Why Roth IRA when you have not maxed out 401k?

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stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Sun Dec 15, 2019 6:31 pm

@retiredjg and @ruralavalon
Huge thanks again to both of you.

Our HR mentioned new HSA option last week, so I hope it is going to be available for 2020 for us. Did a little homework, and I have an option to put $3500 into Lively HSA account, and link it to TD Ameritrade (Believe this is the best, cheapest combo). If I go that route, then that would lower the amount that I put into my traditional 401k, because our 1% admin fee on 401k is the biggest enemy.

Hopefully I've got this all sorted out, as far as allocation between the accounts. I hope both of you would agree with me on this. I am including HSA (hopefully available for 2020)

Roughly:
HSA $3500
IRA $6000 (trad $2400 + Roth $3600)
401k $3500
---------------------
Total: $13000 (my total contribution out of $65K income)

Here is how you told me to calculate it:
1. $12400 to get rid of, in order to reach 12% bracket:
HSA $3500 + tIRA $2400 + 401k $3500 (401K - Need to put at least 5% to get 4% match) = $9400
Health insurance premium deduction $3000 (does not even show on w-2)
2. I still have $3600 to contribute (13,000 - 9,400), so it goes to Roth IRA. That happened to max out IRA $6000 limit. In reality, I need more than $3600 because it is after tax (3600 x 1.12 = $4032) I can handle additional $432 annually!

Following years as my salary increases, I need to increase the contribution into 401k, and decrease the contribution into Roth IRA, to stay in 12% bracket.

mortfree
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Re: Why Roth IRA when you have not maxed out 401k?

Post by mortfree » Sun Dec 15, 2019 6:43 pm

Is the church contribution based on gross income?

Maybe you should calculate based on net income.

I know how this is a sensitive topic but even if you knocked it down to 5800 or 6800 that could help you.

* my church is not responsible when it comes to money, hence my mindset on contributions

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FiveK
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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Sun Dec 15, 2019 6:48 pm

stingray777 wrote:
Sun Dec 15, 2019 6:31 pm
Following years as my salary increases, I need to increase the contribution into 401k, and decrease the contribution into Roth IRA, to stay in 12% bracket.
Or, perhaps keep the Roth IRA contribution constant while the 401k contribution increase matches the salary increase, until you have reached the point at which all your tax-advantaged buckets are filled and you start investing in a taxable (aka regular) brokerage account.

See Prioritizing investments and Investment Order for more.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by 1130Super » Sun Dec 15, 2019 6:56 pm

UnLearnYourself wrote:
Wed Dec 11, 2019 9:46 am
Triple digit golfer wrote:
Sun Dec 08, 2019 4:17 pm
Here is a great thread for you.

viewtopic.php?f=10&t=61529

I tend to agree with you. If your 401k has good, low-cost plans and you plan on being in a lower bracket when you retire, there's a good case for maxing it out before investing in a Roth IRA.

Read the wiki, too. There are other considerations. You can theoretically use a Roth as an emergency fund and withdraw contributions tax and penalty-free, you can use a Roth to "tax diversity," etc.

https://www.bogleheads.org/wiki/Traditional_versus_Roth
How can you be so sure of your tax bracket, or the tax system 20, 30, 40 years out?

Personally I like this staggered approach in order to hedge what the future may hold.

The real answer is...max out both!
Tax rates are going up in 2026 per the current tax code so I’d max Roth as a top priority

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grabiner
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Re: Why Roth IRA when you have not maxed out 401k?

Post by grabiner » Sun Dec 15, 2019 6:58 pm

stingray777 wrote:
Sun Dec 15, 2019 6:31 pm
Our HR mentioned new HSA option last week, so I hope it is going to be available for 2020 for us. Did a little homework, and I have an option to put $3500 into Lively HSA account, and link it to TD Ameritrade (Believe this is the best, cheapest combo). If I go that route, then that would lower the amount that I put into my traditional 401k, because our 1% admin fee on 401k is the biggest enemy.
In a 12% tax bracket, contributing a dollar to the HSA rather than to the 401(k) is an immediate 12% savings because withdrawals are tax-free, and if you will be stuck with that high-expense 401(k) for ten years, that's another 10% savings. So the net savings on $3550 in the HSA could be $800. Is that worthwhile, given the difference in benefits between the HDHP and the conventional plan, and your expected medical costs?

Note that you probably don't want to make HSA contributions by payroll deduction, even if your employer allows them. HSA contributions are fully deductible from your income tax even if you make them yourself; you don't need to itemize deductions. Using payroll deduction will reduce your Social Security tax, but given your relatively low income, you are probably in the range (below the second bend point) where this costs you more in lost Social Security. If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation. If you invest in a Roth IRA to make up that lost benefit, you would need more than $100.
Wiki David Grabiner

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Re: Why Roth IRA when you have not maxed out 401k?

Post by 1130Super » Sun Dec 15, 2019 6:59 pm

stingray777 wrote:
Sun Dec 15, 2019 6:31 pm
@retiredjg and @ruralavalon
Huge thanks again to both of you.

Our HR mentioned new HSA option last week, so I hope it is going to be available for 2020 for us. Did a little homework, and I have an option to put $3500 into Lively HSA account, and link it to TD Ameritrade (Believe this is the best, cheapest combo). If I go that route, then that would lower the amount that I put into my traditional 401k, because our 1% admin fee on 401k is the biggest enemy.

Hopefully I've got this all sorted out, as far as allocation between the accounts. I hope both of you would agree with me on this. I am including HSA (hopefully available for 2020)

Roughly:
HSA $3500
IRA $6000 (trad $2400 + Roth $3600)
401k $3500
---------------------
Total: $13000 (my total contribution out of $65K income)

Here is how you told me to calculate it:
1. $12400 to get rid of, in order to reach 12% bracket:
HSA $3500 + tIRA $2400 + 401k $3500 (401K - Need to put at least 5% to get 4% match) = $9400
Health insurance premium deduction $3000 (does not even show on w-2)
2. I still have $3600 to contribute (13,000 - 9,400), so it goes to Roth IRA. That happened to max out IRA $6000 limit. In reality, I need more than $3600 because it is after tax (3600 x 1.12 = $4032) I can handle additional $432 annually!

Following years as my salary increases, I need to increase the contribution into 401k, and decrease the contribution into Roth IRA, to stay in 12% bracket.
Remember tax brackets are pegged to inflation so the 12% bracket will increase every year

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stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Sun Dec 15, 2019 7:18 pm

mortfree wrote:
Sun Dec 15, 2019 6:43 pm
Is the church contribution based on gross income?

Maybe you should calculate based on net income.

I know how this is a sensitive topic but even if you knocked it down to 5800 or 6800 that could help you.

* my church is not responsible when it comes to money, hence my mindset on contributions
My church contribution is calculated from the gross. So $7800 out of my pocket.
Could you explain where you are going with this? I am lost.

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stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Sun Dec 15, 2019 7:39 pm

FiveK wrote:
Sun Dec 15, 2019 6:48 pm

Or, perhaps keep the Roth IRA contribution constant while the 401k contribution increase matches the salary increase, until you have reached the point at which all your tax-advantaged buckets are filled and you start investing in a taxable (aka regular) brokerage account.
I am losing my grip here. You mean until I reach my 401k limit of $19500? That will never happen.
I cannot keep the same amount every year in Roth IRA in order to stay in 12% bracket either, so that is not what you meant. Or you mean to keep Roth IRA at $6000? Remember I don't have anything in the bag now, and I don't have too much time. tIRA is better for me. I want to use tIRA over 401k due to the higher cost. Roth IRA showed up because lakpr did the calculation for me and found that there was a window for it. In fact, I am really confused. I hope you are not, and can clear up my mind.

