Here’s an example of how the actual percentage of income tax compares to the marginal rate. The ratios will be similar adjusted for inflation by retirement time. Since you mention a future wife let’s look at your income now as a single, and married after retirement.
    • A single person earning $110,000 contributing 15.91% ($17500 ) to a 401(k) and taking the standard deduction of $6,100 and personal exemption of $3900 has a taxable income of $82,500. They'd pay $16,554 federal income tax, $1,595 medicare, and about $6,820 Social Security taxes. They pay their top bracket of 25.% on the top $46,250 of their income. Their federal income tax is 15.05% of their wages and their total fed taxes are 22.7% of their wages. Assuming about $6000 state income tax, their total tax is about $30,969 and their take-home would be about $61,531 per year, $5,128 per month.
Plus in retirement you won't be paying FICA tax on any pensions, social security, or income from investments or retirement accounts. Some folks in lower brackets would pay little or no tax on Social Security, and no more than 85% of it is taxed for anybody. Hopefully your home will be paid for, and you won't have any other debts. And of course you won't be investing for retirement. So you won't need nearly as much income in order to have the same net amount to spend after you retire – at least in the early years before inflation starts nibbling at your money.
    • A married couple would only need a total income of $71,949 contributing 0% to 401(k)s and taking the standard deduction $12,200 and personal exemptions of $7800 for 2 to have a taxable income of $51,949 and pay $6,900 federal income tax, $0 medicare, and $0 Social Security taxes. They would have $34,099 of their income taxes in their top bracket of 15%, and their federal income tax is 9.59% of their income.

      After subtracting $6,900 fed taxes and perhaps $3,513 state taxes, they have $61,536 per year, the same $5,128 per month take-home pay … in terms of today’s dollars.
Also consider that when you're not working, you won't have as many expenses such as commuting, clothing, eating lunch out, etc; and you may be able to do some things for yourself that you had to pay somebody else to do when you didn't have the time -- because you had to go to work.

Notice from the examples that after retirement, there could be considerable increases in the tax brackets across the board and your average tax would still be a lot less than the percentage you get to defer in your highest bracket now.

Another point you need to consider is that the RMDs apply to the Roth 401(k) too, but not to IRAs.

The Roth won't be taxable, but you'll lose the advantage of a Roth for deferring tax on dividends and gain after you must take it out even if you don't need it. So if your income is within limits to be eligible for an IRA, you’d be better off to max the Roth IRA now. That would also give you a potential chance to balance taxable versus non taxable retirement withdrawals that might keep your top bracket down when you reach the RMD age.

By the way, there is apparently no federal limitation on withdrawing contributions from a Roth 401(k), but I’ve seen conflicting information about actual rules for employers. So you need to check to see if there’s a limitation set by your company plan before you count on it as a secondary source of emergency funds the way you can with a Roth IRA.

I think you may also be missing the point that you’ve already paid income tax in your highest bracket on the income before you put it in the taxable account. Then you pay tax on dividends every year, which reduces your net earnings rate, and then capital gains tax too. If you put the money in the tax-deferred 401(k), dividends are reinvested with tax still deferred. Even if you had to pay taxes in your top bracket on all withdrawals –which you won’t-- the taxes you deferred would have grown to enough to make up the difference.

All the more reasons to follow the advice of others here ... to max the 401(k) tax-deferred, and max Roth IRAs if your income allows it.

If your income becomes too high to qualify for a Roth IRA, you could consider splitting some Roth and some tax-deferred to hedge your bets about how the tax laws may change. But chances are that unless there are some major changes in tax law, maxing the tax-deferred 401(k) will be your best bet even with no Roth IRA option.

For investing for retirement rather than saving for a present day emergency fund, there's virtually no advantage that I can see at all in putting any money in taxable accounts before you max the 401(k).

jimb
letsgobobby
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Re: Max out my Roth 401(k) or open taxable investment?

Post by letsgobobby »

We are well into the 33% tax bracket, save forty percent of our income, and are very confident our retirement tax rate will be lower than it is now (barring tax law changes). I also 'crunch the numbers' every few years to make sure nothing has changed. Nothing has changed. You need to understand more about tax brackets, inflation, and asset allocation.
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grabiner
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Re: Max out my Roth 401(k) or open taxable investment?

