Help with explanation in wiki on taxes

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matt87109
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Help with explanation in wiki on taxes

Post by matt87109 » Sun Jul 09, 2017 11:16 pm

I think I understand the following from the wiki, but will somebody state this in simpler terms please? Also I have question below the quote. Thank you!

"A common misunderstanding about traditional accounts is "contributions are taken from the top while withdrawals come from the bottom": in other words, that one saves a marginal rate when contributing but pays only an average rate (starting at 0% for the first dollar withdrawn) when withdrawing. That is true in a limited sense - limited, that is, to the very first traditional contribution one makes. After that, subsequent contributions will be withdrawn on top of the withdrawals due to previous contributions. One must therefore calculate the marginal withdrawal tax rate due to those subsequent contributions.
For example, assume a couple already has enough in traditional accounts to withdraw $42,000/yr (giving a taxable income of $21,300), currently earn $90,000/yr (taxable income of $69,300) and expect to earn that amount for the foreseeable future. They are looking at an $18K 401k contribution and expect it to grow at 5% for 15 years, at which time they will withdraw 4%/yr from what that $18K has grown to, or ~$1,500/yr.
For this couple, the contribution tax rate is 15% (marginal tax rate stays at 15% as the taxable income drops from $69,300 to $51,300), and the withdrawal tax rate is also 15% (marginal tax rate stays at 15% as the taxable income increases from $21,300 to $22,800 and tax goes from $2,268 to $2,493). It would be incorrect to compare a 15% contribution rate to the average withdrawal tax rate of $2,493/$43,500 = 5.7%."

The following is also in the wiki text. Is the marginal rate of 55.5% correct? In other works if I'm getting SS and 24k/year from a traditional account, then additional distributions from a traditional account will be taxed at 55.5%? IF that's the case I'm going to quit working and live in a camper trailer!

"Combining the above two items can produce even higher rates. For a single person age 65, with $12,000 in qualified dividends, $27,000 from social security, and $24,000 in traditional IRA distributions, the marginal rate for more[3]
traditional IRA distributions is 55.5%
qualified dividends is 40.5%
social security income is 12.75%
"
Last edited by matt87109 on Fri Jul 14, 2017 9:20 pm, edited 1 time in total.

Iridium
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Re: Help with explanation in wiki on taxes

Post by Iridium » Sun Jul 09, 2017 11:54 pm

I was able to find the first part in the wiki: https://www.bogleheads.org/wiki/Traditional_versus_Roth and the second part: https://www.bogleheads.org/wiki/Marginal_tax_rate.

To explain the first part: when people try to determine whether to go Traditional or Roth, one common misstep is to calculate the benefit of the tax deduction at the marginal tax rate, while only counting the cost at one's average tax rate. To use some actual numbers: assume someone is currently in the 25% tax bracket. Let's also assume that if s/he was to put all their retirement savings into traditional IRAs/401ks, their taxable income would be high enough to keep them in the 25% tax bracket in retirement. However, because the tax system is progressive and one would qualify for at least the standard deduction in retirement, he/she might only be paying 11% of income in taxes in retirement.

It is a common misconception to believe that a dollar saved in traditional results in $0.25 of tax savings, but only $0.11 of taxes owed down the line. It is subtle, but the reality is that the very first dollar put into a traditional IRA will result in $0.25 of tax savings, and $0 in taxes owed down the line (hypothetically if one had only a single dollar at retirement, it would never be taxed because one's income would stay below the amount of deductions allowed). After some number of dollars, one would totally fill up their ability to withdraw money tax free, so every additional dollar would get taxed at 10%. Eventually, enough dollars would be saved to fill up the 10% tax bracket, and additional money would get taxed at 15%. Eventually that bracket would get filled and additional money would get taxed at 25%. Now, in the above scenario, the average taxes paid is 11%. However, every particular dollar saved was taxed at either 0%, 10%, 15%, or 25%. It is a subtle distinction, but an important one, because for the person in the above scenario, going Traditional vs Roth for some of their dollars would actually be a total wash from an income tax standpoint (with Roth having the advantage in RMDs and social security taxation). However, if that person looked at it as saving $0.25 on the deduction, and then paying $0.11 on the withdrawal, s/he would erroneously believe that saving all retirement in traditional was advantageous.


As far as the 55.5% tax rate, I haven't checked the numbers, but I'm assuming it is correct. Reread the page though about the caveats. My understanding is that it is only a few scenarios that would generate such a high marginal tax.

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Mon Jul 10, 2017 1:07 am

Iridium wrote:I was able to find the first part in the wiki: https://www.bogleheads.org/wiki/Traditional_versus_Roth and the second part: https://www.bogleheads.org/wiki/Marginal_tax_rate.

