Which is better for me: roth contributions or tax gain harvesting?

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ai_3_us
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Which is better for me: roth contributions or tax gain harvesting?

Post by ai_3_us » Fri Aug 03, 2018 1:17 am

I'm a 26 year-old graduate student. As such I'm in the 12% tax bracket and am looking to use up some extra space in that bracket. I have been fortunate enough to have a large portfolio due to generous family members when I was a mere child. Right now I am contributing 100% of my salary to my 403(b) and 457 and living off of (tax free!) LTCG from taxable accounts. It's looking I will still have some room in the bottom tax bracket. I am hoping some people here can help me figure out how best to use up that room.

I know that this question gets asked frequently and that there are n articles online stating definitively that option A is better than option B. But there are also m articles online stating that option B is better than option A. It is clear that which is best is very situation dependent. Unfortunately much of what I read is in regards to roth conversions, which is something I am not yet in a place to do. I think that roth contributions (which are allowed in both my 403(b) and 457) are similar though.

It might be important to note the following. I will be in graduate school for at least one (probably two) more years. I live in a state with no income tax, but will likely move after graduate school. I have enough LTCG right now to live off of for 2-3 years at my current pace.

Any and all thoughts are appreciated!

MotoTrojan
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by MotoTrojan » Fri Aug 03, 2018 2:32 am

ai_3_us wrote:
Fri Aug 03, 2018 1:17 am
I'm a 26 year-old graduate student. As such I'm in the 12% tax bracket and am looking to use up some extra space in that bracket. I have been fortunate enough to have a large portfolio due to generous family members when I was a mere child. Right now I am contributing 100% of my salary to my 403(b) and 457 and living off of (tax free!) LTCG from taxable accounts. It's looking I will still have some room in the bottom tax bracket. I am hoping some people here can help me figure out how best to use up that room.

I know that this question gets asked frequently and that there are n articles online stating definitively that option A is better than option B. But there are also m articles online stating that option B is better than option A. It is clear that which is best is very situation dependent. Unfortunately much of what I read is in regards to roth conversions, which is something I am not yet in a place to do. I think that roth contributions (which are allowed in both my 403(b) and 457) are similar though.

It might be important to note the following. I will be in graduate school for at least one (probably two) more years. I live in a state with no income tax, but will likely move after graduate school. I have enough LTCG right now to live off of for 2-3 years at my current pace.

Any and all thoughts are appreciated!
Are you contributing to a Roth IRA too? If you have room to fill in the bracket, it seems Roth in your 4xx’s is a no brainer at least up to that bracket. From there it depends on what you expect your retirement tax-rate to be.

So basically, why not do both? Or keep doing pretax, sell extra taxable up to the bracket, and fund your Roth IRA to essentially convert taxable to Roth.

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Tamarind
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by Tamarind » Fri Aug 03, 2018 5:34 am

If you are actually deferring all of your earned income to tax-advantaged accounts, are you even eligible to contribute to a Roth IRA? The cap is the lower of of your earned income or $5500. But the amount of your MAGI that is from work is $0. The LTCG are specifically excluded when calculating your Roth contribution limit.

Someone tell me I'm wrong?

retiredjg
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by retiredjg » Fri Aug 03, 2018 8:25 am

Iin the 12% tax bracket, I'd be using Roth 401/457b instead of traditional. But you have to see if that moves you out of the 12% bracket.

Getting money into Roth at only 12% is a good thing.

ai_3_us
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by ai_3_us » Fri Aug 03, 2018 11:26 am

Tamarind wrote:
Fri Aug 03, 2018 5:34 am
If you are actually deferring all of your earned income to tax-advantaged accounts, are you even eligible to contribute to a Roth IRA? The cap is the lower of of your earned income or $5500. But the amount of your MAGI that is from work is $0. The LTCG are specifically excluded when calculating your Roth contribution limit.

Someone tell me I'm wrong?
I am contributing fully to my Roth IRA. I didn't even consider the fact that my earned income is $0 so I may not be eligible for Roth IRA contributions! Thank you for bringing this up. If I begin to make 403(b) roth contributions, would these count towards earned income? If not, this is easily fixable.

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FiveK
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by FiveK » Fri Aug 03, 2018 12:15 pm

ai_3_us wrote:
Fri Aug 03, 2018 11:26 am
If I begin to make 403(b) roth contributions, would these count towards earned income?
I think you mean "...because the Roth contributions would not be deducted from wages, and therefore I'll have more than $5500 in my W-2 Box 1 for 2018."

