To Roth or not?

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thealchemist
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To Roth or not?

Post by thealchemist »

Hi,

I am currently a graduate student and relatively new to investments. I have managed to save up some money and have invested in few stocks and mutual fund and the ubiquitous online savings account.

I am trying to weigh as to if its time to have an IRA account or not? I am 25 years old, single and will be moving to the bay area this year end ... don't know if this helps to answer this question. I am currently in the 15% tax bracket.

Of course, after being exposed to this forum (found it recently), I am thinking strongly about investing in index funds and such. Any advise will be helpful. If more information is needed, please let me know.

Thanks in advance.

The Alchemist
mizz401k
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Post by mizz401k »

As long as you have earned income, it's probably to your advantage to fund a Roth IRA - $4,000/yr. Since you are at such a low tax bracket, you really don't have a significant incentive to get a tax break today with a deductible IRA. There's a very good chance you will be at a higher bracket later in life. Many years of tax free growth should work to your advantage (assuming you have many years until you retire).

There are lots of experts on this forum who can expand on this recommendation and provide you additional guidance.
PatrickS
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Post by PatrickS »

If you don't have any access to a 401k plan with some kind of company match, than a Roth IRA makes perfect sense.

Keep in mind that you have to have the income for the year to contribute to it. If you earned only $500 in the year, you can contribute up to $500 for the year to a Roth IRA. You can't add any more from existing savings.
Pangloss
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Roth

Post by Pangloss »

I opened a Roth IRA several years ago while I was in grad school, and it was definitely the best decision for me. I had a roommate and watched expenses and was actually able to save a bit (thanks to my stipend) and be in school at the same time. You might want to consider the Vanguard Target Retirement funds. Good luck with your decision.
mptfan
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Post by mptfan »

Some people propose the following order of priority for retirement savings:

1. Defer up to whatever amount your employer will match. (it's free money)
2. Fully fund a Roth, if eligible.
3. Defer the maximum in your employer sponsored pretax plan.
4. Invest in taxable accounts.

I disagree with this advice. I think you should follow the following order:

1. Defer the maximum that you can in any pretax plan you have access to.
2. Fully fund a Roth, if eligible.
3. Invest in taxable accounts.

There are good arguments for both strategies.
user
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Post by user »

the lower your tax bracket, the more valuable a Roth IRA is. at 15% bracket i would DEFINITELY go ahead and open one.

since you will not have much at first in your IRA i would recommend choosing one of Vanguard's Target Retirement funds for your money.
Mordoch
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Post by Mordoch »

mptfan wrote:I disagree with this advice. I think you should follow the following order:

1. Defer the maximum that you can in any pretax plan you have access to.
2. Fully fund a Roth, if eligible.
3. Invest in taxable accounts.

There are good arguments for both strategies.
This is simply flat out bad advice for someone in his situation. He's clearly a younger individual in the 15% tax bracket, where there is actually a strong possibility his tax rate will be HIGHER in retirement so if anything tax deferred might be a bit of a negative. The Roth IRA also gives him much more flexibility if he does need to draw upon it early if necessary, such as buying his first home. On top of this he probably will have better investment options with lower expense ratios if he picks the right option for his Roth IRA plan such as through Vanguard. Up to a 401K match is one thing, going beyond that and ignoring the Roth IRA is simply a bad idea for someone in his situation.
mptfan
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Post by mptfan »

Mordoch wrote:
mptfan wrote:I disagree with this advice. I think you should follow the following order:

1. Defer the maximum that you can in any pretax plan you have access to.
2. Fully fund a Roth, if eligible.
3. Invest in taxable accounts.

There are good arguments for both strategies.
This is simply flat out bad advice for someone in his situation. He's clearly a younger individual in the 15% tax bracket, where there is actually a strong possibility his tax rate will be HIGHER in retirement so if anything tax deferred might be a bit of a negative. The Roth IRA also gives him much more flexibility if he does need to draw upon it early if necessary, such as buying his first home. On top of this he probably will have better investment options with lower expense ratios if he picks the right option for his Roth IRA plan such as through Vanguard. Up to a 401K match is one thing, going beyond that and ignoring the Roth IRA is simply a bad idea for someone in his situation.
Mordoch, you may not agree with me, but I think it's unfair to call it "simply flat out bad advice." I admitted that there are good arguments to support your view, but apparantly you are not either open minded or informed enough to understand the good arguments to support my view.
user
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Post by user »

mptfan wrote:
Mordoch wrote:
mptfan wrote:I disagree with this advice. I think you should follow the following order:

1. Defer the maximum that you can in any pretax plan you have access to.
2. Fully fund a Roth, if eligible.
3. Invest in taxable accounts.

