Trying to Put All This Together...

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Topic Author
Testing 123
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Joined: Thu Dec 15, 2011 9:53 pm

Trying to Put All This Together...

Post by Testing 123 »

Hello. I have read The Boglehead's Guide to Investing and quite a bit on this site, and am going to try to actually do something now. Here's where I am:

Emergency Fund: Check

Debt: $0

Tax Filing Status: Married filing jointly
Tax Rate: 25% federal, 0% state, TN

Age: 24
Wife's age: 23

Desired Asset Allocation: 80% stock, 20% bonds

Current Portfolio: ~$13k in my fidelity 401k at work, plus a little over $5k over emergency fund in savings account.

-WIth my 401k, I have been contributing up to my company's match (up to 6% of my salary they make a partial match)

401k fund: Fidelity Freedom 2050
65% Domestic Equity
23% International
12% Bonds
exp. ratio: 0.65%

Questions:
1. My plan is to put $5k in a roth IRA this tax year. Would it make sense to get a target retirement fund in a roth IRA at Vanguard to make my total AA come out to 80/20 when averaged with the fidelity account? Or to just have an 80/20 AA target retirement fund in my 401k and Roth? (Like the 2030 TRF with Fidelity and Vanguard?) Would I be missing something with such a simple portfolio? I'd like to keep it fairly simple, at least while I'm learning.
2. I also don't think I understand how actually to contribute to my portfolio. The 401k is easy because it comes out of my paycheck, but with a roth IRA, would I make payments each pay period? Or make a lump sum payment?
3. And what if I want to save more than my 6% in 401k and $5k in the roth? How do I do that? Should I be putting more into my 401k?
4. Am I even on the right track?

Thanks.

*EDIT* 401k Options:
Large-Cap
Fidelity Contrafund - Class K  0.79
Fidelity Dividend Growth Fund - Class K 0.78
Fidelity Equity-Income Fund - Class K  0.53
Fidelity Growth Company Fund - Class K 0.72
Fidelity Magellan Fund - Class K  0.46
Fidelity OTC Portfolio - Class K 0.8
Mid-Cap
Fidelity Leveraged Company Stock Fund - Class K  0.69
Fidelity Low-Priced Stock Fund - Class K  0.71
Fidelity Value Fund - Class K 0.47
Fidelity Mid-Cap Stock Fund - Class K 0.43
Small-Cap
Allianz NFJ Small-Cap Value Instl CL 0.86
Fidelity Small Cap Growth Fund  0.95
International
Fidelity Diversified International Fund - Class K  0.79
Fidelity Emerging Markets Fund - Class K  0.9
Blended
Fidelity Balanced Fund - Class K  0.48
Fidelity Freedom K 2025 Fund 0.59
Fidelity Freedom K 2030 Fund 0.61
Fidelity Freedom K 2035 Fund  0.63
Fidelity Freedom K 2040 Fund 0.63
Fidelity Freedom K 2045 Fund 0.64
Fidelity Freedom K 2050 Fund  0.65
Bond
Fidelity Capital & Income Fund 0.76
Fidelity GNMA Fund  0.45
Fidelity Inflation-Protected Bond Fund  0.45
Fidelity Institutional Short-Intermediate Gov't Fund 0.45
Last edited by Testing 123 on Thu Dec 22, 2011 12:21 pm, edited 1 time in total.
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Whiggish Boffin
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Re: Trying to Put All This Together...

Post by Whiggish Boffin »

Welcome!

To get the high-grade advice, you'll be asked to list the investments available in your 401(k), according to: Asking Portfolio Questions
Then, senior Bogleheads will recommend optimum portfolios from what's available to you. But, to get started:

1) It would be simplest to pick the 80% stock /20% bond funds in both the 401(k) and the Roth. They are Fidelity Freedom 2035 (83% stock/17% bonds) and Vanguard Target Retirement 2030 (80.5% stock/19.5% bonds). I'm too lazy to analyze how that would change over time, but it doesn't matter. It'll do what you want for a while, and then you'll accumulate enough money, and knowledge, to tune it to your liking. Maybe you won't need to mess with it at all.

2) Vanguard's Target Retirement funds require a minimum investment of $1000. To start the Roth, call Vanguard, have them set it up, and send them a check for $1000 (or more). Then, set up a payroll deduction to Vanguard that completes your $5000 contribution by year's end. You might have to reduce the deduction after the first year, to stay under $5000/year. After the first year, it will be $192.30 if you're paid 26 times a year, or $203.34 if 24 times.

(Maybe you'll have the money in time to make a contribution for 2011. You can do that up to 15 Apr. 2012.)

3) Have your payroll department increase your 401(k) deducton to whatever you want, up to the $16,500 yearly limit.

4) Yes, you're on the right track. You're getting an early start, and educating yourself in time for it to do some good.
Topic Author
Testing 123
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Re: Trying to Put All This Together...

Post by Testing 123 »

Thanks for the reply. I tried to follow the Asking Porfolio Questions rules, but I guess I misunderstood.

In my Fidelity account, I found a list of like 70 "investment options" broken up into large-cap, small-cap, etc groups. Do I need to list all of them here? Or am I looking at the right thing?
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bertilak
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Re: Trying to Put All This Together...

Post by bertilak »

Testing 123 wrote:Thanks for the reply. I tried to follow the Asking Porfolio Questions rules, but I guess I misunderstood.

In my Fidelity account, I found a list of like 70 "investment options" broken up into large-cap, small-cap, etc groups. Do I need to list all of them here? Or am I looking at the right thing?
Some points (numbered points do NOT match the numbers of your questions):
  • 1. Either making both the IRA and the 401k each meet your 80/20 AA or making the combination meet the 80/20 is OK. In one way, having each individually match the 80/20 could be easier since that can almost certainly be accomplished automatically with the 401k. In another way, making the combination work out as a whole is better if doing otherwise might not meet some minimum investment requirement, or if something is not available in the 401k.

