I still don't understand the value of a Backdoor Roth for high income earners

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panhead
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by panhead »

miamivice wrote: Wed Aug 07, 2019 9:05 am <snip>
If one has space for $50k a year (including company matches) and still feels that a backdoor Roth is "necessary", that person is either way behind in the retirement savings department, or projects huge retirement spending needs.
......or a desire to retire early!

Assuming the priority of funding the accounts is followed, the remaining choice is really backdoor Roth or taxable. If one already has a sizable taxable account that throws off significant income from interest & dividends, then using the backdoor Roth instead of taxable at least shields a little more of the income from taxes. This may be important if you are trying to manage income for things like ACA subsidies.
Spirit Rider
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by Spirit Rider »

To give a little more specifics on the value of Roth IRA assets when retiring < age 65 and Medicare.

The ability to make tax-free withdrawals is far more valuable than just the tax savings. I have saved up to $20K/year in medical insurance premiums and out-of-pocket (OOP) costs since 2014.

The ability to Target my AGI/ACA MAGI has been invaluable. This year my ACA premium is $0, saving me > $12K in unsubsidized premium costs. In past years it has saved me up to $7,350 in OOP costs.

Having the ability to fine tune your AGI and various other MAGIs can also be valuable for other purpose such as IRMAA premiums.

For example, my state has a low and moderate income property tax rebate program. My town has an elderly property tax exemption into the low six-figures. This is a cliff based on a MAGI that includes SS benefits. Yet another reason to delay SS to 70.

My non-tax savings from tax-free distributions dwarf the tax savings. This has reduced my distributions necessary to meet expenses by 25% - 30%.
miamivice
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by miamivice »

Bacchus01 wrote: Fri Aug 09, 2019 5:45 am
miamivice wrote: Wed Aug 07, 2019 8:32 am
Bacchus01 wrote: Wed Aug 07, 2019 7:14 amYou’re not the target audience for a Backdoor Roth. You’re likely not a high earner if you aren’t maxing you’re pretax space.
We make around 230k a year which is a higher earner in my book. We just don't see it valuable to max out 401k each year since we have good company matches and lots of pretax space.
You implied you didn’t have enough to make more contribution.

F you do and you don’t, you’re leaving money on the table. But to each their own.
My total pretax space is as follows:

38k - pretax 401k
15k - company match
6k - HSA

for a total of right about $60k a year. We simply don't need to put that much a year into retirement (that would be just over 25% of our income) when we already have a well funded retirement. We have $800k at age 40 in our retirement and spouse and I each will be receiving pension checks in addition to 401k income.

I concur that we should save in taxable accounts money that we plan on using in retirement. As we get closer to retirement, our savings rate will probably increase.
miamivice
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by miamivice »

panhead wrote: Fri Aug 09, 2019 7:19 am
miamivice wrote: Wed Aug 07, 2019 9:05 am <snip>
If one has space for $50k a year (including company matches) and still feels that a backdoor Roth is "necessary", that person is either way behind in the retirement savings department, or projects huge retirement spending needs.
......or a desire to retire early!
I plan to retire at 55 but not before then. I project we'll have plenty to retire at 55 without having to use the backdoor roth.

Again, being a two income familiy with access to 2 401ks changes the "need" for a backdoor roth. If I were 1 income, might be tempted.
Spirit Rider
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by Spirit Rider »

miamivice wrote: Fri Aug 09, 2019 8:55 am I concur that we should save in taxable accounts money that we plan on using in retirement. As we get closer to retirement, our savings rate will probably increase.
Nobody is saying that you should increase your savings rate just to do Backdoor Roths. Although, I never included employer contributions in my savings rate.

What we are saying, is that it is better to invest in a Backdoor Roth than taxable. Any taxable investments should be included in your savings rate. A Backdoor Roth is simply an opportunity to allocate your savings rate in an optimal manner
miamivice
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by miamivice »

Spirit Rider wrote: Fri Aug 09, 2019 9:31 am
miamivice wrote: Fri Aug 09, 2019 8:55 am I concur that we should save in taxable accounts money that we plan on using in retirement. As we get closer to retirement, our savings rate will probably increase.
Nobody is saying that you should increase your savings rate just to do Backdoor Roths. Although, I never included employer contributions in my savings rate.

