Taxable Accounts vs IRA vs Roth IRA

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iagonosi
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Taxable Accounts vs IRA vs Roth IRA

Postby iagonosi » Tue Dec 27, 2016 3:10 pm

I'm trying to understand why one would pick one vehicle over the other for long term savings. For this question lets assume 30 years of age, current 71K AGI but expect lower income in retirement. lets also assume taxes will be relatively similar in 35 years (captial gains, income; big assumption but we need some fixed values) They all have their positives, for example

Traditional IRA is tax deferred so I save money on my current tax bill (71K AGI). I'll end up paying the taxes when I withdraw but I expect my income in retirement to be lower, so in theory a lower lower taxes. Also since the initial contribution is tax deductable doesnt that mean I would have a larger initial seed for 35 years of compound interest?

Roth IRA- pay taxes now which will prob be higher, buuut all the gains will be tax free. Mentally its hard to determine if this tax saving on the back end would be better than the tax savings on the front end with the traditional IRA because my tax bill now will likely be higher than in retirement. Ive used different calculators that give the edge to either, depending on if you invest the tax saving of the traditional somewhere or not.

Taxable accounts- pay taxes on everything buut its only capital gains (long term) which would be lower than the income taxes of the traditional IRA. No current tax deduction. great flexibility but thats not a priority in this analysis. Pay taxes on dividends. I'd plan to invest in index funds with lower sell turnover compared to individual stocks or active funds.

In my mind the lower capital gains rate (15%) would give taxable accounts the edge over a traditional IRA (25%). but the Roth would have a better back end tax at 0% and the same front end tax cost of the taxable accounts. The only thing that gives me pause is conventional wisdom says if your current income is higher than project retirement income, traditional IRA is the way to go. in other words Roth >TA > IRA>Roth..... thus my conundrum.


I do have a 401k, but due to fees and fund choice its easy to rule it out of contention once matching is met.

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Duckie
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Re: Taxable Accounts vs IRA vs Roth IRA

Postby Duckie » Tue Dec 27, 2016 7:43 pm

iagonosi, welcome to the forum.

iagonosi wrote:For this question lets assume 30 years of age, current 71K AGI but expect lower income in retirement.
<snip>
I do have a 401k, but due to fees and fund choice its easy to rule it out of contention once matching is met.

The choice between TIRA and Roth IRA depends on your income. Because you contribute to a 401k your TIRA contributions may not be completely deductible if single. See here. If TIRA contributions are not deductible the Roth IRA wins. And Roth IRAs beat taxable.

Wakefield1
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Re: Taxable Accounts vs IRA vs Roth IRA

Postby Wakefield1 » Tue Dec 27, 2016 7:47 pm

My opinions which might not be what this web site believes: IRAs and Roth IRAs might not hold all of the money you want to save per year-$ 5500. or 6500. per year depending on your age? (I like Roth IRA and always used it when it was available when I was working
Also IRA and 401 and 457 type accounts are really for retirement and have disadvantages if you need to use the money before you reach the prescribed age-although there are limited and complicated ways around that for certain cases-
The 457 or 401 has much more generous yearly maximum allowed contributions than the IRA-
one of the greatest benefits of the Roth IRA over the "plain" one is that when you are over 70.5 you don't have to take yearly required distributions
it seems that in spite of what people were told they end up in higher tax brackets in retirement than they were in on the job-at least in the early years on the job-so that might favor using the Roth IRA if you can afford to fully fund it per year maximum contribution
-the taxable account throws off real income that you can use NOW-(although you have to pay income tax on it)-but depending on what you have in that account you might not have to pay as much tax as you would on the same amount of wages (qualified dividends and/or long term capital gains) especially if your overall total income level is not high (not in a high tax bracket).
Saving in a 401 or 457 might be especially important for someone whose job does not promise a pension for working the traditional 30 or more years

Wakefield1
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Re: Taxable Accounts vs IRA vs Roth IRA

Postby Wakefield1 » Tue Dec 27, 2016 7:52 pm

Income limits on being allowed to contribute to IRA or Roth IRA -I think you can look that up on Vanguard's website or perhaps on the "Wiki" part of this Forum.