    2. Go for simplicity. You want something like this:
    • a) 56% US Stock Market
      b) 24% International Stock Market
      c) 10% US Bonds (some mid-term fund, about 5-6 year duration) <== EDITED! that's 5-6 years, not percent!
      d) 10% TIPS

      NOTES:
      • a+b give you 80% equity. I split that 70/30 US/International. This is somewhat arbitrary but 70/30 is non-controversial, although some would say to forget the international altogether.

        c+d give you 20% bonds split 50/50 nominal/TIPS. Also somewhat arbitrary but non-controversial. And again, some would say to forget the TIPS.
      I would set up something like the above right away and worry about fine-tuning it later. No rush. Look in your available 401k choices for whatever best matches the above, with the lowest expense ratios. Use index funds where available. If nothing matches, that's a good reason to buy the asset(s) in the IRA.
    3. With the IRA you can contribute any amount, any time during the year, as long as you stay within the max. You can even delay into NEXT year as long as it is before you file the taxes.

    4. With the 401k I'm sure you can have the company put in as much as is allowed. ONE CAVEAT: Be sure NOT to hit the max contribution before you reach the company's max matching funds.
Last edited by bertilak on Wed Dec 21, 2011 8:45 pm, edited 1 time in total.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
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Whiggish Boffin
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Re: Trying to Put All This Together...

Post by Whiggish Boffin »

To select your best 401(k) options, we need to know your options. Seventy-some investment options is a lot. To save typing, screen some of them out by expense ratio, fund type, and maybe the gee-whizzery of the fund name. Bogleheads aren't going to recommend funds with expense ratios over 1%, or sector funds (except REITs), or country funds, or super-special secret-formula beat-the-market funds (which have high expense ratios anyway). (Please list the funds by name -- we haven't memorized the ticker symbols and aren't inclined to look them up.)

Many Bogleheads buy into the Fama-French theory, that small-cap stocks and value stocks will beat the overall market in the long run, and should be overweighted in a portfolio. You should list the low-expense value funds and small / mid cap funds.

Do you have funds from Dimensional Fund Advisors (DFA)? They implement the Fama-French style very deliberately and are well-regarded around here. You'd certainly want to list them.

I concur with bertilak's suggested 56%/24%/10%/10% allocation. You'll need to sock away $30k before you can implement it with individual funds, because the bond funds have $3k minimum investments. In the meantime, the Freedom and Target fund combo will get you pretty close to bertilak's recommendation. (Or maybe Vanguard will reduce the minimums and you can do it sooner. They've been doing that a good bit lately.)

You asked "Should I be putting more into my 401k?" We don't know your income, expenses, special circumstances (supporting parents? saving for a house, kids' college, Learjet? inherited a trust fund? hit the Powerball?) so it's hard to advise. You have great advantages in being debt-free and starting early. The rule of thumb is that to retire, save 10% of gross income; to retire comfortably, 15%; and to retire early, 20% or more. (But remember Lazarus Long's rule #2 for a happy marriage: Budget luxuries first.)
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bottlecap
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Re: Trying to Put All This Together...

Post by bottlecap »

You are on the right track - and doing a super job at such a young age, at least relative to when most people even consider whether they are on the right track.

1. Simple is better. Complexity usually adds nothing and when it does it amounts to very little.

2. Your AA looks about right. Using target retirement funds or a few market index funds, you can keep that simple, too.

3. It is up to you, but as long as you're not in danger of getting phased out of Roth contribution limits, you might as well have the amounts withdrawn weekly or monthly out of your checking account and into the IRA.

4. Assuming you have decent 401k options, ie. low cost, by all means contribute as much as you can to the 401k.

Good luck,

JT
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Re: Trying to Put All This Together...

Post by Valuethinker »

Testing 123 wrote:Hello. I have read The Boglehead's Guide to Investing and quite a bit on this site, and am going to try to actually do something now. Here's where I am:

Emergency Fund: Check

Debt: $0

Tax Filing Status: Married filing jointly
Tax Rate: 25% federal, 0% state, TN

Age: 24
Wife's age: 23

Desired Asset Allocation: 80% stock, 20% bonds

Current Portfolio: ~$13k in my fidelity 401k at work, plus a little over $5k over emergency fund in savings account.

-WIth my 401k, I have been contributing up to my company's match (up to 6% of my salary they make a partial match)

401k fund: Fidelity Freedom 2050
65% Domestic Equity
23% International
12% Bonds
exp. ratio: 0.65%

Questions:
1. My plan is to put $5k in a roth IRA this tax year. Would it make sense to get a target retirement fund in a roth IRA at Vanguard to make my total AA come out to 80/20 when averaged with the fidelity account? Or to just have an 80/20 AA target retirement fund in my 401k and Roth? (Like the 2030 TRF with Fidelity and Vanguard?) Would I be missing something with such a simple portfolio? I'd like to keep it fairly simple, at least while I'm learning.
2. I also don't think I understand how actually to contribute to my portfolio. The 401k is easy because it comes out of my paycheck, but with a roth IRA, would I make payments each pay period? Or make a lump sum payment?
3. And what if I want to save more than my 6% in 401k and $5k in the roth? How do I do that? Should I be putting more into my 401k?
4. Am I even on the right track?

Thanks.
Just one rule of thumb.

think carefully before investing in bonds if there is an alternative to repay debt. That's not your situation but future car loans? Mortgage?

The only wrinkle to that is you might lose the opportunity to make a tax advantaged investment. In the very long run, an investment in equities *should* outperform any fixed income investment (or debt repayment). In the very long run only though (let's say 30 years to be safe).

But if you are borrowing at 5%, say that is 6.5% pre tax. That's a *guaranteed* return from repaying debt. Risk free. By contrast, tax free, you can invest in a US Treasury Bond at c. 2.8%. Less than half the return.

Another point. You are a 2 income family. Nonetheless the economy and job market are bad out there for most private sector professionals. Make sure you have 6 months plus of baseline household expenses in the absence of income from one of you (I would include any unemployment insurance you would receive in this). I would argue up to 18 months (that's for those of us 50 and over, where the job search can be very long). This is also true of some vulnerable public sector areas (chiefly state and local government). And don't ever be tempted to go without health insurance.
Topic Author
Testing 123
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Re: Trying to Put All This Together...

