Roth questions from an MD

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iceman99
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Joined: Fri Mar 19, 2010 8:30 pm

Roth questions from an MD

Post by iceman99 »

Hi everyone,

I have been a member of this forum for approximately 4 years and have learned a lot. A nagging question I ask myself is whether a Roth 401K and/or backdoor Roth is/are appropriate for my situation.

Here is my financial picture

41-year old salaried physician (Finished residency/fellowship by age 34)
Annual income – His: $600,000-750,000/yr Hers: $60,000/yr
Tax-filing status = married (with one 2-year old and one on the way)
Emergency funds/short term savings = $400,000 parked in an Ally bank account for possible downpayment on future house/other large expenses.

Debt =

1. Line of credit = $1,500 at 3.00%
2. Mortgage = $570,000 at 3.75% (15-year fixed with 10 years remaining). Home is worth probably about $1.1M
3. Credit card debt = $0
4. School loans = $0
5. Car loans = $0

Tax Rate = 39.6% Federal; 9.3% State
State of Residence = CALIFORNIA

Overall asset allocation 70% stocks/30% bonds (both taxable and retirement)
Stock allocation: 75% domestic/25% international

CURRENT PORTFOLIO

TAXABLE ($570,000) – Invest approximately $80,000-100,000/year

VCADX $70,000
VTIAX $160,000
VTSAX $340,000

2) RETIREMENT

401K
VWENX $330,000 – Invest approximately $43,000/year (my contributions + employer profit sharing)

SEP-IRA
VAIPX $117,000 – Invest approximately $16,000-18,000/year depending on consulting income

Traditional IRA
VEMAX $18,000 – Currently invest $0/year (no tax benefits)
VBTLX $14,500 – Currently invest $0/year (no tax benefits)

DEFERRED COMPENSATION PLAN
VTTVX $200,000 - Invest $84,000/year

I always try to invest about 25-30% of my annual income for the long term in addition to the 10% I set aside in the Ally account for large expenses. I don’t know if I will always be able to invest these amounts given the uncertainties in MD income and other life events but I try to aim for these percentages regardless of income.

Would investing into a Roth 401K (instead of the “regular” 401K) be a better idea at these tax rates?

Should my wife and I consider doing a backdoor Roth via the Trad IRA as a way to add some more “after-tax” investment to help control our future marginal tax rate in retirement?

How would a Backdoor Roth affect my current assets in the Trad IRA and SEP-IRA (as well as future contributions into the SEP-IRA?)

Thanks
SGM
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Re: Roth questions from an MD

Post by SGM »

Aren't you above the limits if you combine the SEP-IRA and 401k totals?

I always contributed to an IRA even if it was not deductible.

The question regarding a Roth contribution vs. traditional IRA is what will be your tax bracket in the future. If you expect to have a long career then it is likely your tax bracket will not go down unless you move to a state with lower income tax rates. Your wife's tax rate will go up in retirement if you pre-decease her.

If you make back door conversions yearly, the taxes will be based on your total in IRAs. Maybe your 401k plan will allow transfers of your traditional IRAs into it.

I have never believed in keeping a lot in cash. Your $400,000 is earning nothing for you. When Vanguard looked at my assets they recommended having $0 in cash.

Can you hire your wife to increase the amount of tax deferred savings she has up to the limit of the SEP-IRA?

You can start sheltering money in a 529 right away. You and your wife could put in a total of $140,000 (5 years x 2 x $14,000)in for the benefit of your two year old and then again for the next child.

Children can have up to $2,000 in income without triggering the kiddie tax. Although gifts to them will need to be subtracted from the $140,000 limit for the 529. After 5 years you can again contribute to the 529 or gift them up to $28,000 per year in an UTMA.
placeholder
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Re: Roth questions from an MD

Post by placeholder »

Almost 50% net tax rate and you consider Roth 401k?
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iceman99
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Re: Roth questions from an MD

Post by iceman99 »

SGM wrote:Aren't you above the limits if you combine the SEP-IRA and 401k totals?

I always contributed to an IRA even if it was not deductible.

The question regarding a Roth contribution vs. traditional IRA is what will be your tax bracket in the future. If you expect to have a long career then it is likely your tax bracket will not go down unless you move to a state with lower income tax rates. Your wife's tax rate will go up in retirement if you pre-decease her.

If you make back door conversions yearly, the taxes will be based on your total in IRAs. Maybe your 401k plan will allow transfers of your traditional IRAs into it.

I have never believed in keeping a lot in cash. Your $400,000 is earning nothing for you. When Vanguard looked at my assets they recommended having $0 in cash.

Can you hire your wife to increase the amount of tax deferred savings she has up to the limit of the SEP-IRA?

You can start sheltering money in a 529 right away. You and your wife could put in a total of $140,000 (5 years x 2 x $14,000)in for the benefit of your two year old and then again for the next child.