Post by grabiner »

I think you want to split your 401(k) investments over your career between traditional and Roth. If you go all-Roth, you may retire in a 15% tax bracket, and you will have paid 33% tax on some of those contributions; this is not a good deal even given the opportunity to tax-defer more in the Roth. But if you go all-Roth now while in a 28% bracket and switch to traditional 401(k) contributions when you are in a 33% tax bracket, you will pay no more than 28% tax on any of your Roth 401(k) contributions, and probably retire in a 25% bracket, with low RMDs because you can roll the Roth 401(k) to a Roth IRA and avoid RMDs while you are still alive.
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260chrisb
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Re: Max out my Roth 401(k) or open taxable investment?

Post by 260chrisb »

I must say; you're doing really well at 26 and doing well just thinking about retirement and what to do with your money now. Why pay the taxes now when you can wait 33 years?? Do what you think is best but I'll offer some advise; be careful as life will happen. You've got a great plan but at 26 you've got the wife thing, kids, cars, a house, college, a job loss/change or three, new jobs, a recession, a depression, a dotcom bust, etc., etc., etc.! Again; I admire you're planning but you've got a lot more to worry about than what your RMD tax rate will be in 44 years!!! Cheers!! :D
Topic Author
coolguy954
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Re: Max out my Roth 401(k) or open taxable investment?

Post by coolguy954 »

jimb_fromATL wrote:
Please do not try to persuade to put all my money into a traditional 401k. I crunch the math and if I max out my 401k and with the company match, it will force me to retire at the 31 or 33% tax bracket (depends on how much my future wife makes)
I think you may not be crunching quite enough numbers, or not looking at them closely enough.

Along with what others have posted, here are some more points to ponder:

I don't see any mention of a pension. Do you have a vested pension, or will you be living entirely on your savings and investments until you reach social security age?

Are you considering the possibility of very high costs for healthcare and health insurance -- especially between your early retirement and Medicare age? Healthcare costs have been going up a lot faster than inflation, and there's no reason to think it's going to change any time soon.

Others have mentioned that you can wihdraw from a 401(k) earlier without penalty if you retire earlier. So that's another reason for maxing your 401(k) first.

But perhaps the biggest misunderstanding is about your highest bracket now, and on your RMDs. A lot of folks including many writers and talk show hosts seem to overlook that you don’t pay your marginal bracket on all of your income. Your marginal rate is your highest bracket and rate you pay on every extra dollar of income -- not on all of your income.

You get to defer taxes now in your highest (marginal) bracket when you contribute to your tax-deferred 401(k). Conversely you guarantee to pay taxes in your highest bracket now if you contribute to a Roth. But because of the standard deduction, personal exemption(s) and graduated steps of lower percentages of taxes in the lower brackets, which all go up with inflation, you don’t pay your marginal rate on all your income now, and you won’t after retirement -- unless you have a very large pension or other income before any withdrawals from your retirement accounts.

Don't overlook that because the tax bracket steps go up with inflation, your RMDs will be in the inflation adjusted tax brackets too ... not set by today's numbers.

There's even more reason to contribute to tax-deferred plans to the max if you live in GA or any other state where you can defer state income tax for your retirement contributions now, but might live in GA or some other state where some or all retirement income is exempt, or else there is no state income tax.

Here’s an example of how the actual percentage of income tax compares to the marginal rate. The ratios will be similar adjusted for inflation by retirement time. Since you mention a future wife let’s look at your income now as a single, and married after retirement.
    • A single person earning $110,000 contributing 15.91% ($17500 ) to a 401(k) and taking the standard deduction of $6,100 and personal exemption of $3900 has a taxable income of $82,500. They'd pay $16,554 federal income tax, $1,595 medicare, and about $6,820 Social Security taxes. They pay their top bracket of 25.% on the top $46,250 of their income. Their federal income tax is 15.05% of their wages and their total fed taxes are 22.7% of their wages. Assuming about $6000 state income tax, their total tax is about $30,969 and their take-home would be about $61,531 per year, $5,128 per month.
Plus in retirement you won't be paying FICA tax on any pensions, social security, or income from investments or retirement accounts. Some folks in lower brackets would pay little or no tax on Social Security, and no more than 85% of it is taxed for anybody. Hopefully your home will be paid for, and you won't have any other debts. And of course you won't be investing for retirement. So you won't need nearly as much income in order to have the same net amount to spend after you retire – at least in the early years before inflation starts nibbling at your money.
    • A married couple would only need a total income of $71,949 contributing 0% to 401(k)s and taking the standard deduction $12,200 and personal exemptions of $7800 for 2 to have a taxable income of $51,949 and pay $6,900 federal income tax, $0 medicare, and $0 Social Security taxes. They would have $34,099 of their income taxes in their top bracket of 15%, and their federal income tax is 9.59% of their income.