Post by Testing 123 »

Thanks everyone. I updated the original post with some 401k options based on Boffin's comments.

Using the simple TRF's:
The Fidelity Freedom 2035 is 80/20, with 60% domestic and 20% int'l stock.
The Vanguard TRF 2030 is 80/20 with 57% domestic and 23% int'l stock.

These seem pretty close to the 56/24/10/10 numbers recommended, but not exactly.

beritalk mentioned the following:
a) 56% US Stock Market
b) 24% International Stock Market
c) 10% US Bonds (some mid-term fund, about 5-6 year duration) <== EDITED! that's 5-6 years, not percent!
d) 10% TIPS

Are those funds available in a Vanguard roth IRA? To obtain this, would I put $5000 X .56 = $2800 in the US Stock Market fund, $1200 in Int'l Stock Market Fund, etc?

Sorry, I know that's a basic question...

Other thoughts?

Thanks again.
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bertilak
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Re: Trying to Put All This Together...

Post by bertilak »

Testing 123 wrote: beritalk mentioned the following:
a) 56% US Stock Market
b) 24% International Stock Market
c) 10% US Bonds (some mid-term fund, about 5-6 year duration) <== EDITED! that's 5-6 years, not percent!
d) 10% TIPS

Are those funds available in a Vanguard roth IRA? To obtain this, would I put $5000 X .56 = $2800 in the US Stock Market fund, $1200 in Int'l Stock Market Fund, etc?
Because the mutual funds generally have a minimum investment of $3K you won't be able to invest in the regular mutual fund share classes. Fortunately, there are equivalent ETFs available from Vanguard for all but the TIPS fund. They would be:

VTI (US Stock market)
VXUS (International Stock Market)
BND (US Bonds)
TIP (TIPS Bonds) This one is not from Vanguard -- they have a fund but no ETF.

You can invest in those in your IRA (ROTH or traditional) with no minimum (well, 1 share). As a bonus, the expenses for the Vanguard ETFs are the same (super low) ratios as their equivalent Admiral shares -- which have high minimum investments ($10K to $50K). ETFs are bought and sold through a broker just like they were stocks in a company. You pay a brokerage fee for each trade (not each share!) and there is a bid/ask spread so at any given time it costs a bit more to buy than you would get if you sold -- just like any stock.

There are other Vanguard funds that would fill similar roles (e.g. S&P500 index for US Shares) but the above are probably the most "generic" and diversified -- which is a good thing if you want to keep things simple, as you should.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
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retiredjg
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Re: Trying to Put All This Together...

Post by retiredjg »

Testing 123 wrote:Are those funds available in a Vanguard roth IRA?
Think of a Roth IRA as a container. You can put anything you want in the container. So, yes, the funds are available and yes, that is how you would do it (except for the problem that you have to have $3k to initially buy each fund - unless you use ETFs instead of mutual funds.)

You could build a portfolio using separate funds - 1 or 2 for US stocks, 1 for international, 1 for bonds. Or you can buy all these things in 1 fund like the Fidelity Freedom Fund or a Vanguard Target Retirement fund. Either approach works just fine - you'd be holding essentially the same (or at least very similar) things, just in a different package.

Ordinarily, the costs of holding the funds separately is less (because the Freedom Funds usually cost more). In the case of your 401k, there is not much difference in the two methods. For now, you could just use a Fidelity Freedom fund in your 401k and a Target Retirement Fund in your Roth IRA and let the funds to all the rebalance work. All you have to do is add money. As has been mentioned, do not pick the fund by the date. Pick it by the stock to bond ratio that you have decided is appropriate for you. If you want 80% stock and 20% bonds, Vanguard's Target 2030 is the one to use. I'm not sure which Fidelity fund would fit the bill, but I'm sure it is not the 2050 fund.
Current Portfolio: ~$13k in my fidelity 401k at work, plus a little over $5k over emergency fund in savings account.
Your emergency fund is part of your wealth, but we ordinarily do not add it into the calculations for your retirement portfolio. So your retirement portfolio is about $8k. Good for you!

If you have more money to save after meeting the match in your 401k and Roth IRA, either put more into the 401k, or increase your emergency fund to 6 months of expenses, or save money in a savings account for your next car or whatever expenditure you would otherwise have to finance. The important thing is to save money.
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Testing 123
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Re: Trying to Put All This Together...

Post by Testing 123 »

retiredjg wrote:
Current Portfolio: ~$13k in my fidelity 401k at work, plus a little over $5k over emergency fund in savings account.
Your emergency fund is part of your wealth, but we ordinarily do not add it into the calculations for your retirement portfolio. So your retirement portfolio is about $8k. Good for you!
Maybe that was a confusing way to put it, I have $5k in addition to my emergency fund, which is what I'm going to use for the roth IRA. Right now it is all in the same account, but when I move the $5k into the roth IRA, I will still have the emergency fund.

I don't have to worry about this now, but I am confused on the individual fund minimum of $3k. I thought the maximum you could contribute in a roth IRA in a year is $5k, so how could you buy more than one fund? Over several years?

And if I were to go the ETF route in the roth IRA, would I still want to make bi-weekly contributions? Or would that cost more than a lump sum because they are charged per trade?

Thanks again.
Bob's not my name
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Re: Trying to Put All This Together...

Post by Bob's not my name »

Testing 123 wrote:Wife's age: 23
Your wife doesn't appear to have any investments. What's up with that?
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Taylor Larimore
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Two Target Funds on the "right track"?

Post by Taylor Larimore »

Hi Testing:
My plan is to put $5k in a roth IRA this tax year.


Excellent idea! If necessary, a Roth can be used as an emergency fund because contributions can be taken out at any time without tax or penalty.
Would it make sense to get a target retirement fund in a roth IRA at Vanguard to make my total AA come out to 80/20 when averaged with the fidelity account? Or to just have an 80/20 AA target retirement fund in my 401k and Roth? (Like the 2030 TRF with Fidelity and Vanguard?) Would I be missing something with such a simple portfolio? I'd like to keep it fairly simple, at least while I'm learning.
Target Funds, designed by company experts, with similar stock/bond ratios in each retirement account result in a simple and usually superior portfolio.
Am I even on the right track?
You are on the right track.