Wakefield1
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Re: Taxable Accounts vs IRA vs Roth IRA

Postby Wakefield1 » Tue Dec 27, 2016 8:15 pm

Duckie wrote:iagonosi, welcome to the forum.

iagonosi wrote:For this question lets assume 30 years of age, current 71K AGI but expect lower income in retirement.
<snip>
I do have a 401k, but due to fees and fund choice its easy to rule it out of contention once matching is met.

The choice between TIRA and Roth IRA depends on your income. Because you contribute to a 401k your TIRA contributions may not be completely deductible if single. See here. If TIRA contributions are not deductible the Roth IRA wins. And Roth IRAs beat taxable.

If O.P. has non-deductible IRA contributions that are not Roth can he do a Roth conversion later with lower tax liability than if all the IRA contributions were deductible? Including having a mix of deductible and non-deductible? (Of course working with IRAs you get into filing Form 8606)

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grabiner
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Re: Taxable Accounts vs IRA vs Roth IRA

Postby grabiner » Tue Dec 27, 2016 9:04 pm

iagonosi wrote:In my mind the lower capital gains rate (15%) would give taxable accounts the edge over a traditional IRA (25%). but the Roth would have a better back end tax at 0% and the same front end tax cost of the taxable accounts.


A dollar in a traditional IRA may not be worth as much as a dollar in a taxable account, but it's still better to invest in a deductible IRA, because it costs less to put that dollar there.

If you have $3000 available for investing, you can put $3000 in a Roth IRA, or $3000 in a taxable account, but you can put $4000 in a traditional IRA. And if you retire in the same 25% bracket, that $4000 in a traditional IRA is just as good as $3000 in a Roth IRA; if the market doubles in value, the traditional IRA will grow to $8000, which is $6000 after tax.

I do have a 401k, but due to fees and fund choice its easy to rule it out of contention once matching is met.


Even that is unlikely when comparing the 401(k) to taxable accounts. Once you have gotten the match, it is better to invest in an IRA (Roth, or traditional if deductible) than to invest in a bad 401(k). But if you can max out your IRA, putting more into the bad 401(k) is usually better than taxable investing. You will only pay the high fees as long as you stay with that employer; when you leave, you can roll the 401(k) into an IRA, and get both low fees and tax deferral.
David Grabiner

iagonosi
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Re: Taxable Accounts vs IRA vs Roth IRA

Postby iagonosi » Wed Dec 28, 2016 9:16 am

Duckie wrote:iagonosi, welcome to the forum.

iagonosi wrote:For this question lets assume 30 years of age, current 71K AGI but expect lower income in retirement.
<snip>
I do have a 401k, but due to fees and fund choice its easy to rule it out of contention once matching is met.

The choice between TIRA and Roth IRA depends on your income. Because you contribute to a 401k your TIRA contributions may not be completely deductible if single. See here. If TIRA contributions are not deductible the Roth IRA wins. And Roth IRAs beat taxable.



Whoa, good point Duckie! I just got married last month we were going to file separate but that would basically rule me out of the tax deductible IRA. I had no idea the income caps changed so much if you got married. My wife and i might have a combined AGI of 110K this year, give or take 10K. lets still assume for this scenario that we qualify for full deduction (we might be able to get our MAGI low enough) Roth vs traditional?

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dsmil
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Re: Taxable Accounts vs IRA vs Roth IRA

Postby dsmil » Wed Dec 28, 2016 9:35 am

iagonosi wrote: In my mind the lower capital gains rate (15%) would give taxable accounts the edge over a traditional IRA (25%)


I think you're forgetting the fact that the money going into your taxable account has already been taxed. So you have your money hit with both an income tax of 25% and a capital gains/dividends tax of 15%. With the traditional IRA, you pay the income tax of 25% (or lower), but not the capital gains taxes.

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Phineas J. Whoopee
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Re: Taxable Accounts vs IRA vs Roth IRA

Postby Phineas J. Whoopee » Wed Dec 28, 2016 1:55 pm

dsmil wrote:
iagonosi wrote: In my mind the lower capital gains rate (15%) would give taxable accounts the edge over a traditional IRA (25%)


I think you're forgetting the fact that the money going into your taxable account has already been taxed. So you have your money hit with both an income tax of 25% and a capital gains/dividends tax of 15%. With the traditional IRA, you pay the income tax of 25% (or lower), but not the capital gains taxes.

Capital gains are only the amount you sold for that was higher than you paid, and dividends, qualified or otherwise, come directly out of share price, so there is no addition of 25% + 15% = 40% of the total value.
PJW


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