There are good arguments for both strategies.
This is simply flat out bad advice for someone in his situation. He's clearly a younger individual in the 15% tax bracket, where there is actually a strong possibility his tax rate will be HIGHER in retirement so if anything tax deferred might be a bit of a negative. The Roth IRA also gives him much more flexibility if he does need to draw upon it early if necessary, such as buying his first home. On top of this he probably will have better investment options with lower expense ratios if he picks the right option for his Roth IRA plan such as through Vanguard. Up to a 401K match is one thing, going beyond that and ignoring the Roth IRA is simply a bad idea for someone in his situation.
Mordoch, you may not agree with me, but I think it's unfair to call it "simply flat out bad advice." I admitted that there are good arguments to support your view, but apparantly you are not either open minded or informed enough to understand the good arguments to support my view.
you call him close minded and uninformed, but you never provided any argument whatsoever to support your view. i think we could do without the personal attacks in any case.
Mordoch
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Post by Mordoch »

mptfan wrote: Mordoch, you may not agree with me, but I think it's unfair to call it "simply flat out bad advice." I admitted that there are good arguments to support your view, but apparantly you are not either open minded or informed enough to understand the good arguments to support my view.
Frankly you need to explain your view then, because it certainly comes across to me as unreasonable in this case. With a 15% tax rate and the fact he's conscientious enough to begin saving at such an early age, its exceedingly probable he'll be looking at a higher tax rate in retirement. This is before you even get into the greater flexibility of a Roth IRA plan with early withdraws and avoiding the 10% penalty from withdrawing from a 401K among other things.

There are some key details in how Roth IRAs are set up which make them effectively politically untouchable as far as the possibility of taxing them in the future goes, (the really rich don't generally benefit from Roth IRAs much) so I really have a hard time seeing how your argument will work in this particular case.
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spangineer
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Post by spangineer »

Definitely fund the Roth. For someone in your tax bracket, the only thing to fund before the Roth would be a company match on a 401(k), but as a grad student you don't have that.

I'm a grad student too, and started a Roth last year with Vanguard with the TR2045 fund. It's an easy way to get started, and once several years of contributions have built up, you can start tweaking the asset allocation. At this point though, the most important thing is to save your money in a place where you won't have to pay any more taxes.

Regarding Roth vs. Traditional, remember that the value of a Roth contribution is higher than that of a traditional contribution--you're allowed to put in $4000 into each, but since you haven't paid taxes on the traditional contribution yet, it's not worth as much to you once it's in there. So if you have the money and need a tax-sheltered place to put the money, put it in the Roth. The only case in which it might be a good idea to do traditional instead is if you 1) don't have $4k after-tax, 2) need all the money you can get right now, and 3) expect to pay lower taxes when you retire (extremely unlikely).
mptfan
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Post by mptfan »

Allow me to offer support for my view that it is generally better to contribute to a tax deferred plan before investing in a Roth. For starters, I prefer to get a tax deduction now, as opposed to waiting many years, perhaps decades before getting the tax deduction, if ever. Therefore, I think it is better to fully fund tax deferred retirement accounts before contributing to a Roth IRA.

Here is why I think that:

1) Almost everyone will die with some money. Some will die with a great deal of money, especially those of us who plan carefully and consider safe withdrawal rates. I have even heard some suggest that they do not plan on touching their principal during retirement, and some have stated that they continue to be net savers even after retirement. Therefore, given the fact that we will likely die with some significant amount of money left over, we will never have to pay taxes on that chunk of money which was tax deferred. Our heirs will have to worry about paying the deferred taxes on that money. So, I much rather save the taxes now, allow my money to grow tax free, and defer a significant chunk of that tax liability beyond my grave to my heirs.

2) I expect my fixed expenses in retirement to be lower than they are now (no mortgage, no tuition bills or other child related expenses, no car payments, no work related expenses), so I will be in a position to regulate my income and only take out what I need up to a given tax bracket. If I want to live a more extravagant lifestyle and withdraw money into the higher tax brackets, so be it, I will have that choice. To that extent, and to that extent only, the Roth may prove to be a better choice in the future, but that does not prove that a Roth is better choice as the first option for my investment money now.

3) By contributing to tax deferred plans, I can reduce my current AGI down to below the threshold at which I can fully take advantage of certain tax credits, such as the child tax credit. If I did not fully take advantage of my deferred plan (and instead contribute to a Roth), my AGI would be correspondingly higher, and I would lose some tax credits, or, the amount of certain tax credits would be reduced.

4) While I agree with the consensus that tax rates will likely be higher in the future, I think it's somewhat naive to have faith that congress will never tax Roth withdrawals, no matter how desperate our government may be in the future for tax revenue. There is a lot of tinkering that can be done in the future, such as reducing the eligibility to take tax free withdrawals, limiting the amount of annual tax free withdrawals, etc. It can (and I think it will) happen.

I do not intend to attack anyone personally, but I would ask that you consider my specific reasons for my views before rejecting my advice outright.
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thealchemist
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Post by thealchemist »

Thank you for the responses thus far. The confusion in my mind mirror the views reflected. (Especially the part about taxing the Roth IRA in future!)

My current tax bracket is the lowest and I am surely going to be in a higher tax bracket as time goes on (and in retirement). This has so far prevented me from putting money in a traditional IRA. That is a different matter that I bumped into the concept of a IRAs while doing my taxes this year.

