Savings and Investing Precedence

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Re: Savings and Investing Precedence

Postby retiredjg » Sat Jun 29, 2013 10:58 am

arthurdawg wrote: Many will simply not be willing to take the time to understand and use this information.

This is true and these are the folks that a general rule of thumb is probably written for (even if it is not the best choice in their specific situation). If they follow the Wiki (or even Laura's earlier version) they are likely to be fine. Maybe not optimal, but fine.
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Re: Savings and Investing Precedence

Postby Investing is boring » Sat Jun 29, 2013 11:00 am

Default User BR wrote:
Investing is boring wrote:Nice to have if variable income complies:
- Taxable
- EE Bonds
- After-Tax 401k

If your plan allows in-service distribution of the after-tax contributions, then it should be much higher on the list.


Brian


It does, EXCEPT after an in-service with Fidelity (at least with my company 401k) you cannot make 401k contributions for the subsequent 6 months. I need to call to verify that both pre and post tax contributions are banned. Will do so next month as I max my pre-tax 401k then.
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Re: Savings and Investing Precedence

Postby Default User BR » Sat Jun 29, 2013 12:28 pm

Investing is boring wrote:It does, EXCEPT after an in-service with Fidelity (at least with my company 401k) you cannot make 401k contributions for the subsequent 6 months. I need to call to verify that both pre and post tax contributions are banned. Will do so next month as I max my pre-tax 401k then.

Yeah, I would check. That seems like the sort of restriction they put on after hardship withdrawals, which this would not be.


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Re: Savings and Investing Precedence

Postby retiredjg » Sat Jun 29, 2013 12:35 pm

I agree. That seems like a mighty weird restriction. In fact, it does not even sound legal to me. I suspect a mis-understanding.
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Re: Savings and Investing Precedence

Postby Investing is boring » Sat Jun 29, 2013 12:41 pm

Thanks for the advice. I will call on monday. It would be great to Backdoor Roth the After-Tax!!
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Re: Savings and Investing Precedence

Postby mike143 » Sat Jun 29, 2013 12:42 pm

Bob's not my name wrote:
mike143 wrote:For me the Roth is functioning as my emergency fund so a Traditional IRA is not ideal in this scenario.
For real emergencies like a major medical setback, disability, premature death leaving dependents, or unemployment, a TIRA is a better emergency fund.

My emergencies may not align with what is allowed. But this is good info to know: http://thefinancebuff.com/your-traditio ... -fund.html
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Re: Savings and Investing Precedence

Postby Sriracha » Sat Jun 29, 2013 1:18 pm

grabiner wrote:Likewise, the reason that our advice recommends maxing out a Roth IRA is that most investors who are considering the precedence issue are ineligible for a deductible traditional IRA, and a Roth (through the backdoor if necessary) is always better than a non-deductible IRA. A non-deductible IRA which is not converted to a Roth is bad for the same reason as a non-deductible 401(k) contribution.


David, do you think it's ever "acceptable" or, well, "not unreasonable," to contribute to a non-deductible IRA without the immediate ability to back-door into a Roth? (If/when our income drops, I'd of course seriously consider taking the back door.) The only tax-deferred accounts my wife and I have that contain funds allowing us to tilt small/value are our non-deductible IRAs. I realize that we could invest in Vanguard's small/value index funds in our taxable account, but I prefer to stick with TSM and total international in taxable for tax efficiency reasons.

(Sorry for the tangent.)
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Re: Savings and Investing Precedence

Postby YDNAL » Sat Jun 29, 2013 1:30 pm

Sriracha wrote:David, do you think it's ever "acceptable" or, well, "not unreasonable," to contribute to a non-deductible IRA without the immediate ability to back-door into a Roth? (If/when our income drops, I'd of course seriously consider taking the back door.)

I'm not David, but your question doesn't make sense. The reason for a "backdoor" Roth contribution IS because high income prevents a straight contribution.
Link: http://www.bogleheads.org/wiki/Backdoor_Roth_IRA
A Backdoor Roth IRA is a technique for contributing to a Roth IRA when your income exceeds the contribution limit. There is no income limit on contributing to a nondeductible Traditional IRA, nor on converting a Traditional IRA to a Roth IRA.
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Re: Savings and Investing Precedence

Postby Sriracha » Sat Jun 29, 2013 1:41 pm

YDNAL wrote:
Sriracha wrote:David, do you think it's ever "acceptable" or, well, "not unreasonable," to contribute to a non-deductible IRA without the immediate ability to back-door into a Roth? (If/when our income drops, I'd of course seriously consider taking the back door.)

I'm not David, but your question doesn't make sense. The reason for a "backdoor" Roth contribution IS because high income prevents a straight contribution.
Link: http://www.bogleheads.org/wiki/Backdoor_Roth_IRA
A Backdoor Roth IRA is a technique for contributing to a Roth IRA when your income exceeds the contribution limit. There is no income limit on contributing to a nondeductible Traditional IRA, nor on converting a Traditional IRA to a Roth IRA.


