Does it really make sense to max out tax-deferred?

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JV
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Does it really make sense to max out tax-deferred?

Post by JV » Wed Jan 15, 2014 12:13 pm

I currently contribute 6% to my 401(k) to capture the employer match and max out our Roth IRAs. I don't contribute to my wife's 403(b) any longer since there is no employer match. Does it truly make sense for a couple, if they have the means, to max out every tax-advantaged account they have? That's upwards of $55k per year, a heckuva lot of money. Since so much can change in retirement, and it is so difficult to know what your "number" will be at that stage, it seems like $55k every year is ridiculously high. Wouldn't it make more sense to keep money out of tax-advantaged so it can be used for other items, such as paying down debt (mortgage, credit card, etc.), building up a liquid portfolio for future purchases like cars, home repairs, etc., and whatever else life throws your way (vacation, college, etc.)?

In full disclosure, I'm 41, and plan on retiring (if everything falls into place) at 58. My wife will have a solid pension, which also factors into my decision to not max out tax-advantaged space.

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Garco
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Re: Does it really make sense to max out tax-deferred?

Post by Garco » Wed Jan 15, 2014 12:33 pm

You don't indicate your current income level or accumulation, so it's hard to offer any nuanced advice. But as a general rule the answer to your question is probably YES. Especially at your age if you can afford to max at that level it will pay off handsomely by the time you retire. If you have kids, then you should also count savings for their college as high priority, and using a tax deferred approach to that also makes sense. But if you turn this opportunity to add to your tax deferred (including from your wife's income and to kids' 529 plans), and are thinking more of spending (consuming) instead of maintaining a high savings rate, I think you're making a mistake.

I am very late in career (soon to retire) and much of my major expenditures, such as supporting college education for my kids, is in the past. But I am throwing as many bucks into my tax deferred accounts now as I can, even though only a fraction of this involves an employer match, and even though at my age the "marginal addition" to my savings that this entails is small relative to my total lifetime accumulation.

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Re: Does it really make sense to max out tax-deferred?

Post by Jeff7 » Wed Jan 15, 2014 12:41 pm

Paying down debt can make more sense. If you've got a debt that's got a high interest rate, that'll siphon money away from you the whole time it's in place.
If you've got debt that's sitting at 0% or 0.9% or something low, then....maybe not so much of a priority.

But as far as tax-deferred goes, that's the government saying, "You owe us some tax....but you don't have to pay us now. In fact, you can wait several years, or even some decades, before you have to pay us. In the meantime, you go invest that money. It's on us. Note: This offer is only good for this year."
Once that space goes by unused, you're not getting it back.

There is of course balance. For some of us, maxing out a $5500/year IRA and $17500/year in 401ks, and maybe even loading up on $10k in savings bonds, would leave just a few crisp dollars a year to live on, or perhaps much less. So obviously maxing those accounts isn't always feasible. It's that "use it or lose it" feature of the tax advantages that's the motivation.

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Re: Does it really make sense to max out tax-deferred?

Post by JV » Wed Jan 15, 2014 12:45 pm

The thing is, my wife and I can afford to max everything out, and I never take that for granted. We are very lucky. She is going to have a nice pension at 57, and we've been contributing to tax-advantaged accts since we were in our early 20's. I apologize for the general question, I know there's no "one size fits all" answer. But in my situation, already having a decent nut saved up, continue to contribute some to it, plus her pension, it just begged the question in my mind if it would make more sense to add to taxable.

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Re: Does it really make sense to max out tax-deferred?

Post by White Coat Investor » Wed Jan 15, 2014 12:47 pm

JV wrote:I currently contribute 6% to my 401(k) to capture the employer match and max out our Roth IRAs. I don't contribute to my wife's 403(b) any longer since there is no employer match. Does it truly make sense for a couple, if they have the means, to max out every tax-advantaged account they have? That's upwards of $55k per year, a heckuva lot of money. Since so much can change in retirement, and it is so difficult to know what your "number" will be at that stage, it seems like $55k every year is ridiculously high. Wouldn't it make more sense to keep money out of tax-advantaged so it can be used for other items, such as paying down debt (mortgage, credit card, etc.), building up a liquid portfolio for future purchases like cars, home repairs, etc., and whatever else life throws your way (vacation, college, etc.)?

In full disclosure, I'm 41, and plan on retiring (if everything falls into place) at 58. My wife will have a solid pension, which also factors into my decision to not max out tax-advantaged space.
You don't need to save more for retirement than you need for retirement. However, tax-advantaged space is a great place to save for retirement, especially early on. For a typical doc, I figure saving in a 401K vs in a taxable account is good for about 2% a year over 30 years. The age 58 thing is a non-factor. It is relatively easy to get to tax-advantaged money before age 59 1/2 without paying a penalty:

http://whitecoatinvestor.com/how-to-get ... age-59-12/

If you want to save in taxable for the first 1.5 years of your retirement (you don't need to) do that in your mid 50s. That way the money has a relatively high basis.

$55K isn't high just because it seems high to you. Lots of docs I know of would love to put $150K or even more into tax-advantaged space, they just aren't able to. But if you only need to save $40K a year toward retirement to meet your goals, then yes, $55K is high.
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Re: Does it really make sense to max out tax-deferred?

Post by The Wizard » Wed Jan 15, 2014 12:55 pm

I've argued about this previously.
Max-out for the current year or not isn't quite the issue.
The issue is more the total tax-deferred nest egg you expect to have at the start of retirement.
When that projected nest egg starts to get "too big" , then it's better to start funneling more contributions to either your taxable account or a Roth 401k/403b.
This is a "problem" that only heavy savers need to worry about. The idea here is to use withdrawals from your tax-deferred accounts to fill up your low tax brackets, but not have so much retirement income from them that gets taxed at 25% federal and above.