To explain the first part: when people try to determine whether to go Traditional or Roth, one common misstep is to calculate the benefit of the tax deduction at the marginal tax rate, while only counting the cost at one's average tax rate. To use some actual numbers: assume someone is currently in the 25% tax bracket. Let's also assume that if s/he was to put all their retirement savings into traditional IRAs/401ks, their taxable income would be high enough to keep them in the 25% tax bracket in retirement. However, because the tax system is progressive and one would qualify for at least the standard deduction in retirement, he/she might only be paying 11% of income in taxes in retirement.

It is a common misconception to believe that a dollar saved in traditional results in $0.25 of tax savings, but only $0.11 of taxes owed down the line. It is subtle, but the reality is that the very first dollar put into a traditional IRA will result in $0.25 of tax savings, and $0 in taxes owed down the line (hypothetically if one had only a single dollar at retirement, it would never be taxed because one's income would stay below the amount of deductions allowed). After some number of dollars, one would totally fill up their ability to withdraw money tax free, so every additional dollar would get taxed at 10%. Eventually, enough dollars would be saved to fill up the 10% tax bracket, and additional money would get taxed at 15%. Eventually that bracket would get filled and additional money would get taxed at 25%. Now, in the above scenario, the average taxes paid is 11%. However, every particular dollar saved was taxed at either 0%, 10%, 15%, or 25%. It is a subtle distinction, but an important one, because for the person in the above scenario, going Traditional vs Roth for some of their dollars would actually be a total wash from an income tax standpoint (with Roth having the advantage in RMDs and social security taxation). However, if that person looked at it as saving $0.25 on the deduction, and then paying $0.11 on the withdrawal, s/he would erroneously believe that saving all retirement in traditional was advantageous.


As far as the 55.5% tax rate, I haven't checked the numbers, but I'm assuming it is correct. Reread the page though about the caveats. My understanding is that it is only a few scenarios that would generate such a high marginal tax.
Thank you. That helped. Basically people don't realize the progressive tax structure and how some of a traditional portfolio's withdrawals would be taxed at a lower rate (compared to the marginal contributions in the past), but not all. The reality being that a retirement income funded, in some part by traditional (larger principal growth and lower taxes (0 or 15 at withdrawal vs. 25 at contribution)) and some part by Roth from early career low marginal tax rate contributions may be optimal with respect to growth and taxes.

Upon further reading I gather than the 55% marginal rate is just a narrow band and quickly corrects back to 25%. Here is a plot https://www.bogleheads.org/wiki/File:SS_single_tax.png. What silliness.

dbr
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Re: Help with explanation in wiki on taxes

Post by dbr » Mon Jul 10, 2017 9:08 am

It might be better to work up a dummy tax calculation and actually compute total tax cost across different scenarios than try to guess or misunderstand what tax rate applies to what.

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Mon Jul 10, 2017 9:49 pm

dbr wrote:It might be better to work up a dummy tax calculation and actually compute total tax cost across different scenarios than try to guess or misunderstand what tax rate applies to what.
Yes thank you. I have done/doing this. Just trying to understand the domain so I can theorize.

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Re: Help with explanation in wiki on taxes

Post by celia » Tue Jul 11, 2017 2:00 am

"Combining the above two items can produce even higher rates. For a single person age 65, with $12,000 in qualified dividends, $27,000 from social security, and $24,000 in traditional IRA distributions, the marginal rate for more[3]
traditional IRA distributions is 55.5%
qualified dividends is 40.5%
social security income is 12.75%"
This example is due to how Social Security is taxed at various income levels. I don't have the relevant numbers available but if your ONLY income is SS AND you started collecting at Full Retirement Age or earlier, then it is federally tax-free. At some point as you add other income to your tax return, each dollar added makes a SS dollar be taxed, up to the point where 85% of your SS is taxed.

So if you were in the 25% bracket and you had qualified dividends that were normally taxed at 15%, if you then add SS benefits, 85% of them will be taxed at the 25% rate. Since some of the SS could have been tax-free, then they say the adding of $100 of dividends to the return makes the taxes increase by $40 (40% = 15% + 25%). It is the combination of both types of incomes that gives you a higher rate on some of the income instead of being able to claim the two separate rates (15% for dividends and 0% for SS).

Overall, the example given in the quote is just the "right combination" of RMDs, Qualified dividends, and SS. If you plan your income streams out before you start SS you can avoid some of this. Or if you are getting all of these, just think as 85% of SS will be taxed at your regular tax rate. For many Bogleheads that will be true regardless of what their other income streams are, for example, if you will have a pension. The pension by itself can put you above the point where any of your SS is tax-free.