The taxable balance of our non-deductible IRAs makes doing a backdoor at this point prohibitive given that taxes will be due immediately (and our brackets are high). Does that impact your opinion?
Last edited by Sriracha on Sat Jun 29, 2013 1:50 pm, edited 1 time in total.
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Re: Savings and Investing Precedence

Postby livesoft » Sat Jun 29, 2013 1:46 pm

I have small value instead in taxable. The gains are so huge that I would not want to pay ordinary income taxes on those gains if they were held in an IRA. It makes much more sense to pay the long-term cap gains tax rate on that asset class. The annual dividends are not much less tax-efficient that TSM and TISM.

Just do the math yourself with the help of Excel. I cannot see how a non-deductible IRA of small-cap value is better than in a taxable account with the exception of converting the IRA to a Roth IRA at a very low tax rate.

And don't forget that years ago, folks with $100K or more of income could not do Roth conversions.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Savings and Investing Precedence

Postby YDNAL » Sat Jun 29, 2013 1:50 pm

Sriracha wrote:
YDNAL wrote:
Sriracha wrote:David, do you think it's ever "acceptable" or, well, "not unreasonable," to contribute to a non-deductible IRA without the immediate ability to back-door into a Roth? (If/when our income drops, I'd of course seriously consider taking the back door.)

I'm not David, but your question doesn't make sense. The reason for a "backdoor" Roth contribution IS because high income prevents a straight contribution.
Link: http://www.bogleheads.org/wiki/Backdoor_Roth_IRA
A Backdoor Roth IRA is a technique for contributing to a Roth IRA when your income exceeds the contribution limit. There is no income limit on contributing to a nondeductible Traditional IRA, nor on converting a Traditional IRA to a Roth IRA.

The taxable balance of our non-deductible IRAs makes doing a backdoor at this point prohibitive given that taxes will be due immediately. Does that impact your opinion?

There is a difference in saying "If/when our income drops..." with no further caveat, then expanding by saying "taxable balance... prohibitive given taxes."

For many people with LARGE deductible (pre-tax) IRAs, it doesn't make sense to backdoor a Roth as it appears to be your case. I'm in the same situation.
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Re: Savings and Investing Precedence

Postby Sriracha » Sat Jun 29, 2013 2:12 pm

livesoft wrote:I cannot see how a non-deductible IRA of small-cap value is better than in a taxable account with the exception of converting the IRA to a Roth IRA at a very low tax rate.

And don't forget that years ago, folks with $100K or more of income could not do Roth conversions.


I see what you are saying.

We started the IRAs years ago, thus the decent gains that stopped us from converting during the recent otherwise-advantageous chance to do so over the course of two tax years. And we still haven't because it just seems crazy to convert in our current tax brackets. At some point, whether voluntarily or not, we see a major drop in income and can convert with (hopefully) a much lower tax hit.

So, at least as far as I understand it, the question of whether we did the wrong thing way back when by starting to contribute to non-deductible IRAs, is moot. The money is in there at this point and that's that. Going forward, I guess it comes down to how best to use that space and whether to continue to contribute. You've given some reasons to re-evaluate whether to continue. Thanks for your thoughts!

As for using that space for the small/value thing, I can only say that I was (perhaps overly) influenced by writings at the time. Those handy dandy tables in Bernstein's Four Pillars, for example, clearly tell you to slap your small/value funds in a sheltered account. I guess the prevailing view has softened on that stance over time. Oh well, if having a modest chunk of our portfolio in non-deductible IRAs is the worst mistake I make, I guess I'll survive :-)
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Re: Savings and Investing Precedence

Postby Sriracha » Sat Jun 29, 2013 2:24 pm

YDNAL wrote:There is a difference in saying "If/when our income drops..." with no further caveat, then expanding by saying "taxable balance... prohibitive given taxes."

For many people with LARGE deductible (pre-tax) IRAs, it doesn't make sense to backdoor a Roth as it appears to be your case. I'm in the same situation.


I'll try to be more precise next time :happy
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Re: Savings and Investing Precedence

Postby John3754 » Sat Jun 29, 2013 2:29 pm

If you have a high income level and contribute to a 401k you are not eligible for a tax deductible traditional IRA contribution, therefore a backdoor Roth is the best option.
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Re: Savings and Investing Precedence

Postby YDNAL » Sat Jun 29, 2013 2:33 pm

Sriracha wrote:
YDNAL wrote:There is a difference in saying "If/when our income drops..." with no further caveat, then expanding by saying "taxable balance... prohibitive given taxes."

For many people with LARGE deductible (pre-tax) IRAs, it doesn't make sense to backdoor a Roth as it appears to be your case. I'm in the same situation.

I'll try to be more precise next time :happy

Sorry, I didn't mean anything with the first paragraph. It just seemed that "income" was the issue when reading your post.
Sriracha wrote:David, do you think it's ever "acceptable" or, well, "not unreasonable," to contribute to a non-deductible IRA without the immediate ability to back-door into a Roth? (If/when our income drops, I'd of course seriously consider taking the back door.)
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Re: Savings and Investing Precedence

Postby retiredjg » Sat Jun 29, 2013 2:47 pm

Sriracha wrote:David, do you think it's ever "acceptable" or, well, "not unreasonable," to contribute to a non-deductible IRA without the immediate ability to back-door into a Roth?

I'm not David either, but I'll also take a stab at your question.

