Whats better to hold, Roth dollars or Tax-deferred dollars ?

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yugaljindle
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Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by yugaljindle » Fri Feb 08, 2019 7:29 pm

Here is what I mean,
- Roth dollars = Money in Roth-401k or money in Roth-IRA
- Tax-deferred dollars = Money in pre-tax 401k or money in traditional IRA (deductible contribution)

Conventionally wisdom explained to me,
- Tax Deffered: If you think you will make less later in your life (at age 60) meaning you will be in a lower tax bracket later, then tax-deferred is better since you will pay less in taxes. (max out your pre-tax 401k and traditional IRA)
- Roth:If you are young and make less money meaning you are in lower tax bracket right now, then roth is better since you can pay taxes on it for Roth today and you will save on taxes when you will withdraw after 60 assuming you will be wiser making more money in higer tax bracket. (max out roth-401k and roth-IRA)

But really, I realized
- Conventional wisdom is assuming you are just "saving" money and you withdraw it later in life.
- We know, you should invest the money and assuming it will gain 9.8% (index growth) compounded over all those years.
- Return will be way more than the "tax" that you would pay even if you were in a relatively higher tax bracket in your early 30s.
- If one is old like 55, making good money and plans to simply retire after 60 (not work) then probably pre-tax is better. (makes sense)

Question:
Given I am in my early 30s, does it make sense to convert all my pre-tax (tax-deferred) contributions to Roth and take the hit of the tax now ?
Assuming, Roth dollars will be invested and compounded over time which will easily exceed the tax paid today.

For some reason, this never occured in any tax saving advisory or bogle books (unless I slept through it).
Do point out if I am missing something in my understanding above ?

[Update to Question] - What I was missing
As pointed out in the responses below, I was missing the fact that (tax-deferred = Roth + taxes), paid taxes will reduce the money in the account that can grow as earnings. So, paying taxes now or later is the same thing assuming the tax slabs remain the same or in other words the conventional wisdom holds true and the realization above is faulty.

Updated Question
Where do you think is advantageous to hold money, Roth or tax-deferred ? Why ?
Last edited by yugaljindle on Sat Feb 09, 2019 1:05 pm, edited 2 times in total.

rkhusky
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by rkhusky » Fri Feb 08, 2019 7:42 pm

But if the taxes paid today to invest in a Roth, were instead invested, they would equal the tax owed in the future on Traditional withdrawals (assuming the same tax rate now and in the future).

Conventional wisdom does take into account investment gains.

Silk McCue
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Silk McCue » Fri Feb 08, 2019 7:46 pm

There are lots of threads on this. There is nothing new under the sun. The search bar is your friend.

I’m old, like 57 lol.

Cheers

software
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by software » Fri Feb 08, 2019 7:53 pm

You are missing the fact that you now have a smaller amount to invest because of having to pay taxes out of it at a high tax rate.

If your tax rate is exactly the same at the time of contribution and the time of withdrawal, there is actually zero difference between tax deferred and Roth. You can do the math yourself to verify.

Here, your tax rate will presumably much higher now (contribution time) because of the large Roth conversion, so you would NOT come out ahead.

In addition, because you now have all Roth dollars and no tax deferred, you would be unable to take advantage of lower tax brackets (since you would already be paying no tax).

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by bertilak » Fri Feb 08, 2019 8:38 pm

I can tell you, as someone who is now retired, I much prefer to have money in a Roth over a traditional IRA account. It costs me nothing to take the money out of the Roth. It costs a LOT to take money out of a traditional IRA.

When you need to withdraw money you no longer care how it got where it is! You only care what it costs to get it out.

So it is better to HOLD money in a Roth.

Unfortunately, I no longer have any money in my Roth as I spent it all paying off my mortgage. But, that might not have been a reasonable thing to do if I had to pay income taxes on that money.
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by KlangFool » Fri Feb 08, 2019 8:44 pm

OP,

The correct answer is both. Max up your tax-deferred accounts and put the tax savings into Roth IRAs.

A) Spend from your Roth IRA that generates zero taxable income

B) Roth converted your tax-deferred account at 0% or lower than your current marginal tax rate.

The best is all 3: Roth, Taxable, Tax-deferred.

A) Spend from your Roth IRA that generates zero taxable income

B) Roth converted your tax-deferred account at 0% or lower than your current marginal tax rate.

C) Tax gain harvesting your taxable account at 0%.

KlangFool
Last edited by KlangFool on Fri Feb 08, 2019 8:59 pm, edited 1 time in total.

