Lower Bracket Using Traditional, Then Contribute to Roth?

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st346
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Joined: Thu Sep 28, 2017 1:01 pm

Lower Bracket Using Traditional, Then Contribute to Roth?

Post by st346 » Thu Oct 12, 2017 8:13 am

Hello,

I'm planning my retirement savings and I'm going to be using the TSP as well as a personal IRA. I'm making 60k/yr which puts me in the 25% tax bracket, but the way I see it, I can use traditional TSP contributions to lower my marginal rate to 15%, meaning if I use a Roth IRA, it will be taxed at the lower rate. I wanted to be sure this makes sense. So, roughly:

$60,000 income
- $6,350 standard deduction
- $4,050 personal exemption
- $3,500 (estimated) for pre-tax insurance premiums and FSA contributions
= $46,100

$46,100
- $37,950
= $8,150

So as far as I can tell, contributing at least $8,150 into the traditional TSP would put me in the 15% bracket, meaning my personal Roth IRA contributions would be taxed at a significantly lower rate, and thus I should contribute at least that much to the trad TSP before making any Roth contributions (to either a personal RIRA or to the Roth TSP). Is this true? I'm not tax-savvy enough to know whether I'm missing some glaring error.

Thanks!

EHEngineer
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Joined: Sat Feb 28, 2015 4:35 pm

Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by EHEngineer » Thu Oct 12, 2017 9:00 am

That's a great analysis.

But, don't forget the key questions.
1) How much do you need/want to save? Both pre-tax and roth are better than a taxable account for long term savings. So if you save more than $5500 you will be using both of them. (Edit: Maybe you have the Roth TSP option?) I'm assuming you are less than 55 y/o.

2) What will your future tax rate be? You can never be assured what it will be, you are left with the question: Do I want to pay my marginal tax rate now, or take my chances with the future tax rate? If you marginal tax rate is 25%, and you believe future taxes will be 20%, then you may prefer the pre-tax savings. If your marginal rate is 15% and you believe future taxes will be 20%, then you may prefer the roth.

Conclusion
If you believe future taxes are >25% then you will put everything in post-tax Roth. If you believe future taxes are < 15% then you put everything in pre-tax TSP.

If you are unsure about future taxes (or don't want to analyze a tiered tax rate system and/or uncertainty), then you can split your contributions and put some in pre-tax and some in post-tax. Tax diversification.

Good luck.
Last edited by EHEngineer on Thu Oct 12, 2017 3:35 pm, edited 1 time in total.
Or, you can ... decline to let me, a stranger on the Internet, egg you on to an exercise in time-wasting, and you could say "I'm probably OK and I don't care about it that much." -Nisiprius

rkhusky
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Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by rkhusky » Thu Oct 12, 2017 12:46 pm

For most people, it is best to max a Traditional 401K and use the tax savings to fund a Roth IRA. Your idea of using Traditional to get into the 15% bracket and then contribute to a Roth IRA is fine, especially since you will be getting a pension. Once you have maxed the Roth IRA, go back to contributing to the Traditional 401K.

Contributing 100% to the Traditional 401K is not a bad choice either.

Just remember that you can contribute more to the Traditional account because of the tax savings, such that your take home pay remains the same.

mega317
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Joined: Tue Apr 19, 2016 10:55 am

Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by mega317 » Thu Oct 12, 2017 1:58 pm

EHEngineer wrote:
Thu Oct 12, 2017 9:00 am
Conclusion
If you believe future taxes are >25% then you will put everything in pre-tax TSP. If you believe future taxes are < 15% then you put everything in post-tax Roth.
I think you have this backwards. If future tax rate will be higher, you would rather pay the tax now (Roth). If future tax rate is lower, you want to defer paying (traditional).

EHEngineer
Posts: 641
Joined: Sat Feb 28, 2015 4:35 pm

Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by EHEngineer » Thu Oct 12, 2017 3:35 pm

mega317 wrote:
Thu Oct 12, 2017 1:58 pm
EHEngineer wrote:
Thu Oct 12, 2017 9:00 am
Conclusion
If you believe future taxes are >25% then you will put everything in pre-tax TSP. If you believe future taxes are < 15% then you put everything in post-tax Roth.
I think you have this backwards. If future tax rate will be higher, you would rather pay the tax now (Roth). If future tax rate is lower, you want to defer paying (traditional).
:oops:

Fixed now.
Or, you can ... decline to let me, a stranger on the Internet, egg you on to an exercise in time-wasting, and you could say "I'm probably OK and I don't care about it that much." -Nisiprius

st346
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Joined: Thu Sep 28, 2017 1:01 pm

Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by st346 » Thu Oct 12, 2017 6:32 pm

Thanks guys!

