In 39% Tax Bracket does a Roth make sense?

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PatrickJoseph
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In 39% Tax Bracket does a Roth make sense?

Post by PatrickJoseph » Thu Mar 19, 2015 7:15 pm

Trying to decide if in the 39% tax bracket does a roth make sense? Im 37 yrs. old and will not need to access contributions until age 70 so about 30 yrs. In the 39% bracket I feel that it makes more sense to not elect roth in my 401k. At this tax bracket I lose almost half the invested amount up front as opposed to not doing a roth. Just looking for other thoughts...maybe I am missing something. Anyone know of a good roth vs. regular calculator that takes into account your tax rate too?

sawhorse
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Re: In 39% Tax Bracket does a Roth make sense?

Post by sawhorse » Thu Mar 19, 2015 7:17 pm

Is this a Roth 401k or a backdoor Roth IRA?

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mhc
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Re: In 39% Tax Bracket does a Roth make sense?

Post by mhc » Thu Mar 19, 2015 7:35 pm

Your analysis is correct. Doing a Roth 401k does not make sense because of your marginal tax rate. It is quite likely you will be able to keep your marginal tax rate below that in retirement, especially if you retire early.

sawhorse
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Re: In 39% Tax Bracket does a Roth make sense?

Post by sawhorse » Thu Mar 19, 2015 7:38 pm

If it's a Roth 401k, then absolutely not. It's hard to imagine that you'll be at an even higher bracket when you retire, and if you are, then money won't be an issue anyway.

madbrain
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Re: In 39% Tax Bracket does a Roth make sense?

Post by madbrain » Thu Mar 19, 2015 7:56 pm

IMO, no, it doesn't make sense - the only exception is if you believe overall tax rates will significantly go up over time. But I wouldn't take that bet.

NightFall
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Re: In 39% Tax Bracket does a Roth make sense?

Post by NightFall » Thu Mar 19, 2015 8:02 pm

Depends. If your choice is between Roth and non-roths accounts, I'd say don't do the Roth. However, if your choice is between Roth and keeping the money in taxable (like the decision as to whether or not to do a backdoor Roth), then definitely Roth. You've already paid the taxes in that case. The question is just do you want to keep paying taxes on the gains or not.

madbrain
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Re: In 39% Tax Bracket does a Roth make sense?

Post by madbrain » Thu Mar 19, 2015 8:39 pm

NightFall wrote:Depends. If your choice is between Roth and non-roths accounts, I'd say don't do the Roth. However, if your choice is between Roth and keeping the money in taxable (like the decision as to whether or not to do a backdoor Roth), then definitely Roth. You've already paid the taxes in that case. The question is just do you want to keep paying taxes on the gains or not.
Op said it was about electing Roth in the 401k - presumably this is a choice between regular pre-tax 401k and Roth 401k .

Between taxable and backdoor Roth, it's not necessarily as clear cut. Muni bonds can be a good option in taxable for avoiding taxes.
Of course, OP is in a 39% bracket and probably afford to do both backdoor Roth and muni in taxable. I am in a lower tax bracket and this is what I do.

ralph124cf
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Re: In 39% Tax Bracket does a Roth make sense?

Post by ralph124cf » Thu Mar 19, 2015 8:53 pm

At your current tax bracket, Roth makes no sense.

If at some point you lose your job, or for some other reason your income goes down substantially, then would be the time to convert from a traditional to a Roth account. If you retire early and you can chose to have a lower taxable income for a few years, while drawing on resources that have already been taxed, then you could convert to Roth at a lower tax rate.

Ralph

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PatrickJoseph
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Re: In 39% Tax Bracket does a Roth make sense?

Post by PatrickJoseph » Thu Mar 19, 2015 10:25 pm

Thanks for the replies. :sharebeer This would be a 401K with the ability to elect Roth. Looks like not electing Roth is the way to go. I agree about having the window opportunity to convert to roth when in a lower tax bracket. I do fully expect to be in a lower tax bracket when retired.

wfrobinette
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Re: In 39% Tax Bracket does a Roth make sense?