I was helping someone with their taxes one year and they were confused when they saw the completed return. They understood Qualified dividends and LT Capital Gains would be tax-free. Technically, they were until their other income reached the 25% tax bracket. But the "other income" included SS, which was suddenly taxed.
Last edited by celia on Tue Jul 11, 2017 2:17 am, edited 1 time in total.

matt87109
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Re: Help with explanation in wiki on taxes

Post by matt87109 » Tue Jul 11, 2017 2:16 am

celia wrote:
"Combining the above two items can produce even higher rates. For a single person age 65, with $12,000 in qualified dividends, $27,000 from social security, and $24,000 in traditional IRA distributions, the marginal rate for more[3]
traditional IRA distributions is 55.5%
qualified dividends is 40.5%
social security income is 12.75%"
This example is due to how Social Security is taxed at various income levels. I don't have the relevant numbers available but if your ONLY income is SS AND you started collecting at Full Retirement Age or earlier, then it is federally tax-free. At some point as you add other income to your tax return, each dollar added makes a SS dollar be taxed, up to the point where 85% of your SS is taxed.

So if you were in the 25% bracket and you had qualified dividends that were normally taxed at 15%, if you then add SS benefits, 85% of them will be taxed at the 25% rate. Since some of the SS could have been tax-free, then they say the adding of $100 of dividends to the return makes the taxes increase by $40 (40% = 15% + 25%). It is the combination of both types of incomes that gives you a higher rate on some of the income instead of being able to claim the two separate rates (15% for dividends and 0% for SS).

Overall, the example given in the quote is just the "right combination" of RMDs, Qualified dividends, and SS. If you plan your income streams out before you start SS you can avoid some of this. Or if you are getting all of these, just think as 85% of SS will be taxed at your regular tax rate. For many Bogleheads that will be true regardless of what their other income streams are, for example, if you will have a pension. The pension by itself can put you above the point where any of your SS is tax-free.
Thank you very much. I gathered that most people above a basic income would just consider this a matter of course.

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FiveK
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Re: Help with explanation in wiki on taxes

Post by FiveK » Tue Jul 11, 2017 6:43 am

matt87109 wrote:Basically people don't realize the progressive tax structure and how some of a traditional portfolio's withdrawals would be taxed at a lower rate (compared to the marginal contributions in the past), but not all.
Correct. A traditional account operates, in effect, on a First In First Out (FIFO) basis. For N years of contributions, to a first approximation an annual withdrawal amount X fills the tax brackets by X/N coming from contributions in the order each was made. Once one has made a significant amount of traditional contributions, those lower brackets for withdrawals are completely filled and subsequent contributions are taxed starting not at 0% but at some higher rate.
Upon further reading I gather than the 55% marginal rate is just a narrow band and quickly corrects back to 25%. Here is a plot https://www.bogleheads.org/wiki/File:SS_single_tax.png. What silliness.
If you ever do traditional to Roth conversions, you may find it not silly at all to understand those marginal rate zones when deciding exactly how much to convert in a given year. ;)

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Tue Jul 11, 2017 8:39 am

FiveK wrote:
matt87109 wrote:Basically people don't realize the progressive tax structure and how some of a traditional portfolio's withdrawals would be taxed at a lower rate (compared to the marginal contributions in the past), but not all.
Correct. A traditional account operates, in effect, on a First In First Out (FIFO) basis. For N years of contributions, to a first approximation an annual withdrawal amount X fills the tax brackets by X/N coming from contributions in the order each was made. Once one has made a significant amount of traditional contributions, those lower brackets for withdrawals are completely filled and subsequent contributions are taxed starting not at 0% but at some higher rate.
Upon further reading I gather than the 55% marginal rate is just a narrow band and quickly corrects back to 25%. Here is a plot https://www.bogleheads.org/wiki/File:SS_single_tax.png. What silliness.
If you ever do traditional to Roth conversions, you may find it not silly at all to understand those marginal rate zones when deciding exactly how much to convert in a given year. ;)
Thank you. I meant silly from the stand point of having a funky marginal tax rate function. The danger being to not convert traditional dollars unnecessarily to Roth paying tax for no reason. A small yearly withdrawal from traditional can avoid paying tax both in the past and present.

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FiveK
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Re: Help with explanation in wiki on taxes

Post by FiveK » Tue Jul 11, 2017 11:07 pm

matt87109 wrote:I meant silly from the stand point of having a funky marginal tax rate function.
As the saying goes, a camel is a horse designed by a committee. The tax system was designed by congress....