I do think it is acceptable in some circumstances. For example, if you need space for bonds, non-deductible contributions to traditional IRA make sense to me. Especially if you see a later time when that money can be converted to Roth at a lower tax rate than now. This accomplishes two things - you have tax-advantaged space for the bonds you need and the bonds won't grow so much that the conversion to Roth later on will cost you a great deal.

Stock funds are a different matter if they can be held reasonably well in a taxable account. That's because the gains will be taxed at a lower rate than if the same funds were held in IRA.

I doubt you did the "wrong thing" back then. At that point it may have been better to hold your small value in IRA than taxable. But that's not as true now - maybe because qualified dividends have made the small value funds more tax-efficient?

I would not worry about what is already there, but you might consider putting new contributions into taxable in the future rather than non-deductible traditional IRA. And as your portfolio morphs over time, you may find you actually need that space in the IRA for more bonds.
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Re: Savings and Investing Precedence

Postby LadyGeek » Sat Jun 29, 2013 2:47 pm

Getting back to the OP's question, the intent is to give advice in a form that someone with no (or very little) investing experience can understand.

For perspective, a backdoor Roth is far too complicated for new investors (never invest in anything you don't understand). When / if they do understand what this is, they won't need the suggestions we're trying to modify - they've grown beyond them.

For that reason, I like the level of detail in Prioritizing investments. The most popular (and easy to understand) choices are listed. Other considerations, of which there are many, can be addressed separately. Perhaps to add a paragraph which explains this?
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Re: Savings and Investing Precedence

Postby retiredjg » Sat Jun 29, 2013 3:01 pm

I like it the way it is. A sentence or short paragraph indicating that there are several possible exceptions would be OK. But if you get into the details of each exception (back door, HSA, after-tax contributions) a new reader is just going to get confused and go away frustrated.
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Re: Savings and Investing Precedence

Postby umfundi » Sat Jun 29, 2013 3:16 pm

LadyGeek wrote:Getting back to the OP's question, the intent is to give advice in a form that someone with no (or very little) investing experience can understand.

For perspective, a backdoor Roth is far too complicated for new investors (never invest in anything you don't understand). When / if they do understand what this is, they won't need the suggestions we're trying to modify - they've grown beyond them.

For that reason, I like the level of detail in Prioritizing investments. The most popular (and easy to understand) choices are listed. Other considerations, of which there are many, can be addressed separately. Perhaps to add a paragraph which explains this?

Sue,

I agree with you. However, I would add a sentence (why?) to each of the points. As in:

Company plan (401k, 403b, etc.) up to the company match
The company match is free money. Take it!
Roth IRA or deductible Traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
In an IRA you can select the investments yourself; low-cost index funds that may not be available in your company plan.
Company plan up to maximum contribution limit
Most plans have some low-cost options. You can balance your asset allocation with your IRA.
Taxable Investing
This is a broad outline suitable for most (beginning) investors. If you are fortunate enough to yet have funds available for taxable investing, you may wish to learn about using tax-advantaged HSA, Coverdell, and 529 accounts.

In the next section:

Invest up to the match
Pay Off high Interest Debt
Tax-Deductible Retirement Accounts
Roth IRA
Taxable Accounts
Nondeductible IRAs and Annuities

I would say that eliminating revolving consumer debt (credit cards) is absolutely the highest priority. Student loans deserve a mention, as do mortgages. As mentioned upthread, non-deductible non-Roth contributions are probably not a good idea, if you have the discipline to leave the money in those taxable accounts alone.

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Re: Savings and Investing Precedence

Postby Sriracha » Sat Jun 29, 2013 3:24 pm

YDNAL wrote:Sorry, I didn't mean anything with the first paragraph. It just seemed that "income" was the issue when reading your post.


No worries. Enjoy the weekend.
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Re: Savings and Investing Precedence

Postby MnD » Sat Jun 29, 2013 3:58 pm

I view the sequence of step 1 and 2 as "bad advice" in our situation which I don't think is very unusual for the BH demographic.

Every penny we contribute to our maxed out 401-K's would have been taxed at least at 28% federal.
Maxing out 401-K's also keeps us out of the "penalty box" with regards to paying AMT.

SS and my modest DB pension will not fill the 15% bracket after accounting for the various exemptions and deductions. Therefore some of the money coming out of our tax deferred accounts at our expected SWR will be taxed at 15% and some at 25%. Zero will be taxed at 28% or higher under current law. Both states we are considering retiring to have considerable tax breaks for retirement plan income, so the tax brackets the deferred comp will be subject to on the state level is even more favorable.

Two maxed out 401-K's including catch-up amounts, fairly generous match, plus some annual tax-qualified stock grants achieves our savings requirement and achieves the general goal of deferring earned income during peak earnings and high marginal tax rate years and realizing that compensation when income and effective tax rates on the compensation are significantly lower.
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Re: Savings and Investing Precedence

Postby Kevin M » Sat Jun 29, 2013 4:40 pm

The Getting Started for Wiki Editors states this:

You should cite sources for the information you contribute. ... Citations help readers verify what you have written ...

The purpose of citing sources is:

  • To ensure that the content of articles can be checked by any reader or editor.
  • To show that your edit is not original research and to reduce editorial disputes.
...


Clearly this is not taken seriously in many, many Wiki articles, including the ones being discussed here. IMO, this is the biggest shortcoming of the BH Wiki.