What we are saying, is that it is better to invest in a Backdoor Roth than taxable. Any taxable investments should be included in your savings rate. A Backdoor Roth is simply an opportunity to allocate your savings rate in an optimal manner
A backdoor Roth is superior to a taxable if a taxable is to be used at retirement. However, if one is saving in a taxable for pre-retirement expenses, it would not be purposeful to put them in a backdoor roth.

As to whether you include employer matches in your savings rate, I sure do because it's my money and I will spend it for my benefit in retirement. Do you also exclude employer matches when you look at your retirement account balances? I sure don't.
Spirit Rider
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by Spirit Rider »

miamivice wrote: Fri Aug 09, 2019 9:47 am A backdoor Roth is superior to a taxable if a taxable is to be used at retirement. However, if one is saving in a taxable for pre-retirement expenses, it would not be purposeful to put them in a backdoor roth.
You are aware that Roth IRA contributions can be withdrawn tax and penalty free at any age and earnings are fully qualified at age 59 1/2 if >= 5 years after the first year of contributions. Backdoor Roths are IDEALLY suited for early retirement when you might need reduced AGI/MAGIs.

It most definitely would be advantageous to put them in a Backdoor Roth even if targeted for early retirement. This is especially true if you expect to make more taxable investments later. Backdoor Roths are a perishable opportunity each year. You can't make up later like you can with taxable.
miamivice
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by miamivice »

Spirit Rider wrote: Fri Aug 09, 2019 9:58 am
miamivice wrote: Fri Aug 09, 2019 9:47 am A backdoor Roth is superior to a taxable if a taxable is to be used at retirement. However, if one is saving in a taxable for pre-retirement expenses, it would not be purposeful to put them in a backdoor roth.
You are aware that Roth IRA contributions can be withdrawn tax and penalty free at any age and earnings are fully qualified at age 59 1/2 if >= 5 years after the first year of contributions. Backdoor Roths are IDEALLY suited for early retirement when you might need reduced AGI/MAGIs.

It most definitely would be advantageous to put them in a Backdoor Roth even if targeted for early retirement. This is especially true if you expect to make more taxable investments later. Backdoor Roths are a perishable opportunity each year. You can't make up later like you can with taxable.
Yes, but I said pre-retirement, not early retirement.

For example, I spend $350,000 of taxable to buy some timberland last year. While in theory I could use Roth IRA money to buy the land, in practice it is difficult and I wouldn't want to do that. Since I needed to spend both contributions and earnings to buy the land, I couldn't just have withdrawn contributions from a Roth IRA to do that.

Your point about optimizing early retirement is well taken. I haven't really thought much about our retirement plan yet. I would like to retire at 55, spouse would like to retire at 65 (we're the same age). Will have to put more thought into that when the time comes.

The rest of our taxable I plan to use to build a house. Not sure what age we will be, partially depends on how quickly we can save. Maybe 42, maybe 47. Again, taxable for us might be used for pre-retirement expenses that we could not otherwise fund.

With all of that said, I think we're fine for retirement without the backdoor Roth. We'll figure out the details later.
rbaldini
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by rbaldini »

Simple rule that will work for most high earners:

If you are a high earner, the first $19k of your savings should go to 401(k), so you can pay the income tax at a lower rate later (hopefully). This is superior to Roth, for most.

But most high earners, by virtue of their high income, can manage to save more than $19k per year. The question then is what to do with extra savings. A backdoor Roth is usually superior to a taxable account, so use it.
miamivice
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by miamivice »

rbaldini wrote: Fri Aug 09, 2019 12:05 pm Simple rule that will work for most high earners:

If you are a high earner, the first $19k of your savings should go to 401(k), so you can pay the income tax at a lower rate later (hopefully). This is superior to Roth, for most.

But most high earners, by virtue of their high income, can manage to save more than $19k per year. The question then is what to do with extra savings. A backdoor Roth is superior to a taxable account, so use it.
As stated, dual income families can do $38k a year. With an HSA, $44k a year. A lot less of high earners can do more than $44k a year.
HockeyFan99
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by HockeyFan99 »

Interesting thread.

Shout out to miamivice for civilly and repeatedly explaining why a backdoor Roth might not be superior to taxable for him/her.

Personally, we use the backdoor Roth (and mega backdoor as well at the one employer kind enough to offer it), but I appreciate seeing the argument for why it may not always be superior to taxable.