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Re: Help with explanation in wiki on taxes

Post by grabiner » Wed Jul 12, 2017 9:08 pm

One way to see why to use marginal rates is to make the decision one dollar at a time. If your employer offers both traditional and Roth options, and you are in the 25% bracket, you could put everything in a Roth 401(k) which will grow tax-free. You could instead contribute $1 less to the Roth 401(k), and $1.33 more to the traditional 401(k). That $1 or $1.33 will be invested; let's assume that it triples. Thus you will withdraw either $3 from your Roth 401(k) or $4 from your traditional 401(k), along with everything else you spend in that year. If you are in a 25% tax bracket, the extra $4 becomes $3 after tax.

If you decide to invest this $1 in a traditional account, you can then invest the next $1, and the next $1, until you finally run out of dollars to move, or your marginal tax rate changes. For example, you probably don't want to contribute so much to the traditional 401(k) that it drops you into a 15% tax bracket.
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Re: Help with explanation in wiki on taxes

Post by matt87109 » Fri Jul 14, 2017 8:59 pm

grabiner wrote:One way to see why to use marginal rates is to make the decision one dollar at a time. If your employer offers both traditional and Roth options, and you are in the 25% bracket, you could put everything in a Roth 401(k) which will grow tax-free. You could instead contribute $1 less to the Roth 401(k), and $1.33 more to the traditional 401(k). That $1 or $1.33 will be invested; let's assume that it triples. Thus you will withdraw either $3 from your Roth 401(k) or $4 from your traditional 401(k), along with everything else you spend in that year. If you are in a 25% tax bracket, the extra $4 becomes $3 after tax.

If you decide to invest this $1 in a traditional account, you can then invest the next $1, and the next $1, until you finally run out of dollars to move, or your marginal tax rate changes. For example, you probably don't want to contribute so much to the traditional 401(k) that it drops you into a 15% tax bracket.

Thank you. I understood the marginal tax issue on contributions, I just was not understanding the wording on the withdrawal side, further complicated by SS getting phased in on being taxed.

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Re: Help with explanation in wiki on taxes

Post by grabiner » Fri Jul 14, 2017 9:09 pm

matt87109 wrote:Thank you. I understood the marginal tax issue on contributions, I just was not understanding the wording on the withdrawal side, further complicated by SS getting phased in on being taxed.
The phase-in of SS is important in this type of computation because it affects your marginal tax rate. If you retire in the 15% tax bracket, your marginal tax rate is likely to be 27.75% once you start taking Social Security.

This is why a Roth account is usually recommended over a traditional account in a 15% tax bracket, as long as you have enough traditional money that you will still be in the 15% tax bracket. You will have 15% marginal tax rate in some years in retirement, and 27.75% in other years.
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Re: Help with explanation in wiki on taxes

Post by matt87109 » Fri Jul 14, 2017 9:19 pm

grabiner wrote:
matt87109 wrote:Thank you. I understood the marginal tax issue on contributions, I just was not understanding the wording on the withdrawal side, further complicated by SS getting phased in on being taxed.
The phase-in of SS is important in this type of computation because it affects your marginal tax rate. If you retire in the 15% tax bracket, your marginal tax rate is likely to be 27.75% once you start taking Social Security.

This is why a Roth account is usually recommended over a traditional account in a 15% tax bracket, as long as you have enough traditional money that you will still be in the 15% tax bracket. You will have 15% marginal tax rate in some years in retirement, and 27.75% in other years.
I think I understand, but will you please elaborate on "as long as you have enough traditional money that you will still be in the 15% tax bracket".

I understand using a traditional to chip down your AGI to a lower marginal tax rate and then switching to Roth on the contribution side. I understand using a small amount of traditional at withdrawal because initially the tax rate is very low, but then drawing on a roth as SS gets phase in for taxing.

Why would one year would it be 15% and others 27.5%?

Sorry. Thanks.

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Re: Help with explanation in wiki on taxes

Post by FiveK » Fri Jul 14, 2017 10:02 pm

grabiner wrote:The phase-in of SS is important in this type of computation because it affects your marginal tax rate. If you retire in the 15% tax bracket, your marginal tax rate is likely to be 27.75% once you start taking Social Security.

This is why a Roth account is usually recommended over a traditional account in a 15% tax bracket, as long as you have enough traditional money that you will still be in the 15% tax bracket. You will have 15% marginal tax rate in some years in retirement, and 27.75% in other years.
Just to elaborate on the above point:
  • Using the average $16,100 Income from Social Security for a single filer age 65 or over, ordinary income that would otherwise put one in the 15% bracket ($19,725 to $48,350 per year, or ~$500K to $1.2MM in traditional accounts at a 4% withdrawal rate), when combined with the SS, is always taxed at more than 15%:
    Image

    Using the average $27,000 Income from Social Security for a couple age 65 or over, ordinary income that would otherwise put one in the 15% bracket ($39,450 to $96,700 per year, or ~$1MM to $2.4MM in traditional accounts at a 4% withdrawal rate), when combined with the SS, is taxed at more than 15% for ~half that range:
    Image
Of course, different amounts of SS income, capital gains, etc. would change the marginal rate map. So many moving pieces that one really should check one's own situation.