I understand that you never know and tax rate will go up, but I will be in a lower bracket when I retire. I do not think about the possibility of the lowest being more than 22%.

Topic Author
stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Sun Dec 15, 2019 7:51 pm

grabiner wrote:
Sun Dec 15, 2019 6:58 pm
stingray777 wrote:
Sun Dec 15, 2019 6:31 pm
Our HR mentioned new HSA option last week, so I hope it is going to be available for 2020 for us. Did a little homework, and I have an option to put $3500 into Lively HSA account, and link it to TD Ameritrade (Believe this is the best, cheapest combo). If I go that route, then that would lower the amount that I put into my traditional 401k, because our 1% admin fee on 401k is the biggest enemy.
In a 12% tax bracket, contributing a dollar to the HSA rather than to the 401(k) is an immediate 12% savings because withdrawals are tax-free, and if you will be stuck with that high-expense 401(k) for ten years, that's another 10% savings. So the net savings on $3550 in the HSA could be $800. Is that worthwhile, given the difference in benefits between the HDHP and the conventional plan, and your expected medical costs?

Note that you probably don't want to make HSA contributions by payroll deduction, even if your employer allows them. HSA contributions are fully deductible from your income tax even if you make them yourself; you don't need to itemize deductions. Using payroll deduction will reduce your Social Security tax, but given your relatively low income, you are probably in the range (below the second bend point) where this costs you more in lost Social Security. If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation. If you invest in a Roth IRA to make up that lost benefit, you would need more than $100.
I really appreciate your help, but this is all greek to me. I have no clue of what you are talking about. Are you telling me all of this after you put yourself in my shoe? Or are you just giving general advice? I am not trying to be tacky. I just do not understand it.

At least, I think you are telling me in the second part, it is OK to use HSA to lower the taxable income, but do not do the payroll deduction. Pay more for your social security tax. Does that apply to everyone of the similar income? I will need to check if there is going to be any match from the employer on this, right? If not, don't do it through the payroll deduction?

lakpr
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Re: Why Roth IRA when you have not maxed out 401k?

Post by lakpr » Sun Dec 15, 2019 8:00 pm

stingray777 wrote:
Sun Dec 15, 2019 7:51 pm
At least, I think you are telling me in the second part, it is OK to use HSA to lower the taxable income, but do not do the payroll deduction. Pay more for your social security tax. Does that apply to everyone of the similar income? I will need to check if there is going to be any match from the employer on this, right? If not, don't do it through the payroll deduction?
@stingray777,

Yes I think @grabiner is saying what you understood.
"Second bend point" regarding social security = approximately $2 million of life time earnings on which social security tax have been paid (inflation adjusted, of course, that $2 million is current dollars).

@grabiner is saying that you are better off NOT doing the HSA contribution through payroll, because it would avoid payroll taxes. Consequently, your SS income in your retirement will be reduced. He's saying that, given your $65k income, it is unlikely you will reach $2 million of inflation-adjusted dollars before you will claim the social security, hence it's advisable to pay those payroll taxes now. In other words, contribute to an HSA outside of payroll.

If there is match from your employer, though, then the equation does change in favor of contributing to HSA through payroll to grab the match.

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grabiner
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Re: Why Roth IRA when you have not maxed out 401k?

Post by grabiner » Sun Dec 15, 2019 9:45 pm

stingray777 wrote:
Sun Dec 15, 2019 7:51 pm
Note that you probably don't want to make HSA contributions by payroll deduction, even if your employer allows them. HSA contributions are fully deductible from your income tax even if you make them yourself; you don't need to itemize deductions. Using payroll deduction will reduce your Social Security tax, but given your relatively low income, you are probably in the range (below the second bend point) where this costs you more in lost Social Security. If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation. If you invest in a Roth IRA to make up that lost benefit, you would need more than $100.
I really appreciate your help, but this is all greek to me. I have no clue of what you are talking about. Are you telling me all of this after you put yourself in my shoe? Or are you just giving general advice? I am not trying to be tacky. I just do not understand it.

At least, I think you are telling me in the second part, it is OK to use HSA to lower the taxable income, but do not do the payroll deduction. Pay more for your social security tax. Does that apply to everyone of the similar income? I will need to check if there is going to be any match from the employer on this, right? If not, don't do it through the payroll deduction?
[/quote]

If you have a HDHP, you want to max out the HSA. Because of the tax advantages, the HSA is a better use of your money than any other investment except a 401(k) with an employer match.

If your employer contributes its own money to your HSA, that is free money, which is an extra incentive for using the HDHP. This is relevant when you decide whether to use the HDHP or a conventional plan.

You can also contribute your own money to the HSA, up to the IRS limit. Some employers allow you to do this by payroll deduction, so that it doesn't count in your salary. If you do not use payroll deduction, the HSA contribution is deducted from your income for income tax purposes, but you pay Social Security and Medicare tax on it. Whether this is good or bad depends on how the income affects Social Security.

Your Social Security benefit is determined by averaging your income over your 35 highest-earning years, adjusting for changes in average wages. But the benefit is not a fixed fraction of your income; it is 90% of the income up to the "first bend point" (which almost everyone reaches), then 32% up to the "second bend point" ($69,420 in 2019), then 15% above that. If you are below the second bend point, using payroll deduction for HSA contributions to reduce your Social Security tax likely costs you more in future benefits. If you are above the second bend point, it is close to break-even. If you are above the maximum SS-taxable wages, there is no SS tax reduction, and eliminating the Medicare tax by payroll deduction is a clear gain.

Regardless of where you are in the SS schedule, paying health insurance by payroll deduction is a good deal, because you avoid income tax as well as SS tax; paying health insurance out of pocket is usually not deductible.
Wiki David Grabiner

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stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Sun Dec 15, 2019 11:24 pm

lakpr wrote:
Sun Dec 15, 2019 8:00 pm
stingray777 wrote:
Sun Dec 15, 2019 7:51 pm
At least, I think you are telling me in the second part, it is OK to use HSA to lower the taxable income, but do not do the payroll deduction. Pay more for your social security tax. Does that apply to everyone of the similar income? I will need to check if there is going to be any match from the employer on this, right? If not, don't do it through the payroll deduction?
@stingray777,

Yes I think @grabiner is saying what you understood.
"Second bend point" regarding social security = approximately $2 million of life time earnings on which social security tax have been paid (inflation adjusted, of course, that $2 million is current dollars).

@grabiner is saying that you are better off NOT doing the HSA contribution through payroll, because it would avoid payroll taxes. Consequently, your SS income in your retirement will be reduced. He's saying that, given your $65k income, it is unlikely you will reach $2 million of inflation-adjusted dollars before you will claim the social security, hence it's advisable to pay those payroll taxes now. In other words, contribute to an HSA outside of payroll.

