Tax Question

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marcus_silvus
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Tax Question

Post by marcus_silvus »

Hi All,
I just got the opportunity to readjust my pretax employer retirement plan (PERS 3 in WA) and would like some input. I was about to invest roughly 20% of my income but decide to do some research and got a bit nervous.

Some individuals were mentioning something called a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals. Furthermore, with the previous COVID relief package and a possible one coming up, taxes may increase significantly in the years to come.

I want to contribute as much as possible to stop working as soon as possible but this got me nervous.

Am I overthinking this?

Any advice would be greatly appreciated.
Thanks!!!!
tibbitts
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Re: Tax Question

Post by tibbitts »

marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm Hi All,
I just got the opportunity to readjust my pretax employer retirement plan (PERS 3 in WA) and would like some input. I was about to invest roughly 20% of my income but decide to do some research and got a bit nervous.

Some individuals were mentioning something called a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals. Furthermore, with the previous COVID relief package and a possible one coming up, taxes may increase significantly in the years to come.

I want to contribute as much as possible to stop working as soon as possible but this got me nervous.

Am I overthinking this?

Any advice would be greatly appreciated.
Thanks!!!!
No, not overthinking, but you've wandered into disallowed discussion territory on Bogleheads.

From personal experience I can tell you that over-deferring is possible. Most things are best in moderation.
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marcus_silvus
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Re: Tax Question

Post by marcus_silvus »

Sorry about that. Thanks for the input.
Best
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samsoes
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Re: Tax Question

Post by samsoes »

marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm Hi All,

Some individuals were mentioning something called a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals. Furthermore, with the previous COVID relief package and a possible one coming up, taxes may increase significantly in the years to come.
Such as?
"Happiness Is Not My Companion" - Gen. Gouverneur K. Warren. | (Avatar is the statue of Gen. Warren atop Little Round Top @ Gettysburg National Military Park.)
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marcus_silvus
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Re: Tax Question

Post by marcus_silvus »

Nobody of note but it got me thinking. I found a few videos on youtube that mentioned putting money in indexed universal life insurance for tax benefits
sport
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Re: Tax Question

Post by sport »

marcus_silvus wrote: Thu Nov 12, 2020 2:42 pm Nobody of note but it got me thinking. I found a few videos on youtube that mentioned putting money in indexed universal life insurance for tax benefits
Well, that would be good for the insurance company and the agent who sells it to you. For you, probably not so much. I suggest that you will get better investment advice from the Bogleheads than you will from YouTube.
milktoast
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Re: Tax Question

Post by milktoast »

Over deferral creating a "tax bomb" is not a forbidden subject. Only speculation about changes in future tax brackets/rates.

It is possible with deferred income to have required minimum distributions during retirement that push you up into a marginal bracket which is higher than your current marginal bracket. In that case, deferring income is unwise.

Honestly, I think fears of this are overblown.

But you need to figure out how much deferred income (IRA, 401k, PERS, other pensions) you'll be forced to take each year in retirement. If that combined with your feelings on future income tax rates tells you you'll pay more taxes by deferring, maybe don't.
Broken Man 1999
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Re: Tax Question

Post by Broken Man 1999 »

OP, how many years are you from your desired retirement date?

No idea about tax rates in the future, but bear in mind tax rates don't remain stable for long periods of time, anyway.

They have been changed several times over my tax-paying life.

My advice is to stash as much as you can, and don't let the tax tail wag the dog!

NO, NO, NO on the insurance idea! There is a small number of people that might get some benefit from that insurance product, but I'm going to go out on a limb and say you most likely are not a good fit for this insurance product. Though, the agent would be your best pal if you bought one.

Broken Man 1999
“If I cannot drink Bourbon and smoke cigars in Heaven then I shall not go. " -Mark Twain
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samsoes
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Re: Tax Question

Post by samsoes »

marcus_silvus wrote: Thu Nov 12, 2020 2:42 pm Nobody of note but it got me thinking. I found a few videos on youtube that mentioned putting money in indexed universal life insurance for tax benefits
:oops:

Friend, stop with the Youtube videos (likely by salesmen) and listening to "nobody of note."

Start here: https://www.bogleheads.org/wiki/Getting_started (and read books by Jack Bogle), and stay the course!
"Happiness Is Not My Companion" - Gen. Gouverneur K. Warren. | (Avatar is the statue of Gen. Warren atop Little Round Top @ Gettysburg National Military Park.)
retire2022
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Re: Tax Question

Post by retire2022 »

marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm Hi All,
I just got the opportunity to readjust my pretax employer retirement plan (PERS 3 in WA) and would like some input. I was about to invest roughly 20% of my income but decide to do some research and got a bit nervous.