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Re: Help with explanation in wiki on taxes

Post by grabiner » Fri Jul 14, 2017 10:48 pm

matt87109 wrote:
grabiner wrote:This is why a Roth account is usually recommended over a traditional account in a 15% tax bracket, as long as you have enough traditional money that you will still be in the 15% tax bracket. You will have 15% marginal tax rate in some years in retirement, and 27.75% in other years.
I think I understand, but will you please elaborate on "as long as you have enough traditional money that you will still be in the 15% tax bracket".
If you put all your retirement savings in Roth accounts (or convert everything to Roth accounts), you will owe no tax, and your marginal tax rate will also be zero (because of the standard deduction and exemptions). This is not desirable; if this might happen, you should have some traditional accounts instead, to use up the untaxed and 10% tax brackets.

More likely, you already have a mixture of traditional and Roth accounts, and will withdraw enough from traditional accounts every year to get into the 15% tax bracket.
Why would one year would it be 15% and others 27.5%?
If you retire in the 15% tax bracket, your marginal tax rate is 15% before you start taking Social Security. It will probably be 27.75% after you start taking Social Security because of the phase-in. (It might be 15% even when you are taking Social Security, if you reach the end of the phase-in, and 85% of your SS plus your non-SS income is still in the 15% bracket).
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Re: Help with explanation in wiki on taxes

Post by matt87109 » Fri Jul 14, 2017 11:45 pm

FiveK wrote:
grabiner wrote:The phase-in of SS is important in this type of computation because it affects your marginal tax rate. If you retire in the 15% tax bracket, your marginal tax rate is likely to be 27.75% once you start taking Social Security.

This is why a Roth account is usually recommended over a traditional account in a 15% tax bracket, as long as you have enough traditional money that you will still be in the 15% tax bracket. You will have 15% marginal tax rate in some years in retirement, and 27.75% in other years.
Just to elaborate on the above point:
  • Using the average $16,100 Income from Social Security for a single filer age 65 or over, ordinary income that would otherwise put one in the 15% bracket ($19,725 to $48,350 per year, or ~$500K to $1.2MM in traditional accounts at a 4% withdrawal rate), when combined with the SS, is always taxed at more than 15%:
    Image

    Using the average $27,000 Income from Social Security for a couple age 65 or over, ordinary income that would otherwise put one in the 15% bracket ($39,450 to $96,700 per year, or ~$1MM to $2.4MM in traditional accounts at a 4% withdrawal rate), when combined with the SS, is taxed at more than 15% for ~half that range:
    Image
Of course, different amounts of SS income, capital gains, etc. would change the marginal rate map. So many moving pieces that one really should check one's own situation.
Thank you very much. For the married couple, it seems obvious you would withdrawal roth dollars as soon as you hit the second marginal rate spike, rather than paying the higher rate on additional traditional withdrawals. That's what I'm supposed to gleam correct?

For the single person, I'm not sure what to make of it. How do you make a decision on that curve? It seems the marginal rate starts high and stays high.

The more I learn about taxes, I'm getting more disappointed in our tax law. My wife is terminal (no condolences please) and it seems like I'm supposed to move into an apartment or cut my house in half. I still have to raise the kids, yet I'm in the 25% bracket sooner and phasing out sooner. Yes the SS payments will offset,but even in retirement you have to pay more taxes as if expenses cut in half when one person is dead. I never realized this, but a retired couple must agonize about lost income and higher taxes after the remaining spouse is no longer a qualifying widow(er).

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Fri Jul 14, 2017 11:50 pm

grabiner wrote:
matt87109 wrote:
grabiner wrote:This is why a Roth account is usually recommended over a traditional account in a 15% tax bracket, as long as you have enough traditional money that you will still be in the 15% tax bracket. You will have 15% marginal tax rate in some years in retirement, and 27.75% in other years.
I think I understand, but will you please elaborate on "as long as you have enough traditional money that you will still be in the 15% tax bracket".
If you put all your retirement savings in Roth accounts (or convert everything to Roth accounts), you will owe no tax, and your marginal tax rate will also be zero (because of the standard deduction and exemptions). This is not desirable; if this might happen, you should have some traditional accounts instead, to use up the untaxed and 10% tax brackets.