If there is match from your employer, though, then the equation does change in favor of contributing to HSA through payroll to grab the match.
This really helped me understand. Thank you very much. May I ask one more question?
Now I will have 4 accounts: 401k, Roth IRA, traditional IRA, HSA. That is more than handful! Do I want to open up accounts like this:
- Vanguard for Roth IRA and traditional IRA (no fee)
- Lively for HSA bank account (no fee)
- TD Ameritrade for investments from Lively (management fee seems between 0.03 - 0.10%. ER the same)

Do I want to open both IRAs at TDA for simpler management as well, or use a separate Vanguard account to save the management fee? If I use Vanguard for IRA, then I will need to go to 3 places for a full picture. Does convenience outweighs the extra fee?

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stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Sun Dec 15, 2019 11:32 pm

grabiner wrote:
Sun Dec 15, 2019 9:45 pm

Your Social Security benefit is determined by averaging your income over your 35 highest-earning years, adjusting for changes in average wages. But the benefit is not a fixed fraction of your income; it is 90% of the income up to the "first bend point" (which almost everyone reaches), then 32% up to the "second bend point" ($69,420 in 2019), then 15% above that. If you are below the second bend point, using payroll deduction for HSA contributions to reduce your Social Security tax likely costs you more in future benefits. If you are above the second bend point, it is close to break-even. If you are above the maximum SS-taxable wages, there is no SS tax reduction, and eliminating the Medicare tax by payroll deduction is a clear gain.
Wow, knowledge is power! Thank you.
Looking back, HR did not mention company contribution, but did mention that we had to shop around and open our HSA account on our own. They are also new to this, but it sounds like there is no payroll deduction option for HSA contribution since they don't have a fixed HSA account. They may be able to do a direct allocation to HSA account, but you don't call that payroll deduction, do you?

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FiveK
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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Sun Dec 15, 2019 11:46 pm

stingray777 wrote:
Sun Dec 15, 2019 7:39 pm
FiveK wrote:
Sun Dec 15, 2019 6:48 pm
Or, perhaps keep the Roth IRA contribution constant while the 401k contribution increase matches the salary increase, until you have reached the point at which all your tax-advantaged buckets are filled and you start investing in a taxable (aka regular) brokerage account.
am losing my grip here. You mean until I reach my 401k limit of $19500? That will never happen.
I cannot keep the same amount every year in Roth IRA in order to stay in 12% bracket either, so that is not what you meant. Or you mean to keep Roth IRA at $6000?
Yes, keep the Roth IRA contribution maximized (aka "constant" if the IRS maximum doesn't change) once you drop to the 12% bracket.

Maybe a picture of sorts will help to explain "drop". One major assumption: in the "diagram" below, A>B>C.

A ---------- <-your gross income

B ---------- <-the top of the 12% bracket (expressed in AGI terms - in other words, the tax table number plus your standard deduction)

C ---------- <-the amount you need for food, clothing, shelter, taxes, etc., now

You may have some "fixed" expenses between A and B. E.g., employer-sponsored medical insurance. Other than that, putting the amount of "A minus B" into traditional accounts seems reasonable. That will cause your "taxable" income to drop from A to B.

Then you could look to put "B minus C" into Roth accounts, if you think your marginal rate in retirement won't be any lower than 12%

Does that make sense, or still clear as mud?
Remember I don't have anything in the bag now, and I don't have too much time. tIRA is better for me. I want to use tIRA over 401k due to the higher cost. Roth IRA showed up because lakpr did the calculation for me and found that there was a window for it. In fact, I am really confused. I hope you are not, and can clear up my mind.

I understand that you never know and tax rate will go up, but I will be in a lower bracket when I retire. I do not think about the possibility of the lowest being more than 22%.
If you expect to be in the 12% bracket in retirement, then lacking any clearer crystal ball it doesn't matter whether you contribute to traditional or Roth in the 12% bracket now. People will give advice based on what they think might happen, but nobody knows what the overall tax picture will be, let alone knowing what your personal circumstances will be.

Whether you choose traditional or Roth for further contributions once you have contributed enough traditional to drop from A to B in the above diagram, the fact that you choose to contribute at all should serve you well in retirement. Good luck!

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Re: Why Roth IRA when you have not maxed out 401k?

Post by grabiner » Sun Dec 15, 2019 11:52 pm

FiveK wrote:
Sun Dec 15, 2019 11:46 pm
If you expect to be in the 12% bracket in retirement, then lacking any clearer crystal ball it doesn't matter whether you contribute to traditional or Roth in the 12% bracket now. People will give advice based on what they think might happen, but nobody knows what the overall tax picture will be, let alone knowing what your personal circumstances will be.
I would prefer Roth in this situation. Even if you are in the 12% tax bracket, your marginal tax rate in retirement is likely to be more than 12% once you start taking Social Security, because of the phase-in of Social Security taxation. For every $1 withdrawn from a traditional IRA, you pay 12% tax on that $1 and on 50 or 85 cents more of your Social Security, for a marginal tax rate of 18% or 22.2%.
Wiki David Grabiner

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FiveK
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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Mon Dec 16, 2019 1:08 am

grabiner wrote:
Sun Dec 15, 2019 11:52 pm
FiveK wrote:
Sun Dec 15, 2019 11:46 pm
If you expect to be in the 12% bracket in retirement, then lacking any clearer crystal ball it doesn't matter whether you contribute to traditional or Roth in the 12% bracket now. People will give advice based on what they think might happen, but nobody knows what the overall tax picture will be, let alone knowing what your personal circumstances will be.
I would prefer Roth in this situation. Even if you are in the 12% tax bracket, your marginal tax rate in retirement is likely to be more than 12% once you start taking Social Security, because of the phase-in of Social Security taxation. For every $1 withdrawn from a traditional IRA, you pay 12% tax on that $1 and on 50 or 85 cents more of your Social Security, for a marginal tax rate of 18% or 22.2%.
That will certainly be true for some, and for those using Roth is indeed strongly indicated.

At some parts of the 12% bracket, even with SS income, the marginal rate is still 12%. One can get a quick idea of where one might fall by looking at the "heat maps" in Taxation of Social Security benefits - Heat map representation.

Other than "determine your own likely situation and act accordingly" ("accordingly" being to minimize the marginal rate one pays between contribution and withdrawal) it's hard to come up with a one size fits all suggestion for t vs. R.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by 1130Super » Mon Dec 16, 2019 4:27 am

FiveK wrote:
Sun Dec 15, 2019 11:46 pm
stingray777 wrote:
Sun Dec 15, 2019 7:39 pm
FiveK wrote:
Sun Dec 15, 2019 6:48 pm
Or, perhaps keep the Roth IRA contribution constant while the 401k contribution increase matches the salary increase, until you have reached the point at which all your tax-advantaged buckets are filled and you start investing in a taxable (aka regular) brokerage account.
am losing my grip here. You mean until I reach my 401k limit of $19500? That will never happen.
I cannot keep the same amount every year in Roth IRA in order to stay in 12% bracket either, so that is not what you meant. Or you mean to keep Roth IRA at $6000?
Yes, keep the Roth IRA contribution maximized (aka "constant" if the IRS maximum doesn't change) once you drop to the 12% bracket.

Maybe a picture of sorts will help to explain "drop". One major assumption: in the "diagram" below, A>B>C.