I currently do NOT have a 401(k) accessible plan. But I do plan to invest in 401(k) when I start working and contribute up to the company match and at the same time try to invest regularly. Like Pangloss and Spangineer, I have been able to save up some money every month from my stipend. My philosophy has been to pay up my bills before thinking about savings and/or investing.

About being able to access the money in Roth IRA, Wikipedia entry says:
"At any time, the IRA owner may withdraw up to the total of his contributions (in nominal dollars)."

Now assuming I put $4000 every year, I can withdraw up to $20K after a period of 5 years but not the additional money as a result of the growth. Am I right in saying this? Or am I missing something here?
ohiost90
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roth or not

Post by ohiost90 »

good conversation here. I'll add my 2 cents. I think everyone would agree that it is a good thing to diversify your investments assets.
Well why not diversify your tax exposure of those assets? Nobody really knows if they will be in a higher or lower tax bracket in the future.
hell, nobody really knows what the brackets will be in the future. So a diversified tax strategy seems to be very prudent.

Hence, I would agree with the advice of 401k to match, full roth, 401k to max, taxable.
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Nosferatu
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Post by Nosferatu »

thealchemist wrote:
Now assuming I put $4000 every year, I can withdraw up to $20K after a period of 5 years but not the additional money as a result of the growth. Am I right in saying this? Or am I missing something here?
You are right. You can withdraw your principal without penalty. The gains you can't touch.
Topic Author
thealchemist
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Post by thealchemist »

Another doubt relating to Roth:

Since I am not participating in any employer-sponsored plan and my AGI is less than $50,000, I can make my contributions tax-deductible. As clarified earlier, one can withdraw the principal without penalty.

So, in principle, I can:
(a)contribute $4k for 2006,
(b)get tax deduction, and
(c)withdraw $4k without any penalty.

I am sure I am missing something, so please pardon my ignorance.

The Alchemist
Nitsuj
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Post by Nitsuj »

Roth contributions can be withdrawn, not Traditional IRA (i.e. Tax deductible) IRAs
ohiost90
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Post by ohiost90 »

thealchemist wrote:Another doubt relating to Roth:
So, in principle, I can:
(a)contribute $4k for 2006,
(b)get tax deduction, and
(c)withdraw $4k without any penalty.

I am sure I am missing something, so please pardon my ignorance.

The Alchemist
Roth IRA can be withdrawn w/o penality. Traditional IRA are tax deductable. You are mixing the two together.

see link for a comparision of the two.

https://flagship.vanguard.com/VGApp/hnw ... ontent.jsp
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Doc
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Mptfan, style

Post by Doc »

Mptfan, In your initial post you wrote.
I disagree with this advice. I think you should follow the following order:
Mordoch challenged your idea and said why. While he was blunt he attacked the idea not you personally. Later you responded with a personal attack.

Later you clarified your point.
Here is why I think that:
You now make some good points in support of your position. Most of them don’t apply to the graduate student in the 15% bracket but at least we can now make an informed judgment regarding your advice.

For a young person in the 15% bracket without access to a matched employer plan the ROTH is probably the better choice. Other posters have elaborated on the reasoning.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
Topic Author
thealchemist
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Post by thealchemist »

Thanks ohiost90. That link helps. I got confused in the documentation I was reading on IRAs.

The Alchemist
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spangineer
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Post by spangineer »

Just a note--remember that if you remove money you've contributed to the Roth, you can't put it back in later. That is, after you take the $20k out you can't put in extra during following years to make it up. Thus, if at all possible, don't take money out of the Roth, because 40+ years of tax-free compounding is a huge asset. But, on the other hand, if you can't afford to start saving for retirement yet, it's better to put money that you'll need soon in a Roth than to leave it in a savings account, where you'll have to pay taxes on gains.
mptfan
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Post by mptfan »

Doc, thank you for summarizing the exchange between me and Mordoch, that was very helpful. :roll:
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Post by Nitsuj »

mptfan wrote:Allow me to offer support for my view that it is generally better to contribute to a tax deferred plan before investing in a Roth.
Did you read the OPs message. Most of these reasons don't apply at all.
In the 15% marginal tax rate is a great time to contribute to a Roth. Chances are extremely good that expenses will be much much higher and taxes will be much higher when the OP retires.
mptfan
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Post by mptfan »

Nitsuj wrote:
mptfan wrote:Allow me to offer support for my view that it is generally better to contribute to a tax deferred plan before investing in a Roth.
Did you read the OPs message. Most of these reasons don't apply at all.
In the 15% marginal tax rate is a great time to contribute to a Roth. Chances are extremely good that expenses will be much much higher and taxes will be much higher when the OP retires.
Yes I did read the OPs message. Most or all of my reasons do apply.

Regarding reason number 1...and despite the popular notion to the contrary....the true difference in tax liability between contributing to a Roth and a tax deferred plan is NOT the difference between paying the current tax rate versus paying the (likely) higher tax rate in retirement, but it is the difference between paying the current tax rate and paying zero taxes. I pick zero.
Mordoch
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Post by Mordoch »

mptfan wrote: Yes I did read the OPs message. Most or all of my reasons do apply.