      After subtracting $6,900 fed taxes and perhaps $3,513 state taxes, they have $61,536 per year, the same $5,128 per month take-home pay … in terms of today’s dollars.
Also consider that when you're not working, you won't have as many expenses such as commuting, clothing, eating lunch out, etc; and you may be able to do some things for yourself that you had to pay somebody else to do when you didn't have the time -- because you had to go to work.

Notice from the examples that after retirement, there could be considerable increases in the tax brackets across the board and your average tax would still be a lot less than the percentage you get to defer in your highest bracket now.

Another point you need to consider is that the RMDs apply to the Roth 401(k) too, but not to IRAs.

The Roth won't be taxable, but you'll lose the advantage of a Roth for deferring tax on dividends and gain after you must take it out even if you don't need it. So if your income is within limits to be eligible for an IRA, you’d be better off to max the Roth IRA now. That would also give you a potential chance to balance taxable versus non taxable retirement withdrawals that might keep your top bracket down when you reach the RMD age.

By the way, there is apparently no federal limitation on withdrawing contributions from a Roth 401(k), but I’ve seen conflicting information about actual rules for employers. So you need to check to see if there’s a limitation set by your company plan before you count on it as a secondary source of emergency funds the way you can with a Roth IRA.

I think you may also be missing the point that you’ve already paid income tax in your highest bracket on the income before you put it in the taxable account. Then you pay tax on dividends every year, which reduces your net earnings rate, and then capital gains tax too. If you put the money in the tax-deferred 401(k), dividends are reinvested with tax still deferred. Even if you had to pay taxes in your top bracket on all withdrawals –which you won’t-- the taxes you deferred would have grown to enough to make up the difference.

All the more reasons to follow the advice of others here ... to max the 401(k) tax-deferred, and max Roth IRAs if your income allows it.

If your income becomes too high to qualify for a Roth IRA, you could consider splitting some Roth and some tax-deferred to hedge your bets about how the tax laws may change. But chances are that unless there are some major changes in tax law, maxing the tax-deferred 401(k) will be your best bet even with no Roth IRA option.

For investing for retirement rather than saving for a present day emergency fund, there's virtually no advantage that I can see at all in putting any money in taxable accounts before you max the 401(k).

jimb

First off thank you for your response..
--No I will not have a pension --
--I forgot to add my company as an HSA which I max out but never use any
--I do have a roth IRA which I max out yearly
-- I fully understand your concept on why using a regular 401k would beneficial. It just that my company matches me up to 6% in pre tax money. Yes my tax burden would be more now going with me contributing in a roth form, but it would be way reduce when I am in retirement. It would leave me with( including adding my ROTH IRA) also a 70% Roth 30%Pre-tax spilt near retirement. Which would guarantee my 25-28% current tax bracket to a 15% during retirement ..

I am so lost now :oops:
letsgobobby
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Re: Max out my Roth 401(k) or open taxable investment?

Post by letsgobobby »

Do you understand that tax brackets also rise with inflation? And that your average tax rate in retirement is likely to be lower than your marginal tax rate now, even if your marginal rates are the same in both cases?

Do not feel bad. It took me a long time to understand this concept.
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jimb_fromATL
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Re: Max out my Roth 401(k) or open taxable investment?

Post by jimb_fromATL »

coolguy954 wrote:
First off thank you for your response..
--No I will not have a pension --
--I forgot to add my company as an HSA which I max out but never use any
--I do have a roth IRA which I max out yearly
-- I fully understand your concept on why using a regular 401k would beneficial. It just that my company matches me up to 6% in pre tax money. Yes my tax burden would be more now going with me contributing in a roth form, but it would be way reduce when I am in retirement. It would leave me with( including adding my ROTH IRA) also a 70% Roth 30%Pre-tax spilt near retirement. Which would guarantee my 25-28% current tax bracket to a 15% during retirement ..

I am so lost now :oops:
You're welcome.

This subject comes up more often these days, and I think it would be useful to go into some more detailed numbers to compare the options of a Roth 401(k) versus traditional 401(k).

Let's clarify a few points about your specific situtation before I go off crunching a bunch of numbers.