A ---------- <-your gross income

B ---------- <-the top of the 12% bracket (expressed in AGI terms - in other words, the tax table number plus your standard deduction)

C ---------- <-the amount you need for food, clothing, shelter, taxes, etc., now

You may have some "fixed" expenses between A and B. E.g., employer-sponsored medical insurance. Other than that, putting the amount of "A minus B" into traditional accounts seems reasonable. That will cause your "taxable" income to drop from A to B.

Then you could look to put "B minus C" into Roth accounts, if you think your marginal rate in retirement won't be any lower than 12%

Does that make sense, or still clear as mud?
Remember I don't have anything in the bag now, and I don't have too much time. tIRA is better for me. I want to use tIRA over 401k due to the higher cost. Roth IRA showed up because lakpr did the calculation for me and found that there was a window for it. In fact, I am really confused. I hope you are not, and can clear up my mind.

I understand that you never know and tax rate will go up, but I will be in a lower bracket when I retire. I do not think about the possibility of the lowest being more than 22%.
If you expect to be in the 12% bracket in retirement, then lacking any clearer crystal ball it doesn't matter whether you contribute to traditional or Roth in the 12% bracket now. People will give advice based on what they think might happen, but nobody knows what the overall tax picture will be, let alone knowing what your personal circumstances will be.

Whether you choose traditional or Roth for further contributions once you have contributed enough traditional to drop from A to B in the above diagram, the fact that you choose to contribute at all should serve you well in retirement. Good luck!

But the 12% bracket will return to the 15% percent bracket in 2026 under current tax law so you still come out ahead to put in Roth if you can contribute while in 12% bracket, unless you expect to move to lower tax state

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FiveK
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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Mon Dec 16, 2019 4:34 am

1130Super wrote:
Mon Dec 16, 2019 4:27 am
FiveK wrote:
Sun Dec 15, 2019 11:46 pm
People will give advice based on what they think might happen, but nobody knows what the overall tax picture will be, let alone knowing what your personal circumstances will be.
But the 12% bracket will return to the 15% percent bracket in 2026 under current tax law so you still come out ahead to put in Roth if you can contribute while in 12% bracket, unless you expect to move to lower tax state
If that is what happens.

To be clear, I agree that someone expecting to be well within the 12% bracket using 2019 numbers is probably well advised to use Roth while paying 12% now. It's just not a sure thing, as either tax laws or personal circumstances could change.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by retiredjg » Mon Dec 16, 2019 8:27 am

stingray777 wrote:
Sun Dec 15, 2019 6:31 pm
@retiredjg and @ruralavalon
Huge thanks again to both of you.

Our HR mentioned new HSA option last week, so I hope it is going to be available for 2020 for us. Did a little homework, and I have an option to put $3500 into Lively HSA account, and link it to TD Ameritrade (Believe this is the best, cheapest combo). If I go that route, then that would lower the amount that I put into my traditional 401k, because our 1% admin fee on 401k is the biggest enemy.

Hopefully I've got this all sorted out, as far as allocation between the accounts. I hope both of you would agree with me on this. I am including HSA (hopefully available for 2020)

Roughly:
HSA $3500
IRA $6000 (trad $2400 + Roth $3600)
401k $3500
---------------------
Total: $13000 (my total contribution out of $65K income)

Here is how you told me to calculate it:
1. $12400 to get rid of, in order to reach 12% bracket:
HSA $3500 + tIRA $2400 + 401k $3500 (401K - Need to put at least 5% to get 4% match) = $9400
Health insurance premium deduction $3000 (does not even show on w-2)
2. I still have $3600 to contribute (13,000 - 9,400), so it goes to Roth IRA. That happened to max out IRA $6000 limit. In reality, I need more than $3600 because it is after tax (3600 x 1.12 = $4032) I can handle additional $432 annually!

Following years as my salary increases, I need to increase the contribution into 401k, and decrease the contribution into Roth IRA, to stay in 12% bracket.
First, you are definitely catching on to how all this works. That's a good thing.

I hate to shake things up, but from my viewpoint, these numbers do not get you into the 12% tax bracket for your entire Roth IRA contribution. See if you can find the difference. I think it is using $12,400 to get rid of in order to reach the 12% bracket. I think that number should be higher.

Here's my calculation:

$65,000 salary...
minus $3,100 health care premiums
minus $3,500 HSA
minus $2,400 tIRA
minus $3,500 401k
minus $12,200 standard deduction

gives you $40,300 taxable income which is $825 higher than the top of the 12% tax bracket. This means that $825 of your Roth IRA contribution is being taxed at 22% instead of 12%. Not that that is a fatal flaw, just that it is different from what you think.

If you really want all the Roth IRA contribution to be taxed at only 12%, you'll need to increase your tIRA contribution by $825 and decrease your Roth IRA contribution by the same. Unless I made a mistake.


As for the HSA...in order to use an HSA do you understand that you must use a High Deductible Health Insurance Plan? That does not suit everybody. Be sure it is right for you. Also be sure you know all the fees that go with using the HSA. There are probably fees in addition to the expense ratios.

If the HSA is right for you, that's great. It will come in handy later in life and that money will never be taxed.

Note if the HDHP premiums are less than what you are currently paying, you'll need to juggle numbers again.

I did not know that HSA premiums can be deducted even if you use the standard deduction. You need to find out where on the tax form to do this and you need to remember to do it.

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stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Mon Dec 16, 2019 10:11 am

FiveK wrote:
Sun Dec 15, 2019 11:46 pm

Whether you choose traditional or Roth for further contributions once you have contributed enough traditional to drop from A to B in the above diagram, the fact that you choose to contribute at all should serve you well in retirement. Good luck!
Thank you again. This says it. What is important is that it was foolish that I did not start it when I was 30 years old, but I am starting it now, and not at 50.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by lakpr » Mon Dec 16, 2019 10:32 am

retiredjg wrote:
Mon Dec 16, 2019 8:27 am
Here's my calculation:

$65,000 salary...
minus $3,100 health care premiums
minus $3,500 HSA
minus $2,400 tIRA
minus $3,500 401k
minus $12,200 standard deduction

gives you $40,300 taxable income which is $825 higher than the top of the 12% tax bracket. This means that $825 of your Roth IRA contribution is being taxed at 22% instead of 12%.
Standard deduction in 2020 is $12,400 ($200 more than in your calculation). So the taxable income is $40,100.
Top of the 12% bracket is $40,125 in 2020 for Singles.

https://taxfoundation.org/2020-tax-brackets/

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Re: Why Roth IRA when you have not maxed out 401k?

Post by retiredjg » Mon Dec 16, 2019 10:38 am

Ok. I was working with all 2019 numbers since we no nothing about 202 salary and health care costs.

As long as stingray777 understands where the numbers come from, that's fine.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Mon Dec 16, 2019 10:41 am

retiredjg wrote:
Mon Dec 16, 2019 8:27 am

Here's my calculation:

$65,000 salary...
minus $3,100 health care premiums
minus $3,500 HSA
minus $2,400 tIRA
minus $3,500 401k
minus $12,200 standard deduction

gives you $40,300 taxable income which is $825 higher than the top of the 12% tax bracket. This means that $825 of your Roth IRA contribution is being taxed at 22% instead of 12%. Not that that is a fatal flaw, just that it is different from what you think.