Congratualations and best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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bertilak
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Re: Trying to Put All This Together...

Post by bertilak »

Testing 123 wrote:I am confused on the individual fund minimum of $3k. I thought the maximum you could contribute in a roth IRA in a year is $5k, so how could you buy more than one fund? Over several years?
The IRS sets a maximum you can contribute yearly. The fund company (e.g. Vanguard) sets the minimum you can invest in a fund. The two have no connection so it is not surprising that they don't line up. EXCEPT -- some fund companies lower their minimum for IRAs. I do not know if this is true for Vanguard or not.

Once you own the minimum allowed for a fund, additional purchases can be much lower -- on the order of $100 minimum.

ETFs are well suited for smaller amounts. There is no minimum and the expense ratios are low. Lower than the equivalent funds until you invest enough in a fund to reach a much higher minimum.

There are two downsides to ETFs -- brokerage fees and bid/ask spreads. If you don't have enough to get into the funds directly, then ETFS may be the only choice but that is not a bad choice anyway. They could be considered the better choice even if you do have enough to meet the minimum for the fund, at least until you meet the minimum for Admiral shares.

Other fund companies may or may not have the concept of Admiral shares (under a different name). I do not know.

It couldn't hurt to call Vanguard and ask about these things. With the info you have received here you should be in a good position to ask the right questions and understand the answers.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
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retiredjg
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Re: Trying to Put All This Together...

Post by retiredjg »

Testing 123 wrote:Maybe that was a confusing way to put it, I have $5k in addition to my emergency fund, which is what I'm going to use for the roth IRA. Right now it is all in the same account, but when I move the $5k into the roth IRA, I will still have the emergency fund.
Yes, that does make a difference. :wink:
I don't have to worry about this now, but I am confused on the individual fund minimum of $3k. I thought the maximum you could contribute in a roth IRA in a year is $5k, so how could you buy more than one fund? Over several years?
Correct for most funds. It would take 2 years to have more than one fund. In the second year, you could have 3 if you wanted. This is one of the reasons it is so convenient to use target funds for your first several years - it avoids the minimums needed to achieve the ratios you want.
And if I were to go the ETF route in the roth IRA, would I still want to make bi-weekly contributions? Or would that cost more than a lump sum because they are charged per trade?
Bi-weekly contributions are a good thing and if you can swing it, that is what I would do. If you buy a Vanguard ETF from somewhere other than Vanguard, there is a transaction fee - it makes no sense to do this on a bi-weekly basis and would be a waste of money. I do not know if there is a transaction fee for Vanguard ETFs at Vanguard. There is no transaction fee for Vanguard mutual funds at Vanguard.
Topic Author
Testing 123
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Re: Trying to Put All This Together...

Post by Testing 123 »

Thanks everyone. I'm going to call Vanguard soon.
Bob's not my name wrote:
Testing 123 wrote:Wife's age: 23
Your wife doesn't appear to have any investments. What's up with that?
My wife recently started PRN as a nurse, so she's not full time and doesn't have benefits or 401k options. It does mean that she gets paid more hourly though, which helped us fund our emergency fund and increase our savings account. It's kind of hard to plan with her money, because she doesn't know how many shifts she's going to get every month. (It's nice though because she is taking pre-med classes so her schedule is very flexible around that.) So we budget based on my salary, and hers goes to savings.

Over the next couple years our plan is to increase retirement savings with my 401k and contribute the $5k/yr in my roth IRA, and continue putting a lot of her salary into savings, rather than retirement, in case she does get into medical school, so we have some flexibility if our life situation changes. And if not then we have a good chunk of money for a down payment or something.

I guess we could take advantage of some tax-sheltered savings if we opened her a roth IRA or something similar though. Thoughts?

Please keep the comments coming, very helpful.
Bob's not my name
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Re: Trying to Put All This Together...

Post by Bob's not my name »

If she may return to school, and if that will reduce your taxable income, you should consider traditional IRAs for both of you rather than Roths. You can withdraw penalty-free (but not tax-free) from both TIRAs to pay for school. You can also withdraw $10,000 from each TIRA penalty-free to buy a first home.

The 2011 income limits for deductible contributions to TIRAs are:

You: $90,000 AGI or about $110,000 gross if you max your 401k and have some pre-tax health insurance premiums
Your wife: $169,000 AGI or about $189,000 gross if you max your 401k and have some pre-tax health insurance premiums

In 2012 these limits are a few thousand dollars higher.

Whether Roth IRAs or TIRAs are a better tax-advantaged vehicle for school/house savings depends upon whether you're near the top or bottom of the 25% bracket. If you're in the middle it may not make much difference, except in subtle differences in the withdrawal rules. See Pub 590. This may also be useful: http://www.bogleheads.org/forum/viewtopic.php?t=69833
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Taylor Larimore
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Investing in IRAs ?

Post by Taylor Larimore »

Testing:

Inasmuch as you and your wife both have income, I suggest you each maximize your individual IRAs before adding beyond the company match in your 401K.

The biggest determinate in deciding whether to use a Traditional or Roth IRA is your future tax rate. If you think it will be larger than your current tax rate a Roth is usually better--otherwise invest in a Traditional IRA.

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
Topic Author
Testing 123
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Re: Trying to Put All This Together...

Post by Testing 123 »

Thanks. I never thought about using an IRA for short term savings.

If we were planning to withdraw from one or both of our IRA's in a couple years for school or a house, would that mean we would need to adjust the asset allocation of the accounts? 80/20 would be too high for that time frame wouldn't it?

And if she did stop working to enroll in classes, we would probably stay in the same tax bracket. So, if that were the case, would there be any advantage of an IRA instead of a regular savings account? Wouldn't the money get taxed the same one way or another? Is there any other benefit of using an IRA short term savings instead of a savings account.