I do not consider one or more forum posters' opinions a reliable reference. Although I also don't consider an article by a single personal finance advisor a very credible reference, at least it would make it clear that a statement is based on the opinion of that particular person, and not based on any academic research, for example.

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Re: Savings and Investing Precedence

Postby grabiner » Sat Jun 29, 2013 4:59 pm

Sriracha wrote:
grabiner wrote:Likewise, the reason that our advice recommends maxing out a Roth IRA is that most investors who are considering the precedence issue are ineligible for a deductible traditional IRA, and a Roth (through the backdoor if necessary) is always better than a non-deductible IRA. A non-deductible IRA which is not converted to a Roth is bad for the same reason as a non-deductible 401(k) contribution.


David, do you think it's ever "acceptable" or, well, "not unreasonable," to contribute to a non-deductible IRA without the immediate ability to back-door into a Roth? (If/when our income drops, I'd of course seriously consider taking the back door.) The only tax-deferred accounts my wife and I have that contain funds allowing us to tilt small/value are our non-deductible IRAs.


What would the investment go into? If it would otherwise go into something tax-efficient such as Total Stock Market or Total International, it may well be worth less in a non-deductible IRA than in a taxable account; the tax on gains will be deferred but will be at your full tax rate. If it would go into something tax-inefficient such as a bond fund, it is better in a non-deductible IRA.

For small-cap value, I'm not sure; I was intending to use small-cap value in my own non-deductible IRA, but the backdoor opened for me before I reached the Roth IRA contribution limit. I would be inclined to use the non-deductible IRA because you will save in taxes now, and may save more later if you increase your bond allocation.
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Emergency fund: Roth or Traditional IRA?

Postby Taylor Larimore » Sat Jun 29, 2013 5:35 pm

Bob's not my name wrote:
mike143 wrote:For me the Roth is functioning as my emergency fund so a Traditional IRA is not ideal in this scenario.
For real emergencies like a major medical setback, disability, premature death leaving dependents, or unemployment, a TIRA is a better emergency fund.

Bob's not my name:

I cannot understand your reasoning. Unlike Roth withdrawals which are not taxable, TIRA (Traditional IRA) withdrawals are taxable.

Please explain.

Thank you and best wishes.
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Re: Savings and Investing Precedence

Postby Sriracha » Sat Jun 29, 2013 6:04 pm

grabiner wrote:For small-cap value, I'm not sure; I was intending to use small-cap value in my own non-deductible IRA, but the backdoor opened for me before I reached the Roth IRA contribution limit. I would be inclined to use the non-deductible IRA because you will save in taxes now, and may save more later if you increase your bond allocation.


Yeah, that's the issue I struggle a bit with. Some folks think it's a no-brainer to stick small value in taxable these days rather than deal with a non-deductible IRA. In the past (as I referenced above using Four Pillars as an example), the prevailing advice seemed to be to stick small value in a sheltered account; as you said, that allows you to save on taxes now. I'm still on the fence, but I may stop contributing to the non-deductible IRA at this point and use the taxable account for any future small value purchases.
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Re: Savings and Investing Precedence

Postby livesoft » Sat Jun 29, 2013 6:10 pm

The old prevailing advice on small-cap value probably stems from the old days when (a) it made cap gains distributions and (b) qualified dividends had no special tax treatment.

One has to be aware of how qualified dividends are taxed FOR YOU in order to make good decisions. Even Total Stock Market Index and Total Int'l pay out dividends, so one cannot avoid dividends. But the fraction of the dividends that are qualified (100% for TSM & TISM; less for Small-cap value) can change the dynamics.

My tax cost in 2012 for something like Vanguard Total Stock Market index would have been 0.32% of end-of-year value. For VBR (small-cap value) it was 0.62% and for VSS (small-cap int'l) it was 0.80%.
Last edited by livesoft on Sat Jun 29, 2013 6:15 pm, edited 1 time in total.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Savings and Investing Precedence

Postby ruralavalon » Sat Jun 29, 2013 6:14 pm

umfundi wrote:
LadyGeek wrote:Getting back to the OP's question, the intent is to give advice in a form that someone with no (or very little) investing experience can understand.
. . . . .
For that reason, I like the level of detail in Prioritizing investments. The most popular (and easy to understand) choices are listed. Other considerations, of which there are many, can be addressed separately. Perhaps to add a paragraph which explains this?

Sue,

I agree with you. However, I would add a sentence (why?) to each of the points. As in:

Company plan (401k, 403b, etc.) up to the company match
The company match is free money. Take it!
Pay off higher interest debt, such as credit card debt. Sometimes this will be the next best "investment" after taking the free money.
Roth IRA or deductible Traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
In an IRA you can select the investments yourself; low-cost index funds that may not be available in your company plan.
Company plan up to maximum contribution limit
Most plans have some low-cost options. You can balance your asset allocation with your IRA.
Taxable Investing
This is a broad outline suitable for most (beginning) investors. If you are fortunate enough to yet have funds available for taxable investing, you may wish to learn about using tax-advantaged HSA, Coverdell, and 529 accounts.