If you really want all the Roth IRA contribution to be taxed at only 12%, you'll need to increase your tIRA contribution by $825 and decrease your Roth IRA contribution by the same. Unless I made a mistake.
First of all, thank you for being patient with me and sticking with me till the end.
Standard deduction for 2020 is $12,400, not 12,200. The top end for 12% bracket is $40,125, not $39475. I think you were using 2019 numbers. So the difference is $850. I think we are on the same boat.
As for the HSA...in order to use an HSA do you understand that you must use a High Deductible Health Insurance Plan? That does not suit everybody. Be sure it is right for you. Also be sure you know all the fees that go with using the HSA. There are probably fees in addition to the expense ratios.

If the HSA is right for you, that's great. It will come in handy later in life and that money will never be taxed.

Note if the HDHP premiums are less than what you are currently paying, you'll need to juggle numbers again.
Our current plan's premium goes up by 20% next year, and HDHP premium is about the same as now (current plan), so that is roughly $650 difference. If I am planning to spend less than $650 next year on medical expense, then it is worth switching. Our health plan is not good. It does not include dental nor vision, yet premium is very high.
I did not know that HSA premiums can be deducted even if you use the standard deduction. You need to find out where on the tax form to do this and you need to remember to do it.
You mean HDHP premium? I need to check with HR. Our current plan premium is pre-tax, as pointed out in this thread, but I do not know any of this myself. HSA contribution on my part is deductible, right? That is why I am bringing into HSA.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by retiredjg » Mon Dec 16, 2019 3:31 pm

No, I do mean HSA contributions. According to this post from grabiner above....
grabiner wrote:
Sun Dec 15, 2019 6:58 pm
HSA contributions are fully deductible from your income tax even if you make them yourself; you don't need to itemize deductions. Using payroll deduction will reduce your Social Security tax, but given your relatively low income, you are probably in the range (below the second bend point) where this costs you more in lost Social Security. If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation. If you invest in a Roth IRA to make up that lost benefit, you would need more than $100.
...even if you make the contributions yourself and even if you use the standard deduction, you can still deduct this contribution from taxable Income. I don't know how or where you enter this on your tax return, but you should find out.

The premiums for your HDHP should be coming out of your check just as they do now.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by lakpr » Mon Dec 16, 2019 3:39 pm

retiredjg wrote:
Mon Dec 16, 2019 3:31 pm
No, I do mean HSA contributions. According to this post from grabiner above....
grabiner wrote:
Sun Dec 15, 2019 6:58 pm
HSA contributions are fully deductible from your income tax even if you make them yourself; you don't need to itemize deductions. Using payroll deduction will reduce your Social Security tax, but given your relatively low income, you are probably in the range (below the second bend point) where this costs you more in lost Social Security. If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation. If you invest in a Roth IRA to make up that lost benefit, you would need more than $100.
...even if you make the contributions yourself and even if you use the standard deduction, you can still deduct this contribution from taxable Income. I don't know how or where you enter this on your tax return, but you should find out.

The premiums for your HDHP should be coming out of your check just as they do now.
@retiredjg,

Form 1040, Schedule 1, Line 12 has "Health Savings Account deduction. Attach Form 8889" .... this figure directly reduces the income to arrive at the Adjusted Gross Income, and the standard deduction applies after the AGI is computed.

https://www.irs.gov/pub/irs-pdf/f1040s1.pdf

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Re: Why Roth IRA when you have not maxed out 401k?

Post by retiredjg » Mon Dec 16, 2019 3:48 pm

Well, there you go! It's found!

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stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Thu Dec 19, 2019 12:03 am

I just read that you have to be in simple ira for at least two years before you roll over to 401k. Otherwise you pay a huge anount of penalty. I am only with them for a year.

Does this apply to employer's switchover to 401k? Not you switching the employer?

I told the HR to put all from my next paycheck. This will be very bad.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by retiredjg » Thu Dec 19, 2019 8:21 am

stingray777 wrote:
Thu Dec 19, 2019 12:03 am
I just read that you have to be in simple ira for at least two years before you roll over to 401k. Otherwise you pay a huge anount of penalty. I am only with them for a year.

Does this apply to employer's switchover to 401k? Not you switching the employer?

I told the HR to put all from my next paycheck. This will be very bad.
It is my understanding that a SIMPLE IRA can only be rolled to a SIMPLE IRA in the first 2 years (2 years from first employee or employer contribution). As far as I know, this applies even when the employer switches. I tried to warn you about this in an early post, but there was a lot going on and maybe you missed it.

It may end up being "not my best decision", but doubt it will be very bad. The important thing is saving money.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Thu Dec 19, 2019 8:27 am

retiredjg wrote:
Thu Dec 19, 2019 8:21 am
stingray777 wrote:
Thu Dec 19, 2019 12:03 am
I just read that you have to be in simple ira for at least two years before you roll over to 401k. Otherwise you pay a huge anount of penalty. I am only with them for a year.

Does this apply to employer's switchover to 401k? Not you switching the employer?

I told the HR to put all from my next paycheck. This will be very bad.
It is my understanding that a SIMPLE IRA can only be rolled to a SIMPLE IRA in the first 2 years (2 years from first employee or employer contribution). As far as I know, this applies even when the employer switches. I tried to warn you about this in an early post, but there was a lot going on and maybe you missed it.

It may end up being "not my best decision", but doubt it will be very bad. The important thing is saving money.
Oh... My bad. Very bad. Thanks for the warning. I completely missed it. My paycheck come in tomorrow!
Thanks you, though. I just emailed our salesman. He did not tell us about this.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by retiredjg » Thu Dec 19, 2019 8:56 am

stingray777 wrote:
Thu Dec 19, 2019 8:27 am
retiredjg wrote:
Thu Dec 19, 2019 8:21 am
stingray777 wrote:
Thu Dec 19, 2019 12:03 am
I just read that you have to be in simple ira for at least two years before you roll over to 401k. Otherwise you pay a huge anount of penalty. I am only with them for a year.

Does this apply to employer's switchover to 401k? Not you switching the employer?

I told the HR to put all from my next paycheck. This will be very bad.
It is my understanding that a SIMPLE IRA can only be rolled to a SIMPLE IRA in the first 2 years (2 years from first employee or employer contribution). As far as I know, this applies even when the employer switches. I tried to warn you about this in an early post, but there was a lot going on and maybe you missed it.

It may end up being "not my best decision", but doubt it will be very bad. The important thing is saving money.
Oh... My bad. Very bad. Thanks for the warning. I completely missed it. My paycheck come in tomorrow!
Thanks you, though. I just emailed our salesman. He did not tell us about this.
Your salesman has nothing to do with your old plan. I would not expect him to comment on it at all. In fact, it might even be inappropriate for him to comment on it.

I think I said this in an earlier post, but maybe you'll be more open to hearing it now. It feels like you are just trying to do everything too fast - pushing, pushing to make it happen. Maybe you could slow down a little and just let this process occur. It does not need to be pushed. And you don't need to be anxious about it.

You are in such a rush that you are not/may not be making the best decisions. Just leave all this stuff alone for a few weeks (other than signing up to put money in the new plan when the time comes). It may take a month or two or even three for the new plan to get set up and running perfectly. Give it time. All you need to do right now is save money. You can perfect the details a little later. And you can transfer your SIMPLE IRA to the new plan in a year.