Thanks again.
pkcrafter
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Re: Trying to Put All This Together...

Post by pkcrafter »

I just wanted to clarify what you said about tapping your IRAs. Do you actually mean IRA or Roth? You can withdraw from a TIRA for a first home purchase, but you are limited to one time 10k. I would not remove money from an IRA for school expenses, although there is a provision for penalty-free qualified withdrawals for higher education. If you meant Roth, be sure to identify clearly as Roth.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
Bob's not my name
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Re: Trying to Put All This Together...

Post by Bob's not my name »

You can use either, as I said. If your tax bracket contributing and withdrawing is the same, the only advantage of using either type of IRA is tax-free compounding, which is a minimal effect in the short term. The withdrawal rules are a little different, so you should read about them in Pub 590. You can each withdraw $10,000 from your TIRAs ($20,000 total) for a first home, or any amount to pay for your school. Penalty-free Roth withdrawals may be limited to your contributions, but you can withdraw your contributions for any reason.
Bob's not my name
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Re: Trying to Put All This Together...

Post by Bob's not my name »

pkcrafter wrote:you are limited to one time 10k
You can actually do it multiple times, in that it can be your first home or any home after a two-year period without owning a home. This detail is relevant to me because I qualify under the latter rule.
Dandy
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Re: Trying to Put All This Together...

Post by Dandy »

You are off to a great start!!

Questions:
1. My plan is to put $5k in a roth IRA this tax year. Would it make sense to get a target retirement fund in a roth IRA at Vanguard to make my total AA come out to 80/20 when averaged with the fidelity account? Or to just have an 80/20 AA target retirement fund in my 401k and Roth? (Like the 2030 TRF with Fidelity and Vanguard?) Would I be missing something with such a simple portfolio? I'd like to keep it fairly simple, at least while I'm learning.
Ans - It doesn't matter whether you have both 80/20 or one 70/30 and the other 90/10. Just make sure you look at the underlying allocations not the title of the fund -- not all Target Funds 2030 have the same allocations.

2. I also don't think I understand how actually to contribute to my portfolio. The 401k is easy because it comes out of my paycheck, but with a roth IRA, would I make payments each pay period? Or make a lump sum payment?
Ans. Once you open a Roth account at fidelity or vanguard you can write a check or have money taken directly from your checking account on a periodic basis e.g. monthly. Having it automatically taken out of your checking account is the better option.

3. And what if I want to save more than my 6% in 401k and $5k in the roth? How do I do that? Should I be putting more into my 401k?
Ans. Adding more to your 401k is a good option as long as you have access to the low cost funds you want.

4. Am I even on the right track?
Ans. Oh yeah!! At your age if you are focused on diversified low cost passive investing and are able to keep that up during all of life's challenges such as raising children, paying for college, buying a home, staying employed, etc you will be in fine shape well before retirement age.If you are in Target Date funds the equity allocation will gradually be reduced as you age. If you have interest and time you may decide to buy individual funds instead of using the Target Date funds and you will save some expenses for very little additional work on your part. This is not a big deal especially when your assets are modest and investment knowledge and experience are on the low side.
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Re: Trying to Put All This Together...

Post by pkcrafter »

Bob's not my name wrote:
pkcrafter wrote:you are limited to one time 10k
You can actually do it multiple times, in that it can be your first home or any home after a two-year period without owning a home. This detail is relevant to me because I qualify under the latter rule.
Thanks for clarifying the home withdrawal rule.


Paul
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Re: Trying to Put All This Together...

Post by retiredjg »

Testing 123 wrote:Thanks. I never thought about using an IRA for short term savings.
You should not consider your IRA a place for short term savings.

If you have $5k to invest and do not know if the money will go to education or to retirement, there is nothing to lose by putting it in IRA. It's available for education, but if education does not happen, it is there for retirement. If you had put the money into savings instead, you could not go back and put it into IRA for years that are gone by.

If you know the money is going to education, just put it in savings. Since you don't know what the money will be used for and since you can't do both, the IRA is a good choice.
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Re: Trying to Put All This Together...

Post by ebotrd »

Hey, Testing,
You're doing awesome for a 20-something! Starting so young, you're making it a lot easier on yourself for years to come. I've read that due to "the miracle of compounding interest" every dollar saved in your 20's and 30's is worth like $8 saved in your 50's & 60's. While I'm not so sure that considers inflation, it still boggles the mind, right?

I'm definitely no expert here, but I've been reading fairly often for almost a year now. You've got successful investing authors commenting here and all kinds of other brainiacs, so the fact that you're reading the Bogleheads forum as a 20-something is huge I think.

So, understanding that I'm no expert, I'd say for someone in their 20's, Roth IRA's are a slam dunk! All those years the money sits in there growing, until finally in your 60's or whenever you start taking it out all of it is tax free. Nobody really knows for sure whether taxes will be higher or lower in the future, but I think it's safe to say a lot of us think they'll be higher. Plus, It's reassuring to know you can take out your principle (not the earnings) from your Roths penalty-free for emergencies. Plus, starting so young you're likely to do so well with retirement saving that I think it's a big deal that leaving Roth money to heirs is perhaps the best way to leave it because it's tax-free for them too. Likewise, starting so early you're likely to have a nice nest egg by retirement, so you're tax bracket will probably be on the higher end of the scale, again making Roth a much better choice than TIRA.

Some other posters say that brokerage fees are a disadvantage of ETF's. I think that's incorrect. I think it was a pretty recent development, but I believe it was sometime in 2010, many brokerages starting allowing fee-free ETF trading, including Vanguard of course. I think ETFs are great in that you can start out without a big portfolio and the expense ratios are tiny just like the index fund equivalents. However, so far, you can't just set up weekly or monthly contributions directly from your checking account to buy ETFs like you can to buy index funds. So, when you get enough to switch to the Admiral Shares index funds, you might switch to the equivalent if only for that reason...makes "dollar cost averaging" a lot easier.