Children can have up to $2,000 in income without triggering the kiddie tax. Although gifts to them will need to be subtracted from the $140,000 limit for the 529. After 5 years you can again contribute to the 529 or gift them up to $28,000 per year in an UTMA.
SGM,

Why lock funds into a Trad IRA if it is not deductible? To help create Bond space? Why not buy Tax-Exempt Bonds in taxable instead?

I don't think I can hire my wife. I am not incorporated.

Part of the $400,000 is from selling a condo last year. The cash is there for the eventual purchase of a new house. Not for longterm. Where would you put that money instead?

Already contributing to 529 at about $10,000/year.

As far as I know, our 401K plan does not allow transfers but I will ask.

Thank you for your responses.
toofache32
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Re: Roth questions from an MD

Post by toofache32 »

iceman99 wrote:
Tax Rate = 39.6% Federal; 9.3% State
State of Residence = CALIFORNIA
:shock:
SGM
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Joined: Wed Mar 23, 2011 4:46 am

Re: Roth questions from an MD

Post by SGM »

I put money in traditional IRAs when they were not deductible and Roth conversions were not possible or earlier were not even available. I was happy to have the traditional IRAs in 2010 when conversions became available to higher income folks. I also had income from 2010 not given to me until 2011 because of a glitch with Medicare. You might put money in traditional IRAs and later convert if you have a lower income year. Maybe if you choose to take some sort of a sabbatical?

As far as cash, I stay fully invested according to my long term plan. I don't worry about the ups and downs of the market particularly. When I have bought homes it was when the market was up and I sold positions with capital gains to pay for the homes. Vanguard suggested in my plan that the cash go into the total international fund. I don't know what is best but I stay fully invested. I would also own California muni bond funds. I bought some when they tanked a few years ago. Kids or their trusts can also be part owners of real estate.

I liked the S corporation form of business for several reasons. One was that I could higher my spouse and put a great deal of money into her 401k. The limits for the 401k were higher than for an unincorporated business. You are paying a lot in taxes so you might want to incorporate. Your wife has not reached the limit. An LLC taxed not as a corporation would allow her to have over 28K in a 401k. It Is higher yet for an S corp.

Why only 10k a year in a 529? You and your wife can gift a total of 28K to each child yearly. It can also be an estate planning tool as left over funds can be given to grandchildren or used by you or spouse for educational purposes.
JW-Retired
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Re: Roth questions from an MD

Post by JW-Retired »

Should my wife and I consider doing a backdoor Roth via the Trad IRA as a way to add some more “after-tax” investment to help control our future marginal tax rate in retirement?

How would a Backdoor Roth affect my current assets in the Trad IRA and SEP-IRA (as well as future contributions into the SEP-IRA?)
You should definitely do a "backdoor" Roth for your wife. Not sure if some of the tIRA money is hers but it isn't that much so I would just convert it. Then you can get at least her $5500 into her Roth yearly going forward.

Your own tIRA and the SEP are both considered to be part of your "IRA" for pro-rata taxes on any conversions to a Roth. See IRS form 8606. Could you replace your SEP with a personal 401k and move your SEP money to that? If so then you could be in a position to do the same yearly backdoor Roth too.
JW
ps: Once you are free of any pre-tax IRAs, the backdoor Roth is "tax-free" not "after-tax" investing. Much better. :)
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Zabar
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Re: Roth questions from an MD

Post by Zabar »

If you're only looking at current vs. future marginal tax rates, then a Roth doesn't make sense. However, a Roth gives you other advantages that you might consider worthwhile despite your current tax rate:

• You aren't required to take distributions at 70.5 y.o., which gives you greater ability to control your overall tax rate during retirement.

• You can provide a tax-free "stretch" IRA to a child or grandchild that takes incredible advantage of compound growth.

Whether these are appropriate to your situation is your decision.
niceguy7376
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Re: Roth questions from an MD

Post by niceguy7376 »

In your current employer 401k, how much is your employee contributions?
I dont know what the limit is for a combined employee 401k contributions and sep ira (employer) contributions per year basis.

For you to be eligible for backdoor roth conversion, you need to eliminate the trad ira and sep ira amounts to have any tax benefit. With your existing trad ira being non deductible contributions, i dont know how you can convert to roth type and what the tax situation is.

As for SEP, if you can open a solo 401k plan that allows rollovers from SEP, then you can move your SEP balance into it. BUT, with you already having a 401k plan at other company, you might not be able to contribute to solo 401k as employee and employer contributions will be limited to 20 or 25% of your salary. Thus, you need to calculate the benefit of this.

Does your spouse have 401k at her work? I did not see the mention of it. Contributing to 401k at her work place or through your solo 401k plan by making her an employee of your company will increase the pre-tax contributions of your family.
broadreach
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Re: Roth questions from an MD

Post by broadreach »

I am in a similar position and wondered for a long time whether the roth 401K was worthwhile. After considerable research and reviewing lengthy discussions on this forum, I came to the conclusion that the roth 401K was probably not worth the considerable up front cost of losing the tax benefit for a high income earner. In all likelihood there will be a time in your 60s after you retire before RMDs start at 70.5 where roth conversions might be possible at a lower tax bracket.