The important thing is to save money. While you are doing that relax and try to enjoy life a little. :happy

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stingray777
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Thu Dec 19, 2019 1:31 pm

retiredjg wrote:
Thu Dec 19, 2019 8:56 am
You are in such a rush that you are not/may not be making the best decisions. Just leave all this stuff alone for a few weeks (other than signing up to put money in the new plan when the time comes). It may take a month or two or even three for the new plan to get set up and running perfectly. Give it time. All you need to do right now is save money. You can perfect the details a little later. And you can transfer your SIMPLE IRA to the new plan in a year.

The important thing is to save money. While you are doing that relax and try to enjoy life a little. :happy
Ha ha, I might be being a deaf right now. The salesman said we could have both 401k and Simple IRA, so I am not forced out. it's just going to sit there until I come to the two year end. You are right. I don't understand how people who are into active investment can enjoy life, but I do appreciate your help.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Sun Dec 22, 2019 3:32 pm

grabiner wrote:
Sun Dec 15, 2019 9:45 pm
Your Social Security benefit is determined by averaging your income over your 35 highest-earning years, adjusting for changes in average wages. But the benefit is not a fixed fraction of your income; it is 90% of the income up to the "first bend point" (which almost everyone reaches), then 32% up to the "second bend point" ($69,420 in 2019), then 15% above that. If you are below the second bend point, using payroll deduction for HSA contributions to reduce your Social Security tax likely costs you more in future benefits. If you are above the second bend point, it is close to break-even. If you are above the maximum SS-taxable wages, there is no SS tax reduction, and eliminating the Medicare tax by payroll deduction is a clear gain.

Regardless of where you are in the SS schedule, paying health insurance by payroll deduction is a good deal, because you avoid income tax as well as SS tax; paying health insurance out of pocket is usually not deductible.
If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation. If you invest in a Roth IRA to make up that lost benefit, you would need more than $100.
This is about payroll deduction.
I am re-visiting your comment, because most of other things are hammered out. Thanks to everybody here.

According to your comments, if I put the HSA max amount of $3550, then that is going to be $35 per month that I will be losing. Let's say I live another 20 years after retirement, then the total would be $8400.
If i did direct deposit:
$3550 x FICA 7.65% x 20 years (till retirement)= $5431, which is my saving amount, so direct deposit loses. Now, that is $271 annually, and it can earn 7-8% in 401k, and 20 years later, I think it earns more than $3000. Am I wrong? I am not a numbers person, so I am happy to be wrong. Maybe inflation changes the picture. I am not sure where $1 /month loss per every $100 came from, but I trust you that the number is correct.

Then you mentioned $69,420. This is your pure gross income (even before 401k, traditional IRA and health insurance premium), right? Hopefully I will hit that in 2021. Then I would benefit more (or at least break even) to do HSA direct deposit?

Lastly, what do you do to reduce the initial withholdings from your paychecks to minimize the tax return? With T-IRA and HSA, the calculation is off by roughly $9000 annually (my case). Claim more dependents, or just don't worry about it (with 12% bracket, $1080)?

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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Sun Dec 22, 2019 4:26 pm

grabiner wrote:
Sun Dec 15, 2019 6:58 pm
If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation.
Could you elaborate on this?

Some back of the envelope calculations:
- a $4200 change in total indexed earnings will change the Average Indexed Monthly Earnings (AIME) by $10.
- A $10 change in AIME for someone between the first and second bend points changes the base PIA by $3.20.
- For someone born in 1954, the base PIA gets multiplied by ~1.069 to get the COLA PIA at FRA, but that's still going to change the monthly benefit by only 3 (maybe 4) dollars.

$3 - $4 dollars per $4200 is a much lower effect than $1 per $100, thus the question.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by grabiner » Sun Dec 22, 2019 7:52 pm

FiveK wrote:
Sun Dec 22, 2019 4:26 pm
grabiner wrote:
Sun Dec 15, 2019 6:58 pm
If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation.
Could you elaborate on this?

Some back of the envelope calculations:
- a $4200 change in total indexed earnings will change the Average Indexed Monthly Earnings (AIME) by $10.
- A $10 change in AIME for someone between the first and second bend points changes the base PIA by $3.20.
- For someone born in 1954, the base PIA gets multiplied by ~1.069 to get the COLA PIA at FRA, but that's still going to change the monthly benefit by only 3 (maybe 4) dollars.

$3 - $4 dollars per $4200 is a much lower effect than $1 per $100, thus the question.
A $4200 change in indexed earnings reduces your Social Security earnings by 7.65% of $4200, which is $321. This reduces your PIA by $3.20, which is where my factor of 100 comes from.
Wiki David Grabiner

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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Sun Dec 22, 2019 8:45 pm

grabiner wrote:
Sun Dec 22, 2019 7:52 pm
FiveK wrote:
Sun Dec 22, 2019 4:26 pm
grabiner wrote:
Sun Dec 15, 2019 6:58 pm
If you reduce your Social Security contribution by $100, you will lose $1 per month in benefits at full retirement age, adjusted for inflation.
Could you elaborate on this?

Some back of the envelope calculations:
- a $4200 change in total indexed earnings will change the Average Indexed Monthly Earnings (AIME) by $10.
- A $10 change in AIME for someone between the first and second bend points changes the base PIA by $3.20.
- For someone born in 1954, the base PIA gets multiplied by ~1.069 to get the COLA PIA at FRA, but that's still going to change the monthly benefit by only 3 (maybe 4) dollars.

$3 - $4 dollars per $4200 is a much lower effect than $1 per $100, thus the question.
A $4200 change in indexed earnings reduces your Social Security earnings by 7.65% of $4200, which is $321. This reduces your PIA by $3.20, which is where my factor of 100 comes from.
Ah, ok, the $4200 change in indexed earnings changes the FICA (SS + Medicare) tax paid by $321, etc. Thanks.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Sun Dec 22, 2019 11:02 pm

Could you explain what just went on here? $4200 comes from withholding allowance, but no idea from there.
Also, is it still best that I do not do a direct deposit?

Thank you.

[addition]
Oh, do I need to wait until I actually start HDHP to open a HSA account? New health plan will start in January, but can I open HSA account now, say at Fidelity?

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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Sun Dec 22, 2019 11:43 pm

stingray777 wrote:
Sun Dec 22, 2019 11:02 pm
Could you explain what just went on here? $4200 comes from withholding allowance, but no idea from there.
Also, is it still best that I do not do a direct deposit?

Thank you.

[addition]
Oh, do I need to wait until I actually start HDHP to open a HSA account? New health plan will start in January, but can I open HSA account now, say at Fidelity?
The last question is the easiest: you may not contribute to the HSA until you are covered by the HDHP. If the broker will let you open an empty account now, that's ok, but again no contributions until January for you. In most states the HSA isn't technically opened until the first dollar goes in, so the earlier in January that can happen the better (just in case you incur a large medical expense early next year).

That $4200 appears in other parts of the tax code is purely a coincidence here. Calculating SS benefits includes finding the monthly average of the highest 35 years of earnings. There are 12 * 35 = 420 months in 35 years, so $4200 was used because I can divide $4200 by 420 months in my head to get $10/month.

