Just imagine <POLITICAL> and implementing the Fair Tax. Roth IRAs would become completely worthless, with Traditional IRAs being the best deal around. Or imagine a future of 60% marginal tax rates, which would make pre-existing Roth IRAs nirvana.
livesoft wrote:If you use real math and model your retirement expenses and taxes, then you will see whether the Roth 401k makes sense. It seems that it works if you are in a low tax bracket and you aren't really paying any taxes anyways. And it works for folks who work until they begin taking SS benefits and who have a pension.
I don't think it works for most people reading this forum. My numbers show that I am in the 33% marginal income tax bracket now, but my average tax rate is around 15%. In my retirement, my average tax rate will drop even more as I do not have a pension and have many years before drawing on SS. My expenses will be paid by return of capital (not taxed), long term capital gains (tax favorably), and qualified dividends (also tax favorably). The first several thousand dollars of my income will be in the 0% tax bracket. I will be able to rollover my 401(k) to traditional IRA from where I will convert portions of it to a Roth IRA over decade or so. Modelling suggests that I will pay between 5% and 10% tax on that money.
So which tax rate would you rather pay 33% or 5%?
For folks who will have a pension that puts them in the 25% tax bracket from the first day they retire, then perhaps a Roth401k makes sense.
allenmickers wrote:This model works great if the 5,000 page IRS tax code which has historically changed every since since its inception almost 100 years ago, stays exactly the same for the next 100 years.
livesoft wrote:This is not rhetoric: The Roth 401(k) serves to confuse folks and probably costs them real money in the long term.
allenmickers wrote:One large previously unmentioned advantage to the Roth for me personally, is that I know exactly how much money I have for retirement. The number in my account, is the number I have. I dont have to estimate tax costs or anything else. This is why I refuse to buy any funds that have an exit cost like VEIEX emerging markets. I want to know exactly how much I have.
Audience Member: Do you foresee a change in tax policies and how do we prepare for them? Will 15% tax on dividends disappear in 2010? Will that cause an adverse impact on high-yielding stocks? Why didn’t the reduction in the dividend tax rate cause high-yielding stocks to move much higher?
A. Sue Stevens: Tax rates will go up. Do the Roth IRA conversion when you can. Currently, capital gains rates are low and they will go up.
A. Mel Lindauer: I agree. I expect that the rates will go up.
A. Rick Ferri: There will be innovations in financial markets to reflect what is happening in Washington. There are, for example, ETN, or Exchange Traded Notes. They guarantee market return, including dividends, but they do not distribute dividends; you only pay capital gains when you sell. Depending on what the Congress does, different vehicles will be more attractive. If dividends get taxed higher, people will be buying more ETNs. In fact, there will be different results, depending on whether capital gains or dividends (or both) will be taxed higher.
A. Dr. Bernstein: Roth conversion is one of the most painful and most useful things to do.
A. Taylor Larimore: A good time to convert to Roth is during the low-tax period after one retires and before one starts collecting Social Security or receiving Required Minimum Distributions (RMD).
A. Mel Lindauer: I retired early and have been converting from Traditional IRA to Roth for a number of years. I cannot say that I am in the lowest tax bracket, but at the age of 70.5, when my mandatory distributions start, my tax bracket will be even higher.
A. Laura: In 2008, there will be a special window where those in a low tax bracket (15%) will not be paying taxes on capital gains. One could sell equities, wait for 30 days and buy them right back. It is also a good way to get out of bad investments.
dphmd wrote:One other advantage to Roth accounts (I assume this is the same for 401k's as it is for IRA's, anyway) is that there are no MRD's.
EmergDoc wrote:An interesting article for those who actually have the opportunity to make this decision. More interesting than the article, is this comment posted afterward, which I believe is correct.
I do not agree with the statement that the Roth and the 401K are mathematically equivalent (assuming tax rates stay the same). The roth 401K is taxed at your current marginal tax rate, say 25%. The traditional 401K is taxed upon withdrawal and is likely to be the majority of your income during retirement (maybe some social security also). That means the tradional 401K will be essentially taxed at an effective tax rate. Under the current tax structure, the maringal tax rate for a single person earning up to $77100 is 25%. For that same person to have an effective tax rate of 25%, their income would have to increase to ~$165,000. Unless your income is going to increase drastically over your career, the traditional 401k is likely your best bet.
Posted By Jeff, Greensboro, Nc : March 4, 2008 9:51 am
What do you think?
I liked the idea of contributing YOUR contributions to the Roth and the match to the traditional (as is required) as a way of hedging your bets. Plus that allows you to put more after-tax money into a tax-protected investment, for those of us able to max it out. But I am hesitant when I think about the fact posted by Jeff above.
http://asktheexpert.blogs.money.cnn.com ... n=money_pf
Apologies if this has been posted already. Please post a link to that thread if it has.
mptfan wrote:Redbeard, that is simply wrong. Let's assume you are currently retired, and you withdraw $50,000 this year from tax deferred accounts to fund your retirement. (This figure is close to the average household income) Let's also assume you have no other income sources, either because you retire before you are eligible for social security, or, you have elected to delay taking social security to get higher benefits in the future. Let's also assume that you are married, and you have no tax deductions or credits other than the standard deduction. Here is what your taxes would be:
Gross Income: 50k
Standard Deduction: 10.9k
Personal Exemptions: 7k
Taxable Income: 32k
Effective (Avg) tax rate: 8%
Marginal Tax Rate: 15%
As you can see, the effective or average tax rate on the funds that you withdrew is 8% (4k/50k), even though you are in the 15% marginal tax bracket.
By contrast, if you earn the same income while working (50k), when you defer income into a tax deferred plan (401k, etc) while working, you save taxes at your marginal tax rate, which is 15%. So, you save 15% in taxes for every dollar that you contribute to a tax deductible account, and when you retire, you pay 8% in taxes for every dollar you withdraw from that same account. Seems like a good deal to me.
mptfan wrote:redbeard, I don't know where to begin. You are so confused that you don't realize that you are confused.
Your examples are hoplelessly flawed and prove nothing.
First, my scenario did NOT assume a higher marginal rate in retirement. I explicitly assumed that someone had the same income (50k) before and after retirement, and I explicitly assumed that the current tax rates apply and used 15% as the marginal tax rate in both cases.
Second, in your example you assume a present marginal tax rate of 20%, and yet no such marginal tax rate exists. The current tax brackets are 0%, 10%, 15%, 25%, 28%, 33%, and 35%.
Third, the annual rate of return on invested funds is irrelevant to this analysis. We are comparing the taxes saved while working to the taxes paid in retirement.
Fourth, you "assume" a future average tax rate of 15%, but you don't explain how you came up with this number. In my example, I showed exactly how I came up with the average tax rate of 8% in retirement, and you haven't disputed it.
mptfan wrote:redbeard, you are getting lost in your own calculations, and you have overlooked a very important point....
In your Scenario 1, you forgot that the initial investment of $7,432.18 into the IRA is tax deductible at the marginal tax rate of 15%. Therefore, when you make the intial investment, you immediately save $1,114.82 off of your income tax liability (15% of $7,432.18 ). You failed to account for this tax savings in any of your calculations. So, you save 15% when you make the contribution, then you only pay 8 or 9% tax on the money withdrawn from the very same account when you make the withdrawal. Pretty good deal, huh?
redbeard wrote:Tax: $4,815 (you have this as $4,018, but I assume that is a typo)
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