Post by wfrobinette » Fri Mar 20, 2015 12:49 pm

at 39.6 tax bracket your lucky you don't fall victim to the HCE issue.

I'm only in the 33% but can only get 4% into the 401k because of the HCE testing. NO roth and no deductible IRA. The only thing the save me is the deferred comp match at 50% of the first 10% I put in.

Put in a trad 401k to the max if you can.

alex_686
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Re: In 39% Tax Bracket does a Roth make sense?

Post by alex_686 » Fri Mar 20, 2015 1:01 pm

PatrickJoseph wrote:Anyone know of a good roth vs. regular calculator that takes into account your tax rate too?
This is not one because one does not need a calculator to figure this out. The Trad and Roth IRA will result in exactly the same returns. The math work out the same for both types. However, if you make 2 assumptions.

1, you invest exactly the same amount after tax in both. i.e. a $1,639 contribution in a Trad is the same as a $1000 contribution to a Roth, after factoring in the 39% tax rate.

2, you must assume that you will have the same tax rates. That is, your tax rate will be at 39% when you are 70. If you belive you will be in a lower tax bracket in the future it always makes more sense to contribute to a Trad. If you think you will be in a higher bracket it always make sense to invest in the Roth.

NightFall
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Re: In 39% Tax Bracket does a Roth make sense?

Post by NightFall » Fri Mar 20, 2015 1:30 pm

madbrain wrote: Between taxable and backdoor Roth, it's not necessarily as clear cut. Muni bonds can be a good option in taxable for avoiding taxes.
Of course, OP is in a 39% bracket and probably afford to do both backdoor Roth and muni in taxable. I am in a lower tax bracket and this is what I do.
This is off topic from the OP's original question, which has been answered many times already. However, I don't see how roth vs taxable is not clear cut. True, muni's aren't taxed. However, a bond fund in ROTH should produce a higher return all other things being equal. If not, you can put a muni in your ROTH (usually not advisable due to the previous point). The only difference in my mind between ROTH and taxable (besides some restrictions prior to FRA) is no taxes vs taxes in the future.

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Electron
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Re: In 39% Tax Bracket does a Roth make sense?

Post by Electron » Fri Mar 20, 2015 2:56 pm

In the 39.6% bracket, investing in a traditional 401K with the upfront tax savings is the best choice. Just make sure that the tax savings are invested and not spent.

When it comes time to withdraw from the account and pay taxes, that upfront tax savings will cover at least a portion of the taxes due.
Electron

inbox788
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Re: In 39% Tax Bracket does a Roth make sense?

Post by inbox788 » Fri Mar 20, 2015 4:30 pm

Rarely. I don't think anyone has mentioned the conditions necessary for this to make sense. I will first restate the obvious cases where it does and doesn't make sense.

1) Have you exhausted all your other tax advantage space, and this is additional tax advantage space in Roth? (i.e. Backdoor Roth)
YES! it makes sense.
2) You are reducing tax deferred space (IRA/401k) and you expect to be in a somewhat lower tax bracket at retirement when you withdraw funds.
NO, just keep tax deferred
3) You have maxed out tax deferred space, but can use Roth to expand the tax advantaged space and you expect same or higher tax bracket in retirement. (Roth can expand tax advantaged space because you're using post-tax dollars vs pre-tax dollars)
YES, this is the rare situation.

Say you have $50,000 to invest, but only $30,000 in tax advantaged space. Your choices are:
A) Pay 40% tax now, invest $30,000 in Roth. Gains are tax free
B) Invest $30,000 in 401k, pay 40% taxes later. Pay 40% taxes on $20,000, so $8,000 and invest remaining $12,000 in taxable.