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JMacDonald
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by JMacDonald » Fri Feb 08, 2019 8:53 pm

I like both the Roth and an IRA. I would fund the Roth first. It is entirely possible that you could be push into a higher tax bracket by withdrawing from an IRA. That won't happen with the Roth.
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aristotelian
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by aristotelian » Fri Feb 08, 2019 8:55 pm

Generally, Traditional will come out ahead. Roth might be better if you are in a low tax bracket. Try this handy dandy spreadsheet to see for yourself. (Would appreciate feedback from other Bogleheads too).
https://docs.google.com/spreadsheets/d/ ... 1374797127

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by aristotelian » Fri Feb 08, 2019 8:58 pm

bertilak wrote:
Fri Feb 08, 2019 8:38 pm
I can tell you, as someone who is now retired, I much prefer to have money in a Roth over a traditional IRA account. It costs me nothing to take the money out of the Roth. It costs a LOT to take money out of a traditional IRA.
Not always true. Keep your withdrawal under $24K (the standard deduction) and it costs 0. Saving pretax can be very powerful if you plan accordingly. Roth may have been optimal for you, but for most folks taxable income is lower in retirement. OP should run numbers for his own situation.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by FoolMeOnce » Fri Feb 08, 2019 9:17 pm

software wrote:
Fri Feb 08, 2019 7:53 pm
You are missing the fact that you now have a smaller amount to invest because of having to pay taxes out of it at a high tax rate.

If your tax rate is exactly the same at the time of contribution and the time of withdrawal, there is actually zero difference between tax deferred and Roth. You can do the math yourself to verify.
Actually, in most cases, if the marginal rate is the same now and at the time of withdrawal, you will be better off with tax-deferred. Right now, your contributions are coming off the top, so are all mostly in your top marginal rate. Withdrawals first fill up your deductions and lower brackets before reaching your top marginal rate. So assuming equal top marginal rates, tax-deferred comes out ahead for most people.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by rkhusky » Fri Feb 08, 2019 9:24 pm

aristotelian wrote:
Fri Feb 08, 2019 8:58 pm
bertilak wrote:
Fri Feb 08, 2019 8:38 pm
I can tell you, as someone who is now retired, I much prefer to have money in a Roth over a traditional IRA account. It costs me nothing to take the money out of the Roth. It costs a LOT to take money out of a traditional IRA.
Not always true. Keep your withdrawal under $24K (the standard deduction) and it costs 0. Saving pretax can be very powerful if you plan accordingly. Roth may have been optimal for you, but for most folks taxable income is lower in retirement. OP should run numbers for his own situation.
He isn’t saying Roth was optimal, just that he likes having the Roth, no matter how much it cost to get it.

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David Jay
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by David Jay » Fri Feb 08, 2019 9:28 pm

aristotelian wrote:
Fri Feb 08, 2019 8:58 pm
bertilak wrote:
Fri Feb 08, 2019 8:38 pm
I can tell you, as someone who is now retired, I much prefer to have money in a Roth over a traditional IRA account. It costs me nothing to take the money out of the Roth. It costs a LOT to take money out of a traditional IRA.
Not always true. Keep your withdrawal under $24K (the standard deduction) before the start of Social Security and it costs 0. Saving pretax can be very powerful if you plan accordingly. Roth may have been optimal for you, but for most folks taxable income is lower in retirement. OP should run numbers for his own situation.
Note the minor edit. If you are receiving Social Security then the taxable portion of SS likely eats up some of the 24,000. For me, it looks like about $17,000 or so is the effective top of the 0% bracket.
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celia
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by celia » Sat Feb 09, 2019 3:10 am

yugaljindle wrote:
Fri Feb 08, 2019 7:29 pm
Question:
Given I am in my early 30s, does it make sense to convert all my pre-tax (tax-deferred) contributions to Roth and take the hit of the tax now ?
Assuming, Roth dollars will be invested and compounded over time which will easily exceed the tax paid today.
If you are thinking of converting, you don’t have to convert all of your tax-deferred. You can convert part of it or spread it over multiple years so that you only convert to the top of your current tax bracket.

Consider that we are currently in a historically low tax environment which will expire at the end of 2025 unless Congress decides to make it permanent. This is a good time to convert because of the low tax brackets.

Another good time to convert is when the stock market drops 50% (as an example). If the cost of your shares are now only half of what they used to be, the taxes on the conversion will be about half compared to if you had converted when they were fully valued.

A third time when it is good to convert is when you have lower income for a given year. If you are unemployed, work part-time, quit to take classes full time, get sick, or take care of someone else full time, your tax bracket may be so low that it could be a shame not to take advantage of it.

rkhusky wrote:
Fri Feb 08, 2019 7:42 pm
But if the taxes paid today to invest in a Roth, were instead invested, they would equal the tax owed in the future on Traditional withdrawals (assuming the same tax rate now and in the future).

Conventional wisdom does take into account investment gains.
But people have short term memories. Many don’t remember that they agreed to pay the taxes later. All they see is that they get statements showing their tax-deferred account growing. Their name is at the top showing them as the owner. But the account really belongs to them, Uncle Sam, and their state. That’s a small detail they’ve easily forgotten after 30+ years of working.

When they get close to retirement, they estimate they need $x a month for living expenses. But they really need to withdraw about 20-40% more to pay the taxes and have $x left for living expenses.