Some individuals were mentioning something called a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals. Furthermore, with the previous COVID relief package and a possible one coming up, taxes may increase significantly in the years to come.

I want to contribute as much as possible to stop working as soon as possible but this got me nervous.

Am I overthinking this?

Any advice would be greatly appreciated.
Thanks!!!!
Marcus additional information is required

-Do you have a pension?
-Do you have Roth 403b or 457b?
-Do you have Roth IRA?

How old are you from retirement? what is your current tax bracket?

I can concur you could over save if you have a pension, I am one of them, I will be at a higher tax bracket at 72, with a current balance of pretax 457 of 1.289 million and growing. I will be at a higher tax bracket at 72 (RMD) Required Minimum Distribution than while working.

You are not overthinking this.
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FiveK
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Re: Tax Question

Post by FiveK »

marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm Hi All,
I just got the opportunity to readjust my pretax employer retirement plan (PERS 3 in WA) and would like some input. I was about to invest roughly 20% of my income but decide to do some research and got a bit nervous.

Some individuals were mentioning something called a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals. Furthermore, with the previous COVID relief package and a possible one coming up, taxes may increase significantly in the years to come.

I want to contribute as much as possible to stop working as soon as possible but this got me nervous.

Am I overthinking this?

Any advice would be greatly appreciated.
Thanks!!!!
Discussing how one might analyze one's own investment strategy is not only allowed but a significant reason for the existence of this forum. :)

What isn't allowed are debates about the goodness or likelihood of potential legislation. See item #4 in Bogleheads.org - Rules for specifics.

Back to your question. For general suggestions, see Investment Order and Prioritizing investments.

Specific to "...a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals," don't let the amount of tax paid distract you from what really matters: the amount of spendable money you have after all taxes are paid. See the second of two Common misconceptions for more on that (and the rest of that wiki for more on the whole traditional vs. Roth issue).

To recap, you can overlay your own opinion of what tax rates you will pay in the future on top of the math that determines your spendable amount after tax. The Bogleheads forum will help you with the math, but the political part is yours alone. ;)
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marcus_silvus
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Re: Tax Question

Post by marcus_silvus »

sport wrote: Thu Nov 12, 2020 2:47 pm
marcus_silvus wrote: Thu Nov 12, 2020 2:42 pm Nobody of note but it got me thinking. I found a few videos on youtube that mentioned putting money in indexed universal life insurance for tax benefits
Well, that would be good for the insurance company and the agent who sells it to you. For you, probably not so much. I suggest that you will get better investment advice from the Bogleheads than you will from YouTube.
Yep, that's why I'm here
humblecoder
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Re: Tax Question

Post by humblecoder »

samsoes wrote: Thu Nov 12, 2020 2:30 pm
marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm Hi All,

Some individuals were mentioning something called a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals. Furthermore, with the previous COVID relief package and a possible one coming up, taxes may increase significantly in the years to come.
Such as?
I assume he is talking about how Required Minimum Distributions force you to withdraw money from tax-deferred accounts at age 72 and beyond, which could force you into a higher tax bracket.

There are two parts to this discussion. Part 1 is the Traditional vs Roth decision (https://www.bogleheads.org/wiki/Traditional_versus_Roth). In other words, is it better to pay tax now (Roth) or later (Traditional)? The reference wiki page provides a good framework for this decision.

Part 2 is, if you do put money into a tax-deferred account, how do you best spread out your withdrawals so that you don't have a large required withdrawal (tax bomb) at age 72? Generally, you would want to spread out your withdrawals (or Roth conversions) leading up to age 72 to reduce your RMD so that the RMD doesn't throw you into a higher tax bracket. There are various tools/spreadsheets that I have seen referenced on this message boards to help with make that decision, but I don't have any personal experience with them.

This is a complicated topic so it is worth educating yourself on this. However, don't let the term tax bomb make you afraid to contribute to your tax-deferred accounts.
Soon2BXProgrammer
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Re: Tax Question

Post by Soon2BXProgrammer »

marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm Hi All,
I just got the opportunity to readjust my pretax employer retirement plan (PERS 3 in WA) and would like some input. I was about to invest roughly 20% of my income but decide to do some research and got a bit nervous.

Some individuals were mentioning something called a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals. Furthermore, with the previous COVID relief package and a possible one coming up, taxes may increase significantly in the years to come.

I want to contribute as much as possible to stop working as soon as possible but this got me nervous.

Am I overthinking this?