Roth 401k (.6) Taxable (.8)
invested $30k $30k(18k) $12k
gain 100% $30k $30k(18k) $12k ($9.6k)

I'm guessing in this example a 5% reduction in taxes at withdrawal is about break even.

Also, this assumes there isn't any concern about inheritance and basis step ups, which favors tax deferment.

Another factor is state tax, and whether you move from a high state income tax to low income tax or no income tax state or in reverse.

chessmannextmove
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Re: In 39% Tax Bracket does a Roth make sense?

Post by chessmannextmove » Fri Mar 20, 2015 5:01 pm

sawhorse wrote:If it's a Roth 401k, then absolutely not. It's hard to imagine that you'll be at an even higher bracket when you retire, and if you are, then money won't be an issue anyway.
Agreed

toto238
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Re: In 39% Tax Bracket does a Roth make sense?

Post by toto238 » Fri Mar 20, 2015 5:10 pm

Here are the circumstances that might warrant doing SOME Roth:

You don't have any Roth assets already.
You are retiring very soon within a year or two.
You are very uncertain what your tax rate will be in retirement.
You are very averse to tax risk, and want to eliminate it as much as possible.

If all of these are true, it might make sense to put SOME in Roth. Not everything though. The advantage this would have is if tax rates went through the roof you'd have a small reserve to access to give you some flexibility in your spending in retirement. What you are doing is expected to have a negative return, but you're ok with that because you're insuring yourself against the risk of taxes skyrocketing.

The bottom line is that tax risk is a very real thing, but it's usually one of the smaller risks that Bogleheads worry about. Maybe tax rates will increase in the future, maybe they won't. But today's tax rates are the best estimate we have of what future tax rates will be. You can reduce tax risk by putting more in a Roth, but it is my opinion that in your situation you would be paying a very steep price to gain just a tiny bit of security. You would have to be in a very precarious situation in which you can't afford any shocks at all to your retirement plans.

Bottom line: Doing Roth would be illogical and I don't recommend it. However, you're probably making enough that you could do it anyway and still be perfectly fine. If it helps you sleep better at night, you'll probably do just fine either way.

cbeck
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Re: In 39% Tax Bracket does a Roth make sense?

Post by cbeck » Sat Mar 21, 2015 4:45 am

No one has mentioned the estate planning implications of a Roth. In general, the value of a Roth depends on the lifespan of the Roth account itself. Most discussion focuses on the owner's life span, but if there are to be heirs it changes the picture. The value of the Roth also depends on the rate of return, the tax rates, now and in the future. It is not enough just to compare current with expected tax rate in retirement. The OP doesn't mention dependents so perhaps this doesn't apply to him, but if he had, say, a younger wife and/or young children the tax-free feature for both spouse and children and the RMD-free feature for the spouse might mean the Roth is still feeding some family member tax-free more than 50 years from now.

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loves2read
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Re: In 39% Tax Bracket does a Roth make sense?

Post by loves2read » Sat Mar 21, 2015 11:54 pm

That aspect of the Roth account was a significant factor in our decision to convert my small IRA and my husband's larger one--even though we are in high brackets.

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Electron
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Re: In 39% Tax Bracket does a Roth make sense?

Post by Electron » Sun Mar 22, 2015 4:50 pm

The Roth IRA does have valuable benefits in regards to estate planning. The taxes paid in doing a Roth Conversion can lower the taxable value of one's estate. Holding a Roth IRA rather than a Traditional IRA also lowers MAGI possibly lessening the impact of the new Medicare Investment Income tax and any Medicare Part B and Part D surcharges.

In regards to heirs, a Roth IRA can be a very nice tax-free gift to children and grandchildren even though it would now be subject to RMDs. It may be best to do Roth Conversions in retirement when in a lower tax bracket. Keep in mind that budget related legislation has been proposed that could impact IRAs in a number of different ways if passed. That would be another reason to wait until retirement. There could be an impact on the stretch IRA which currently provides a significant benefit to heirs.
Electron

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