If they saved over a million in tax-deferred, their large withdrawals could make their Medicare premium increase (as well as supplemental and drug plan premiums). And it could make their SS become taxable. It is not so simple to say someone will be in a low tax bracket in retirement. At age 30, there’s almost no way to tell what someone’s situation will be like in another 30 years.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.


retiredjg
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by retiredjg » Sat Feb 09, 2019 8:39 am

yugaljindle wrote:
Fri Feb 08, 2019 7:29 pm
Given I am in my early 30s, does it make sense to convert all my pre-tax (tax-deferred) contributions to Roth and take the hit of the tax now ?
The usual answer to this is "no". Is there a reason you think your situation may be unusual?

Whats better to hold, Roth dollars or Tax-deferred dollars ?
During accumulation, it is better to use tax-deferral since that reduces your taxes. In retirement, it is better to hold Roth since that reduces your taxes. So the best answer is to have both.


To really consider your question, you need to think about your tax bracket, your marital status, your age, your expected career income, and maybe another thing or two. There are a few situations where converting at age 30 would make good sense.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by haban01 » Sat Feb 09, 2019 8:56 am

After seeing the effects on an early accumulator vs. Someine going into retirement taking WD, RMDs, and the tax torpedo with SS, Id strive for a 50/50 split in Roth vs Traditional.
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Epsilon Delta » Sat Feb 09, 2019 11:16 am

Everyone wants to go the heaven, but nobody wants to die.

Choosing Roth over deferred involves taxes. There is no Roth fairy.

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SpringMan
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by SpringMan » Sat Feb 09, 2019 11:20 am

If you are investing for your heirs, it is better to inherit a Roth.
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Jags4186 » Sat Feb 09, 2019 11:26 am

Very easy to have both. That way no matter which one ends up better you have some of the winner.

Diversify assets
Diversify account types
Diversify tax uncertainty

That said, I’m a big believer in deferring taxes as long as possible. As much as people say this won’t happen, I do believe that we will not see meaningful income tax increases in any immediate or intermediate time frame. People freak out over income taxes. Cutting income taxes is one of the easiest ways for politicians to get wins. They can always increase payroll taxes later to make up the shortfall without making people’s “refunds” go away.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Ketawa » Sat Feb 09, 2019 12:10 pm

Commutative property of multiplication. If the marginal tax rates going in and coming out of the accounts are equal, then properly adjusted, tax-free (Roth) and tax-deferred (Traditional) accounts are equivalent for equal contributions of pre-tax dollars.

There is a small advantage for Roth accounts if you are contributing the max, which means you are effectively able to shelter more pre-tax dollars. It's only an advantage of about 2-3% in tax rates, so being able to fill up the standard or itemized deductions and lower tax brackets with withdrawals from Traditional accounts is far more important.

OP, you didn't mention how you would pay conversion taxes today. For an appropriate comparison, you have to assume it comes from money you would have invested in a taxable account or from reduced retirement savings. Otherwise, of course the small dollar size today will be dwarfed by taxes you would pay in the future after your Traditional account compounds.
Last edited by Ketawa on Sat Feb 09, 2019 12:28 pm, edited 1 time in total.

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FiveK
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by FiveK » Sat Feb 09, 2019 12:22 pm

Ketawa wrote:
Sat Feb 09, 2019 12:10 pm
Commutative property of multiplication. If the marginal tax rates going in and coming out of the accounts are equal, then properly adjusted, tax-free (Roth) and tax-deferred Traditional accounts are equivalent for equal contributions of pre-tax dollars.

There is a small advantage for Roth accounts if you are contributing the max, which means you are effectively able to shelter more pre-tax dollars.
+1. Exactly this.

See Traditional versus Roth - Bogleheads for a more elaborate answer.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Darth Xanadu » Sat Feb 09, 2019 1:07 pm

Jags4186 wrote:
Sat Feb 09, 2019 11:26 am
Very easy to have both. That way no matter which one ends up better you have some of the winner.

Diversify assets
Diversify account types
Diversify tax uncertainty

That said, I’m a big believer in deferring taxes as long as possible.
My thinking on this has evolved over the last few years (thanks in large part to BH!) and this reflects my current thinking precisely.
"A courageous teacher, failure is."

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Jags4186 » Sat Feb 09, 2019 1:19 pm

Darth Xanadu wrote:
Sat Feb 09, 2019 1:07 pm
Jags4186 wrote:
Sat Feb 09, 2019 11:26 am
Very easy to have both. That way no matter which one ends up better you have some of the winner.

Diversify assets
Diversify account types
Diversify tax uncertainty

That said, I’m a big believer in deferring taxes as long as possible.
My thinking on this has evolved over the last few years (thanks in large part to BH!) and this reflects my current thinking precisely.
Another advantage of the traditional 401k is if you live in a high income tax state you can later move to a low or no income tax state. This is one huge benefit of the traditional over the Roth.

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yugaljindle
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by yugaljindle » Sat Feb 09, 2019 1:32 pm

Consider that we are currently in a historically low tax environment which will expire at the end of 2025 unless Congress decides to make it permanent. This is a good time to convert because of the low tax brackets.