How much of your own money are you now contributing to your 401(k)?
Does your employer match $1 for $1 on the 6% of your income that you contribute?

I know that normally, a single person with your income is paying 25% federal tax on any money you don't contribute to a tax-deferred retirement plan.

Do you have a state income tax?
If so, what's your top bracket percentage?

Does your state exempt any retirement income from income tax?
...or when you retire, do you expect to move to a state that has no income, or to a state that exempts retirement income from income tax ...like Georgia does on a bunch of it?

How money did you estimate you would have in your 401(k) and in your Roth IRA at retirement?
How much in the 401(k) did you estimate to be taxable, and how much in the Roth portion?

DId you calculate the future value based in today's dollars ... I.E. the same amount contributed every year, or did you adjust it for inflation and probable raises?

The IRS life actuarial tables currently require a RMD of 1/27.4 of the amount in a 401(k) the first year. So a RMD of $150,000 would be for $4,110,000.
Did you calculate that for the taxable portion alone, or is it for the whole amount you have in your 401(k) , tax-deferred and Roth?

What earnings rate are you estimating from now until retirement at 60?
What rate after 60?

When you calculate the RMD of $150K, how did you estimate the tax bracket?
Did you adjust it for inflation?
Did you calculate your tax at your top bracket on the entire amount of the RMD?

jimb
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Re: Max out my Roth 401(k) or open taxable investment?

Post by retiredjg »

coolguy954 wrote:Please do not try to persuade to put all my money into a traditional 401k. I crunch the math and if I max out my 401k and with the company match, it will force me to retire at the 31 or 33% tax bracket (depends on how much my future wife makes)
RMD at age 70 1/2 would be 150k :oops:
I think this is where you are making your mistake.

Even if you do retire in a high tax bracket (somewhat unlikely), all of your RMDs would not be taxed at the high marginal rate. Some is not taxed, some is taxed at 10%, some at 15%, some at 25%, some at 28%..... So the bulk would not be taxed at a high rate.

You should probably be maxing out your traditional 401k and a Roth IRA. Or some traditional and some Roth 401k and Roth IRA. Your idea of all Roth 401k and then on to taxable is not a good one in my opinion.
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Re: Max out my Roth 401(k) or open taxable investment?

Post by retiredjg »

Also, even if you do retire early, there are ways to use not only an IRA but also a 401k or 403b or whatever before reaching age 59.5 without penalty.
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Re: Max out my Roth 401(k) or open taxable investment?

Post by coolguy954 »

jimb_fromATL wrote: You're welcome.

This subject comes up more often these days, and I think it would be useful to go into some more detailed numbers to compare the options of a Roth 401(k) versus traditional 401(k).

Let's clarify a few points about your specific situtation before I go off crunching a bunch of numbers.

How much of your own money are you now contributing to your 401(k)?

----37K

Does your employer match $1 for $1 on the 6% of your income that you contribute?

---Yes

I know that normally, a single person with your income is paying 25% federal tax on any money you don't contribute to a tax-deferred retirement plan.

Do you have a state income tax?
---No (FL)
If so, what's your top bracket percentage?

Does your state exempt any retirement income from income tax?
---Retirement income is not taxed. (FL)

...or when you retire, do you expect to move to a state that has no income, or to a state that exempts retirement income from income tax ...like Georgia does on a bunch of it?

How money did you estimate you would have in your 401(k) and in your Roth IRA at retirement?
----adjusted with inflation 800k at age 60 (IRA)
---trad 401 (K)---3 mil (Only at 10% contribution)

How much in the 401(k) did you estimate to be taxable, and how much in the Roth portion?

DId you calculate the future value based in today's dollars ... I.E. the same amount contributed every year, or did you adjust it for inflation and probable raises?
---with inflation and assuming and get NO raises

The IRS life actuarial tables currently require a RMD of 1/27.4 of the amount in a 401(k) the first year. So a RMD of $150,000 would be for $4,110,000.
Did you calculate that for the taxable portion alone, or is it for the whole amount you have in your 401(k) , tax-deferred and Roth?
----Just 401k

What earnings rate are you estimating from now until retirement at 60?
---7% after inflation

What rate after 60?
---4% after inflation

When you calculate the RMD of $150K, how did you estimate the tax bracket?
--No

Did you adjust it for inflation?
----No

Did you calculate your tax at your top bracket on the entire amount of the RMD?
--Yes :(
jimb

my head still hurts :oops:
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Re: Max out my Roth 401(k) or open taxable investment?