The terminology used in some posts (including mine) hasn't been precise. That may have led to confusion on your part when you calculated "if I put the HSA max amount of $3550, then that is going to be $35 per month that I will be losing." If you contribute $3550 via payroll deductions, that will reduce your FICA tax by $3550 * 7.65% = $272. With grabiner's 100 to 1 ratio, that reduces your expected SS benefit by ~$3/mo or $36/yr.

Thus you save $272 now but lose $36/yr later. Thus whatever you do is not likely to have a significant impact on your standard of living in retirement. :)
But if it's just as easy for you to contribute to the HSA yourself as it is to have payroll deduction, then you'll likely do slightly better (by somewhere between $0 and $36/yr) by contributing yourself.

Is that any clearer?

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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Thu Dec 26, 2019 4:44 pm

FiveK wrote:
Sun Dec 22, 2019 11:43 pm

That $4200 appears in other parts of the tax code is purely a coincidence here. Calculating SS benefits includes finding the monthly average of the highest 35 years of earnings. There are 12 * 35 = 420 months in 35 years, so $4200 was used because I can divide $4200 by 420 months in my head to get $10/month.

The terminology used in some posts (including mine) hasn't been precise. That may have led to confusion on your part when you calculated "if I put the HSA max amount of $3550, then that is going to be $35 per month that I will be losing." If you contribute $3550 via payroll deductions, that will reduce your FICA tax by $3550 * 7.65% = $272. With grabiner's 100 to 1 ratio, that reduces your expected SS benefit by ~$3/mo or $36/yr.

Thus you save $272 now but lose $36/yr later. Thus whatever you do is not likely to have a significant impact on your standard of living in retirement. :)
But if it's just as easy for you to contribute to the HSA yourself as it is to have payroll deduction, then you'll likely do slightly better (by somewhere between $0 and $36/yr) by contributing yourself.

Is that any clearer?
Thank you so much for your support.
I understand that where $4200 came from, but not your previous comments. It is OK.
In essence, my choice is between $272 now annually and $36 annually later, right? My question was for the next 20 years I will be saving $5440. With compound interest at 7%, it will grow to be almost $12K, or $600 /year.

I must be wrong somewhere. I feel too bad to ask for more explanation, so please just tell me that I am wrong. Then I will do contribute manually.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Thu Dec 26, 2019 5:24 pm

stingray777 wrote:
Thu Dec 26, 2019 4:44 pm
In essence, my choice is between $272 now annually and $36 annually later, right?
Yes, as edited.

Each year that you pay $272 in FICA tax gets you another $36/yr when you start taking SS.

Or, looking at it from the opposite direction, 20 years of not paying $272/yr = $5440 (plus whatever interest you can earn), but also means losing $720/yr in SS (plus whatever Cost Of Living Adjustments are added to the SS).

And all this assumes you are between the first and second bend points in the SS benefit calculation.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Thu Dec 26, 2019 7:24 pm

FiveK wrote:
Thu Dec 26, 2019 5:24 pm

Or, looking at it from the opposite direction, 20 years of not paying $272/yr = $5440 (plus whatever interest you can earn), but also means losing $720/yr in SS (plus whatever Cost Of Living Adjustments are added to the SS).

And all this assumes you are between the first and second bend points in the SS benefit calculation.
OK. Thank you! This is the conclusion.

Now, in 15 years or so, unless the government does something, SS account will be empty said they. So personally it is NOT an easy, no-brainer.
I suppose this is more likely than income tax rate going much higher in 15 years, as some people mentioned here, even though no one knows the future.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by grabiner » Thu Dec 26, 2019 10:01 pm

stingray777 wrote:
Thu Dec 26, 2019 4:44 pm
In essence, my choice is between $272 now annually and $36 annually later, right? My question was for the next 20 years I will be saving $5440. With compound interest at 7%, it will grow to be almost $12K, or $600 /year.
The choice is between $272 this year and $36 annually adjusted for inflation after you retire, so the investment is just the $272; if you use payroll deductible next year, you save another $272 and lose another $36 annually. And since SS is essentially risk-free (the rules may change, but you don't expect the government to default), the fair comparison is to low-risk but long-term investments. The current yield on 20-year TIPS is 0.36%, so if you put that $272 in your Roth IRA and invest in long-term TIPS, you will have $292 plus inflation, which will provide only eight years of $36 inflation-adjusted withdrawals.
Wiki David Grabiner

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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Mon Dec 30, 2019 11:16 pm

grabiner wrote:
Thu Dec 26, 2019 10:01 pm
stingray777 wrote:
Thu Dec 26, 2019 4:44 pm
In essence, my choice is between $272 now annually and $36 annually later, right? My question was for the next 20 years I will be saving $5440. With compound interest at 7%, it will grow to be almost $12K, or $600 /year.
The choice is between $272 this year and $36 annually adjusted for inflation after you retire, so the investment is just the $272; if you use payroll deductible next year, you save another $272 and lose another $36 annually. And since SS is essentially risk-free (the rules may change, but you don't expect the government to default), the fair comparison is to low-risk but long-term investments. The current yield on 20-year TIPS is 0.36%, so if you put that $272 in your Roth IRA and invest in long-term TIPS, you will have $292 plus inflation, which will provide only eight years of $36 inflation-adjusted withdrawals.
Thanks for the clarification. I have been pondering on this, and I still cannot figure out though I understand your comment. So I am very sorry for the late reply.
1. Do I really lose $36 annually.
2. When I reitre the benefit will be (much) less, because SS will run out.

I found a calculator (viewtopic.php?f=2&t=262772&start=50#p4791837), and plugged in my numbers until 2018 by using my SS document - "your taxed social security earnings." On 2019 and for the next 22 (till 67) years, I put $60,000. Then compared it against $59,728. I used $65,000, but the difference was the same.

The difference in monthly benefit at age 67 and 70 is $4 and $5. I don't know if I should subtract 401K and T-IRA amount (Is it basically AGI before standard deduction?), but $5 for the next 20 years after retirement is $1200 vs $272 x 20 years. I don't see the loss of $36 annually.

Maybe I am using wrong numbers in the calculation. maybe I am totally wrong.

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grabiner
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Re: Why Roth IRA when you have not maxed out 401k?

Post by grabiner » Mon Dec 30, 2019 11:41 pm

stingray777 wrote:
Mon Dec 30, 2019 11:16 pm
grabiner wrote:
Thu Dec 26, 2019 10:01 pm
stingray777 wrote:
Thu Dec 26, 2019 4:44 pm
In essence, my choice is between $272 now annually and $36 annually later, right? My question was for the next 20 years I will be saving $5440. With compound interest at 7%, it will grow to be almost $12K, or $600 /year.
The choice is between $272 this year and $36 annually adjusted for inflation after you retire, so the investment is just the $272; if you use payroll deductible next year, you save another $272 and lose another $36 annually. And since SS is essentially risk-free (the rules may change, but you don't expect the government to default), the fair comparison is to low-risk but long-term investments. The current yield on 20-year TIPS is 0.36%, so if you put that $272 in your Roth IRA and invest in long-term TIPS, you will have $292 plus inflation, which will provide only eight years of $36 inflation-adjusted withdrawals.
Thanks for the clarification. I have been pondering on this, and I still cannot figure out though I understand your comment. So I am very sorry for the late reply.
1. Do I really lose $36 annually.
2. When I reitre the benefit will be (much) less, because SS will run out.