Any advice would be greatly appreciated.
Thanks!!!!
In WA you also have access to the WA DCP 457b plan. this is an additional 19.5K pretax deferral option.

I am not an expert on the PERS3 plan, but there is both a traditional pension and a contribution plan. So you need to think about how many years of service and how big that pension might be..

Then the question is how much total other pretax assets it makes to have. Are you using the 457b plan? if not, this is another option for saving pretax. having this might affect your decision about how much PERS3 dollars you save.

(i'm assuming you have the WA DCP as an option, you should validate)

these articles don't include your pension. but its good reading:

https://www.gocurrycracker.com/is-your-401k-too-big/
https://www.gocurrycracker.com/is-your- ... ig-part-2/
Last edited by Soon2BXProgrammer on Thu Nov 12, 2020 2:59 pm, edited 1 time in total.
Doctor Rhythm
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Re: Tax Question

Post by Doctor Rhythm »

marcus_silvus wrote: Thu Nov 12, 2020 2:42 pm Nobody of note but it got me thinking. I found a few videos on youtube that mentioned putting money in indexed universal life insurance for tax benefits
Tax “bomb” is such a scary word. I prefer maybe “unintended consequence” or maybe “surprise”. If you think your tax rate will be higher when you retire than it is right now, then open a Roth IRA and max it out first.

YouTube is great for cat videos - not for investing advice, especially if it involves insurance products.
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marcus_silvus
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Re: Tax Question

Post by marcus_silvus »

Soon2BXProgrammer wrote: Thu Nov 12, 2020 2:57 pm
marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm
In WA you also have access to the WA DCP 457b plan. this is an additional 19.5K pretax deferral option.

I am not an expert on the PERS3 plan, but there is both a traditional pension and a contribution plan. So you need to think about how many years of service and how big that pension might be..

Then the question is how much total other pretax assets it makes to have. Are you using the 457b plan? if not, this is another option for saving pretax. having this might affect your decision about how much PERS3 dollars you save.

(i'm assuming you have the WA DCP as an option, you should validate)

these articles don't include your pension. but its good reading:

https://www.gocurrycracker.com/is-your-401k-too-big/
https://www.gocurrycracker.com/is-your- ... ig-part-2/
Thanks for the input everyone. I max out my Roth each year, I'm investing my HSA contributions, I'm currently giving 5% of my income through PERS 3 and I'm currently giving 10% of my income through the DCP. As of now, I'm set to hit my retirement number in approximately 15 years.

Due to a temporary layoff and rehire, I'm now able to adjust my PERS 3 contribution which is why I'm curious

I understand that YouTube is for cat videos but a question came up and it made me think so I brought it to the erudite Boglehead Community
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Stinky
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Re: Tax Question

Post by Stinky »

marcus_silvus wrote: Thu Nov 12, 2020 2:42 pm I found a few videos on youtube that mentioned putting money in indexed universal life insurance for tax benefits
Bad idea.

Really bad idea.

Post back if you want to further understand how truly BAD this idea is. Don’t mix “investing” and insurance.
It's a GREAT day to be alive - Travis Tritt
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marcus_silvus
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Re: Tax Question

Post by marcus_silvus »

Stinky wrote: Thu Nov 12, 2020 3:14 pm
marcus_silvus wrote: Thu Nov 12, 2020 2:42 pm I found a few videos on youtube that mentioned putting money in indexed universal life insurance for tax benefits
Bad idea.

Really bad idea.

Post back if you want to further understand how truly BAD this idea is. Don’t mix “investing” and insurance.
But the insurance sales man told me he would give me a free koozie if I signed with him...

Just to be clear, my original question was about taxes in the future as it relates to retirement withdrawals. Not about hiring a YouTube money manager
Last edited by marcus_silvus on Thu Nov 12, 2020 3:24 pm, edited 1 time in total.
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Re: Tax Question

Post by marcus_silvus »

FiveK wrote: Thu Nov 12, 2020 2:51 pm
marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm
Discussing how one might analyze one's own investment strategy is not only allowed but a significant reason for the existence of this forum. :)

What isn't allowed are debates about the goodness or likelihood of potential legislation. See item #4 in Bogleheads.org - Rules for specifics.

Back to your question. For general suggestions, see Investment Order and Prioritizing investments.

Specific to "...a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals," don't let the amount of tax paid distract you from what really matters: the amount of spendable money you have after all taxes are paid. See the second of two Common misconceptions for more on that (and the rest of that wiki for more on the whole traditional vs. Roth issue).