-The backdoor roth is however very worthwhile. As other posters have outlined, if you moved your tIRA and SEP-IRA to an individual 401K, then you could make yearly contributions to tIRA then convert to roth without any impact on fed taxes. My i-401K is at Schwab, which allows rollovers of SEP or tIRA.

-You are in a very high tax bracket with high state taxes, so everything you can do to minimize additional taxes helps: tax efficient investing. 529's for kids. ESA's for kids (you would need a UTMA for kids 1st then make ESA contribution from UTMA). Maybe small UTMA for kids. As noted above first $2K of income to kids is essentially free of fed taxes. You are already doing everything else right.

-Backdoor roth IRA for your spouse would be very helpful. However, I do not feel as strongly as other posters that employing your wife with your consulting income just to have a SEP-IRA (or SEP-401K) contribution for her would be that worthwhile. Here's why: you would have to pay self-employment taxes on her salary (~15%) in order to make the employer contribution. If, however, she has no employer plan where she works it might make some sense....but it is a bit of a hassle.

-Does your wife have any retirement plan at work? If so, she should max out her employee contributions to the 17,500 max. This would save considerably on fed and state taxes.
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White Coat Investor
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Re: Roth questions from an MD

Post by White Coat Investor »

iceman99 wrote:Hi everyone,

I have been a member of this forum for approximately 4 years and have learned a lot. A nagging question I ask myself is whether a Roth 401K and/or backdoor Roth is/are appropriate for my situation.

Here is my financial picture

41-year old salaried physician (Finished residency/fellowship by age 34)
Annual income – His: $600,000-750,000/yr Hers: $60,000/yr
Tax-filing status = married (with one 2-year old and one on the way)
Emergency funds/short term savings = $400,000 parked in an Ally bank account for possible downpayment on future house/other large expenses.

Debt =

1. Line of credit = $1,500 at 3.00%
2. Mortgage = $570,000 at 3.75% (15-year fixed with 10 years remaining). Home is worth probably about $1.1M
3. Credit card debt = $0
4. School loans = $0
5. Car loans = $0

Tax Rate = 39.6% Federal; 9.3% State
State of Residence = CALIFORNIA

Overall asset allocation 70% stocks/30% bonds (both taxable and retirement)
Stock allocation: 75% domestic/25% international

CURRENT PORTFOLIO

TAXABLE ($570,000) – Invest approximately $80,000-100,000/year

VCADX $70,000
VTIAX $160,000
VTSAX $340,000

2) RETIREMENT

401K
VWENX $330,000 – Invest approximately $43,000/year (my contributions + employer profit sharing)

SEP-IRA
VAIPX $117,000 – Invest approximately $16,000-18,000/year depending on consulting income

Traditional IRA
VEMAX $18,000 – Currently invest $0/year (no tax benefits)
VBTLX $14,500 – Currently invest $0/year (no tax benefits)

DEFERRED COMPENSATION PLAN
VTTVX $200,000 - Invest $84,000/year

I always try to invest about 25-30% of my annual income for the long term in addition to the 10% I set aside in the Ally account for large expenses. I don’t know if I will always be able to invest these amounts given the uncertainties in MD income and other life events but I try to aim for these percentages regardless of income.

Would investing into a Roth 401K (instead of the “regular” 401K) be a better idea at these tax rates?

Should my wife and I consider doing a backdoor Roth via the Trad IRA as a way to add some more “after-tax” investment to help control our future marginal tax rate in retirement?

How would a Backdoor Roth affect my current assets in the Trad IRA and SEP-IRA (as well as future contributions into the SEP-IRA?)

Thanks
Pretty awesome income, nice work.

If I were you, I'd be doing some pretty heavy Roth contributions/conversions. I'd do a personal and spousal backdoor Roth IRA, and make the employee contribution of any employer provided or solo 401(k)s as Roth contributions. You'll still have plenty of tax-deferred stuff each year, and it looks like taxable too.

In order to do backdoor Roth IRAs, you'll need to get rid of your SEP-IRA and traditional IRAs. You can either roll those into a 401(k), (avoiding the tax bill) or do Roth conversions with them, paying taxes with the money you would invest in a taxable account instead. I wrote a series of posts for high-income docs that I think you'd find useful. But concentrate on the part about Roth stuff.

http://whitecoatinvestor.com/financial- ... e-doctors/

Be aware that you're also highly likely to have an estate tax problem given your income and savings rate. Look into that earlier rather than later.

P.S. What's up with the $1500 debt?
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
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LAlearning
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Re: Roth questions from an MD

Post by LAlearning »

I think you've underestimated your CA tax rate...