Another good time to convert is when the stock market drops 50% (as an example). If the cost of your shares are now only half of what they used to be, the taxes on the conversion will be about half compared to if you had converted when they were fully valued.
This is really interesting thought.
- Low tax environment expires in 2025, this can inform the decision until then. Its also possible that they would raise taxes like europe in the long run.
- When stocks drop significantly is something I never thought off, in the face of bad times you can very well shift the dropped-stocks (even if you want to continue hold them) to roth and hold them there and pay lower taxes. (Super Useful)

celia wrote:
Sat Feb 09, 2019 3:10 am
yugaljindle wrote:
Fri Feb 08, 2019 7:29 pm
Question:
Given I am in my early 30s, does it make sense to convert all my pre-tax (tax-deferred) contributions to Roth and take the hit of the tax now ?
Assuming, Roth dollars will be invested and compounded over time which will easily exceed the tax paid today.
If you are thinking of converting, you don’t have to convert all of your tax-deferred. You can convert part of it or spread it over multiple years so that you only convert to the top of your current tax bracket.

Consider that we are currently in a historically low tax environment which will expire at the end of 2025 unless Congress decides to make it permanent. This is a good time to convert because of the low tax brackets.

Another good time to convert is when the stock market drops 50% (as an example). If the cost of your shares are now only half of what they used to be, the taxes on the conversion will be about half compared to if you had converted when they were fully valued.

A third time when it is good to convert is when you have lower income for a given year. If you are unemployed, work part-time, quit to take classes full time, get sick, or take care of someone else full time, your tax bracket may be so low that it could be a shame not to take advantage of it.

rkhusky wrote:
Fri Feb 08, 2019 7:42 pm
But if the taxes paid today to invest in a Roth, were instead invested, they would equal the tax owed in the future on Traditional withdrawals (assuming the same tax rate now and in the future).

Conventional wisdom does take into account investment gains.
But people have short term memories. Many don’t remember that they agreed to pay the taxes later. All they see is that they get statements showing their tax-deferred account growing. Their name is at the top showing them as the owner. But the account really belongs to them, Uncle Sam, and their state. That’s a small detail they’ve easily forgotten after 30+ years of working.

When they get close to retirement, they estimate they need $x a month for living expenses. But they really need to withdraw about 20-40% more to pay the taxes and have $x left for living expenses.

If they saved over a million in tax-deferred, their large withdrawals could make their Medicare premium increase (as well as supplemental and drug plan premiums). And it could make their SS become taxable. It is not so simple to say someone will be in a low tax bracket in retirement. At age 30, there’s almost no way to tell what someone’s situation will be like in another 30 years.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by KlangFool » Sat Feb 09, 2019 1:38 pm

yugaljindle wrote:
Sat Feb 09, 2019 1:32 pm
Consider that we are currently in a historically low tax environment which will expire at the end of 2025 unless Congress decides to make it permanent. This is a good time to convert because of the low tax brackets.

Another good time to convert is when the stock market drops 50% (as an example). If the cost of your shares are now only half of what they used to be, the taxes on the conversion will be about half compared to if you had converted when they were fully valued.
This is really interesting thought.
- Low tax environment expires in 2025, this can inform the decision until then. Its also possible that they would raise taxes like europe in the long run.
yugaljindle,

I do not think this is true. As far as I know, they are lowering the income tax and increases the consumption/sale/GST/VAT taxes. Please correct me if you have something to show me that I am wrong.

KlangFool

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FiveK
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by FiveK » Sat Feb 09, 2019 1:57 pm

celia wrote:
Sat Feb 09, 2019 3:10 am
When they get close to retirement, they estimate they need $x a month for living expenses. But they really need to withdraw about 20-40% more to pay the taxes and have $x left for living expenses.
FWIW, assuming tIRA withdrawals are the only income:
- For a single person under age 65 living in Oregon (a high tax state), the need to withdraw at least 20% more starts at ~$40K/yr after-tax spending.
- For a couple both 65 or older living in a no income tax state, the after-tax spending can be up to ~$500K/yr before they need to withdraw ~40% more.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by ginmqi » Sat Feb 09, 2019 2:16 pm

Would it make sense to prefer Roth in the following scenario? (realizing I would still sock away good amount of money for tax-deferred dollars for diversification as noted above)

- For 2019, will be at 32% marginal rate (MFJ), and likely staying here or potentially increase for the rest of my working career

- For the majority of next 20-25 working years, I expect to be at this level of income or higher consistently (above avg profession + looking into side hustle/additional income sources)

- Prodigious saver/frugality during working/wealth accumulating years in next 20-25 years, plan for 60%+ savings/investing rate annually

- Plan to fat FIRE and retire in mid to late 50s

- Plan to DRASTICALLY increase annual spending (currently aiming for 200k/yr of post-tax spending) once I start retirement to really reap/enjoy the previous 20-25 yrs of hard work

Given above factors, to me it feels like I should prefer roth more than tax-deferred dollars?
Last edited by ginmqi on Sat Feb 09, 2019 2:22 pm, edited 1 time in total.