I found a calculator (viewtopic.php?f=2&t=262772&start=50#p4791837), and plugged in my numbers until 2018 by using my SS document - "your taxed social security earnings." On 2019 and for the next 22 (till 67) years, I put $60,000. Then compared it against $59,728. I used $65,000, but the difference was the same.
You are confusing SS earnings and the tax you pay on your SS earnings here. If you contribute $3550 to an HSA by payroll deduction, this reduces your "taxed Social Security earnings" by $3550. The tax savings is only $272, as you avoid paying SS and Medicare tax on that $3550.

Under the current formula, that will reduce your SS benefit (at full retirement age, and assuming you are between the first and second bend points) by $3 monthly, or $36 annually. This number will grow with inflation. If the solvency of SS is addressed by reducing benefits by a fixed percentage (rather than increasing taxes or taking money from elsewhere in the federal budget), the $36 will be reduced by the same percentage.
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Wed Jan 01, 2020 4:24 pm

grabiner wrote:
Mon Dec 30, 2019 11:41 pm

You are confusing SS earnings and the tax you pay on your SS earnings here. If you contribute $3550 to an HSA by payroll deduction, this reduces your "taxed Social Security earnings" by $3550. The tax savings is only $272, as you avoid paying SS and Medicare tax on that $3550.

Under the current formula, that will reduce your SS benefit (at full retirement age, and assuming you are between the first and second bend points) by $3 monthly, or $36 annually. This number will grow with inflation. If the solvency of SS is addressed by reducing benefits by a fixed percentage (rather than increasing taxes or taking money from elsewhere in the federal budget), the $36 will be reduced by the same percentage.
This is utterly embarrassing. My big apology here. I was taking $272 and comparing it. I plugged in numbers and calculated again.

If I start drawing SS at 67, then the monthly difference is $59. That is $14160 in 20 years if I die at 87, whereas $272 x 20 years = $5440 until I retire. At 6% interest, it will grow to be $17500. You start drawing, so the growth from that point is probably very little. I don't know. Then, You pay tax, and inflation.

Paying SS now will still come ahead?

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Re: Why Roth IRA when you have not maxed out 401k?

Post by grabiner » Wed Jan 01, 2020 11:02 pm

(if you contribute $272 less per year for the next 20 years)
stingray777 wrote:
Wed Jan 01, 2020 4:24 pm
If I start drawing SS at 67, then the monthly difference is $59. That is $14160 in 20 years if I die at 87, whereas $272 x 20 years = $5440 until I retire. At 6% interest, it will grow to be $17500. You start drawing, so the growth from that point is probably very little. I don't know. Then, You pay tax, and inflation.

Paying SS now will still come ahead?
This is a difference of risk. If your investments earn 6% per year above inflation, you will come out slightly ahead by contributing less to SS and investing the money. But you need to take a lot of risk to earn 6% above inflation; this is about the expected return of the stock market. While it has never happened in the US, there have been many markets, most recently Japan, in which the stock market did not keep up with inflation over a 20-year period. In contrast, contributing $272 more to SS is a low-risk investment.

Another way to look at this is to consider the following choices.

A. Contribute $272 more to Social Security.
B. Invest $272 in TIPS.
C. Contribute $272 more to Social Security, and sell $272 in TIPS (or other low-risk bonds) to buy stock.
D. Invest $272 in stock.

Given the return of TIPS and of SS contributions, A is better than B, and C is better than D, which says that either A or C is the right strategy if you have all four options. If your investments are 100% stock, you don't have C as an option, and it is theoretically possible that you have enough risk tolerance to prefer D to A.
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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Fri Jan 03, 2020 11:35 pm

grabiner wrote:
Wed Jan 01, 2020 11:02 pm

This is a difference of risk. If your investments earn 6% per year above inflation, you will come out slightly ahead by contributing less to SS and investing the money. But you need to take a lot of risk to earn 6% above inflation; this is about the expected return of the stock market. While it has never happened in the US, there have been many markets, most recently Japan, in which the stock market did not keep up with inflation over a 20-year period. In contrast, contributing $272 more to SS is a low-risk investment.
Thank you so much for making it very clear and holding your position. I will manually deduct HSA amount, and pay extra $272.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by stingray777 » Tue Mar 24, 2020 9:05 pm

I called Vanguard to ask for recharacterization of my IRA contribution for 2019. I was told that I needed to submit Form 8606, but to consult with my tax specialist. I don't think so.

I put $6000 into my Traditional IRA in Dec of 2019, not realizing that I had to deduct my health insurance premium from my taxable income. I am already in a lower tax bracket, so I want to put the maximum amount possible back into Roth IRA and still stay in this tax bracket, just like 401k gurus told me here. That is the reason for my recharacterization.

So I want to recharacterize $2400 back into Roth IRA now. My question is: Do I need to submit Form 8606? Reading the example on instructions for Form 8606, I read that I do not file it but to attach a statement to 1040. I do not do anything on my 1040 next year either, because Recharacterization takes place in March of 2020 (now).

Could you please confirm? Thank you :)

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Re: Why Roth IRA when you have not maxed out 401k?

Post by FiveK » Tue Mar 24, 2020 9:20 pm

stingray777 wrote:
Tue Mar 24, 2020 9:05 pm
Could you please confirm? Thank you :)
Given the thread has 147 posts, it might be helpful if you listed everything you have done (contributions, recharacterizations, conversions, etc.) with your IRAs since, say, Jan 2018.

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Re: Why Roth IRA when you have not maxed out 401k?

Post by retiredjg » Wed Mar 25, 2020 9:26 am

stingray777 wrote:
Tue Mar 24, 2020 9:05 pm
I called Vanguard to ask for recharacterization of my IRA contribution for 2019. I was told that I needed to submit Form 8606, but to consult with my tax specialist. I don't think so.

I put $6000 into my Traditional IRA in Dec of 2019, not realizing that I had to deduct my health insurance premium from my taxable income. I am already in a lower tax bracket, so I want to put the maximum amount possible back into Roth IRA and still stay in this tax bracket, just like 401k gurus told me here. That is the reason for my recharacterization.

So I want to recharacterize $2400 back into Roth IRA now. My question is: Do I need to submit Form 8606? Reading the example on instructions for Form 8606, I read that I do not file it but to attach a statement to 1040. I do not do anything on my 1040 next year either, because Recharacterization takes place in March of 2020 (now).

Could you please confirm? Thank you :)
It appears the only thing you have done so far (before the phone call) is put $6k into traditional IRA for 2019. Now you wish some of that - $2,400 - had gone to Roth IRA. Having Vanguard recharacterize it is the appropriate thing to do.

I too would question the need for a Form 8606.

Is it possible they may have done a conversion instead of a recharacterization. Or maybe they actually did a recharacterization and the person you talked to does not know the difference? Or maybe you used the word "convert" when you should have said "recharacterize". Any number of things may have happened.

The first thing to do is find out for sure what they did.

A recharacterization from tIRA to Roth IRA does not require a Form 8606...except that may be the place where the "statement" saying you did a recharacterization is recorded? Is it possible that is what the phone rep was talking about?

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Re: Why Roth IRA when you have not maxed out 401k?

Post by retiredjg » Wed Mar 25, 2020 9:32 am

Wait, wait...your contribution to tIRA was deductible. If you now recharacterize that to Roth, you will owe more taxes.

Have you filed your taxes yet or are you still working on your taxes?

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