I occasionally worry about the dangers (to me) of groupthink in my decision making, not just on Bogleheads, and so I’ve very much enjoyed this thread even though it won’t change our own savings approach for now.
"I'm spending a year dead for tax reasons." - Hotblack Desiato
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PhysicianOnFIRE
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by PhysicianOnFIRE »

MoneyMarathon wrote: Tue Aug 06, 2019 10:08 pm
mhalley wrote: Tue Aug 06, 2019 9:16 pm Physician on Fire did some calculations that put the value of the backdoor vs taxable investment as $30 to $50 per yr per spouse.
It's wrong. Whatever other good things Physician on Fire has said, this advice is terrible, about as bad as it gets without telling you to, literally, light money on fire.
Did you read the article? Or the followup article?

What I stated is true in year one. The benefit is additive and compounding does take effect over time, but I think the benefit of the Backdoor Roth is often way overstated (and I'm someone who's been doing it since 2013). People seriously fret over not being able to do this when increasing their savings rate by even 1% would have a much bigger impact on their financial futures.

:beer
-PoF
lakpr
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by lakpr »

PhysicianOnFIRE wrote: Fri Aug 09, 2019 5:47 pm
MoneyMarathon wrote: Tue Aug 06, 2019 10:08 pm
mhalley wrote: Tue Aug 06, 2019 9:16 pm Physician on Fire did some calculations that put the value of the backdoor vs taxable investment as $30 to $50 per yr per spouse.
It's wrong. Whatever other good things Physician on Fire has said, this advice is terrible, about as bad as it gets without telling you to, literally, light money on fire.
Did you read the article? Or the followup article?

What I stated is true in year one. The benefit is additive and compounding does take effect over time, but I think the benefit of the Backdoor Roth is often way overstated (and I'm someone who's been doing it since 2013). People seriously fret over not being able to do this when increasing their savings rate by even 1% would have a much bigger impact on their financial futures.

:beer
-PoF
I did read the article and also the follow up articles on Rothschilds and Rothmans, I found that you did take into account the tax drag in taxable accounts, but neglected the capital gains taxes which would be around 15%. Your examples assumed only growth but never withdrawals.

Also remember that the CG taxes are levied on nominal growth, not the “real return”, so at the time of selling investments in taxable as opposed to withdrawing from Roth, you should apply a “real CG rate” of around 17% (2% inflation assumption).

Edit: state taxes further skew the balance towards back door Roth.
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PhysicianOnFIRE
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Re: I still don't understand the value of a Backdoor Roth for high income earners

Post by PhysicianOnFIRE »

lakpr wrote: Fri Aug 09, 2019 6:46 pm
PhysicianOnFIRE wrote: Fri Aug 09, 2019 5:47 pm
MoneyMarathon wrote: Tue Aug 06, 2019 10:08 pm
mhalley wrote: Tue Aug 06, 2019 9:16 pm Physician on Fire did some calculations that put the value of the backdoor vs taxable investment as $30 to $50 per yr per spouse.
It's wrong. Whatever other good things Physician on Fire has said, this advice is terrible, about as bad as it gets without telling you to, literally, light money on fire.
Did you read the article? Or the followup article?

What I stated is true in year one. The benefit is additive and compounding does take effect over time, but I think the benefit of the Backdoor Roth is often way overstated (and I'm someone who's been doing it since 2013). People seriously fret over not being able to do this when increasing their savings rate by even 1% would have a much bigger impact on their financial futures.

:beer
-PoF
I did read the article and also the follow up articles on Rothschilds and Rothmans, I found that you did take into account the tax drag in taxable accounts, but neglected the capital gains taxes which would be around 15%. Your examples assumed only growth but never withdrawals.

Also remember that the CG taxes are levied on nominal growth, not the “real return”, so at the time of selling investments in taxable as opposed to withdrawing from Roth, you should apply a “real CG rate” of around 17% (2% inflation assumption).

Edit: state taxes further skew the balance towards back door Roth.
Capital gains were addressed in both articles, with the term appearing 6 times in the followup article.

What an individual pays in capital gains will range from 0% in no-income-tax state with taxable income < $78,400 (married filing jointly / half that for single filers) to nearly 37% with taxable income > $1 Million in California.

The idea is that you figure out what you might pay and plan accordingly. I'm not suggesting you're among them, but too few people realize that a "taxable" account is really a post-tax account that can be taxed minimally or not at all when drawn down.

:beer
-PoF
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