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FiveK
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by FiveK » Sat Feb 09, 2019 2:21 pm

$200K income for MFJ would just barely put you in the 24% bracket now, even if that is all ordinary income. Saving 32% now by using traditional still looks better.

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ginmqi
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by ginmqi » Sat Feb 09, 2019 2:24 pm

FiveK wrote:
Sat Feb 09, 2019 2:21 pm
$200K income for MFJ would just barely put you in the 24% bracket now, even if that is all ordinary income. Saving 32% now by using traditional still looks better.
Indeed, this is the big assumption that no one knows for sure but its so crucial to these analysis....what will the tax brackets look like in 20-30+ years?

Ugh, if only we had a future time machine.... :wink:

Given that this topic can very easily wander into the realm of politics, I can see how many people prefer roth over tax-deferred given people's political inclinations/fears....

But looks like I should still lean towards tax-deferred while still maximizing things like Roth IRA.

I may be less eager to put in lot of dollars to my roth solo 401k then this year....

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ginmqi
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by ginmqi » Sat Feb 09, 2019 2:30 pm

Would it make sense then to step aside from the math for a second and look at maybe the human/psychological factor?

In a way, if you prefer Roth you are betting that the overall tax climate will become UNFAVORABLE in the far future, especially if you have a larger than avg portfolio and plan to live large, so to speak.

If you prefer tax-deferred, then you are betting that the overall tax climate will stay the SAME or IMPROVE in the far future, especially if you have smaller portfolio and do not plan to spend big in retirement years.

Could there be an argument made from a psychological/societal/hedging perspective? (or am I off base in the above analysis)

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by averagedude » Sat Feb 09, 2019 2:45 pm

The answer is it depends. One thing i would like to point out that is overlooked by some is this example. If you say that you are going to invest $10000 into a tax deferred account, a Roth is better everytime in my opinion if you don't invest the tax savings. If you choose a traditional account, it can be better, but only if you invest the tax savings. So if you decide to invest in a traditional account and you are in the 22% bracket, you should invest $12200 instead of $10000 because you are savings $2200 in taxes. Most average Americans usually just take the tax savings as a larger refund, and blow it on consumption goods, instead of investing it. This is the behavior part of this decision between Roth and Traditional that is overlooked by some.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by retiredjg » Sat Feb 09, 2019 2:45 pm

ginmqi wrote:
Sat Feb 09, 2019 2:16 pm
Would it make sense to prefer Roth in the following scenario? For 2019, will be at 32% marginal rate (MFJ), and likely staying here or potentially increase for the rest of my working career
No.

It makes no sense to pay 32% now when there is no guarantee you will pay at least 32% in the future. I'm sure there are some people who pay 32% in retirement, but it would be unusual. Probably VERY unusual. And the $200k/per year would not get you anywhere near a 32% bracket in most half way reasonable scenarios.

Could there be an argument made from a psychological/societal/hedging perspective?
If you know and accept that you will end up with less money, but you prefer paying the taxes now so you don't have to worry later, I suppose you could make that argument.

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FiveK
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by FiveK » Sat Feb 09, 2019 2:46 pm

ginmqi wrote:
Sat Feb 09, 2019 2:30 pm
Would it make sense then to step aside from the math for a second and look at maybe the human/psychological factor?

In a way, if you prefer Roth you are betting that the overall tax climate will become UNFAVORABLE in the far future, especially if you have a larger than avg portfolio and plan to live large, so to speak.

If you prefer tax-deferred, then you are betting that the overall tax climate will stay the SAME or IMPROVE in the far future, especially if you have smaller portfolio and do not plan to spend big in retirement years.

Could there be an argument made from a psychological/societal/hedging perspective? (or am I off base in the above analysis)
Even if bracket rates increase, it still depends on "how much" they increase. E.g., if instead of paying 22% you pay 26%, saving 32% now is still likely favorable. Although, Roth can still work out better if your future withdrawal tax rate is "somewhat" less than what you save now.

See Maxing out your retirement accounts for details, and either of the two spreadsheets linked there to quantify one's personal "somewhat".

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ginmqi
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by ginmqi » Sat Feb 09, 2019 2:52 pm

retiredjg wrote:
Sat Feb 09, 2019 2:45 pm
No.

It makes no sense to pay 32% now when there is no guarantee you will pay at least 32% in the future. I'm sure there are some people who pay 32% in retirement, but it would be unusual. Probably VERY unusual. And the $200k/per year would not get you anywhere near a 32% bracket in most half way reasonable scenarios.

If you know and accept that you will end up with less money, but you prefer paying the taxes now so you don't have to worry later, I suppose you could make that argument.
It is hard to imagine being in that bracket in retirement compared to now. I think I'm swayed away from roth and more to tax-deferred dollars now.

Obviously short of something financially exceptional happening (say a big lottery win, or business venture absolutely taking off and making the retirement portfolio gigantic allowing you for very large spending each year - say very heavy 6-figures), it does seem reasonable to save on the marginal rate now.