More likely, you already have a mixture of traditional and Roth accounts, and will withdraw enough from traditional accounts every year to get into the 15% tax bracket.
Why would one year would it be 15% and others 27.5%?
If you retire in the 15% tax bracket, your marginal tax rate is 15% before you start taking Social Security. It will probably be 27.75% after you start taking Social Security because of the phase-in. (It might be 15% even when you are taking Social Security, if you reach the end of the phase-in, and 85% of your SS plus your non-SS income is still in the 15% bracket).
Sorry I'm so dense, but when you say "retire in the 15% bracket, your marginal tax rate is 15% before you start taking social security". Does this mean retire at 60 and drawing funds up into the 15% bracket, then at 62, you add SS and the marginal goes up due to SS tax phase in?

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Re: Help with explanation in wiki on taxes

Post by FiveK » Fri Jul 14, 2017 11:58 pm

matt87109 wrote:Thank you very much. For the married couple, it seems obvious you would withdrawal roth dollars as soon as you hit the second marginal rate spike, rather than paying the higher rate on additional traditional withdrawals. That's what I'm supposed to gleam correct?
Yes, that is one use.
For the single person, I'm not sure what to make of it. How do you make a decision on that curve? It seems the marginal rate starts high and stays high.
Pretty much, yes.
The more I learn about taxes, I'm getting more disappointed in our tax law. My wife is terminal (no condolences please) and it seems like I'm supposed to move into an apartment or cut my house in half. I still have to raise the kids, yet I'm in the 25% bracket sooner and phasing out sooner. Yes the SS payments will offset,but even in retirement you have to pay more taxes as if expenses cut in half when one person is dead. I never realized this, but a retired couple must agonize about lost income and higher taxes after the remaining spouse is no longer a qualifying widow(er).
Forewarned is forearmed.

Another use for these types of charts, in addition to the withdrawal strategy, is to consider them now when you have the choice of
- contributing to traditional vs. Roth, or
- deciding how much to convert from traditional to Roth,
- when to start taking SS, etc.
depending on where you are in life.

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Sat Jul 15, 2017 2:09 am

FiveK wrote:
matt87109 wrote:Thank you very much. For the married couple, it seems obvious you would withdrawal roth dollars as soon as you hit the second marginal rate spike, rather than paying the higher rate on additional traditional withdrawals. That's what I'm supposed to gleam correct?
Yes, that is one use.
For the single person, I'm not sure what to make of it. How do you make a decision on that curve? It seems the marginal rate starts high and stays high.
Pretty much, yes.
The more I learn about taxes, I'm getting more disappointed in our tax law. My wife is terminal (no condolences please) and it seems like I'm supposed to move into an apartment or cut my house in half. I still have to raise the kids, yet I'm in the 25% bracket sooner and phasing out sooner. Yes the SS payments will offset,but even in retirement you have to pay more taxes as if expenses cut in half when one person is dead. I never realized this, but a retired couple must agonize about lost income and higher taxes after the remaining spouse is no longer a qualifying widow(er).
Forewarned is forearmed.

Another use for these types of charts, in addition to the withdrawal strategy, is to consider them now when you have the choice of
- contributing to traditional vs. Roth, or
- deciding how much to convert from traditional to Roth,
- when to start taking SS, etc.
depending on where you are in life.
Thank you. In fact my motivation is trying to understand my traditional vs roth 401k contributions. Are you aware of a published method to analyze this? I'll have to work until I'm 60, so I don't think a roth ladder matters for me, but at my income I'm wondering if doing any roth in my 401k makes sense (taxed at 25%). I understand that I should model my taxes and see what traditional deductions do to my marginal tax rate. I'm phasing out child tax credits and frankly I'm not sure what all the rules and add this column to that column and if it's more add this turns all this into as far as making a decision. Making the tax law work for one's self should not require an above average IQ. Most people will never try to understand this stuff and I can see why. Thanks for helping me!

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FiveK
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Re: Help with explanation in wiki on taxes

Post by FiveK » Sat Jul 15, 2017 8:43 am

matt87109 wrote:Thank you. In fact my motivation is trying to understand my traditional vs roth 401k contributions. Are you aware of a published method to analyze this?
Not sure it rises to the level of a "published method" but the tool used to generate those marginal rate charts (see Personal finance toolbox) has been helpful to me. I've used it enough to answer some questions, and #cruncher wrote some in To help others use it, here are some hints.

There is a brief step-by-step estimation procedure for retirement rates in Investment Order (item #4, including the footnote to it).