Yes, my approach is tax-diversification because lots of things, including my work income, retirement income, and tax law, are very uncertain. So my plan is to contribute enough to Traditional TSP to get down to 15% marginal rate, then $5,500 to a Roth IRA, and then any additional retirement savings back into the Traditional TSP up to max. To be honest though the $13,650 already seems like plenty for the time being, given that I've also got the 5% employer match and 4.4% of my income going to my pension fund.

aristotelian
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Joined: Wed Jan 11, 2017 8:05 pm

Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by aristotelian » Thu Oct 12, 2017 6:50 pm

I like it. Only other question I would have is whether you have any capital gains you could harvest in taxable accounts to take advantage of the extra 15% space from a full traditional contribution.

Also, if there is any chance you might receive income from an unexpected source - stock dividends, side job, etc - you might want to wait until after Jan 1 to make sure you have a complete picture of your taxes before making a decision.

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celia
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Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by celia » Thu Oct 12, 2017 7:55 pm

I look at it from the other direction. When you are young, your salary tends to be lower since you don't have much experience or education compared to your later working years. Your tax bracket is usually at its lowest when you are earning the least and is highest when you are earning your maximum. So let's reverse engineer the calcs:
st346 wrote:
Thu Oct 12, 2017 8:13 am
$60,000 income
- $6,350 standard deduction
- $4,050 personal exemption
- $3,500 (estimated) for pre-tax insurance premiums and FSA contributions
= $46,100
Set aside your income. Add $6,350 + 4,050 + 3,500 = $13,900. Let's add that to the top of each tax bracket, assuming Single:

10% tops out at $9,325 of "Taxable Income" but you can earn 13,900 more and still be taxed at 10% or less since that amount will be subtracted before the tax is calculated. That gives you $9,325 + 13,900 = $23,225 of income.

15% tops out at $37.950 of "Taxable Income" but you can earn 13,900 more, which totals $51,850 of income.

25% tops out at $91,900 of "Taxable Income" but you can earn 13,900 more, which totals $105,800 of income.

Looking at your current $60,000 of income puts you only $60,000 - 51,850 = $8,150 above the top of the 15% tax bracket. So you only need to tax-defer that much before your Roth contributions are taxed at 15%.

I would want to put as much as I could in the Roth when my income was low, if my income would be expected to increase in the future. You also have time on your side so the investment has more time to compound compared to someone who is doing this in her 50s or 60s.

After you tax-defer $8,150 and put $5,500 in a Roth IRA, if you want to save more for retirement, find out if you can make Roth contributions to the TSP. Of course, the employer contributions will always be put in tax-deferred.
Sounds like tax diversification to me!

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FiveK
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Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by FiveK » Thu Oct 12, 2017 8:41 pm

st346 wrote:
Thu Oct 12, 2017 8:13 am
So as far as I can tell, contributing at least $8,150 into the traditional TSP would put me in the 15% bracket, meaning my personal Roth IRA contributions would be taxed at a significantly lower rate, and thus I should contribute at least that much to the trad TSP before making any Roth contributions (to either a personal RIRA or to the Roth TSP). Is this true? I'm not tax-savvy enough to know whether I'm missing some glaring error.
You are tax-savvy enough to have figured this correctly - well done!

Reasonable arguments can be made in general for contributing to either traditional or Roth when paying a 15% marginal rate now. In your particular case, with a pension likely, Roth will probably be better.

It appears you are early in your career and in retirement saving, so the error bar on your likely withdrawal marginal rate is huge. As the years go by you will be able to refine that estimate. See the part about "Estimating withdrawal tax rates" in Investment Order for one approach. After you work through that or similar calculation, you can ignore rules of thumb and do what you expect will be best for you.

TropikThunder
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Joined: Sun Apr 03, 2016 5:41 pm

Re: Lower Bracket Using Traditional, Then Contribute to Roth?

Post by TropikThunder » Thu Oct 12, 2017 10:09 pm

celia wrote:
Thu Oct 12, 2017 7:55 pm
Your tax bracket is usually at its lowest when you are earning the least and is highest when you are earning your maximum.
:twisted:

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