Of course if any of those amazing things happen, you've truly won the game of life and the ability to enjoy life at that level will likely outweigh any regrets you may have had by not taking roth in your earlier years.

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ginmqi
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by ginmqi » Sat Feb 09, 2019 2:56 pm

FiveK wrote:
Sat Feb 09, 2019 2:46 pm
Even if bracket rates increase, it still depends on "how much" they increase. E.g., if instead of paying 22% you pay 26%, saving 32% now is still likely favorable. Although, Roth can still work out better if your future withdrawal tax rate is "somewhat" less than what you save now.

See Maxing out your retirement accounts for details, and either of the two spreadsheets linked there to quantify one's personal "somewhat".
For sure. Thanks for that link. I'll have some more reading to do today. And indeed I did see that spreadsheet shared as well. I gotta keep doing my homework on these things.

Thanks again for your time/insight/advice! :sharebeer

SGM
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by SGM » Sat Feb 09, 2019 3:17 pm

I had no choice but to use tax deferred only until 2010 when the law allowed anyone to make a conversion regardless of income. We started Roth conversions when I went to part time work and before starting delayed SS and a work related annuity. Our investment and real estate income went up in retirement. We are hit with high IRMMA payments in retirement too but not quite as high if we had RMDs.

Then there is a strong likelihood one of us will live to a ripe old age and pay taxes as a single person. There were some years in our 30s when both of us were working and federal and state tax rates were quite high that the deferral came in handy. After 2010 we were putting large amounts in a solo 401k while converting large amounts of traditional IRAs. I could pay DW a salary and defer her income too. Eventually we converted all into Roth accounts although I would have preferred to leave a little in a traditional IRA for qualified charitable donations after 70. But DW wanted simplification. We still make some charitable contributions but have been able to donate stocks with large capital gains.

I always believed in paying taxes later, but sometimes Roth conversions make more sense. In our situation conversions were the better deal. Still with paying taxes out of our taxable account our taxable funds grew considerably.


I liked lowering my taxable dividends and increasing my never taxed dividends. A little surprise was that the stock market kept going up and our expenses were low so we added to taxable too. I really feel good about not having to take an RMD when I am 70 1/2. The Roth accounts don't have to touched for many years if ever.

CrossOverGuy
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by CrossOverGuy » Sat Feb 09, 2019 3:18 pm

Unless the way things are taxed changes (which might be an argument for having both regular IRAs and Roths), I think Roths might be better in the long run. Say for instance you had saved $250K in a Roth by the time you retired; that would be about the equivalent of having approximately $400K in a regular IRA or a 401(k) because those latter two are going to be taxed when you make have to make required withdrawals. Roth IRAs aren't subject to having required withdrawals, but if you do, they aren't considered income. Plus Regular IRAs and 401Ks are taxable which will raise your income when you are retired which might make your Social Security income subject to being taxable as well. Of course, this site has lots of very rich folks on it, frugally trying to get free advice to save on financial advisors (which has also helped them get rich) :happy , so it may not apply to them, but someone who hasn't accumulated millions, it might make that kind of difference to them. The other income might also disqualify you from other programs like SCRIE (senior citizen rent increase exemption) if you have a rent-stabilized apartment in NY; I don't think Roth IRA distributions count as income there either or for other governmental programs.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by KlangFool » Sat Feb 09, 2019 4:24 pm

CrossOverGuy wrote:
Sat Feb 09, 2019 3:18 pm
Unless the way things are taxed changes (which might be an argument for having both regular IRAs and Roths), I think Roths might be better in the long run. Say for instance you had saved $250K in a Roth by the time you retired; that would be about the equivalent of having approximately $400K in a regular IRA or a 401(k) because those latter two are going to be taxed when you make have to make required withdrawals.
CrossOverGuy,

There is a basic mistake in your assumption. You pre-paid high marginal tax rate on that 250K in Roth. If you saved 250K in Roth, you probably have at least 400K in the tax-deferred account. If not more.

<< those latter two are going to be taxed when you make have to make required withdrawals. >.

At a lowered rate when you retired for most people. And, at 400K, withdrawing 16K (4%) per year, you pay 0%,

So, as per your example, it is a no-brainer to contribute to the tax-deferred account. It is a mistake to contribute to the Roth IRA/401K.

KlangFool

CrossOverGuy
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by CrossOverGuy » Sat Feb 09, 2019 6:39 pm

No, I'm saying that if a total at retirement Roth IRA is 250K (assuming it grew to that, the contributions were significantly lower), that $250K Roth might be equal to a $400K Regular IRA or 401(K) (again with a much less contribution rate, having grown over the years). Yet distributions will be taxed on the distributions from the 401(K) or Reg. IRA, but not on the Roth. So they would have about equal buying power. Yet, any taxable distributions from the Reg. IRA or 401(k) will be considered for Social Security taxation and/or consideration for government programs, possibly causing additional taxes or non-qualifying status, respectively.