Still, I agree with the others recommending the Target Retirement funds for you. The expense ratio's will overall be a little bit higher, but probably worth it because you can rest easy that it's taken care of with almost no time commitment once you've set it up, and you're money is being used to the fullest advantage. This is especially true because it sounds like you have all your investments in tax-advantaged (aka "qualified") accounts -- the 401k and IRA. If you eventually get to the point of saving/investing beyond that (in a taxable or "non-qualified" brokerage account), then it'd probably make sense to start to try to maximize the tax benefits -- for example, by keeping bonds in the tax-advantaged accounts and some of the stock/equities funds in the taxable. Target Retirement funds don't allow this kind of dividing things up. By then you'll have had time to learn more about it all too.

Best wishes to you and your future, Testing!
Last edited by ebotrd on Sun Dec 25, 2011 2:30 pm, edited 1 time in total.
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An excellent contribution for Christmas.

Post by Taylor Larimore »

Ebotrd:

Your post is an excellent example of Bogleheads at their best.

Thank you and Merry Christmas!

Taylor
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Testing 123
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Re: Trying to Put All This Together...

Post by Testing 123 »

Great info. Thanks again everyone for your responses. I feel better about going through with this stuff after hearing from you.

Happy Boxing Day.
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Re: Trying to Put All This Together...

Post by Bob's not my name »

ebotrd wrote:you're likely to have a nice nest egg by retirement, so you're tax bracket will probably be on the higher end of the scale, again making Roth a much better choice than TIRA.
Have you seen this thread: http://www.bogleheads.org/forum/viewtop ... =2&t=87471 ?
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Re: Trying to Put All This Together...

Post by ebotrd »

Noted, "Bob'sNot", but you gotta admit, the kid's 24 -- $1 in a Roth now is worth like $15 when he's 65 (@7% annually compounding interest)...OK, like $4 to $5 adjusted for inflation (@3% annual inflation). If you pay any tax at all, isn't it still way better to pay tax on $1 than on $4+?
When something is important enough, you do it even if the odds are not in your favor. -- E. Musk.
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Re: Trying to Put All This Together...

Post by Bob's not my name »

The math on traditional and Roth is the same, so time has nothing to do with it.

Mfinal(Roth) = Minitial * (1 - tax rate) * Growth
Mfinal(trad) = Minitial * Growth * (1 - tax rate)

If the tax rate is the same, the outcome is the same. So it comes down to the unknowable: tax rate now vs. later.

Youth actually argues for traditional. A 24-year-old might reasonably expect (or at least hedge against the possibility) that in the next half century he'll move to a lower tax state or one of the states that doesn't tax TIRA withdrawals, be disabled, return to school, have a period of voluntary or involuntary unemployment, retire early, have significant medical expenses (such as assisted living) in retirement, or drop into a lower bracket due to family tax breaks, or that the tax code will be modified to favor middle class families or retirees, or that RMD rules will be changed in response to boomers protesting on the Capitol steps, etc.
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Re: Trying to Put All This Together...

Post by ebotrd »

Whoa, "Bob'sNot"! :confused
Can you put some example numbers on your formulas there?

My understanding is that TIRA contributions are tax exempt, but earnings are taxed later on when you take money out.
Roth contributions are taxed at your current rate, but earnings are tax free.

So if Mr. & Mrs.; "Testing" (25% tax bracket) contribute $10k to TIRAs now, they get a nice $2500 deduction, but in their 60's the $10k has grown to over $150k, so they pay whatever their tax rate is in retirement on all $150k...they'd need a retirement tax rate of <2% to pay less than $2500 on $150k.

With Roths, they pay 25% tax on Roth contributions now ($2500 on $10k). But in their 60's, the entire $150k is all completely tax free.
When something is important enough, you do it even if the odds are not in your favor. -- E. Musk.
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Re: Trying to Put All This Together...

Post by Bob's not my name »

They're formulas. Plug in any numbers you like.
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Re: Trying to Put All This Together...

Post by BolderBoy »

[quote="ebotrd"]Noted, "Bob'sNot", but you gotta admit, the kid's 24 -- $1 in a Roth now is worth like $15 when he's 65 (@7% annually compounding interest)...OK, like $4 to $5 adjusted for inflation (@3% annual inflation). If you pay any tax at all, isn't it still way better to pay tax on $1 than on $4+?[/quote]


I follow your reasoning a bit better than BobSnot's (?).

Aren't taxes delayed merely taxes accumulated? Even if the tax *rate* happens to be lower in retirement?
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Re: Trying to Put All This Together...

Post by Bob's not my name »

Read the formulas. Look up "commutative property of multiplication".
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Re: Trying to Put All This Together...

Post by pkcrafter »

For same tax rate now as in retirement--

$1000 to invest in 25% bracket:

Put $1000 into a pretax account and withdraw $1000 at retirement. The $1000 is taxed at 25% leaving a $750 to spend.

For a Roth, start with $1000 and pay 25% tax--$750 left to invest. At retirement withdraw $750. Net in both cases is $750. Chances are tax rate in retirement will be lower.


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Re: Trying to Put All This Together...

Post by retiredjg »

Bob's not my name wrote:Read the formulas. Look up "commutative property of multiplication".
I don't think that's the issue.

I think the question is "why is that formula right in the first place?" And I don't have an answer for that. I think it has been worked out in the Wiki though.
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Re: Trying to Put All This Together...

Post by retiredjg »

BolderBoy wrote:Aren't taxes delayed merely taxes accumulated? Even if the tax *rate* happens to be lower in retirement?
No, taxes are not accumulated. They are postponed and might be different at a later time. If your $100 is taxed at 25% on Monday, you pay $25. If you postpone when the money is taxed till Thursday, you may only have to pay $15.

It is more likely than not that your overall tax rate (the rate paid as you withdraw from a tax-deferred account) will be lower after retirement than your marginal tax rate (the rate you put money in) is today.
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Re: Trying to Put All This Together...

Post by Bob's not my name »

retiredjg wrote:I think the question is "why is that formula right in the first place?" And I don't have an answer for that.
?

Those are the formulas.