You need to get rid of other tIRA and that SEP before you consider that road.
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retiredjg
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Re: Roth questions from an MD

Post by retiredjg »

iceman99 wrote:Would investing into a Roth 401K (instead of the “regular” 401K) be a better idea at these tax rates?
I cannot imagine any circumstance where Roth 401k would be a good idea for you. The whole idea behind deferral of taxes is to put taxes off until a time when you will be in a lower tax bracket. It seems to me that you will be very wealthy in retirement, but I can't imagine that you will still be in the 39.6% tax bracket. In fact, if you do things right, you could be in a very low tax bracket.

What I don't know is if you lose some of the benefit of deferring taxes because of the Alternative Minimum Tax (something I know almost nothing about). Nevertheless, I still can't imagine that Roth 401k would be good for you.
Should my wife and I consider doing a backdoor Roth via the Trad IRA as a way to add some more “after-tax” investment to help control our future marginal tax rate in retirement?
If she has no traditional, SEP, or SIMPLE IRA, the back door could be a good idea for her. Considering the amounts of money involved, I doubt it will ever amount to a very large percentage though.
How would a Backdoor Roth affect my current assets in the Trad IRA and SEP-IRA (as well as future contributions into the SEP-IRA?)
If you have assets in tIRA and/or SEP IRA, those assets would be pulled into the calculations for the tax on your conversion to Roth. You probably don't want to go there. If you could roll this money into a 401k, the answer would be different.

You seem to feel like you have no after-tax money, but your taxable account is largely after tax. And even the gains are not taxed at 39.6%. I would not worry to much about not having much in Roth. Well, yes, it would be nice, but...

One avenue you may not be aware of...after-tax contributions to 401k. This is not the same as contributing to Roth 401k. Have you heard of this?
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retiredjg
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Re: Roth questions from an MD

Post by retiredjg »

EmergDoc wrote:If I were you, I'd be doing some pretty heavy Roth contributions/conversions. I'd do a personal and spousal backdoor Roth IRA, and make the employee contribution of any employer provided or solo 401(k)s as Roth contributions. You'll still have plenty of tax-deferred stuff each year, and it looks like taxable too.
Are you talking about the $17,500 in elective deferrals going into Roth 401k instead of traditional 401k? That would surprise me, but it seems that is what you are saying.
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iceman99
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Re: Roth questions from an MD

Post by iceman99 »

retiredjg wrote:
iceman99 wrote:Would investing into a Roth 401K (instead of the “regular” 401K) be a better idea at these tax rates?
I cannot imagine any circumstance where Roth 401k would be a good idea for you. The whole idea behind deferral of taxes is to put taxes off until a time when you will be in a lower tax bracket. It seems to me that you will be very wealthy in retirement, but I can't imagine that you will still be in the 39.6% tax bracket. In fact, if you do things right, you could be in a very low tax bracket.

What I don't know is if you lose some of the benefit of deferring taxes because of the Alternative Minimum Tax (something I know almost nothing about). Nevertheless, I still can't imagine that Roth 401k would be good for you.
Should my wife and I consider doing a backdoor Roth via the Trad IRA as a way to add some more “after-tax” investment to help control our future marginal tax rate in retirement?
If she has no traditional, SEP, or SIMPLE IRA, the back door could be a good idea for her. Considering the amounts of money involved, I doubt it will ever amount to a very large percentage though.
How would a Backdoor Roth affect my current assets in the Trad IRA and SEP-IRA (as well as future contributions into the SEP-IRA?)
If you have assets in tIRA and/or SEP IRA, those assets would be pulled into the calculations for the tax on your conversion to Roth. You probably don't want to go there. If you could roll this money into a 401k, the answer would be different.

You seem to feel like you have no after-tax money, but your taxable account is largely after tax. And even the gains are not taxed at 39.6%. I would not worry to much about not having much in Roth. Well, yes, it would be nice, but...

One avenue you may not be aware of...after-tax contributions to 401k. This is not the same as contributing to Roth 401k. Have you heard of this?
I have heard of after tax contributions to the 401K but I do not believe our employer-sponsored plan allows this. I asked about it some time ago. I am not sure how much I could contribute anyway given that I put away $17,500 + the $26,000 from our profit sharing plan (total: $43,500). I could contribute an additional $5,500 in theory.
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iceman99
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Re: Roth questions from an MD

Post by iceman99 »

EmergDoc wrote:
iceman99 wrote:Hi everyone,

I have been a member of this forum for approximately 4 years and have learned a lot. A nagging question I ask myself is whether a Roth 401K and/or backdoor Roth is/are appropriate for my situation.

Here is my financial picture

41-year old salaried physician (Finished residency/fellowship by age 34)
Annual income – His: $600,000-750,000/yr Hers: $60,000/yr
Tax-filing status = married (with one 2-year old and one on the way)
Emergency funds/short term savings = $400,000 parked in an Ally bank account for possible downpayment on future house/other large expenses.