In the next section:

Invest up to the match
Pay Off high Interest Debt
Tax-Deductible Retirement Accounts
Roth IRA
Taxable Accounts
Nondeductible IRAs and Annuities

I would say that eliminating revolving consumer debt (credit cards) is absolutely the highest priority. Student loans deserve a mention, as do mortgages. As mentioned upthread, non-deductible non-Roth contributions are probably not a good idea, if you have the discipline to leave the money in those taxable accounts alone.

Keith



An idea for further clarification, with explanation, in blue above.

The general priority will be clearer if stated in the first section, the broad outline.
Last edited by ruralavalon on Sat Jun 29, 2013 6:31 pm, edited 1 time in total.
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Re: Savings and Investing Precedence

Postby grabiner » Sat Jun 29, 2013 6:16 pm

livesoft wrote:The old prevailing advice on small-cap value probably stems from the old days when (a) it made cap gains distributions and (b) qualified dividends had no special tax treatment.

One has to be aware of how qualified dividends are taxed FOR YOU in order to make good decisions. Even Total Stock Market Index and Total Int'l pay out dividends, so one cannot avoid dividends. But the fraction of the dividends that are qualified (100% for TSM & TISM; less for Small-cap value) can change the dynamics.


Total International doesn't have 100% qualified dividends (TM International is Vanguard's only international fund which does), but its dividends are actually taxed at a lower effective tax rate because of the foreign tax credit, so it has an even larger disadvantage in a non-deductible IRA. If a dividend is 75% qualified (taxed at 15%) and 25% non-qualified (taxed at 25%) but you also get 7% back in foreign tax credit, the effective tax rate is 10.5%.
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Re: Savings and Investing Precedence

Postby livesoft » Sat Jun 29, 2013 6:21 pm

^ It can be more complicated than that as I found out with TurboTax. We are in the 25% marginal income tax bracket, but the reality is that due to loss of credits and other preference items, we actually pay income tax at a real marginal rate of about 48%. That is, every $100 of unqualified dividends costs $48 in taxes.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Savings and Investing Precedence

Postby bayview » Sat Jun 29, 2013 6:21 pm

umfundi wrote:
LadyGeek wrote:Getting back to the OP's question, the intent is to give advice in a form that someone with no (or very little) investing experience can understand.

For perspective, a backdoor Roth is far too complicated for new investors (never invest in anything you don't understand). When / if they do understand what this is, they won't need the suggestions we're trying to modify - they've grown beyond them.

For that reason, I like the level of detail in Prioritizing investments. The most popular (and easy to understand) choices are listed. Other considerations, of which there are many, can be addressed separately. Perhaps to add a paragraph which explains this?

Sue,

I agree with you. However, I would add a sentence (why?) to each of the points. As in:

Company plan (401k, 403b, etc.) up to the company match
The company match is free money. Take it!
Roth IRA or deductible Traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
In an IRA you can select the investments yourself; low-cost index funds that may not be available in your company plan.
Company plan up to maximum contribution limit
Most plans have some low-cost options. You can balance your asset allocation with your IRA.
Taxable Investing
This is a broad outline suitable for most (beginning) investors. If you are fortunate enough to yet have funds available for taxable investing, you may wish to learn about using tax-advantaged HSA, Coverdell, and 529 accounts.

In the next section:

Invest up to the match
Pay Off high Interest Debt
Tax-Deductible Retirement Accounts
Roth IRA
Taxable Accounts
Nondeductible IRAs and Annuities

I would say that eliminating revolving consumer debt (credit cards) is absolutely the highest priority. Student loans deserve a mention, as do mortgages. As mentioned upthread, non-deductible non-Roth contributions are probably not a good idea, if you have the discipline to leave the money in those taxable accounts alone.

Keith

(my apologies for the mega-quote)

Speaking for the mostly-unheard, not-rich/not-financially-sophisticated :D portion of the BH demographic, and therefore someone who has tried to refer to the Wiki and been frequently frustrated, I'd like to see the Wiki entry matching the Prioritizing Investments entry at a minimum. It's quite maddening for us noobs to read one thing in one place and then something different elsewhere, both sites linked to by others, and then try to figure out why they conflict. I especially like the bolded red additions above amplifying the "why" of each. I don't care how informed all the members here are; OK, well yes, I do care and appreciate it, but I'm not doing a trust fall with my personal finances and following advice on a Wiki without some explanation of the advice.

Also agree with the second paragraph.

But even if no changes were made, I'd love to see this current thread (Savings and Investing Precedence) listed as a link on the Wiki. That would allow readers of varying levels of sophistication, income, and tax brackets to possibly inflect the advice given.

And also, regarding the so-called "rule", why can't it be called advice or guidance instead? Usage of the word "rule" seems to get folks stirred up.
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Re: Emergency fund: Roth or Traditional IRA?

Postby Bob's not my name » Sat Jun 29, 2013 7:30 pm

Taylor Larimore wrote:
Bob's not my name wrote:
mike143 wrote:For me the Roth is functioning as my emergency fund so a Traditional IRA is not ideal in this scenario.
For real emergencies like a major medical setback, disability, premature death leaving dependents, or unemployment, a TIRA is a better emergency fund.

Bob's not my name:

I cannot understand your reasoning. Unlike Roth withdrawals which are not taxable, TIRA (Traditional IRA) withdrawals are taxable.