Regarding reason number 1...and despite the popular notion to the contrary....the true difference in tax liability between contributing to a Roth and a tax deferred plan is NOT the difference between paying the current tax rate versus paying the (likely) higher tax rate in retirement, but it is the difference between paying the current tax rate and paying zero taxes. I pick zero.
Your logic to this one is seriously flawed though. If you're simply planning on being selfish, your goal should be to spend essentially all your money while you are alive. (Or at least you try to time things so you spend your last dollar right as you die.) This means the money INCLUDING what is in your tax deferred plan, so you are definitely not getting out of paying the taxes on it. If you do care about your heirs inheriting, than the benefits of them not having to pay taxes on a Roth IRA matter again.
mptfan
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Post by mptfan »

Mordoch wrote:
mptfan wrote: Yes I did read the OPs message. Most or all of my reasons do apply.

Regarding reason number 1...and despite the popular notion to the contrary....the true difference in tax liability between contributing to a Roth and a tax deferred plan is NOT the difference between paying the current tax rate versus paying the (likely) higher tax rate in retirement, but it is the difference between paying the current tax rate and paying zero taxes. I pick zero.
Your logic to this one is seriously flawed though. If you're simply planning on being selfish, your goal should be to spend essentially all your money while you are alive. (Or at least you try to time things so you spend your last dollar right as you die.) This means the money INCLUDING what is in your tax deferred plan, so you are definitely not getting out of paying the taxes on it. If you do care about your heirs inheriting, than the benefits of them not having to pay taxes on a Roth IRA matter again.
My logic is not flawed, it is sound. Most of us are careful planners and will end up with significant money when we die. It's a fact. Also, I don't know when I will die, so I have to plan as if I will live a long life. Do you know when you will die? If you do, congratulations, you can plan to run out of money at the exact time that you run out of breath. But the rest of us have to plan so that our money lasts well into a ripe old age, regardless of when we actually die.

As far as my heirs go, I refuse to pay one extra dollar in taxes so that their inheritence will be larger.

And let me add yet another reason why deferring taxes is better than a Roth, even at a young age when you are in the 15 percent bracket: when you are young, every marginal dollar that you have means a lot more than when you are old for those of us who plan carefully and save. When you are young, you are trying to pay off student loans, car loans, other debt, and trying to save for kids, retirement, a house, etc. etc. Hopefully, with proper planning and saving, when you are older, these things are done and you have saved a nice nest egg. So, the marginal benefit of saving money when you are young is much greater than saving the difference in taxes when you are old and have a large nest egg.
Mordoch
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Post by Mordoch »

mptfan wrote: My logic is not flawed, it is sound. Most of us are careful planners and will end up with significant money when we die. It's a fact. Also, I don't know when I will die, so I have to plan as if I will live a long life. Do you know when you will die? If you do, congratulations, you can plan to run out of money at the exact time that you run out of breath. But the rest of us have to plan so that our money lasts well into a ripe old age, regardless of when we actually die.

As far as my heirs go, I refuse to pay one extra dollar in taxes so that their inheritence will be larger.

And let me add yet another reason why deferring taxes is better than a Roth, even at a young age when you are in the 15 percent bracket: when you are young, every marginal dollar that you have means a lot more than when you are old for those of us who plan carefully and save. When you are young, you are trying to pay off student loans, car loans, other debt, and trying to save for kids, retirement, a house, etc. etc. Hopefully, with proper planning and saving, when you are older, these things are done and you have saved a nice nest egg. So, the marginal benefit of saving money when you are young is much greater than saving the difference in taxes when you are old and have a large nest egg.
You frankly are being outright irrational. To repeat, if you end up living and needing all that money you will pay the taxes anyways. Your effective margin of safety money wise is greater if the money your withdrawing is from a Roth IRA. You are gaining no benefit at all from deferring taxes because you need to account for the tax issues when considering how much you have left for retirement. If you intend to be selfish you should actually be planning to basically spend all your money and enjoying it while alive by the way.

Now on point two it depends what we're talking about exactly and can get more complicated with a 401K plan involved, but if we're talking about a Traditional IRA versus a Roth IRA, you're effectively allowed to contribute more into a Roth since its tax free at that point (its true that you're literally allowed to put 4,000 in each.) This means as you take advantage of all those years for the money to compound, (assuming identical investments) you're going to end up with a greater amount of money you can actually withdraw from the IRA when taxes are factored in with the Roth.
mptfan
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Post by mptfan »

Mordoch wrote:
mptfan wrote: If you intend to be selfish you should actually be planning to basically spend all your money and enjoying it while alive by the way.
Mordoch, I agree. Please tell me the day that I am going to die, and I will spend all of my money before that day comes.