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grabiner
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Re: Help with explanation in wiki on taxes

Post by grabiner » Sat Jul 15, 2017 8:59 am

matt87109 wrote:
grabiner wrote:
matt87109 wrote:
Why would one year would it be 15% and others 27.5%?
If you retire in the 15% tax bracket, your marginal tax rate is 15% before you start taking Social Security. It will probably be 27.75% after you start taking Social Security because of the phase-in. (It might be 15% even when you are taking Social Security, if you reach the end of the phase-in, and 85% of your SS plus your non-SS income is still in the 15% bracket).
Sorry I'm so dense, but when you say "retire in the 15% bracket, your marginal tax rate is 15% before you start taking social security". Does this mean retire at 60 and drawing funds up into the 15% bracket, then at 62, you add SS and the marginal goes up due to SS tax phase in?
Yes. There is a large range in which every $1 of additional non-SS income makes 85 cents of SS taxable. In that range, if you earn $1, your taxable income goes up by $1.85, and you pay 15% of that $1.85 in tax, which is 27.75 cents. This phase-in affects most retirees who have significant investments and who are in the 15% bracket.

One of the previous posts showed a brief spike to 46.25%, which affects some retirees who are in the 25% bracket and haven't reached the top of the phase-in. (At most 85% of SS is taxable, so the phase-in ends when you reach that point.)

See Taxation of Social Security benefits on the wiki for more details.
David Grabiner

matt87109
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Re: Help with explanation in wiki on taxes

Post by matt87109 » Sun Jul 16, 2017 12:59 am

FiveK wrote:
matt87109 wrote:Thank you. In fact my motivation is trying to understand my traditional vs roth 401k contributions. Are you aware of a published method to analyze this?
Not sure it rises to the level of a "published method" but the tool used to generate those marginal rate charts (see Personal finance toolbox) has been helpful to me. I've used it enough to answer some questions, and #cruncher wrote some in To help others use it, here are some hints.

There is a brief step-by-step estimation procedure for retirement rates in Investment Order (item #4, including the footnote to it).
I'm blown away by the concept of the mega roth I found in the investment order link. Thank you VERY much. The mega roth seems TOO good to true. Those articles are from several years ago. Does this hold today still? What I'm reading is if my 401k will allow after-tax contributions and in-service roll overs, then I can start putting an extra ~30k per year in a roth. This seems unbelievable. Since I'm mid-40s and feel the pressure of not being able to stuff enough in my retirements accounts, and I really need to work until I'm 60 anyway (kids, college), then this seems like perfection.

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FiveK
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Re: Help with explanation in wiki on taxes

Post by FiveK » Sun Jul 16, 2017 1:15 am

matt87109 wrote:
FiveK wrote:
matt87109 wrote:Thank you. In fact my motivation is trying to understand my traditional vs roth 401k contributions. Are you aware of a published method to analyze this?
Not sure it rises to the level of a "published method" but the tool used to generate those marginal rate charts (see Personal finance toolbox) has been helpful to me. I've used it enough to answer some questions, and #cruncher wrote some in To help others use it, here are some hints.

There is a brief step-by-step estimation procedure for retirement rates in Investment Order (item #4, including the footnote to it).
I'm blown away by the concept of the mega roth I found in the investment order link. Thank you VERY much. The mega roth seems TOO good to true. Those articles are from several years ago. Does this hold today still? What I'm reading is if my 401k will allow after-tax contributions and in-service roll overs, then I can start putting an extra ~30k per year in a roth. This seems unbelievable. Since I'm mid-40s and feel the pressure of not being able to stuff enough in my retirements accounts, and I really need to work until I'm 60 anyway (kids, college), then this seems like perfection.
As Robert Ripley would say, Believe It or Not! - it's true.

Google search for relevant articles within the past year: mega backdoor Roth - Google Search

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Sun Jul 16, 2017 9:22 am

grabiner wrote:
matt87109 wrote:
grabiner wrote:
matt87109 wrote:
Why would one year would it be 15% and others 27.5%?
If you retire in the 15% tax bracket, your marginal tax rate is 15% before you start taking Social Security. It will probably be 27.75% after you start taking Social Security because of the phase-in. (It might be 15% even when you are taking Social Security, if you reach the end of the phase-in, and 85% of your SS plus your non-SS income is still in the 15% bracket).
Sorry I'm so dense, but when you say "retire in the 15% bracket, your marginal tax rate is 15% before you start taking social security". Does this mean retire at 60 and drawing funds up into the 15% bracket, then at 62, you add SS and the marginal goes up due to SS tax phase in?
Yes. There is a large range in which every $1 of additional non-SS income makes 85 cents of SS taxable. In that range, if you earn $1, your taxable income goes up by $1.85, and you pay 15% of that $1.85 in tax, which is 27.75 cents. This phase-in affects most retirees who have significant investments and who are in the 15% bracket.

One of the previous posts showed a brief spike to 46.25%, which affects some retirees who are in the 25% bracket and haven't reached the top of the phase-in. (At most 85% of SS is taxable, so the phase-in ends when you reach that point.)