Please explain.

Thank you and best wishes.
Taylor
Sure. Unlike TIRA contributions which are not taxable, Roth contributions are taxable. The major emergencies I cite above will typically result in a lower tax rate at emergency time than at contribution. And there's no early withdrawal penalty in these situations (nor in some non-emergency situations like college tuition). And withdrawals for major medical expenses over 10% of AGI are essentially tax-free. More explanation here: http://thefinancebuff.com/your-traditio ... -fund.html

Why pay 30% tax on your IRA contribution today when you could be unemployed next year and pay 0% tax on your emergency withdrawal? Roth contributions are anti-insurance.

If your "emergency" is a new set of tires, Roth would probably be better (unless you live in one of the states listed above).
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Re: Savings and Investing Precedence

Postby grabiner » Sat Jun 29, 2013 10:48 pm

So it appears that a simple consensus would be:

1. Employer plan up to the match
2. IRA (Traditional if it is deductible, otherwise Roth)
3. Employer plan beyond the match
4. Taxable investing

Yes, it can happen that unmatched contributions to a 401(k) are better than Roth IRA investments, but most 401(k) plans either have higher costs or are missing a good option in some asset class which can be filled by a 401(k), so most investors should prefer an IRA even if it has to be a Roth.
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Re: Savings and Investing Precedence

Postby livesoft » Sat Jun 29, 2013 11:20 pm

1. Employer plan up to the match
2. IRA (Traditional if it is deductible, otherwise Roth) or Employer plan beyond the match (if good plan or one needs the tax deduction)
3. Whatever in 2 is unfinished
4. HSA if available or 529 plans or other tax-advantaged account
5. Taxable investing, but invested tax-efficiently
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Savings and Investing Precedence

Postby IlliniDave » Sun Jun 30, 2013 8:07 am

retiredjg wrote:
Sriracha wrote:David, do you think it's ever "acceptable" or, well, "not unreasonable," to contribute to a non-deductible IRA without the immediate ability to back-door into a Roth?

I'm not David either, but I'll also take a stab at your question.

I do think it is acceptable in some circumstances. For example, if you need space for bonds, non-deductible contributions to traditional IRA make sense to me. Especially if you see a later time when that money can be converted to Roth at a lower tax rate than now. This accomplishes two things - you have tax-advantaged space for the bonds you need and the bonds won't grow so much that the conversion to Roth later on will cost you a great deal.



I think I'm getting confused. If you're making a contribution now to a nondeductible traditional IRA, you've already paid taxes on the contribution amount. If you backdoor it right away into a Roth you never pay taxes on any of the future earnings (except maybe on some token amount if you happen to make a few dollars on it before the conversion). If you leave it in a nondeductible traditional IRA you'll get taxed on the earnings at withdrawal/conversion irrespective of the investment. The only wrinkle I know of is you have to leave the money in the newly converted Roth for 5 years before you can withdraw the contributed money without the penalty tax (if you're under 59 1/2).

What I've done the last couple years since the backdoor conversion became available is contribute to a nondeductible IRA in a lump sum then in a day or two when the transaction clears convert it to a Roth. That way at worst I've only got a day or two of positive return for a tax liability. Even if you contribute weekly for a year to build up to the nondeductible limit at worst you have a year's gains for tax liability.

For a traditional deductible IRAs (or nondeductible IRAs that have been held for many years and have a lot of growth) it's a bit different because conversion would be a substantial taxable event. In that case I could see where it makes sense to possibly wait until your tax bracket lowers to begin conversions. But for new nondeductible IRAs, it's hard to see any reason not to convert it right away. Maybe I'm missing something?
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Re: Emergency fund: Roth or Traditional IRA?

Postby Taylor Larimore » Sun Jun 30, 2013 8:14 am

Bob's not my name wrote:
Taylor Larimore wrote:
Bob's not my name wrote:
mike143 wrote:For me the Roth is functioning as my emergency fund so a Traditional IRA is not ideal in this scenario.
For real emergencies like a major medical setback, disability, premature death leaving dependents, or unemployment, a TIRA is a better emergency fund.

Bob's not my name:

I cannot understand your reasoning. Unlike Roth withdrawals which are not taxable, TIRA (Traditional IRA) withdrawals are taxable.

Please explain.

Thank you and best wishes.
Taylor
Sure. Unlike TIRA contributions which are not taxable, Roth contributions are taxable. The major emergencies I cite above will typically result in a lower tax rate at emergency time than at contribution. And there's no early withdrawal penalty in these situations (nor in some non-emergency situations like college tuition). And withdrawals for major medical expenses over 10% of AGI are essentially tax-free. More explanation here: http://thefinancebuff.com/your-traditio ... -fund.html

Why pay 30% tax on your IRA contribution today when you could be unemployed next year and pay 0% tax on your emergency withdrawal? Roth contributions are anti-insurance.

If your "emergency" is a new set of tires, Roth would probably be better (unless you live in one of the states listed above).

Bob's not my name:

Thank you for your excellent response containing a good link to my question. It is the first time I have heard the sound argument that in certain circumstances a traditional IRA can be a better emergency fund than a Roth.