To recap, you can overlay your own opinion of what tax rates you will pay in the future on top of the math that determines your spendable amount after tax. The Bogleheads forum will help you with the math, but the political part is yours alone. ;)
Thank you so much. This is helpful!
sport
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Re: Tax Question

Post by sport »

The possibly higher taxes you may pay in retirement is only one edge of a two-edged sword. The other edge is that you get tax deferred growth of dividends and capital gains distributions. So, like most things, it is not all bad nor all good. The ability to use Roth IRAs and the ability to make Roth IRA conversions gives you a lot of flexibility of how best to proceed over the years.
Gill
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Re: Tax Question

Post by Gill »

Broken Man 1999 wrote: Thu Nov 12, 2020 2:49 pm My advice is to stash as much as you can, and don't let the tax tail wag the dog!
Broken Man 1999
I agree. My entire working life I plowed the maximum into every tax deferred vehicle offered by my employers. It worked out quite well.
Gill
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BL
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Re: Tax Question

Post by BL »

Anything that even hints of insurance or annuities as an alternative to investing is suspect, as it guarantees good money for the salesperson. Do consider low-cost level Term insurance if you have someone depending on your income. An independent agent can shop several companies for you.

Use some of the references above to decide on Roth vs traditional 4xx contributions. Always fill your Roth IRA, and if income has or will become too great to allow it, read up on "Backdoor Roth" in the Wiki if you don't have any big non-Roth IRAs.

Many folks use time between retirement and age 72 to convert traditional IRAs to Roth IRAs, as their income may be lowest then. With a good pension, you may not have any very low-income years, but Roth IRAs are great to have.
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Re: Tax Question

Post by cchrissyy »

marcus_silvus wrote: Thu Nov 12, 2020 3:21 pm Just to be clear, my original question was about taxes in the future as it relates to retirement withdrawals. Not about hiring a YouTube money manager
indeed! but i think it matters that the insurance person is one of the voices who says there is something bad about retirement savings accounts but don't worry, their product will help! the scary term "bomb" is no accident. they want you afraid of managing your own money in retirement accounts and normal brokerage accounts so you'll hand it over to them, grateful they saved you from a "problem" you didn't know you had.
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CAsage
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Re: Tax Question

Post by CAsage »

marcus_silvus wrote: Thu Nov 12, 2020 3:21 pm Just to be clear, my original question was about taxes in the future as it relates to retirement withdrawals. Not about hiring a YouTube money manager
As one who is suffering from a tax bomb... sort of... I spent 30+ years at MegaCorp, maxing out my pretax 401k for about the last 25 years. The "tax bomb" syndrome refers (generally) to an over accumulation of pretax money, which then results in RMD in your older years immediately pushing you into higher tax brackets and/or making more of your SS taxable and/or meaning that for a couple, when the first one passes, the second one now has double the RMD but only the lower single tax bracket. I can also add that if you both die, one's heirs only have 10 year to take it all out and pay taxes. I will assure you that this is in fact a problem that very few Americans in general have, though more Bogleheads.
How much of that will apply in your case depends on how much money you (and your spouse, if any) have in pre-tax 401K/IRA, your current tax bracket, and what you might enjoy for taxable income. E.g. if you are in the 12% tax bracket, only consider pretax to get any employer matching, Roth is better. If you are in a higher tax bracket, maximize that pretax to save real money today, and it's likely if you retire before you get SS you can spend a chunk of it or do Roth conversions. It's a tricky thing to model, since there are many variables. Make a guess-timate of what a modestly growing portfolio would be worth, what your future RMD will be, and strive to level your tax load across the years.
Salvia Clevelandii "Winifred Gilman" my favorite. YMMV; not a professional advisor.
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Re: Tax Question

Post by grabiner »

marcus_silvus wrote: Thu Nov 12, 2020 1:48 pm Some individuals were mentioning something called a "tax bomb" saying that even if you are in a lower tax bracket when you retire, you're going to pay a significant amount in taxes upon withdrawals.
This is correct but misleading. Your goal is to have more money after tax, not to minimize taxes.

Suppose you are in a 22% tax bracket now, and you will retire in a 15% tax bracket (which the 12% bracket is scheduled to become in 2026). If you contribute $10,000 to a traditional 401(k), you save $2200 in taxes. If your contribution doubles in value before you withdraw it, you pay $3000 in taxes when you withdraw the $20,000, leaving you $17,000 to spend.

But you are better off than if you had made a Roth contribution. You could only contribute $7800 to a Roth 401(k) for the same out-of-pocket cost. If that doubles in value, you have $15,600 to spend. You pay $800 less in tax this way, but you have $1400 less to spend, so you are worse off.
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