Debt =

1. Line of credit = $1,500 at 3.00%
2. Mortgage = $570,000 at 3.75% (15-year fixed with 10 years remaining). Home is worth probably about $1.1M
3. Credit card debt = $0
4. School loans = $0
5. Car loans = $0

Tax Rate = 39.6% Federal; 9.3% State
State of Residence = CALIFORNIA

Overall asset allocation 70% stocks/30% bonds (both taxable and retirement)
Stock allocation: 75% domestic/25% international

CURRENT PORTFOLIO

TAXABLE ($570,000) – Invest approximately $80,000-100,000/year

VCADX $70,000
VTIAX $160,000
VTSAX $340,000

2) RETIREMENT

401K
VWENX $330,000 – Invest approximately $43,000/year (my contributions + employer profit sharing)

SEP-IRA
VAIPX $117,000 – Invest approximately $16,000-18,000/year depending on consulting income

Traditional IRA
VEMAX $18,000 – Currently invest $0/year (no tax benefits)
VBTLX $14,500 – Currently invest $0/year (no tax benefits)

DEFERRED COMPENSATION PLAN
VTTVX $200,000 - Invest $84,000/year

I always try to invest about 25-30% of my annual income for the long term in addition to the 10% I set aside in the Ally account for large expenses. I don’t know if I will always be able to invest these amounts given the uncertainties in MD income and other life events but I try to aim for these percentages regardless of income.

Would investing into a Roth 401K (instead of the “regular” 401K) be a better idea at these tax rates?

Should my wife and I consider doing a backdoor Roth via the Trad IRA as a way to add some more “after-tax” investment to help control our future marginal tax rate in retirement?

How would a Backdoor Roth affect my current assets in the Trad IRA and SEP-IRA (as well as future contributions into the SEP-IRA?)

Thanks
Pretty awesome income, nice work.

If I were you, I'd be doing some pretty heavy Roth contributions/conversions. I'd do a personal and spousal backdoor Roth IRA, and make the employee contribution of any employer provided or solo 401(k)s as Roth contributions. You'll still have plenty of tax-deferred stuff each year, and it looks like taxable too.

In order to do backdoor Roth IRAs, you'll need to get rid of your SEP-IRA and traditional IRAs. You can either roll those into a 401(k), (avoiding the tax bill) or do Roth conversions with them, paying taxes with the money you would invest in a taxable account instead. I wrote a series of posts for high-income docs that I think you'd find useful. But concentrate on the part about Roth stuff.

http://whitecoatinvestor.com/financial- ... e-doctors/

Be aware that you're also highly likely to have an estate tax problem given your income and savings rate. Look into that earlier rather than later.

P.S. What's up with the $1500 debt?
I'll read up on your posts. Thank you.

The $1500 debt is from an old line of credit I had as a medical student. I always kept a balance because I didn't want the bank to take it away in case of an emergency. I think it's time to pay it off.
Bill M
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Re: Roth questions from an MD

Post by Bill M »

iceman99 wrote: Would investing into a Roth 401K (instead of the “regular” 401K) be a better idea at these tax rates?
Assume you are in a 50% tax bracket (Fed+State), and have $10K of income to invest (at age 41). Two choices are:

(a) $5K into a pre-tax 401k account, $2.5K into taxable account and $2.5K for taxes (50% of the $5K not put into 401k)

(b) $5K into a Roth 401k account, and $5K for taxes (50% of the entire $10K)

Now we leave the two accounts untouched, except for charging the taxable account 50% of its earnings each year to cover the taxes on the earnings for that year. After 30 years (at age 71) the marginal tax rate goes down to 25% and the balances are:

(a) the pre-tax account has grown by rate R each year, and the taxable account by R/2. Withdrawing the money from the pre-tax account reduces it by 25%. So available net worth is: 5000*((1+R)^30)*0.75 + 2500*(1+R/2)^30

(b) the roth account has grown by rate R each year, and all of it is available for tax-free withdrawal: 5000*(1+R)^30

Which is better? Depends on R, the rate of return on the investments. By my calculations, at 4.786% they are equal. If you get investment returns of 5% or better, the Roth alternative is better. If you get investments return of 4.5% or less, the pre-tax alternative is better.

Perhaps charging the taxable account 50% was unfair, since dividends get special treatment -- Fed 25% plus the net investment surtax of 3.8% plus state taxes. If we charge the taxable account only 35% to cover the taxes on the dividends, the breakeven point is an investment return of 6.982%; Roth alternative is better if your rate of return is 7% or better.
jasper
Posts: 127
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Re: Roth questions from an MD

Post by jasper »

same age and profession, nowhere near this income but my advice:

1) work on getting money into roth without doing a roth 401k, lots of ideas mentioned above on how to do this (but i agree the roth 401k makes no sense for you and is probably is not a good idea. a few of my partners go this route - roth 410k - but the numbers don't add up in our current environment. but also one of my partners has elected to go 100% in gold in his 401k, so better advice here in the forum than in the physician lounge). percentage wise (for your overall investments) for you it is peanuts how much you can put in there per year, but after 15-20 years of growth and when you hit early retirement (if you want) and rollover money into roth in low income years this will be a sizable chunk of money. it will be great for tax or estate planning