Best wishes.
Taylor
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Re: Savings and Investing Precedence

Postby retiredjg » Sun Jun 30, 2013 8:44 am

IlliniDave wrote: But for new nondeductible IRAs, it's hard to see any reason not to convert it right away. Maybe I'm missing something?

Almost all that you said is correct.

What you are missing is that the poster who asked the question already has significant taxable gains in tIRA. This makes conversion to Roth an unattractive choice because all of the gains in all of the IRAs will be brought into the calculations at conversion. Since this poster is still in a higher tax bracket, it would be better to postpone conversion till later.
Last edited by retiredjg on Sun Jun 30, 2013 12:51 pm, edited 1 time in total.
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Re: Savings and Investing Precedence

Postby letsgobobby » Sun Jun 30, 2013 9:25 am

livesoft wrote:
livesoft wrote:I will say that non-deductible [traditional] 401(k) contributions are bad unless they can be immediately converted to Roth. Can you figure out why?

When one withdraws from a traditional IRA, the untaxed money is taxed at one's marginal income tax rate which is always higher than the long-term capital gains tax rate. So if one makes non-deductible contributions, not only does one have to keep track of a basis in the 401(k) for the future, one will also have to pay a higher tax rate on the gains when the money is withdraw.

In contrast, if the same contribution is just invested tax-efficiently in a taxable account, one will be able to tax-loss harvest capital losses and pay taxes on the gains at the long-term cap gains tax rate which can be as low as 0%. Plus there is no penalty for early withdrawal nor any contribution limits.

Therefore, if one does not get a benefit from a traditional 401(k) (tax-deferral on the contribution) or a Roth 401(k) (tax-free gains) or maybe an employer match, then don't bother with a 401(k) contribution.

Good explanation, and true now, though it wasn't true from 2006-2010 - knowing that money could be converted to a Roth in 2010 regardless of income made holding a nondeductible IRA well worthwhile beginning in 2006..
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Re: Savings and Investing Precedence

Postby IlliniDave » Sun Jun 30, 2013 9:30 am

retiredjg wrote:
IlliniDave wrote: But for new nondeductible IRAs, it's hard to see any reason not to convert it right away. Maybe I'm missing something?

All that you said is correct.

What you are missing is that the poster who asked the question already has significant taxable gains in tIRA. This makes conversion to Roth an unattractive choice because all of the gains in all of the IRAs will be brought into the calculations at conversion. Since this poster is still in a higher tax bracket, it would be better to postpone conversion till later.


Okay, I misunderstood, I thought the question was about contributing to (as in now and going forward) and staying in nondeductible IRA versus converting to Roth more-or-less from a clean slate. I take it all nondeductible IRA's are considered together as a single entity when converting, even if they are in different accounts, so that you can't do "last-in, first-out" conversions?
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Re: Savings and Investing Precedence

Postby retiredjg » Sun Jun 30, 2013 10:14 am

IlliniDave wrote: I take it all nondeductible IRA's are considered together as a single entity when converting, even if they are in different accounts, so that you can't do "last-in, first-out" conversions?

Correct. All of a person's IRAs - traditional (with deductible and/or non-deductible contributions), SEP IRA, and SIMPLE IRA are considered as a single entity when converting IRA to Roth IRA. Different accounts do not matter. There is no last in, first out. That's why the "back door" is not an attractive maneuver for people with other IRAs sitting around.
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Re: Savings and Investing Precedence

Postby Bob's not my name » Sun Jun 30, 2013 11:14 am

retiredjg wrote:All that you said is correct.
This part is incorrect:
IlliniDave wrote:The only wrinkle I know of is you have to leave the money in the newly converted Roth for 5 years before you can withdraw the contributed money without the penalty tax (if you're under 59 1/2)
No penalty for withdrawing contributions from a nondeductible TIRA converted to a Roth. interplanet janet has explained this in several threads.
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Re: Savings and Investing Precedence

Postby IlliniDave » Sun Jun 30, 2013 11:24 am

retiredjg wrote:
IlliniDave wrote: I take it all nondeductible IRA's are considered together as a single entity when converting, even if they are in different accounts, so that you can't do "last-in, first-out" conversions?

Correct. All of a person's IRAs - traditional (with deductible and/or non-deductible contributions), SEP IRA, and SIMPLE IRA are considered as a single entity when converting IRA to Roth IRA. Different accounts do not matter. There is no last in, first out. That's why the "back door" is not an attractive maneuver for people with other IRAs sitting around.


Gotha, thanks. :happy
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Re: Savings and Investing Precedence

Postby retiredjg » Sun Jun 30, 2013 11:47 am

Bob's not my name wrote:
retiredjg wrote:All that you said is correct.
This part is incorrect:
IlliniDave wrote:The only wrinkle I know of is you have to leave the money in the newly converted Roth for 5 years before you can withdraw the contributed money without the penalty tax (if you're under 59 1/2)
No penalty for withdrawing contributions from a nondeductible TIRA converted to a Roth. interplanet janet has explained this in several threads.