Post by jimb_fromATL »

coolguy954 wrote:
jimb_fromATL wrote:
How much of your own money are you now contributing to your 401(k)?

----37K
That can't be. The maximum allowed by the feds is $17,500 per year. Maybe a typo?
How money did you estimate you would have in your 401(k) and in your Roth IRA at retirement?
----adjusted with inflation 800k at age 60 (IRA)
---trad 401 (K)---3 mil (Only at 10% contribution)
Don't adjust your earnings or total amount or inflation. Use the actual numbers. No matter what the dollar is worth, what matters in deciding which is the best way to invest is to find out which way gives you the most of them.
DId you calculate the future value based in today's dollars ... I.E. the same amount contributed every year, or did you adjust it for inflation and probable raises?
---with inflation and assuming and get NO raises
That's OK to get an estimate in terms of today's dollars. It will still be relative assuming your income and contributions go up with inflation. But you need to calculate the future values not adjusting the earnings for inflation.
The IRS life actuarial tables currently require a RMD of 1/27.4 of the amount in a 401(k) the first year. So a RMD of $150,000 would be for $4,110,000.
Did you calculate that for the taxable portion alone, or is it for the whole amount you have in your 401(k) , tax-deferred and Roth?
----Just 401k
That's another problem. As I understand it, you'll have to base your RMD on the total in both portions of the 401(k).
Did you calculate your tax at your top bracket on the entire amount of the RMD?
--Yes :(
There's the biggest problem. Assuming all factors are adjusted for inflation at the same rate, you'll still have roughly the top tax bracket and percentage of total tax that I described in my earlier post. Even if you end up with higher RMD than your equivalent income now and have a higher top/marginal tax bracket,the total tax will be a lot less than your top bracket.

Just as an example:
  • A single person withdrawing $150,000 from their 401(k) and taking the standard deduction of $6,100 and personal exemption of $3900 has a taxable income of $140,000. They'd pay $32,493 federal income tax. They pay their top bracket of 28.% on the top $52,150 of their income, but that total federal income tax is only 21.66% of their withdrawals.

    They would NOT be paying the 7.65 % FICA and the contributions to retirement, so before RMD age they don't have to withdraw nearly as much to have the same net take-home pay as they did before they retired.
More to come after I think about it some more.

jimb
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Re: Max out my Roth 401(k) or open taxable investment?

Post by coolguy954 »

jimb_fromATL wrote:
coolguy954 wrote:
jimb_fromATL wrote:
How much of your own money are you now contributing to your 401(k)?

----37K
That can't be. The maximum allowed by the feds is $17,500 per year. Maybe a typo?
How money did you estimate you would have in your 401(k) and in your Roth IRA at retirement?
----adjusted with inflation 800k at age 60 (IRA)
---trad 401 (K)---3 mil (Only at 10% contribution)
Don't adjust your earnings or total amount or inflation. Use the actual numbers. No matter what the dollar is worth, what matters in deciding which is the best way to invest is to find out which way gives you the most of them.
DId you calculate the future value based in today's dollars ... I.E. the same amount contributed every year, or did you adjust it for inflation and probable raises?
---with inflation and assuming and get NO raises
That's OK to get an estimate in terms of today's dollars. It will still be relative assuming your income and contributions go up with inflation. But you need to calculate the future values not adjusting the earnings for inflation.
The IRS life actuarial tables currently require a RMD of 1/27.4 of the amount in a 401(k) the first year. So a RMD of $150,000 would be for $4,110,000.
Did you calculate that for the taxable portion alone, or is it for the whole amount you have in your 401(k) , tax-deferred and Roth?
----Just 401k
That's another problem. As I understand it, you'll have to base your RMD on the total in both portions of the 401(k).
Did you calculate your tax at your top bracket on the entire amount of the RMD?
--Yes :(
There's the biggest problem. Assuming all factors are adjusted for inflation at the same rate, you'll still have roughly the top tax bracket and percentage of total tax that I described in my earlier post. Even if you end up with higher RMD than your equivalent income now and have a higher top/marginal tax bracket,the total tax will be a lot less than your top bracket.

Just as an example:
  • A single person withdrawing $150,000 from their 401(k) and taking the standard deduction of $6,100 and personal exemption of $3900 has a taxable income of $140,000. They'd pay $32,493 federal income tax. They pay their top bracket of 28.% on the top $52,150 of their income, but that total federal income tax is only 21.66% of their withdrawals.