You put money in a TIRA, it grows, then you pay tax.
You pay tax, you put money in a Roth, it grows.

If you start with a given amount of money and invest in the same portfolio for the same length of time, growth is the same. Therefore the only variable is tax rate. If tax rate is the same, the formulas are the same.

Tax rate is of course not likely the same. Your tax rate in retirement is likely lower. Most states exempt some or all TIRA withdrawals for retirees, so your state tax rate is probably lower. Your tax rate if you return to school is typically lower. Your tax rate if you are disabled is lower. If you die your widow's tax rate will typically be lower. If you're old and in assisted living your tax rate is lower. If you retire early and live off your taxable investment principal your tax rate is lower. All these effects favor TIRA (and the eventual conversion of some TIRA to Roth at low rates). Unfortunately, a deductible TIRA is available only to the people to whom it is least valuable. The spousal TIRA is a notable exception because it's available in the 25%-100% tax brackets that result from AGI-based phaseouts. A traditional 401k is more widely available.
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Re: Trying to Put All This Together...

Post by ebotrd »

OK "Bob'sNot", I see your points. Admittedly you've significantly weakened my pro-Roth argument.

Taxes could be lower for a lot of reasons, but they could be higher, too. These kids are starting out saving for retirement in their 20's -- likely to end up multi-millionaires in their 60s if they keep it up. Many believe federal tax rates are headed up in the future, not down, but who really knows, right? Seems like the prudent thing to do would be have your $$ in different baskets -- 401k $$ will be taxed, TIRA would be a similarly taxable pot. Roth keeps Uncle Sam's greedy little fingers at bay. Also, as 20-somethings, the "Testing's" earning potential is likely to increase in the next few decades, perhaps pushing them up into the 28% or 33% brackets -- making TIRAs a little more attractive then...better to get that Roth money squirreled away now.

Also, your forumula doesn't seem to take into account some details.
Take my example from before:
....................................................................
....................................................................
So if Mr. & Mrs.; "Testing" (25% tax bracket) contribute $10k to TIRAs now, they get a nice $2500 deduction, but in their 60's the $10k has grown to over $150k, so they pay whatever their tax rate is in retirement on all $150k...they'd need a retirement tax rate of <2% to pay less than $2500 on $150k.

With Roths, they pay 25% tax on Roth contributions now ($2500 on $10k). But in their 60's, the entire $150k is all completely tax free.
....................................................................
....................................................................
FORMULA:
Mfinal(Roth) = Minitial * (1 - tax rate) * Growth
Mfinal(trad) = Minitial * Growth * (1 - tax rate)

Using those numbers, they contribute $10k into TIRAs & get $2500 dedution. I guess your formula implies that they take the $2500 deduction and prudently invest it as well. The math almost works out...the $2500 grows to about $35k in 40 years -- just about enough to pay the 25% taxes on their nice $150k TIRA nest egg. Problem with that is that the $2500's growth is either in the 401k or a taxable account, so they don't really end up with $35k, but rather 25% less or $26k.
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Re: Trying to Put All This Together...

Post by Bob's not my name »

ebotrd wrote:So if Mr. & Mrs.; "Testing" (25% tax bracket) contribute $10k to TIRAs now, they get a nice $2500 deduction, but in their 60's the $10k has grown to over $150k, so they pay whatever their tax rate is in retirement on all $150k...they'd need a retirement tax rate of <2% to pay less than $2500 on $150k.

With Roths, they pay 25% tax on Roth contributions now ($2500 on $10k). But in their 60's, the entire $150k is all completely tax free.
Here you're still failing to use the commutative property of multiplication. A x B x C = A x C x B. It makes no difference how large the tax bill is in absolute dollars, the Roth and traditional yield the same after taxes if the tax rate is the same. You often see Roths described as "tax-free", which is absurd, because you have to pay the tax up front. One could similarly call a TIRA tax-free because you only have to pay tax at the end. Also absurd.
ebotrd wrote:I guess your formula implies that they take the $2500 deduction and prudently invest it as well.
It does not imply that. A formula can't "imply". Where do you see that in the formula? You're creating a shadow deduction that doesn't exist (because the real deduction is settled all comfy in the TIRA for a half century). If you have $10,000 of gross income to invest, you can either invest it all* in a TIRA/401k or you can voluntarily pay taxes on it and invest the remainder in a RIRA/Roth 401k. If the tax rate coming and going is the same 25% and the portfolio grows tenfold by withdrawal:

Mfinal(Roth) = $10,000 * (1 - 0.25) * 10 = $75,000
Mfinal(trad) = $10,000 * 10 * (1 - 0.25) = $75,000

They are very simple formulas and they tell the truth.

There are many minor differences between Roth and traditional IRAs and 401k's, but it's important to first grasp this basic equivalency. The secondary factors are numerous, but include different emergency withdrawal rules, different RMD rules, different state tax treatment, one-way convertability, different income limits on eligibility (except for a spouse MFJ not covered by an employer plan, in which case the limits are the same), and absolute dollar capacity for the enduring saturation case (viz., a very high earner who maxes all tax-advantaged accounts every year for a half century).

*Unless you live in MA, PA, or NJ. See the Backdoor Both thread: http://www.bogleheads.org/forum/viewtop ... 10&t=86262

Here are some more threads you may find useful:

Why the Roth IRA Bias? http://www.bogleheads.org/forum/viewtopic.php?t=61529
TIRA as Emergency Fund / Insurance: http://www.bogleheads.org/forum/viewtopic.php?t=69833
Using a TIRA to travel through time and space: http://www.bogleheads.org/forum/viewtop ... =2&t=87683
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Re: Trying to Put All This Together...