2) check the after tax 401k issue. none of my partners knew about this, HR did not know about this, but the 401k provider did and walked me through how to do this. do your due diligence. i am putting everything i can above 17000k into roth via this

3) look into a HDHP HSA. my job gives free money toward this, and i will not reiterate the virtues of an HSA here as i assume you know this. but with baby number2 on the way you would want to wait a year or two after birth for this. again, peanuts for how much you are saving but it will compound for a long time...
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retiredjg
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Re: Roth questions from an MD

Post by retiredjg »

I had a chance this morning to read EmergDoc's link regarding very high income earners. His point, as I understand it, is that someone earning close to $1 million a year (give or take) for a lot of years is probably going to be in the 39.6% tax bracket in retirement anyway. If that is the case, he believes there is no benefit in getting the tax-deferral now by using traditional 401k - because 39.6% paid today results in the same balance as 39.6% paid later.

Since this makes sense to me, I now think the concept of using Roth 401k deserves some consideration (in contrast to my earlier post).



So what would it take to be in the highest tax bracket in retirement? Today, it would be taxable income greater than $457,600 for a couple filing jointly. First, I suppose you'd have to consider whether you would actually want to draw more than $457,600 (to compensate for exemptions and deductions) a year from your nest egg. But even for folks who would not want to spend that much in retirement, RMDs do loom on the horizon at which point there may be no choice other than to draw more than you need or want from the nest egg.



Where does taxable income come from in retirement? What comes to my mind are
  • -dividends from taxable account (your first source of income since this money will be taxed even if you don't spend it)

    -capital gains if you sell anything in the taxable account,

    -withdrawals from 401k/IRA,

    -income from a SPIA, but I don't see any point in doing this

    -SS, but lets leave that out just for simplicity


Just to play with some money a little bit, how big would your taxable account have to be to produce $457,600 in dividends? If you had $22,880,000 in taxable paying out 2% in dividends, that would amount to $457,600. This amount seems like an unlikely scenario for the "average" very high income earner, so let's assume 4% in dividends. That's still a lot of money in taxable ($11,440,000).

But...dividends are not necessarily taxed the same as ordinary income. Qualified dividends would be taxed at 20%, not 39.6%. So just having a lot in taxable is not going to put most people into the category where dividends alone will make the difference. However, I don't know how the AMT works. Maybe dividends are taxed higher for income subject to AMT? I'm speculating - I have no idea.



Looking at capital gains....since long term capital gains are also taxed at the lower capital gains rate of 20% in this case (assuming enough taxable income to go over $457,600), that's not going to be the deciding factor here either.



What really does get my attention is whether a person could have enough money saved in 401k/IRA tax-deferred vehicles to make a big difference when AMT RMD time comes. I certainly agree that could push you up into a higher tax bracket. But all the way to the $457,600 mark? I don't do RMDs yet and I don't know just how much you have to take, but it seems like you'd have to have an awful lot in tax deferred accounts for your RMDs to push you that high.

Secondly, It seems to me that a high earner making $1 million a year won't have much more in 401k/IRA than a plain old high earner. The limits are the same for each.



Other things to consider.
  • -All income coming from a 401k/IRA is not taxed at the top rate. A person in the 39.6% bracket would have to have income of $457,600 before any money taken from the 401kIRA to be taxed at $39.6%. This does not seem likely to me.

    -You don't have to drop very far from $457,600 to be taxed at a lower rate. For a couple, below $457,600 is taxed at 35% (big savings there) and below $405,100 is taxed at 33% (a really big drop from 39.6%).

    -During the years following retirement and before RMD, if one lives on the taxable account (much of which is already taxed), Roth conversions can be made at much lower rates than 39.6%.

    -Everything changes with divorce (not unlikely), second marriage (fairly likely) or death of a partner.


So, while I agree with EmergDoc's thinking (39.6% now is the same money as $39.6% later), I am having trouble picturing how most very high income earners could actually be paying 39.6% later. Even if they are actually in the 39.6% bracket.

I'll be the first to admit that I just can't envision what happens with money and taxes when a person makes that much in a year. And I don't mean to be argumentative. I just can't see how EmergDoc's point works out in practice for this poster. But I hope that some of this discussion will help the original poster in figuring it out.

And for those who see something I've overlooked, please tell me what it is. :happy
Last edited by retiredjg on Mon Sep 01, 2014 9:10 am, edited 1 time in total.
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Re: Roth questions from an MD

Post by JW-Retired »

retiredjg wrote: So, while I agree with EmergDoc's thinking (39.6% now is the same money as $39.6% later), I am having trouble picturing how most very high income earners could actually be paying 39.6% later. Even if they are actually in the 39.6% bracket.
Agree. No way. I tried putting $0.5M and $1M RMD retirement incomes into TaxCaster for a MFJ age 70 couple. It gives federal taxes owed of 28% and 33.8% on these gross amounts.