    They would NOT be paying the 7.65 % FICA and the contributions to retirement, so before RMD age they don't have to withdraw nearly as much to have the same net take-home pay as they did before they retired.
More to come after I think about it some more.

jimb

You have beaten me into submission..you win.. trad 401k it is
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Re: Max out my Roth 401(k) or open taxable investment?

Post by jimb_fromATL »

coolguy954 wrote: You have beaten me into submission..you win.. trad 401k it is
Actually, you win by:

first, having a lot of income now;

... and second, taking the time and effort to figure out how to end up with the most dollars in the future for the same out of pocket now.

And I -- and maybe some other folks-- win because this head-scratching exercise helps (me at least) keep the old brain from fosselizing quite as much as it mght have otherwise -- at least for another day.

It will be interesting to come up with some more numbers to see a little better how the options compare.

jimb
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Re: Max out my Roth 401(k) or open taxable investment?

Post by inbox788 »

I believe the traditional 401k is the correct answer in most situations including this one.

A few situations go the reverse, such as increasing income in retirement getting into the high 30% tax brackets, which may average out to more than the 25-28%. So not always a wash. This likely involves high tax brackets during the high income years, and t401k is also beneficial, so earlier lower income years should be used for Roth accounts (I.e. surgical residents).

If tax rates are expected to be indifferent, then there is advantage in Roth of shielding a greater mount of income, so if you're maxing out the 17.5k, then you can get about an extra 25% shielded by going the Roth route.

Another factor is state tax, and that might be the deciding factor. If you're living in a state tax state, the t401k benefits from move in retirement. If you're sitting on the fence and there is no state tax, then paying the fed tax now in a Roth avoids future additional tax moving into a state tax state.

So unless you have several of these, traditional probably provides the most benefit, plus if things dont go as planned, you don't unnecessarily pay extra taxes. If you have to pay more, you'll be better off and can better handle the added burden.
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Re: Max out my Roth 401(k) or open taxable investment?

Post by cherijoh »

coolguy954 wrote:
FatCat wrote:If you're saving for retirement you should maximize contributions to your tax-advantaged accounts before your taxable accounts. With the Roth 401k (and especially with a good one) you really don't have any good reason to not max it out. Contributions to Roth accounts can be withdrawn without tax or penalty at any time. You should fill up your Roth 401k and probably a Roth IRA before contributing to your taxable account... it doesn't make sense to leave tax advantages on the table if you don't have to.
I guess I was reading about roth 401k wrong...Never knew I can pull out my contributions in a Roth 401k like a Roth IRA..then I think I would be fine in maxing out my Roth 401k then
I don't think you can while you continue to work for the company. Unless your company allows in-service withdrawals.
pele218
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Re: Max out my Roth 401(k) or open taxable investment?

Post by pele218 »

Perhaps I am missing something but every time I read a post about investing in a Traditional 401(k) as opposed to a Roth 401(k) - or Traditional IRA as opposed to a Roth IRA - everyone seems to dismiss the huge advantage of tax-free compounding growth offered within the Roth accounts. Even if you are going to in a much lower tax bracket in retirement, at 26 years old, the Roth money has the ability double multiple times. You would have to be in an extremely low tax bracket in retirement in order to make the Traditional 401(k) better than the Roth 401(k). Additionally, because it's the only tax-free money you own, and it's not subject to RMDs (Roth IRA money that is) and your beneficiaries (kids, grandkids, etc.) will inherit the money income tax free as well and have the ability to stretch the payments over the course of their lifetimes, it seems to be the last bucket of money you would want to touch in your life. Someone help me understand if I am missing something here.
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Re: Max out my Roth 401(k) or open taxable investment?

Post by mnvalue »

pele218 wrote:everyone seems to dismiss the huge advantage of tax-free compounding growth offered within the Roth accounts
The commutative property of multiplication means that if the tax rate is constant, things work out exactly the same. This has a parable version of that, as well as other information: http://www.obliviousinvestor.com/good-a ... -roth-ira/

The thing is, the tax rate is NOT constant, since we have a progressive tax structure. So you contribute to a Roth and pay your marginal tax rate, but when you withdraw from a Traditional account, some of that will fill in lower brackets first. An exception to this is if you have a pension that will fill the lower brackets either way; then you're back to the textbook situation of comparing marginal rates only.
pele218 wrote:Additionally, because it's the only tax-free money you own, and it's not subject to RMDs (Roth IRA money that is) and your beneficiaries (kids, grandkids, etc.) will inherit the money income tax free as well and have the ability to stretch the payments over the course of their lifetimes
Yes, these are advantages of Roth funds that have some value. Also, Roth has the advantage of "locking in" the current tax rate, removing the risk that it may go up across the board.
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Re: Max out my Roth 401(k) or open taxable investment?