Post by Bob's not my name »

ebotrd wrote:Taxes could be lower for a lot of reasons, but they could be higher, too. These kids are starting out saving for retirement in their 20's -- likely to end up multi-millionaires in their 60s if they keep it up. Many believe federal tax rates are headed up in the future, not down, but who really knows, right?
Multi-millionaires can retire early and use their pre-SS, pre-RMD years to convert TIRA to Roth, as you read about in livesoft's thread. You must also consider that the tax rate you pay today on your marginal dollar is known, minimally controllable, and probably high, whereas the tax rate you pay on withdrawals may be high during the post-RMD, pre-assisted living years (today this is age 70-83, typically), very controllable during early retirement (60-70 today), and low or zero during late retirement (typically 83+ today), so your average tax rate on withdrawals may be quite low even if it is high in some years.

A young accumulator in the 15% federal bracket and living in a no tax state or a Backdoor Both state can prioritize Roth without getting much debate here. His tax rate in retirement might end up being lower than 15%, but he's making a reasonable bet.

In the 25% federal bracket it's debatable. In higher federal brackets I think traditional should be prioritized.

There's also the problem of asymmetric consequences. If you're in the 25% bracket and in a no tax state and you choose Roth and later you die young and your widow would have been making TIRA withdrawals in the 15% bracket, you've thrown away 12% (10/85) of her money. That may be a mistake you can't afford. On the other hand, if you choose TIRA and live a long and happy life and don't die before retirement or become disabled before retirement or have a stretch of unemployment before retirement or retire before retirement and you have a successful career and you move from your no tax state to a high tax state, you might end up paying 35% tax on withdrawals, and you'll have thrown away 13% (10/75) of your money. But it will be a mistake you can afford.

In this thread I suggested consideration of a TIRA not for retirement, but because the OP's wife will return to school. If there is unused TIRA space, it might be used effectively to shift income from a high bracket year to a low bracket year in the near future. This is less speculative than saving for far off retirement. However, it appears the OP is in the middle of the 25% bracket, so it may not make much difference whether a Roth or TIRA is used, because the tax rate coming or going will still be 25%.
Last edited by Bob's not my name on Wed Dec 28, 2011 6:54 am, edited 1 time in total.
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Re: Trying to Put All This Together...

Post by celia »

3. Are you aware that whether your wife has earned income or not, you each can put $5,000 into a Roth (or traditional) IRA as long as your joint earned income is at least $10,000? If one of you doesn't have earned income, it is considered a spousal IRA. "Spousal" is not part of the account name or anything. It just indicates how the owner is eligible--married and spouse has the income.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Trying to Put All This Together...

Post by Bob's not my name »

celia wrote:3. Are you aware that whether your wife has earned income or not, you each can put $5,000 into a Roth (or traditional) IRA as long as your joint earned income is at least $10,000? If one of you doesn't have earned income, it is considered a spousal IRA. "Spousal" is not part of the account name or anything. It just indicates how the owner is eligible--married and spouse has the income.
This is not exactly correct. The deductible spousal TIRA is available to a spouse who is not covered by an employer plan -- he may have earned income. The MAGI phaseout begins at $169,000 for 2011, $173,000 for 2012.

For the spouse who is covered by an employer plan, the deductible TIRA MAGI phaseout begins at $90,000 for 2011, $92,000 for 2012.

So many couples are eligible for a deductible spousal TIRA, but not a second deductible TIRA.
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Re: Trying to Put All This Together...

Post by ebotrd »

Your reasoning seems sound, "Bob'sNot", but I'm still missing something -- when you chose the numbers for your formulas:

Mfinal(Roth) = $10,000 * (1 - 0.25) * 10 = $75,000
Mfinal(trad) = $10,000 * 10 * (1 - 0.25) = $75,000

...can you explain the "10"?
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Re: Trying to Put All This Together...

Post by Bob's not my name »

Bob's not my name wrote:the portfolio grows tenfold by withdrawal
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Re: Trying to Put All This Together...

Post by ebotrd »

OK, so the difference between our conceptions of the Roth is that you're saying only $7500 ends up invested in the Roth. I'm saying it's the whole 10,000, with the $2500 paid out of additional after tax income. In other words:

MRoth = ($12,500 - $2,500) * 1 * 10 = $100,000 tax free.
MTIRA = $2500 (tax refund...which hopefully is prudently invested) + ($10,000 * 1 * 10) = $100,000 taxable.
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Re: Trying to Put All This Together...

Post by Bob's not my name »

You're dealing with the enduring saturated case I mentioned, and your formulas don't make sense. If you're not in the enduring saturated situation (all tax-advantaged accounts maxed every year for a half century), the argument that you can stuff more in a Roth doesn't apply.

As for the TIRA formula, you keep seeing ghosts. If you contribute $10,000 to a TIRA that $10,000 is exempt from taxation -- i.e., you get a $10,000 deduction from your AGI and thus your taxable income. You do not get another $2,500 deduction.

Your Roth formula doesn't make sense either, since that $2,500 doesn't really belong in the formula. You're straining to make the Roth "tax-free". It's not. You pay the tax up front. It's like electing to amputate your leg and saying "Well, at least I won't lose that to diabetes later."

To invest $10,000 in the Roth you need to pay $3,333 in taxes up front, not $2,500.
Last edited by Bob's not my name on Wed Dec 28, 2011 10:52 am, edited 1 time in total.
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Re: Trying to Put All This Together...

Post by ebotrd »

Bob'sNot, I relent that my beloved Roth gets less attractive if the couple's unable to "saturate" their retirement savings. But, if you agree that, for retirement purposes at least, a couple should usually follow this recipe:
#1. First contribute to their 401k's up to their matches.
#2. Then contribute the $10k max allowed for an IRA.
#3. Then contribute any extra funds up to the 401k's maxes.
...and you do contribute enough to "saturate" #1 & #2 at least, then the Roth IRA has the edge, especially for a couple of 20-somethings even in the 25% bracket, don't you think?

"Testing" did say:
Over the next couple years our plan is to increase retirement savings with my 401k and contribute the $5k/yr in my roth IRA,
To me that meant he wanted to saturate #1 & #2 (and would add another $5k Roth for his spouse).

Like you said you can also withdrawal Roth contributions penalty-free if desparate for cash, but his wife's going to med school. They should be able to "saturate" even with student loans to pay off.
When something is important enough, you do it even if the odds are not in your favor. -- E. Musk.
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