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FiveK
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by FiveK » Sat Feb 09, 2019 7:08 pm

CrossOverGuy wrote:
Sat Feb 09, 2019 6:39 pm
No, I'm saying that if a total at retirement Roth IRA is 250K (assuming it grew to that, the contributions were significantly lower), that $250K Roth might be equal to a $400K Regular IRA or 401(K) (again with a much less contribution rate, having grown over the years). Yet distributions will be taxed on the distributions from the 401(K) or Reg. IRA, but not on the Roth. So they would have about equal buying power. Yet, any taxable distributions from the Reg. IRA or 401(k) will be considered for Social Security taxation and/or consideration for government programs, possibly causing additional taxes or non-qualifying status, respectively.
It would have taken a 37.5% tax on contributions to equate a $250K Roth with a $400K traditional account.

As long as the withdrawal tax rate on the traditional account is low enough (simply below 37.5% to a first approximation, or perhaps lower if one maxed the contributions) then the traditional will have been better.

See the commutative property of multiplication as it applies to this topic.

H-Town
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by H-Town » Sat Feb 09, 2019 7:25 pm

yugaljindle wrote:
Fri Feb 08, 2019 7:29 pm
Question:
Given I am in my early 30s, does it make sense to convert all my pre-tax (tax-deferred) contributions to Roth and take the hit of the tax now ?
Assuming, Roth dollars will be invested and compounded over time which will easily exceed the tax paid today.

For some reason, this never occured in any tax saving advisory or bogle books (unless I slept through it).
Do point out if I am missing something in my understanding above ?

[Update to Question] - What I was missing
As pointed out in the responses below, I was missing the fact that (tax-deferred = Roth + taxes), paid taxes will reduce the money in the account that can grow as earnings. So, paying taxes now or later is the same thing assuming the tax slabs remain the same or in other words the conventional wisdom holds true and the realization above is faulty.

Updated Question
Where do you think is advantageous to hold money, Roth or tax-deferred ? Why ?
You asked the wrong question. What you should ask is: "How do I maximize my after-tax portfolio?" The better you minimize tax, the more wealth will be yours. By holding either Roth or Tax-deferred only will not help you achieve this.

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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Longdog » Sat Feb 09, 2019 7:44 pm

If I could instantly, and without any tax consequence, convert all of my assets to Roth, I'd do that because there is then no further tax obligation on growth or earnings, and I would be immune from tax law changes. But that is obviously not possible which brings me to my main point: that pondering "which is better to hold, Roth or tax-deferred" is too simplistic a question because the real answer of what's best to hold at any point in time depends greatly on the path to getting there (which accounts do you contribute to at which point in time and under what circumstances), not just a snapshot in time. In terms of which accounts to contribute to, the general rule is to contribute to Roth if you are in a low tax bracket and contribute to a pre-tax account if you are in a high tax bracket. And if you find yourself in a low tax bracket at some point in your life, it is beneficial to convert pre-tax dollars to Roth dollars up to the top of that low bracket, paying the taxes from taxable accounts.
Steve

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F150HD
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by F150HD » Sat Feb 09, 2019 8:07 pm

haven't read this whole thread but in another thread a year ago someone made a great supplemental point about tax-deferred:

if you choose tax deferred (no Fed or State taxes up front) then when retiring you move to a state w/ no State income tax, that's a huge bonus.

Not that everyone will move but....I found that interesting to ponder.

bryansmile
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by bryansmile » Sat Feb 09, 2019 8:23 pm

F150HD wrote:
Sat Feb 09, 2019 8:07 pm

if you choose tax deferred (no Fed or State taxes up front) then when retiring you move to a state w/ no State income tax, that's a huge bonus.
This is exactly what I plan to do :D
Only saves on state income tax though.

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Epsilon Delta
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Epsilon Delta » Sat Feb 09, 2019 8:50 pm

F150HD wrote:
Sat Feb 09, 2019 8:07 pm
haven't read this whole thread but in another thread a year ago someone made a great supplemental point about tax-deferred:

if you choose tax deferred (no Fed or State taxes up front) then when retiring you move to a state w/ no State income tax, that's a huge bonus.

Not that everyone will move but....I found that interesting to ponder.
Of course you could move the other way.

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yugaljindle
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by yugaljindle » Sat Feb 09, 2019 9:34 pm

What ways are available to maximize your after tax portfolio? (Reasonable)

- clever ways/timing to convert to roth?
- Backdoor roth - done
- mega-backdoor roth - done
- anything else?
H-Town wrote:
Sat Feb 09, 2019 7:25 pm
yugaljindle wrote:
Fri Feb 08, 2019 7:29 pm
Question:
Given I am in my early 30s, does it make sense to convert all my pre-tax (tax-deferred) contributions to Roth and take the hit of the tax now ?
Assuming, Roth dollars will be invested and compounded over time which will easily exceed the tax paid today.

For some reason, this never occured in any tax saving advisory or bogle books (unless I slept through it).
Do point out if I am missing something in my understanding above ?