What's that you say? You don't know when I will die? Oh, then I better plan to live to a ripe old age, even though chances are I won't. :roll:
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Post by mptfan »

Mordoch wrote:
mptfan wrote: Now on point two it depends what we're talking about exactly and can get more complicated with a 401K plan involved, but if we're talking about a Traditional IRA versus a Roth IRA, you're effectively allowed to contribute more into a Roth since its tax free at that point (its true that you're literally allowed to put 4,000 in each.) This means as you take advantage of all those years for the money to compound, (assuming identical investments) you're going to end up with a greater amount of money you can actually withdraw from the IRA when taxes are factored in with the Roth.
This is ONLY true if you assume that the tax rate at withdrawal is higher than the tax rate at contribution. That may turn out to be true, but it is not necessarily true.
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Mordoch. a clarification

Post by Doc »

you're effectively allowed to contribute more into a Roth since its tax free at that point (its true that you're literally allowed to put 4,000 in each.)
Saying this a different way:

The limits are both the same in dollar terms but the TIRA is pre-tax dollars and the ROTH is after-tax dollars so that "you're effectively allowed to contribute more into the ROTH".

The term "tax free" creeps me out. :D It probably shouldn't but I don't have much faith in the Federal government regarding taxes.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
Mordoch
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Post by Mordoch »

mptfan wrote:This is ONLY true if you assume that the tax rate at withdrawal is higher than the tax rate at contribution. That may turn out to be true, but it is not necessarily true.
The problem is its exceedingly probable in this particular case that the thread starter will be in that situation.

Frankly the reason I'm so irritated with you in this thread is you brought up your argument without initially explaining the reasoning behind it at all, and now it turns out that virtually everything you've brought up is irrelevant to the thread starter and his particular concerns. You need to be careful about giving advice and making sure its relevant for the particular situation in question.

Obviously we're generally going to be giving different advice to a 20 year old versus a 50 year old who asks about what we would suggest his current bond allocation percentage would be, a Roth IRA versus deferred tax plan is also generally quite dependent on age along with income.
Last edited by Mordoch on Sat Apr 14, 2007 10:36 am, edited 1 time in total.
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lucky7
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ROTH IT

Post by lucky7 »

Roth it. Think of it this simple way for, 15% tax bracket, for $4000: Which then would you rather do, save $600 up front and later pay full taxes on whatever that $4000 grows to up, to the time your 70 1/2 years old (when required minimum distributions must begin) or pay the $600 now and keep that whole future amount completely tax free when again say for comparison you're 70 1/2 y.o. (or actually even beyond for Roths have no required minimum distributions). If like graphs on various different scenarios (and yes the $600 would grow as tax after investment in first example) good book is Lange's, Retire Secure. You will probably conclude by far better choice is the Roth vs TIRA. Many even start Roths or have started for them (as per previous poster) in their teens. Also agree with sequence of free money via employer match, then Roth, then unmatched company plan (e.g.401k, 403b, etc.). Anyhow good luck.

Bob
mptfan
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Post by mptfan »

Mordoch wrote:
mptfan wrote:This is ONLY true if you assume that the tax rate at withdrawal is higher than the tax rate at contribution. That may turn out to be true, but it is not necessarily true.
The problem is its exceedingly probable in this particular case that the thread starter will be in that situation.

Frankly the reason I'm so irritated with you in this thread is you brought up your argument without initially explaining the reasoning behind it at all, and now it turns out that virtually everything you've brought up is irrelevant to the thread starter and his particular concerns. You need to be careful about giving advice and making sure its relevant for the particular situation in question.

Obviously we're generally going to be giving different advice to a 20 year old versus a 50 year old who asks about what we would suggest his current bond allocation percentage would be, a Roth IRA versus deferred tax plan is also generally quite dependent on age along with income.
First, I don't agree that it is "exceedingly probable" that a young person will pay taxes at a higher marginal rate when they are retired. Re-read my reason number two.

I don't care that you are irritated with me, and I disagree that my points are irrelevant to the poster, and I have already told you that. The mere fact that YOU think they are irrelevant does not conclude the point. I agree that my opinions differ from many on this point, but I still think they are valid, whether you think so or not. And after all, isn't the point of this message board to allow for the expression of different points of view?

Finally, for all the reasons I've expressed already, I don't think your last paragraph is obvious at all.
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Post by Nitsuj »

mptfan wrote:First, I don't agree that it is "exceedingly probable" that a young person will pay taxes at a higher marginal rate when they are retired. Re-read my reason number two.
Then frankly your opinion is wrong. It is indeed extremely probably that the OP will be in a higher marginal tax rate at retirement.
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Post by mptfan »

Nitsuj wrote:
mptfan wrote:First, I don't agree that it is "exceedingly probable" that a young person will pay taxes at a higher marginal rate when they are retired. Re-read my reason number two.
Then frankly your opinion is wrong. It is indeed extremely probably that the OP will be in a higher marginal tax rate at retirement.
Nitsuj, how in the world can you say that? How do you know how much money he or she will be spending 40 years from now, or, what marginal tax bracket he or she will be in at that time, or, even if he or she will live that long?? The answer is that you don't, yet you assume that you do, and you use that ASSUMPTION to criticize my opinion as being wrong. You need to stop jumping to conclusions and criticizing people as a result, I resent that.
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Post by Mordoch »

mptfan wrote: First, I don't agree that it is "exceedingly probable" that a young person will pay taxes at a higher marginal rate when they are retired. Re-read my reason number two.
You simply are ignoring the situation in this case. He's an individual who is merely in the 15% tax bracket right now, and is responsible enough to start saving at any early age AND ask on here to get advice on how to properly invest that money wisely. Obviously there are no guarantees in life, but I'd put the likelihood to be above 90% that he will have a higher tax bracket upon retirement. You assess the probabilities and give advice.