If that's what you mean, you are correct.

infotrader
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by infotrader » Fri Aug 03, 2018 12:19 pm

You can also contribute to Roth IRA using the backdoor. Just contribute to traditional ira and convert it to roth the next day.

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FiveK
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by FiveK » Fri Aug 03, 2018 12:28 pm

infotrader wrote:
Fri Aug 03, 2018 12:19 pm
You can also contribute to Roth IRA using the backdoor. Just contribute to traditional ira and convert it to roth the next day.
That has the same issue as direct Roth contribution in the OP's case: perhaps not enough "compensation" (aka "earned income") to allow contributions. A backdoor Roth is useful when one may have too much Modified Adjusted Gross Income.

One may "double dip" by using the same $5500 compensation to justify both Roth 403b and Roth IRA in OP's situation.

adam1712
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by adam1712 » Fri Aug 03, 2018 12:43 pm

I was in your exact situation as a graduate student and went 100% Roth in the 12% bracket. It's unclear to me if you are worried about the capital gains taxes needed to have money to live on or if you are planning to also sell taxable and reinvest again to tax gain harvest. I would max out your 403b and 457 with as much of it being Roth as possible without going out of the 12% bracket. Unless the capital gains are huge, it seems like you could likely be all Roth and stay within the 12% bracket. I would prioritize that over tax gain harvesting just to reinvest.

ai_3_us
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by ai_3_us » Fri Aug 03, 2018 1:35 pm

FiveK wrote:
Fri Aug 03, 2018 12:15 pm
ai_3_us wrote:
Fri Aug 03, 2018 11:26 am
If I begin to make 403(b) roth contributions, would these count towards earned income?
I think you mean "...because the Roth contributions would not be deducted from wages, and therefore I'll have more than $5500 in my W-2 Box 1 for 2018."

If that's what you mean, you are correct.
That's what I mean. And W-2 box 1 == earned income?

ai_3_us
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by ai_3_us » Fri Aug 03, 2018 1:40 pm

adam1712 wrote:
Fri Aug 03, 2018 12:43 pm
I was in your exact situation as a graduate student and went 100% Roth in the 12% bracket. It's unclear to me if you are worried about the capital gains taxes needed to have money to live on or if you are planning to also sell taxable and reinvest again to tax gain harvest. I would max out your 403b and 457 with as much of it being Roth as possible without going out of the 12% bracket. Unless the capital gains are huge, it seems like you could likely be all Roth and stay within the 12% bracket. I would prioritize that over tax gain harvesting just to reinvest.
I am not worried about capital gains taxes, since they are 0% for me. In the future the capital gains tax will probably be more for me though, so I was considering taking the gains now to raise the basis.

Right now I am doing both. I am taking some capital gains to live on, but have also sold some positions and reinvested just to raise the basis.

I don't have high enough salary to max out both the 403 and the 457, but I will do my best. However my salary (all going to roth) + what I need to live would push me out of the 12% bracket. I will just do this carefully.

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FiveK
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by FiveK » Fri Aug 03, 2018 1:46 pm

ai_3_us wrote:
Fri Aug 03, 2018 1:35 pm
That's what I mean. And W-2 box 1 == earned income?
Yes. See What Is Compensation? for more.

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Tamarind
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by Tamarind » Fri Aug 03, 2018 1:59 pm

ai_3_us wrote:
Fri Aug 03, 2018 1:40 pm
adam1712 wrote:
Fri Aug 03, 2018 12:43 pm
I was in your exact situation as a graduate student and went 100% Roth in the 12% bracket. It's unclear to me if you are worried about the capital gains taxes needed to have money to live on or if you are planning to also sell taxable and reinvest again to tax gain harvest. I would max out your 403b and 457 with as much of it being Roth as possible without going out of the 12% bracket. Unless the capital gains are huge, it seems like you could likely be all Roth and stay within the 12% bracket. I would prioritize that over tax gain harvesting just to reinvest.
I am not worried about capital gains taxes, since they are 0% for me. In the future the capital gains tax will probably be more for me though, so I was considering taking the gains now to raise the basis.

Right now I am doing both. I am taking some capital gains to live on, but have also sold some positions and reinvested just to raise the basis.