See Taxation of Social Security benefits on the wiki for more details.
So you are going to be lower income, have lots of roth, or have most of your SS taxed. I just learned about the mega roth IRA. I'm still in disbelief. Thanks

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Sun Jul 16, 2017 10:25 pm

FiveK wrote:
matt87109 wrote:
FiveK wrote:
matt87109 wrote:Thank you. In fact my motivation is trying to understand my traditional vs roth 401k contributions. Are you aware of a published method to analyze this?
Not sure it rises to the level of a "published method" but the tool used to generate those marginal rate charts (see Personal finance toolbox) has been helpful to me. I've used it enough to answer some questions, and #cruncher wrote some in To help others use it, here are some hints.

There is a brief step-by-step estimation procedure for retirement rates in Investment Order (item #4, including the footnote to it).
I'm blown away by the concept of the mega roth I found in the investment order link. Thank you VERY much. The mega roth seems TOO good to true. Those articles are from several years ago. Does this hold today still? What I'm reading is if my 401k will allow after-tax contributions and in-service roll overs, then I can start putting an extra ~30k per year in a roth. This seems unbelievable. Since I'm mid-40s and feel the pressure of not being able to stuff enough in my retirements accounts, and I really need to work until I'm 60 anyway (kids, college), then this seems like perfection.
As Robert Ripley would say, Believe It or Not! - it's true.

Google search for relevant articles within the past year: mega backdoor Roth - Google Search
I just spent two hours reading everything online in my retirement plan area at vanguard. Not a single mention of after-tax contributions other than being able to roll it into the plan from other 401k plans, but I did see a 54k contribution limit. Also I noticed I just passed the threshold for highly compensated employee, yet not a single mention of what this means or how it may further limit me. Is this typical of vanguard? Does this mean I may end up not being able to do a mega roth? I went to the plan rules area hoping there would be a large pdf document with all the answers i could want, but it was just a bunch of links to canned info and a few indicates of how it applied to my plan. Do I need to ask for a certain thing to get this info? I sent them an Email asking about the highly compensated details, how to do after-tax contributions, and how to do mega roth conversions, but based on what I've read here I'm concerned that it may be hard to get a good answers. Thank you for anybody that has some insight with your vanguard managed company 401k plan. Now off to watch GoT!!!

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FiveK
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Re: Help with explanation in wiki on taxes

Post by FiveK » Sun Jul 16, 2017 11:04 pm

matt87109 wrote:Is this typical of vanguard?
It's not Vanguard's rules as much as it is your employer's rules.
Do I need to ask for a certain thing to get this info?
The "Summary Plan Description" is the document to request. Your employer is obligated to provide it. It's not light reading, but it is what you want and will need - unless your benefits department is unusually helpful at explaining things. Good luck!

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Mon Jul 17, 2017 12:06 am

FiveK wrote:
matt87109 wrote:Is this typical of vanguard?
It's not Vanguard's rules as much as it is your employer's rules.
Do I need to ask for a certain thing to get this info?
The "Summary Plan Description" is the document to request. Your employer is obligated to provide it. It's not light reading, but it is what you want and will need - unless your benefits department is unusually helpful at explaining things. Good luck!
Thanks. I'm chipping away at this one bit at a time. Seems silly that Vanguard would not have it for download.

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House Blend
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Re: Help with explanation in wiki on taxes

Post by House Blend » Mon Jul 17, 2017 11:28 am

matt87109,

Not sure why no one has curbed your enthusiasm yet, but the main reason that you've never heard of the MegaBackdoor Roth until recently is that so few people have the opportunity to make use of it.

First, as noted, your plan has to offer after-tax employee contributions. This is rare. Also it is completely different from the vastly more common option to make Roth contributions in your 401(k). And plan custodian CSRs and your HR staff are likely to be confused on this point as well.

Second, the option to do in-service rollovers of after-tax amounts (and their gains) before age 59.5 is also rare.

Good luck, but it will be a small miracle if you can do the MBD Roth.

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Re: Help with explanation in wiki on taxes

Post by matt87109 » Mon Jul 17, 2017 2:45 pm

House Blend wrote:matt87109,

Not sure why no one has curbed your enthusiasm yet, but the main reason that you've never heard of the MegaBackdoor Roth until recently is that so few people have the opportunity to make use of it.

First, as noted, your plan has to offer after-tax employee contributions. This is rare. Also it is completely different from the vastly more common option to make Roth contributions in your 401(k). And plan custodian CSRs and your HR staff are likely to be confused on this point as well.

Second, the option to do in-service rollovers of after-tax amounts (and their gains) before age 59.5 is also rare.

Good luck, but it will be a small miracle if you can do the MBD Roth.
It seemed to good to be true, but I'll follow the lead till it dies. Thanks for crushing my hopes and dreams ;)

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