Frankly your opinion appears to simply be ignoring the circumstances in this case. While you're allowed to express different points of view if had said something like "I think you should invest in funds with a load and make sure that they have a high expense ratio too because you get what you pay for", you shouldn't expect a pleasant response on this board! At this point you're simply continuing to advocate bad advice for his situation.
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Post by tfb »

Wow, this thread has gone wild. It takes 30+ posts to figure out if the OP is better off in a Roth?

The Alchemist, if you are still following this, please ignore the fancy debate and go ahead with a Roth. With a low tax bracket, you don't really lose much. It's more flexible for you. If you ever run into an emergency, you can even take the principal out without being taxed. No, you don't have to wait 5 years. You can withdraw principal at any time if you want to. Be confident and good luck to you.
Harry Sit, taking a break from the forums.
mptfan
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Post by mptfan »

Mordoch wrote:
mptfan wrote: First, I don't agree that it is "exceedingly probable" that a young person will pay taxes at a higher marginal rate when they are retired. Re-read my reason number two.
You simply are ignoring the situation in this case. He's an individual who is merely in the 15% tax bracket right now, and is responsible enough to start saving at any early age AND ask on here to get advice on how to properly invest that money wisely. Obviously there are no guarantees in life, but I'd put the likelihood to be above 90% that he will have a higher tax bracket upon retirement. You assess the probabilities and give advice.

Frankly your opinion appears to simply be ignoring the circumstances in this case. While you're allowed to express different points of view if you said "I think you should invested in fund with a load and make sure that they have a high expense ratio too because you get what you pay for", you shouldn't expect a pleasant response on this board! At this point you're simply continuing to advocate bad advice for his situation.
Mordoch, you can continue to repeat yourself as many times as you like, but it won't make your statement correct. The fact is that my advice is different than yours, but that doesn't make it bad advice. I have presented several specific reasons why my advice is valid, and I stand by those reasons, and the fact that you disagree with them does not make them invalid.

It turns out that my initial impression of you was correct, you are close minded. You have proven that you can't accept points of view that are valid and well articulated because they differ from yours. On the other hand, I agree that your points are valid and should be considered. It's too bad that you don't give me the same courtesy.
wx27
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Retirement savings contribution credit

Post by wx27 »

thealchemist wrote:Another doubt relating to Roth:

Since I am not participating in any employer-sponsored plan and my AGI is less than $50,000, I can make my contributions tax-deductible. As clarified earlier, one can withdraw the principal without penalty.

So, in principle, I can:
(a)contribute $4k for 2006,
(b)get tax deduction, and
(c)withdraw $4k without any penalty.

I am sure I am missing something, so please pardon my ignorance.

The Alchemist
I'm sure you already figured out that (b) only applies to traditional IRAs, but I'll just add that if your AGI was less that 25K, you are eligible for a retirement savings contribution credit no matter which type of IRA you are funding. Not knowing your exact AGI, this may not apply to your situation.
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Re: ROTH IT

Post by Doc »

Lucky7 wrote: Roth it. Think of it this simple way for, 15% tax bracket, for $4000: Which then would you rather do, save $600 up front and later pay full taxes on whatever that $4000 grows to up ...
I think this is "dangerous" reasoning. Here's why:

There are three factors affecting the ROTH/TIRA choice.

The primary one is the tax rate when making the contribution compared to the tax rate in the future when you make the withdrawal. If the tax rates are higher at withdrawal you start out already "in the hole" by the amount of the tax difference. This is the situation our original poster is likely to be in when he retires.

As Mordoch pointed out a secondary consideration is that you can contribute more pre-tax dollars to the ROTH. These extra dollars being sheltered from tax can sometimes overcome the a difference in tax rates if you have a long time horizon and good investment returns.

The last factor is the growth rate. The growth rate is independent to the TIRA/ROTH choice directly but can become important when combined with the higher pre-tax ROTH contribution.

If the tax rates are unchanged (1-TaxRate), you invest the same amount in pre-tax dollars (PreTax$Invested), and you invest in the same assets (Growth) than the ROTH and TIRA have exactly the same future value.

The controlling equation for the future value of either type of IRA is

Future Value = (PreTax$Invested) x (1-TaxRate) x (Growth)

The reason I think your comment is "dangerous" is that is too simple and makes several assumptions which are not specified.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
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Post by Mordoch »

mptfan wrote: Mordoch, you can continue to repeat yourself as many times as you like, but it won't make your statement correct. The fact is that my advice is different than yours, but that doesn't make it bad advice. I have presented several specific reasons why my advice is valid, and I stand by those reasons, and the fact that you disagree with them does not make them invalid.
Frankly I've carefully considered your reasons for your advice and they are all clearly bad in this case. Yes we don't know what his situation will be upon retirement for sure, but we certainly can determine what is far more probable and given advice based on that. There are good reasons that you are the only one in the thread arguing against a Roth IRA in this case.