I don't have high enough salary to max out both the 403 and the 457, but I will do my best. However my salary (all going to roth) + what I need to live would push me out of the 12% bracket. I will just do this carefully.
If you can find a salary percentage for Roth contributions that would result in $5500 Roth 403 contributions by the end of 2018, I think it would be a good idea. Doing that would let you put $5500 into the Roth IRA as well. You could still defer the rest of your salary into traditional. So long as the (harvested capital gains + $5500 Roth 403 contributions + any taxable interest from savings and dividends from the taxable account) doesn't exceed the 0% LTCG range ($50,600 for a single person taking the standard deduction in 2018), you would get to take $5500 of the gains and move them into Roth where they can grow tax free. That's pretty awesome.

If you have lots of space before getting to $50,600, you could either harvest more gains or make more of your 403 contributions Roth. Be careful with year-end distributions from your holdings possibly pushing you over. Dollar $50,601 kicks all your LTCG into 15%.

Edited to strike wrong info about capital gains tax rate.
Last edited by Tamarind on Fri Aug 03, 2018 3:09 pm, edited 1 time in total.

ai_3_us
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by ai_3_us » Fri Aug 03, 2018 2:09 pm

Tamarind wrote:
Fri Aug 03, 2018 1:59 pm
If you have lots of space before getting to $50,600, you could either harvest more gains or make more of your 403 contributions Roth. Be careful with year-end distributions from your holdings possibly pushing you over. Dollar $50,601 kicks all your LTCG into 15%.
Yes it's a bit scary so I like to give myself some cushion. It's also nice to know that if I do hit $50,601 I can just recharacterize $1 of Roth IRA contributions to traditional contributions... another advantage of having that rIRA.

Edit: Tamarind, I just noticed that you said "$5500 Roth 403 contributions"... but the 403 Roth contributions will almost certainly be greater than that. I think you mean $5500 Roth IRA contributions + 403 Roth contributions.

adam1712
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by adam1712 » Fri Aug 03, 2018 2:15 pm

ai_3_us wrote:
Fri Aug 03, 2018 1:40 pm


I am not worried about capital gains taxes, since they are 0% for me. In the future the capital gains tax will probably be more for me though, so I was considering taking the gains now to raise the basis.

Right now I am doing both. I am taking some capital gains to live on, but have also sold some positions and reinvested just to raise the basis.

I don't have high enough salary to max out both the 403 and the 457, but I will do my best. However my salary (all going to roth) + what I need to live would push me out of the 12% bracket. I will just do this carefully.
I would personally prioritize going Roth versus taking gains just to raise the basis as that's what I did. It's probably a close to a toss up but it's my preference. The raised basis doesn't really benefit you until you actually sell. Something I don't plan to do for a very long time with my taxable accounts now that I can fully fund my retirement accounts with salary.

Just to make sure, you've taken into account the standard deduction as well as determined the cost basis for your capital gains when determining the top of the 12% bracket?

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FiveK
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by FiveK » Fri Aug 03, 2018 2:18 pm

Tamarind wrote:
Fri Aug 03, 2018 1:59 pm
If you have lots of space before getting to $50,600, you could either harvest more gains or make more of your 403 contributions Roth. Be careful with year-end distributions from your holdings possibly pushing you over. Dollar $50,601 kicks all your LTCG into 15%.
Fortunately, that's not the way it works. Dollar $50,601 (if that is ordinary plus LTCG) means $1 of LTCG is taxed at 15%. If the extra dollar was ordinary income, it will be taxed at 12% and push $1 of LTCG to be taxed at 15%, for a total of 27%. But only on that $1.

ai_3_us
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by ai_3_us » Fri Aug 03, 2018 2:29 pm

adam1712 wrote:
Fri Aug 03, 2018 2:15 pm
Just to make sure, you've taken into account the standard deduction as well as determined the cost basis for your capital gains when determining the top of the 12% bracket?
Yes, I have. Last year and this year there were some holdings that I needed to sell ASAP (high ER actively managed funds) so I took many gains there. At the end of this year I will take a look at my actual spending and see if I can pull it off with ALL going to roth. If it's not possible, it will certainly be close.

I also just noticed that my 457 does NOT have a roth option, so 25% of my salary will have to go to traditional anyway.

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BL
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by BL » Fri Aug 03, 2018 3:03 pm

I suggest you wait with Roth IRA until early next year when you have W-2 in hand. Then you should know exactly what you can contribute (Box 1 up to 5500) to the Roth (by April 2019) without going over. Estimating is especially important for the rest that you can only do during this calendar year. I hope you are familiar with doing your own taxes.