Post by Hub »

pele218 wrote:Perhaps I am missing something but every time I read a post about investing in a Traditional 401(k) as opposed to a Roth 401(k) - or Traditional IRA as opposed to a Roth IRA - everyone seems to dismiss the huge advantage of tax-free compounding growth offered within the Roth accounts. Even if you are going to in a much lower tax bracket in retirement, at 26 years old, the Roth money has the ability double multiple times. You would have to be in an extremely low tax bracket in retirement in order to make the Traditional 401(k) better than the Roth 401(k). Additionally, because it's the only tax-free money you own, and it's not subject to RMDs (Roth IRA money that is) and your beneficiaries (kids, grandkids, etc.) will inherit the money income tax free as well and have the ability to stretch the payments over the course of their lifetimes, it seems to be the last bucket of money you would want to touch in your life. Someone help me understand if I am missing something here.
On the flip side the same is true of the unpaid taxes in your 401k or tIRA. Compounding over and over as your very own money. If you're in the same tax bracket on both ends then it's a wash.

OP, you should max out HSA, regular 401k, Roth IRA, and then save in taxable. Pre-paying taxes at anything above 15% is crazy talk imo considering the multitude of ways to retire early into the low tax brackets.
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Re: Max out my Roth 401(k) or open taxable investment?

Post by jimb_fromATL »

pele218 wrote:Perhaps I am missing something but every time I read a post about investing in a Traditional 401(k) as opposed to a Roth 401(k) - or Traditional IRA as opposed to a Roth IRA - everyone seems to dismiss the huge advantage of tax-free compounding growth offered within the Roth accounts. Even if you are going to in a much lower tax bracket in retirement, at 26 years old, the Roth money has the ability double multiple times.
All of the money including the money that you deferred in taxes in a traditional 401(k)will also double multiple times. In fact, if your taxes were exactly the same before and after retirement, the money that was deferred from taxes will grow to exactly enough to pay the taxes and give you the same amount after taxes.
You would have to be in an extremely low tax bracket in retirement in order to make the Traditional 401(k) better than the Roth 401(k).
Not necessarily, and not likely. If your income is high enough to put your top tax bracket for the feds above the bottom bracket, then to put your money to its best use the way the tax laws now stand and are likely to remain, you'll probably do best to max the 401(k) with tax-deferred funds. Also max a Roth IRA (if your income allows it) for your pre-taxed funds.

That's because you get to defer taxes in your highest bracket and invest that money for yourself now, but because of the standard deduction, personal exemption, and graduated steps in lower rate tax brackets -- which all go up with inflation-- you'll most likely pay a smaller percentage of tax on your withdrawals after retirement. There's more detail and an example illustrating it in my post in this thread

It's even better to go with tax-deferred retirement accounts if you live in GA or some other stete where you can defer state income taxes now and have some or all of your retirement income exempt from state income taxes after retirement. (Or if you can defer state taxes now and move to GA or another state where it won't be taxed by the state in retirement.)

You'll also have better control of the Roth money in an IRA during your working years. You can witdraw your contributions at any time without tax or penalty, so it can be a secondary source of emergency funds. And it won't be subject to the RMD (Required Minimum Withdrawal) when you reach age 70½. That could prevent having to take money out that you don't really need at that time... possibly keeping you in a lower bracket too. (To reiterate -- you won't have any choice with a Roth 401(k) after age 70½ because it is subject to the RMDs.)

Depending on your tax brackets in retirement, being able to withdraw more or less from tax-deferred and no-tax funds might also help you keep some withdrawals from the taxable funds in a lower tax bracket.

Additionally, because it's the only tax-free money you own, and it's not subject to RMDs (Roth IRA money that is) and your beneficiaries (kids, grandkids, etc.) will inherit the money income tax free as well and have the ability to stretch the payments over the course of their lifetimes, it seems to be the last bucket of money you would want to touch in your life. Someone help me understand if I am missing something here.