The only argument with any validity is that a Roth IRA might get taxed in the future. However this is highly unlikely when you get down to it. Because of the income cutoff for Roth IRA contributions, not to mention those close to the cutoff can merely contribute a lower portion of their money in a Roth IRA in the first place than those making less money, Roth IRAs clearly benefit those that are more in the middle class and the poor than the really rich. Trying to suddenly go out and tax them would be effectively political suicide for a politician since they would clearly be implementing a tax that would hurt those in the poor and middle class more. For all the talk about how the money in Roth IRAs will be allot eventually, the reality is its far easier from a political standpoint to tax virtually anything else.
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Hi Doc

Post by lucky7 »

Doc and I have had similiar discussion on other post. I hope I have been cordial. Nonetheless,
I will divorce myself from offering my opinion but simply refer to several books have read all by CPAs, and two by CPA/attorneys. Ed Slott, Retirement Savings Time Bomb, Retire Secure by James Lange, the New Rules of Retirement by Robert Carlson. A lot of data, scenarios and I think important reads. Draw own conclusions. Also the sequencing preference echoed by other standard sources, e.g. See Boglehead's Guide pg 134, "1-Invest in your 401k up to company match. The company match is free money you cannot afford to forfeit. 2-If eligible invest in a Roth IRA up to the maximum. 3- Contribute to the 401k up to the maximum. 4.Additional funds should go into tax efficient mutual funds."

Take care.

Bob
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Post by mptfan »

Mordoch, please read the following with an open mind. I know that what I am saying goes against the conventional wisdom on this point, but that doesn't mean I am wrong or that my points are not valid for consideration. Consider:

1. Even if marginal tax rates are higher in the future (and I agree it is likely), the higher marginal rates will be for the higher income earners. It is always easier to raise taxes "on the rich" as opposed to the middle class or poor. Can we at least agree on that?

2. Most people will not spend enough in retirement to get into the higher marginal tax rates. This is true for several reasons. First, it is a statistical fact that the higher marginal tax rates only apply to those who spend significantly more than the average household. (The 25 percent marginal rate currently kicks in at about 150% of average household income) Therefore, it is a logical fact to conclude that MOST people will not spend enough to get into the higher marginal tax brackets in retirement. The second reason why this is true is because people tend to spend less in retirement.

http://www.fpanet.org/journal/articles/ ... 5-art7.cfm

So, the statistics support my conclusion that MOST people will not be taxed at the higher marginal tax rates in retirement due to their relatively lower spending, and due to the fact that the higher marginal tax rates will likely be focused on those with income significantly above average.

Therefore, when you make the blanket assertion that "tax rates will be higher in the future" as a justification for investing in a Roth, you are making an overly simplistic statement which ignores the specific points I raised above which apply to most people, and those points actually undermine the validity of your blanket statement as applied to most people.
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Post by Mordoch »

mptfan wrote: So, the statistics support my conclusion that MOST people will not be taxed at the higher marginal tax rates in retirement due to their relatively lower spending, and due to the fact that the higher marginal tax rates will likely be focused on those with income significantly above average.
Ok, for starters in case there is any confusion on this point, a key reason a Roth IRA is such a slam dunk in his case is that its probable he'll be in a higher tax bracket in retirement, you don't even have to make any assumptions about taxes in general being higher in the future.

Your arguments make some sense as very general advice, but we're talking about a specific individual here. Starting so early with his savings and going here to get advice on how to do it makes him a distinct minority of the population who is likely to be financially better off than the average person in the future. Furthermore, while I did not bring up it yet, he also appears to be about to receive a graduate degree, which puts him in a select group out of the general population which tends to statistically earn more than the average individual. All these things are why its likely he will be in a higher tax bracket than the relatively low 15% upon retirement.
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Post by thealchemist »

Hi,

Thank you for your arguments supporting your views. I just found a couple of other posts on the forum discussing similar scenario. I site them below:

http://diehards.org/forum/viewtopic.php?p=15020 (found this from a current discussion http://www.diehards.org/forum/viewtopic.php?t=1739)

I had been debating myself between opening a TIRA or Roth and my personal thinking that I might end up in a higher tax bracket (which currently is in the 15%) does not result in a much advantage if I open a TIRA. So I have, for now, opened a Roth IRA contributing to the max for 2006 and will continue as long as I am a grad student (which hopefully will only be until the end of the year :|).

If only I had known about these financial details earlier, I would have been able to save a little more and have a nice little nest egg. Better late than never.

Allow me to say that this forum has helped me re-think my saving/investment strategies. I am sure a lot of people share my opinion.

Thanks again.
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Should know better but can't help myself with reply to Doc.

Post by lucky7 »

Doc, or others who read my entire prior post, would note reference was made to the consideration of the tax savings up front. Felt should reply since only a portion, not reflective of this, included in Doc's quote box.
Actually, here is an opinion would definitely offer. Would read as much on topics to make own decision. Discussion boards are fun, often, but would only use as a jump-off to self educate before making any decision about money.

