Putting money in Roth IRA vs taxable account for early retirees

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abhi764
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Putting money in Roth IRA vs taxable account for early retirees

Post by abhi764 »

From a FIRE perspective, after maximizing 401K contribution and HSA, does it make sense to put money in Roth IRA (using megabackdoor Roth) or just into taxable account (like Vanguard)? Suppose the person wants to retire at 40 and would need investment income for 20 years before being able to tap into retirement accounts.
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samsoes
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by samsoes »

Generally speaking, a dollar in a Roth account is worth more than a dollar in a taxable account due to tax drag on the earnings in a taxable account.

(And a dollar in a taxable account is worth more than a dollar in a traditional IRA/401k, since all funds in a traditional IRA are fully taxable.)

However, if you need the earnings before age 59.5 then choose a taxable account.
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sailaway
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by sailaway »

Since we can withdraw the contributions, we chose MBD Roth.

-This means we are not paying capital gains tax on these amounts while accumulating.
-between taxable funds, regular Roth contributions and starting MBD a few years before retirement, we have no concerns about running into the 5 year or 10% penalty on the pre rollover earnings. Even if we did, 10% + retirement tax rate will likely be lower than our current tax rate.
-It gives us tax flexibility throughout our retirement, since we have a mix of traditional, Roth and taxable to play with.

Since you mention 20 years before being able to tap retirement accounts, be sure to look at Roth withdrawals, the Roth conversion ladder and the less popular SEPP.

The Roth withdrawal rules, as they apply to MBD are a bit confusing, due to the ordering. This can be avoided by rolling earnings to traditional IRA, but that has its own complications.
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David Jay
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by David Jay »

Here is a table of Roth distribution limitations for further understanding:
Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified
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gr7070
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by gr7070 »

Roth for starters.

Additionally, if one is going to FIRE they're highly likely to *eventually* save above and beyond the 401k and IRA limits. So you'll likely end up with taxable Investing anyway.

Thus you may as well take advantage of that tax-advantage capacity while it is available to you.

Who knows, you might eventually end up with a job that provides a 457 plan, as well. Something I would have never expected for myself 10 and 25 years ago, but did. The 457 will come in handy for me!
sailaway
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by sailaway »

David Jay wrote: Sat Jun 06, 2020 3:06 pm Here is a table of Roth distribution limitations for further understanding:
Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified
This is missing the disclaimer that points out that the order listed is a required order.

I get that I can take out any and all contributions at any time.

But it bogles my mind that the taxed portion of conversions comes next, but it is all good as long as I stick to conversions made at least 5 years ago.

The chart looks like I would have to take out all of the taxable conversions before I could access the non taxable conversions, owing the penalty on anything less than 5 years old. However, I am assured that is not the case

That is, this chart is an oversimplification because the ordering (as I understand it) is really:

-contributions
-first year conversions (taxable)
-first year conversions (non taxable)
-second year conversions (taxable)
-second year conversions (non taxable)
Etc
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FrankTheViking
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by FrankTheViking »

Put money in 401k or traditional IRA. When you retire, assuming you have zero income, you can do a roth conversion up to a point tax free. This money can then be used 5 years later.

Key points:
Put in Roth now you can only withdraw what you directly put in, NO EARNINGS until 59.5
If you put in a traditional IRA, in 10 years when you retire you can ROLLOVER to a roth IRA ideally tax free, and use that money in 5 years.
Rollover money does not count as a DIRECT contribution but when rolled over, everything rolled is the same as direct after 5 years.
The key is bridging the FIRST 5 years, after that you're gold. Take advantage of tax deferred space.
Any EARNINGS in a Roth are untouchable without penalty until 59.5.
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sailaway
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by sailaway »

@MrJedi said it better!
MrJedi wrote: Wed Jun 03, 2020 2:27 pm One small gotcha on your early withdrawal scenario.