If it is all from taxable dividends the tax is only 19.2% on a million bucks.
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Re: Roth questions from an MD

Post by retiredjg »

That's encouraging. However, EmergDoc is one smart guy, so I don't think he pulled his thoughts out of nowhere.

I think there is probably more to it than what I've thought of, but for now I'm still going to vote on the side of using traditional 401k over Roth 401k.
anil686
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Re: Roth questions from an MD

Post by anil686 »

bump for a response from emergdoc

same situation as the op (a few years younger) - have only done a traditional 401K but have option for Roth 401K - have not done it because of what the last few posters have said (at least that was my thinking since I only spend $10K per month now and I can see that going down in retirement).

Thanks for any insights

anil
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Re: Roth questions from an MD

Post by newpup »

I am a California MD in a similar situation. Although we don't know what future tax rates will be, the one constant is change. I have a hard time paying 50% tax now for Roth 401k contributions when I'm not sure where tax rates will be in the future, nor where I will be. California's highest tax bracket is now the highest in the US, and if you retire ANYWHERE else, you will likely have a lower rate on withdrawal. Also, all the current talk about tax reform seems to center around lowering rates and eliminating loopholes, which is good for highly-salaried employees with few available deductions. I am hoping that combined state and federal tax rates will be lower for me at retirement than they are now.

Another point: if tax rates go lower at ANY time before retirement, you may opt to do an in-plan Roth conversion of your pre-tax contributions if your plan allows it.

Hedge your bets with a backdoor Roth for yourself and spouse. Good luck.
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Re: Roth questions from an MD

Post by letsgobobby »

retiredjg wrote:I had a chance this morning to read EmergDoc's link regarding very high income earners. His point, as I understand it, is that someone earning close to $1 million a year (give or take) for a lot of years is probably going to be in the 39.6% tax bracket in retirement anyway. If that is the case, he believes there is no benefit in getting the tax-deferral now by using traditional 401k - because 39.6% paid today results in the same balance as 39.6% paid later.
This is only true if the pretax accounts grow at very high rates. But in many cases they will be bond heavy and therefore grow very slowly relative to inflation, and their future marginal tax rate will not be as high as imagined.

In the OP's case he's deferring about $145k per year which is about 2/3 of his annual contribution. If his asset location were split equally across accounts then the pretax accounts would be in a 70/30 mix and would increase at a (historic estimated) rate of maybe 4%, starting from about $680k in assets, which would be equal to $4 million (real) in his mid 60s. If he pulled 3% per year from that we have $120k per year. Throw in taxable income, capital gains, etc., and he'll easily be in the 28%+9% = 37% tax bracket. But that's a long way from 50%, where he is now. Furthermore, this seems a good argument for NOT placing assets equally across all accounts. If he kept his pretax accounts 50/50 and his taxable accounts 100% stocks (for instance), then the pretax accounts might grow closer to 3% real over 30 years, or only $3.4 million, for annual income of under $100k. This really isn't that high. Not enough to pass up a 50% tax break right now.

I agree with Jan.
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Re: Roth questions from an MD

Post by Artsdoctor »

Iceman,

First, your MARGINAL tax rates are different than our tax brackets described. The only way for you to understand how much tax you'd pay on converting to a Roth is to calculate your marginal rates.

Second, I would recommend that you not try a guess what federal and state rates might be in 25 years.

You can try plugging your personal numbers into a 2013 TurboTax program (or similar). Then you can see what happens when you try to convert.

I live in CA and understand your numbers. I would be very, very hard-pressed to recommend Roth conversions for you.
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Re: Roth questions from an MD

Post by iceman99 »

I think I'm leaning towards staying as I am with my investment strategy.

I can't imagine having an annual income > $450,000 in retirement unless I work like this until I'm 70! I always planned for something in the $200K range (gross) which roughly meant getting to $5-6M. Achievable in 10-15 years, I think, assuming income stays the same and my spending habits don't change too much.

Haven't even factored in Social Security...
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Re: Roth questions from an MD

Post by retiredjg »

iceman99 wrote:I think I'm leaning towards staying as I am with my investment strategy.
I hope this doesn't mean you aren't going to use the back door contribution to Roth IRA, at least for your spouse.
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Re: Roth questions from an MD

Post by iceman99 »

retiredjg wrote:
iceman99 wrote:I think I'm leaning towards staying as I am with my investment strategy.
I hope this doesn't mean you aren't going to use the back door contribution to Roth IRA, at least for your spouse.
I am going to do the backdoor Roth for my spouse. (It doesn't trigger a tax event for my SEP-IRA, correct?)
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retiredjg
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Re: Roth questions from an MD