Take care.

Bob
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Post by mptfan »

Mordoch wrote:
mptfan wrote: So, the statistics support my conclusion that MOST people will not be taxed at the higher marginal tax rates in retirement due to their relatively lower spending, and due to the fact that the higher marginal tax rates will likely be focused on those with income significantly above average.
Ok, for starters in case there is any confusion on this point, a key reason a Roth IRA is such a slam dunk in his case is that its probable he'll be in a higher tax bracket in retirement, you don't even have to make any assumptions about taxes in general being higher in the future.

Your arguments make some sense as very general advice, but we're talking about a specific individual here. Starting so early with his savings and going here to get advice on how to do it makes him a distinct minority of the population who is likely to be financially better off than the average person in the future. Furthermore, while I did not bring up it yet, he also appears to be about to receive a graduate degree, which puts him in a select group out of the general population which tends to statistically earn more than the average individual. All these things are why its likely he will be in a higher tax bracket than the relatively low 15% upon retirement.
Mordoch, you continue to make assumptions which are not supported. The fact that he is starting to save at an early age is good, but it does not mean that he will be in a higher marginal tax bracket at retirement. This is simply a leap of logic on your part. There are a number of variables: 1. after building up a significant nest egg at middle age, he could decide to retire early and live a modest yet comfortable life on modest income. I can assure you that there are many early retirees who have earned a high income during the early part of their life, and who have graduate degrees.

www.early-retirement.org

2. he could work to a normal retirement age and build up a large nest egg and yet still live a modest life out of frugality, 3. he could suffer a financial event that thwarts his savings plans (illness, injury, divorce, job loss, etc). The point is that there is so much that can occur over someone's lifetime that it is foolish of you to assume that he or she will spend much more than average in retirement. The statistics do not support your assumption.
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Post by Mordoch »

mptfan wrote: 2. he could work to a normal retirement age and build up a large nest egg and yet still live a modest life out of frugality, 3. he could suffer a financial event that thwarts his savings plans (illness, injury, divorce, job loss, etc). The point is that there is so much that can occur over someone's lifetime that it is foolish of you to assume that he or she will spend much more than average in retirement. The statistics do not support your assumption.
They actually do when you get down to it. We're not talking about a random person here, but someone with key traits we can identify. If he does in fact get a graduate degree I could even look up the precise statistics on how that raises the likely amount of money he will earn during his lifetime for instance. The reality is virtually anyone young who shows up on this board and expresses interest in saving money and how to invest it properly already is a self selected minority of the population so the statistics you have brought up are not very relevant.

The thing is why all your examples can occur, its still is much more likely he will be at a higher tax bracket upon retirement. I'd say that would still probably be the case even with suffering from a job loss for instance. If he was in a higher tax bracket than 15% right now the decision would become more debatable, but at that level the odds should firmly strongly favor him being at a higher level upon retirement all things considered. The advice we're giving is based on a reasonable estimate of his future likely situation, he can ask for all the details on why to make this decision, (and he's effectively getting it if he reads all of this thread) but making suggestions on strong probabilities is generally the right call.

I.E. if the future is utter anarchy in the US without any sort of law and order and the government in general breaking down, the sensible investments would probably be guns, ammunition, and canned food, but I would not consider this to be the most likely future so I will refrain from suggesting this strategy to all prospective investors on this board. :lol:
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Reply to Lucky7

Post by Doc »

Hi Bob,

I didn’t mean to start an argument with you on this subject. In the case under discussion, young graduate student, I think that your conclusion of the ROTH being better is correct. My problem with your argument is that it uses words to describe a situation involving a discounted cash flow analysis that can only really be answered by doing the mathematics. In doing the math you have to make several assumptions like tax rates now and in the future, assets in the account (growth rate), the time the assets are going to be left to grow and whether the TIRA “tax savings” are going to be invested in a taxable account or in a ROTH. (Published IRA calculators can use either or both places to put the savings and often don’t tell you which they are using.)

In using a descriptive argument, it is easy to overlook what assumptions are being made. All of us tend to talk and argue from our own point of view – our own experiences. Often these assumptions are so familiar to ourselves that we don’t even realize that they assumptions. One good example of this was a recent post looking at the effect of state taxes on bonds returns. Two people were getting different results because one was a home owner and the other a renter. The home owner never considered the idea that renters often take the standard deduction and therefore don’t get a deduction for state tax.

The reason I called Bob’s reasoning “dangerous” is because a descriptive argument often has these assumptions left unstated and further that others often pick up the result and use them in a context that does not apply.

Instead of the young graduate student, if you had a couple nearing retirement making $100k and investing their tax sheltered money in bonds you will likely get a different result.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
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Post by mptfan »

Mordoch wrote:
mptfan wrote: If he does in fact get a graduate degree I could even look up the precise statistics on how that raises the likely amount of money he will earn during his lifetime for instance.
You seem to miss the point no matter how many times I say it... the issue is NOT how much money he is projected to earn in his lifetime (and even that is debatable depending on which field he gets a degree in), the issue is how much he is likely to spend once he is retired.
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