According to Roth IRA ordering rules, taxable conversions to Roth are distributed before nontaxable conversions (note that direct Roth IRA contributions come out before all else, taxable vs nontaxable conversions are also ordered by year, i.e. 2019 taxable conversion withdraws before 2019 nontaxable conversion, which withdraws before 2020 taxable conversion).
It bears mentioning that this also means that any backdoor Roth earnings will have a higher priority than the MBD contributions rolled over in the same year.
Last edited by sailaway on Sat Jun 06, 2020 4:14 pm, edited 1 time in total.
teaman
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by teaman »

FrankTheViking wrote: Sat Jun 06, 2020 4:05 pm Put money in 401k or traditional IRA. When you retire, assuming you have zero income, you can do a roth conversion up to a point tax free. This money can then be used 5 years later.
I think the assumption here is that the OP is already maxing out his Traditional 401k. and his income is over the direct contribution limits for Roth IRA, so does a Backdoor IRA. What is the use of contributing to a TIRA when one cannot avail any tax deduction?
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FrankTheViking
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by FrankTheViking »

teaman wrote: Sat Jun 06, 2020 4:12 pm
FrankTheViking wrote: Sat Jun 06, 2020 4:05 pm Put money in 401k or traditional IRA. When you retire, assuming you have zero income, you can do a roth conversion up to a point tax free. This money can then be used 5 years later.
I think the assumption here is that the OP is already maxing out his Traditional 401k. and his income is over the direct contribution limits for Roth IRA, so does a Backdoor IRA. What is the use of contributing to a TIRA when one cannot avail any tax deduction?
+1. That explains the 401k to begin with. :sharebeer
No EF. 80% Total U.S. / 20% Total International. 100% equity. Is there a gun to your head? Is there a tiger in the room? No? What's the problem?
Topic Author
abhi764
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by abhi764 »

teaman wrote: Sat Jun 06, 2020 4:12 pm
FrankTheViking wrote: Sat Jun 06, 2020 4:05 pm Put money in 401k or traditional IRA. When you retire, assuming you have zero income, you can do a roth conversion up to a point tax free. This money can then be used 5 years later.
I think the assumption here is that the OP is already maxing out his Traditional 401k. and his income is over the direct contribution limits for Roth IRA, so does a Backdoor IRA. What is the use of contributing to a TIRA when one cannot avail any tax deduction?
Yes, I am able to max out Traditional 401K and HSA first. Let's say I am able to save $75K a year, 50k would goto retirement accounts (401K + HSA + MBD roth 401k) and the remaining 25K to taxable (vanguard). Let's say I retire early at 40, does it make sense to max out MBD Roth, and deal with the hassles of roth conversion ladder, SEPP, ordering rules for withdrawal, etc to get access to the money before 60? Or should I just keep it simple, and put most of the after-tax money in Vanguard?
sailaway
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Re: Putting money in Roth IRA vs taxable account for early retirees

Post by sailaway »

abhi764 wrote: Sun Jun 07, 2020 9:43 am
teaman wrote: Sat Jun 06, 2020 4:12 pm
FrankTheViking wrote: Sat Jun 06, 2020 4:05 pm Put money in 401k or traditional IRA. When you retire, assuming you have zero income, you can do a roth conversion up to a point tax free. This money can then be used 5 years later.
I think the assumption here is that the OP is already maxing out his Traditional 401k. and his income is over the direct contribution limits for Roth IRA, so does a Backdoor IRA. What is the use of contributing to a TIRA when one cannot avail any tax deduction?
Yes, I am able to max out Traditional 401K and HSA first. Let's say I am able to save $75K a year, 50k would goto retirement accounts (401K + HSA + MBD roth 401k) and the remaining 25K to taxable (vanguard). Let's say I retire early at 40, does it make sense to max out MBD Roth, and deal with the hassles of roth conversion ladder, SEPP, ordering rules for withdrawal, etc to get access to the money before 60? Or should I just keep it simple, and put most of the after-tax money in Vanguard?
For us, the MBD Roth requires:
-changing the 401k election twice a year
-making one phone call a year
-receiving one extra tax form a year and subsequent entering of that information in Turbo Tax
-making one database entry per year (actually a spreadsheet, but this is how we track what we can take penalty free)

In return, we aren't paying capital gains on dividends and disbursements.

In retirement, it won't make much difference over taxable, but it will allow for more conversion space to give us access to traditional accounts.

If one of us passes, the other has less concern about tax brackets.

If we both pass, since his mother is his secondary beneficiary, his parents will have ten years to manage any tax impacts. They have enough grandkids that they could give it all away in that time frame.
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