[Update to Question] - What I was missing
As pointed out in the responses below, I was missing the fact that (tax-deferred = Roth + taxes), paid taxes will reduce the money in the account that can grow as earnings. So, paying taxes now or later is the same thing assuming the tax slabs remain the same or in other words the conventional wisdom holds true and the realization above is faulty.

Updated Question
Where do you think is advantageous to hold money, Roth or tax-deferred ? Why ?
You asked the wrong question. What you should ask is: "How do I maximize my after-tax portfolio?" The better you minimize tax, the more wealth will be yours. By holding either Roth or Tax-deferred only will not help you achieve this.

Rouster
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by Rouster » Sat Feb 09, 2019 9:53 pm

Let's say you are investing in a company 401K and are under 30. The company offers a Roth and has matching. Take up to the matching percentage. This will accumulate your money in a Roth and the company match in a traditional deferred account. Next step, fill your Roth to max allowable in a core account in a major brokerage house (Fidelity, Vanguard, T Rowe Price, etc.) for you to decide how you want to manage it. Additional money thereafter, Roth in the 401K. Why?

Taxes are the lowest since the 1920"s. Given the national debt of about 21 Trillion and rising, the demographic profile will change and taxes will certainly increase after 2025, if not earlier. Same type of thing for an IRA. Roth first, due to the horizon of the federal tax implications. If in the 20-30's, income is lower, thus less taxes now. After that, accumulation of traditional IRA's increases, look for tax diversification in a Roth. Yes, exceptions exist, but I am addressing the constituents of this website.

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emlowe
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by emlowe » Sat Feb 09, 2019 9:56 pm

yugaljindle wrote:
Sat Feb 09, 2019 9:34 pm
What ways are available to maximize your after tax portfolio? (Reasonable)

- clever ways/timing to convert to roth?
- Backdoor roth - done
- mega-backdoor roth - done
- anything else?
HSA
Muni Bonds
I Bonds
EE Bonds
Very Tax Efficient ETFs (e.g VTI)
Tax Managed Funds (e.g VTMFX - Vanguard Tax Managed Balanced)

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teen persuasion
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by teen persuasion » Sat Feb 09, 2019 10:38 pm

OP, you need to recognize there are 2 different issues here: where is it better to CONTRIBUTE to (in the accumulation phase), and where is it better to HOLD retirement savings? Obviously everyone would prefer to hold Roth dollars, but it's more advantageous to contribute to tax deferred. Thus the answer is some of each. How much of each depends on your situation, on a year to year basis.

Several posters have mentioned contributing to Roth when in a low tax bracket, but that decision should actually be based on low marginal tax rate, not bracket. As an example, consider our situation: relatively low income, MFJ, 5 kids, eligible for EITC and CTC, state matches EITC at 30%. Our tax bracket was nominally 10% but effectively zero due to (past dependent exemptions and) CTC refundable credits, but contributions to tax deferred 401k increases our EITC by reversing the 21% phaseout. That credit is also refundable. The state version of EITC depends on the federal credit, so it also increases (30% match of additional 21% = 6.3%). Lowering our AGI reduces our tax bracket to actual zero% (avoiding the 10% federal and 4% state tax rates), increasing the refundable portion of the CTC we get as cash. So in all, contributions to tax deferred 401k net us 21% + 6.3% + 10% + 4% = 41.3%. That's the true marginal rate for us, not our zero bracket.

Then those tax savings (refunds) were/are used to fund Roth IRAs for both of us. A traditional IRA contribution won't increase EITC (it can't reduce line 7 wages), so it's of no value to us. The Roth IRAs are thus funded tax free, and balance our retirement buckets out. We are roughly 1/3 Roth to 2/3 traditional.

When we retire early, we can begin a Roth conversion ladder, to gain penalty free access to traditional IRA withdrawals (convert an annual income amount to Roth, withdraw similar amount from Roth contributions, letting new conversions season 5 years, rinse and repeat) before age 59.5 and to spend down traditional accounts somewhat before SS and RMDs. If there's room in the standard deduction space plus credits like AOTC, we could convert extra to Roth (over what we want to withdraw for spending) for more shifting from traditional to Roth at little tax cost.

But this is very much a year by year decision. Taxes with 5 young kids looked quite different than now with only 2 left, and one in college (only 1 CTC). Roth conversions have a negative impact on FAFSA calculations, so we'll pause on those while DS5 is in FAFSA years. EITC and CTC and AOTC go away when dependents grow up and leave the nest. So our tax bracket will definitely increase in retirement, but our marginal rate will likely decrease.

sawdust60
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Re: Whats better to hold, Roth dollars or Tax-deferred dollars ?

Post by sawdust60 » Sun Feb 10, 2019 12:16 am

Also keep in mind that marginal tax rates are different with SS income. Up to 85% of SS is taxable, but it is dependent on non-SS income. This and more in prior post about Roth at 22%+ : viewtopic.php?f=2&t=271875#p4365173

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