You are right not-Bob! :happy

If no tax was paid on the conversion, there is no 5 year waiting period. If tax was paid on the conversion, there is a 5 year waiting period for the part that was taxed.
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Re: Savings and Investing Precedence

Postby umfundi » Sun Jun 30, 2013 11:58 am

Bob's not my name wrote:
retiredjg wrote:All that you said is correct.
This part is incorrect:
IlliniDave wrote:The only wrinkle I know of is you have to leave the money in the newly converted Roth for 5 years before you can withdraw the contributed money without the penalty tax (if you're under 59 1/2)
No penalty for withdrawing contributions from a nondeductible TIRA converted to a Roth. interplanet janet has explained this in several threads.

I believe the five years is after a Roth is established, not after the date of the contribution.

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Re: Savings and Investing Precedence

Postby boggler » Sun Jun 30, 2013 12:00 pm

Why are variable annuities not at the bottom of the list before taxable accounts?
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Re: Savings and Investing Precedence

Postby KyleAAA » Sun Jun 30, 2013 12:06 pm

I think a very strong case can be made for investing in a Roth IRA rather than a traditional IRA on tax-diversification grounds, even if its not mathematically optimal. Since we really can only speculate on what tax rates will be in 30+ years when we retire, it's wise to cover all your bases. A ROTH buys you a lot of flexibility you can't get with just tax-deferred accounts.
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Re: Savings and Investing Precedence

Postby livesoft » Sun Jun 30, 2013 12:16 pm

boggler wrote:Why are variable annuities not at the bottom of the list before taxable accounts?

Variable annuities are like a non-deductible traditional IRA to me and should be avoided except in the very special circumstances of putting a very tax-inefficient investment class outside of retirement accountants.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Savings and Investing Precedence

Postby Bob's not my name » Sun Jun 30, 2013 12:36 pm

KyleAAA wrote:we really can only speculate on what tax rates will be in 30+ years when we retire, it's wise to cover all your bases.
The unknowable future argues for pre-tax retirement savings. Voluntarily paying taxes today based on the assumption that you'll remain a high earner for 30+ years is a little reckless. I agree that a Roth is great to have, but it's the getting that's the problem.
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Re: Savings and Investing Precedence

Postby retiredjg » Sun Jun 30, 2013 12:38 pm

boggler wrote:Why are variable annuities not at the bottom of the list before taxable accounts?

A variable annuity, even the lower cost ones sold by Vanguard, is usually not as good a place to store money as a taxable account.

    -The money going into a variable annuity (in this situation) has already been taxed. The money going into a taxable account has already been taxed. So there is no benefit there on either side.

    -The earnings in a variable annuity are tax-deferred. The distributions in a poorly chosen mutual fund in taxable may cost you some tax each year. The distributions in a well chosen tax-efficient mutual fund in taxable will cost something, but not much. Variable annuity may win this one, but the win is probably very small.

    -At withdrawal, the earnings in a variable annuity are taxed at your ordinary tax rate. The earnings in a taxable account are taxed at the capital gains rate which is always* less than your ordinary rate. Taxable wins this one.

    -Similar funds cost more in a variable annuity than in taxable. For example, at Vanguard, Total Bond Market costs .10% (admiral shares) while the variable annuity version of Total Bond costs .50%. Over time, this adds up. As I understand it (never looked it up), a similar VA at another custodian is probably way more expensive than at Vanguard. Taxable wins this one.

    -You can annuitize a variable annuity for guaranteed income if you want. But if you need guaranteed income, why not just pay less during all the accumulation years and then buy a SPIA for guaranteed income when the time comes?

    -Occasionally, an investor is just dead set on buying something that should not be placed in taxable and they can't fit it into their tax-advantaged accounts. REIT is an example. For those people, a low cost REIT VA at Vanguard might be a solution. I suspect the higher costs outweigh the benefit of extra REIT, but some people just have to have it. I have occasionally suggested a VA as the best way to handle that. I suspect some people think that is nuts.

Does that help?


* There may be an exception to that way back in tax history, but I don't believe the capital gains rate has ever been higher than ordinary tax rate.
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Re: Savings and Investing Precedence

Postby Sriracha » Sun Jun 30, 2013 12:46 pm

retiredjg wrote:
IlliniDave wrote: But for new nondeductible IRAs, it's hard to see any reason not to convert it right away. Maybe I'm missing something?

All that you said is correct.

What you are missing is that the poster who asked the question already has significant taxable gains in tIRA. This makes conversion to Roth an unattractive choice because all of the gains in all of the IRAs will be brought into the calculations at conversion. Since this poster is still in a higher tax bracket, it would be better to postpone conversion till later.


Exactly. Retiredjg has correctly summarized my situation, IlliniDave.
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Re: Savings and Investing Precedence

Postby retiredjg » Sun Jun 30, 2013 12:50 pm

umfundi wrote:I believe the five years is after a Roth is established, not after the date of the contribution.

There is a 5 year waiting period (and a 59.5 year age requirement or disability) for a Roth IRA to be qualified. But any ordinary contribution (not earnings) can be withdrawn at any time for any reason without penalty. Even though it is not qualified yet, there is no penalty. The same is true of conversions that were not taxable at the time of conversion (such as from a non-deductible contribution).

On the other hand, a taxable conversion (such as from a deductible contribution) does carry a 5 year waiting period. In fact, each taxable conversion carries its own 5 year waiting period. Once the Roth IRA itself becomes qualified (5 years from start and 59.5 or disabled) all the 5 year waiting periods go poof.

Mind-boggling.
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