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Tamarind
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by Tamarind » Fri Aug 03, 2018 3:07 pm

FiveK wrote:
Fri Aug 03, 2018 2:18 pm
Tamarind wrote:
Fri Aug 03, 2018 1:59 pm
If you have lots of space before getting to $50,600, you could either harvest more gains or make more of your 403 contributions Roth. Be careful with year-end distributions from your holdings possibly pushing you over. Dollar $50,601 kicks all your LTCG into 15%.
Fortunately, that's not the way it works. Dollar $50,601 (if that is ordinary plus LTCG) means $1 of LTCG is taxed at 15%. If the extra dollar was ordinary income, it will be taxed at 12% and push $1 of LTCG to be taxed at 15%, for a total of 27%. But only on that $1.
I'm really happy to be corrected here, thanks!. I knew it worked this way for ordinary income (no cliff) but thought that the next dollar changed the rate for ALL long term capital gains. I'll add a note to my post.

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Tamarind
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by Tamarind » Fri Aug 03, 2018 3:15 pm

ai_3_us wrote:
Fri Aug 03, 2018 2:09 pm
Tamarind wrote:
Fri Aug 03, 2018 1:59 pm
If you have lots of space before getting to $50,600, you could either harvest more gains or make more of your 403 contributions Roth. Be careful with year-end distributions from your holdings possibly pushing you over. Dollar $50,601 kicks all your LTCG into 15%.
Yes it's a bit scary so I like to give myself some cushion. It's also nice to know that if I do hit $50,601 I can just recharacterize $1 of Roth IRA contributions to traditional contributions... another advantage of having that rIRA.

Edit: Tamarind, I just noticed that you said "$5500 Roth 403 contributions"... but the 403 Roth contributions will almost certainly be greater than that. I think you mean $5500 Roth IRA contributions + 403 Roth contributions.
Note that fivek corrected me on that. Only the next dollar of LTCG is taxed at 15%, not all of them. But there's little point in realizing capital gains at a rate higher than your rate on ordinary income.

Re the $5500 403 contributions, you certainly can have more, but you need to have at least $5500 in Roth 403 contributions to be able to contribute the max to the Roth IRA. Roth 403 contributions are great for you at 12%, but they directly reduce the amount of capital gains at 0%, so you'll want to balance them so you get enough gains out to cover your living expenses.

adam1712
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by adam1712 » Fri Aug 03, 2018 3:44 pm

ai_3_us wrote:
Fri Aug 03, 2018 2:29 pm

Yes, I have. Last year and this year there were some holdings that I needed to sell ASAP (high ER actively managed funds) so I took many gains there. At the end of this year I will take a look at my actual spending and see if I can pull it off with ALL going to roth. If it's not possible, it will certainly be close.

I also just noticed that my 457 does NOT have a roth option, so 25% of my salary will have to go to traditional anyway.
Got it. Sounds like you're on top of things and it's an excellent opportunity you are taking advantage of. You can't go too wrong any way you do it.

ai_3_us
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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by ai_3_us » Fri Aug 03, 2018 4:34 pm

Tamarind wrote:
Fri Aug 03, 2018 3:15 pm
Roth 403 contributions are great for you at 12%, but they directly reduce the amount of capital gains at 0%, so you'll want to balance them so you get enough gains out to cover your living expenses.
I don't know if this will matter much. If I contribute all of those LTCG to a Roth, I can take substantially equal payments after rolling my roth 403 into my rIRA, in which case I'll get that money tax free anyway.

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Re: Which is better for me: roth contributions or tax gain harvesting?

Post by grabiner » Fri Aug 03, 2018 8:31 pm

ai_3_us wrote:
Fri Aug 03, 2018 4:34 pm
Tamarind wrote:
Fri Aug 03, 2018 3:15 pm
Roth 403 contributions are great for you at 12%, but they directly reduce the amount of capital gains at 0%, so you'll want to balance them so you get enough gains out to cover your living expenses.
I don't know if this will matter much. If I contribute all of those LTCG to a Roth, I can take substantially equal payments after rolling my roth 403 into my rIRA, in which case I'll get that money tax free anyway.
You cannot take Substantially Equal Periodic Payments tax-free from a Roth IRA before 59-1/2. These payments avoid the 10% penalty, but they are still taxable if they are withdrawals of not-yet-taxed money. This strategy would work only for a traditional IRA.

However, you can withdraw contributions (including money originally contributed to a Roth 403(b) and rolled into the Roth IRA) tax-free at any time, and conversions tax-free after five years. Thus, if you retire before 59-1/2 with a large Roth balance, you will probably have enough Roth money to use for living expenses.
Wiki David Grabiner

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