It is true that if your crystal ball is accurate that you will have far more money than you will ever need to withdraw; and if you don't want to use the Roth IRA withdrawals to possibly reduce your taxes in your top bracket; it could possibly help your kids for you to pay the taxes in your highest brackets while you're alive -- but that's only IF your kids are still expected to be in a lower top bracket by the time you die.

jimb
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Re: Max out my Roth 401(k) or open taxable investment?

Post by pele218 »

Thank you for all of the replies. I'm learning a lot here.

One other quick question to get your thoughts on:

If the government only allows $17,500 deferral into either a Traditional 401(k) or Roth 401(k) and you have the ability to max it out, would it make sense to max out the Roth 401(k)? I guess what I am getting at is that, to keep things simple, if you have a marginal tax rate of 20%, putting $17,500 into a Roth 401(k) is equivalent to putting $21,875 into a Traditional 401(k), which obviously you cannot do since the max is $17,500.
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Re: Max out my Roth 401(k) or open taxable investment?

Post by sunnyday »

pele218 wrote:Thank you for all of the replies. I'm learning a lot here.

One other quick question to get your thoughts on:

If the government only allows $17,500 deferral into either a Traditional 401(k) or Roth 401(k) and you have the ability to max it out, would it make sense to max out the Roth 401(k)? I guess what I am getting at is that, to keep things simple, if you have a marginal tax rate of 20%, putting $17,500 into a Roth 401(k) is equivalent to putting $21,875 into a Traditional 401(k), which obviously you cannot do since the max is $17,500.
Traditional is typically better for most people - http://thefinancebuff.com/case-against-roth-401k.html
If you fill up all of your tax-advantage space, then you could invest in a taxable account
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Re: Max out my Roth 401(k) or open taxable investment?

Post by grabiner »

pele218 wrote:Thank you for all of the replies. I'm learning a lot here.

One other quick question to get your thoughts on:

If the government only allows $17,500 deferral into either a Traditional 401(k) or Roth 401(k) and you have the ability to max it out, would it make sense to max out the Roth 401(k)?
This is discussed in the wiki: Traditional versus Roth. Being able to effectively tax-defer more money makes the Roth better than the Traditional account if you retire in the same tax bracket, and may make it better if you retire in a close tax bracket (28% versus 25%).

But if you go all-Roth for most or all of your career, you will be in a lower tax bracket in retirement, because most of your retirement income will come from the non-taxable Roth. Therefore, you don't want to put everything in a Roth for your whole career; there is no point in paying 28% tax to tax-defer more money when the money would have only been taxed at 15% on withdrawal. It may be good to go all-Roth when you are in a lower bracket, and all-Traditional when you are in a higher bracket (or a higher marginal tax rate because you hit some phase-out such as the child tax credit).
Wiki David Grabiner
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Re: Max out my Roth 401(k) or open taxable investment?

Post by simpsonlang »

The taxation of social security benefits in later years and possibly other benefits can have an impact with traditional accounts. Personally I'm doing a small portion as roth in my more aggressive asset allocation, traditional for everything else, and anything left over to taxable for TSM or TIS. The bulk will not be roth. Then I plan to delay SS till 70 and spend down or convert my traditional assets so my RMDs don't trigger 50% social security taxation.

http://www.esplanner.com/case-timing-withdrawls
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Re: Max out my Roth 401(k) or open taxable investment?

Post by Laura »

Another factor is whether you hit income limits for roths or other tax credits by using a roth rather than a traditional 401k that reduces your taxable income. It is also important to consider whether you drop into a lower income tax bracket by using the traditional. That extra money from saving on your tax bracket can also be reinvested for your long term benefit.

Laura
The views presented are my own and not necessarily those of the Department of State or the U.S. Government.
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Re: Max out my Roth 401(k) or open taxable investment?

Post by simpsonlang »

To get my idea around the progressive way the tax code works would this make sense? Take the average taxes paid for a given bracket then determine the real top percentage of actual taxes paid. So for example if it's the 2013 28% tax bracket something like =((17850*.1)+((72500-17851)*.15)+((146400-72501)*.25)+((223050-146401)*.28))/223050*1 would come out to 22.38% actual taxes paid. So if you manage to deduct your IRA contribution and those dollars came off the top of the 25% tax bracket then you could actually have RMDs kick in and so long as your below the top of the 28% tax bracket your still ahead pretty good. Is my math flawed? I think after reading the progressive tax code posts it got me thinking and convinced me I needed to really nail it for myself as I've struggled with which way to go from time to time.
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