Post by retiredjg »

iceman99 wrote:
retiredjg wrote:
iceman99 wrote:I think I'm leaning towards staying as I am with my investment strategy.
I hope this doesn't mean you aren't going to use the back door contribution to Roth IRA, at least for your spouse.
I am going to do the backdoor Roth for my spouse. (It doesn't trigger a tax event for my SEP-IRA, correct?)
Correct. Your SEP IRA does not affect her.
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Re: Roth questions from an MD

Post by Theory »

Great thread, another perspective:

Option 1: Benefits of Roth 401K option
*higher after-tax equivalent contribution (an after tax dollar goes further than a pre-tax dollar)- by ~9K now if in 50% marginal tax bracket now.
A) Increases asset protection
B) More $ to compound (however growth rate likely inadequate to compensate for forgone tax deduction of doing the Traditional 401k).
*Tax diversification in the event tax law changes favorably, esp. as employer contribution (unlike the employee contribution) to Roth 401ks are pre-tax rather than after-tax.

Option 2: Benefits of traditional 401K:
If 50% marginal tax bracket now & 25% bracket at retirement--> 9k after-tax saved now (can invest in taxable) compared to 18k*0.75=13.5K after tax at withdrawal. Net benefit of 13.5-9 = 4.5K saved (less any additional tax free growth in the Roth).

Savings in option 2 is quite small compared to the total amount saved, so going with the Roth (option1) for additional diversification may not be such a bad idea....
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Re: Roth questions from an MD

Post by Theory »

I think retiredjp's calculation is worth a closer look:

In emergdoc's thread at http://whitecoatinvestor.com/financial- ... e-doctors emergdoc argued that "for someone making $1 Million a year for several decades," it probably is NOT still true that this high income individual would be "withdrawing money at an effective tax rate far lower than their marginal tax rate at the time they put it into their retirement accounts." Emergdoc's argument there was that there is little “tax-rate arbitrage” and therefore investing in a Roth 401K is preferable in that situation.

Retiredjp's calculation above seems to contradict this assumption, even for the case of "someone making $1 Million a year for several decades." Retiredjp's back of the envelope calculations suggest that there would still remain a significant tax-rate arbitrage even for someone in this situation. One of the posters, Anil686, was interested in emergdoc's response to this. Did I miss his response in another thread perhaps?

Emerdoc is not only a great financial advocate but also a very sharp investor... the same could be said of retiredjp! I would also love to read emergdoc's response, thoughts and analysis of the accuracy of the calculations performed by retiredjp and his counter-conclusion.

(Thanks in advance emergdoc - love your blog!).
Last edited by Theory on Mon Sep 01, 2014 1:18 pm, edited 1 time in total.
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Re: Roth questions from an MD

Post by PoeticalDeportment »

I am surprised that so many answers can be given by so many financially savvy individuals when missing a key element: how long does this MD plan on working? That changes the answers to all of the questions being asked in a rather profound way.

If he retires in 10 years, he would benefit tremendously from the tax rate arbitrage of pre-tax contributions and he would not have an estate tax problem.
If he plans to work until age 70 (and not decrease his savings rate - which he has indicated he might), it would probably make sense to make some ROTH contributions and draw up an estate plan.

Using the excel future value function and assuming retirement age of 65 (5% for balanced portfolio, 24 years, annual contributions of $234,000, and present value of $1,249,500) - his total portfolio would be about 15 million, with 6 million in taxable. This is because his $400,000 is on the sidelines and earmarked for consumption - he could throw it in the mix though.

Maybe he will get more/less that 5% growth (nobody knows), work longer/shorter (even OP doesn't know for sure), save more/less per year (he can control). These answers all change the outcome quite a bit. If I were him I wouldn't start Roth 401k contributions though, especially if, as he has indicated, if he plans to save less in the future. If he can get rid of the TIRA/Sep IRA via rolling over into qualified plan he should start backdoor Roths.

He makes enough money that he could have serious tax problems in retirement and pay a lot of estate taxes... but he doesn't save enough money to clearly have those problems.

For the benefit of people not in medicine: The kind of procedures you have to do to make $750,000/year are not the kind of things I would ever let a 70 year old do to me.
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Re: Roth questions from an MD

Post by Theory »

Great point PoeticalDeportment, the duration of investment is a critical factor.

I think retiredjg's example along with yours illustrates that even at high income levels and historical returns - and with valuations and interest rates that would be optimistic - even for an income of 1M/year and a multi-decade time horizons, that Traditional 401K trumps the Roth barring estate considerations.

I found a tool that may help examine the impact of return and length of time:

Harry Sit created a Zoho spreadsheet at https://docs.zoho.com/sheet/published.d ... 37d6fddfc7
He describes how it may be used at http://thefinancebuff.com/roth-401k-for ... e-max.html

The spreadsheet default numbers appear to be outdated, but the tax rates and other assumptions can be modified to different situations. If I am using it correctly, it seems to support retiredjg's conclusions.
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