More work needs doing to quantify these numbers for different income levels and married vs single. I wish Jim Otar or Wade Pfau could do something with this...
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Re: Does it really make sense to max out tax-deferred?

Post by MoonOrb » Wed Jan 15, 2014 12:56 pm

Generally yes it makes sense, but maybe you have a compelling reason why it wouldn't make sense?

This might be nit-picking a little bit, but why would you invest money that you anticipate you'll need for other expenditures (home repair, car, vacation)? I budget for these things.

As far as paying off low-interest debt, I'd argue that the tax advantages of tax-deferred investing plus tax-deductible mortgage interest probably allowing you to itemize more than offset whatever advantages you get by paying off your mortgage ahead of schedule, but there are approximately 11 disagreements a day about that topic here.

If you're thinking about what would be ideal, the ideal thing would be to have enough both for the things in your budget and your retirement. It's not clear whether you're in this position or not if you're saying that you are wondering whether to invest money that should be set aside for likely expenses.

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Re: Does it really make sense to max out tax-deferred?

Post by The Wizard » Wed Jan 15, 2014 12:59 pm

JV wrote:The thing is, my wife and I can afford to max everything out, and I never take that for granted. We are very lucky. She is going to have a nice pension at 57, and we've been contributing to tax-advantaged accts since we were in our early 20's. I apologize for the general question, I know there's no "one size fits all" answer. But in my situation, already having a decent nut saved up, continue to contribute some to it, plus her pension, it just begged the question in my mind if it would make more sense to add to taxable.
YES, it most likely makes more sense to do more contribs to taxable now, since you'll likely only be paying 15% federal tax on dividends received there, vs 25% or 28% on dividends received on ADDITIONAL contributions to your tax-deferred...
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Re: Does it really make sense to max out tax-deferred?

Post by The Wizard » Wed Jan 15, 2014 1:04 pm

EmergDoc wrote:
Lots of docs I know of would love to put $150K or even more into tax-advantaged space, they just aren't able to. But if you only need to save $40K a year toward retirement to meet your goals, then yes, $55K is high.
In the other thread on High Incomes, one doc mentioned that in retirement, his RMD is double what he made when he was working.
While that's "nice" from an income point of view, tax-wise it's not so nice.
Probably would've been better to have put more in after-tax investments in the later working years, no?
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pastafarian
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Re: Does it really make sense to max out tax-deferred?

Post by pastafarian » Wed Jan 15, 2014 1:07 pm

Edit-- uh, never mind.
Last edited by pastafarian on Mon Feb 24, 2014 9:00 pm, edited 1 time in total.

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Re: Does it really make sense to max out tax-deferred?

Post by 123 » Wed Jan 15, 2014 1:11 pm

I have maxed out 401K and IRA contributions for over 20 years and I'm very glad I did. That said I think an extraordinarily disciplined investor could do just as well with taxable accounts when all is said and done. Long-term capital gain taxes are more favorable then regular income taxes on tax-deferred accounts and taxable accounts don't run into RMD requirements. Taxable accounts transfer wealth to heirs better avoiding capital gains taxes and taxes on distributions from inherited traditional IRAs.

The extraordinary accumulation and growth potential of Roth IRA/401K accounts make them a no-brainer.

The difficulty in taxable accounts is having the discipline to maintain regular deposits to the account and not to prematurely raid the corpus of the account to meet pre-retirement needs or wants. While trades in tax-deferred accounts do not generate any immediate tax consequences trades in taxable accounts do. Taxable accounts may discourage rebalancing due to tax consequences. Taxable accounts discourage the holding of dividend or interest bearing assets because of the tax burden imposed as the positions become large.

The tax-deferred account provides a lot of flexibility. While I do have some regrets about having "too much" of my assets in tax-deferred accounts I realize that without tax-deferred accounts over the long term my assets would be significantly less, even considering all the tax consequences.
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Re: Does it really make sense to max out tax-deferred?

Post by JV » Wed Jan 15, 2014 1:37 pm

pastafarian wrote:We share your extremely fortunate situation. There are a couple calculators that can help you, at least they helped us. Play around with http://www.i-orp.com and Jim Otar's http://www.retirementoptimizer.com...the free Trial version. I reckon I could retire now, at least Otar's product tells me I can stop saving for retirement. With that in mind, and the potential for very large RMDs absent large Roth conversions, I stopped traditional 401(k) contributions two years ago.

:sharebeer
This is helpful. Thank you, and thanks to all of you for the advice. I've tried a number of calculators, plugging in different scenarios, and they all arrive at diffferent numbers. I'll try these when I get home.

I've always had trouble with that balance of prepping for retirement via tax-deferred and thinking that adding to taxable would be smart, especially in light of the recession and seeing many people I know struggle because they were unprepared and lost their jobs. Liquidity has gained in importance for me, and knowing I have a sizeable pot available to me at any time brings a nice sense of peace. I'm strongly considering cranking up a taxable acct using VG TM Balanced this year.

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Re: Does it really make sense to max out tax-deferred?

Post by Ketawa » Wed Jan 15, 2014 2:36 pm

123 wrote:I have maxed out 401K and IRA contributions for over 20 years and I'm very glad I did. That said I think an extraordinarily disciplined investor could do just as well with taxable accounts when all is said and done. Long-term capital gain taxes are more favorable then regular income taxes on tax-deferred accounts and taxable accounts don't run into RMD requirements. Taxable accounts transfer wealth to heirs better avoiding capital gains taxes and taxes on distributions from inherited traditional IRAs.

The extraordinary accumulation and growth potential of Roth IRA/401K accounts make them a no-brainer.

The difficulty in taxable accounts is having the discipline to maintain regular deposits to the account and not to prematurely raid the corpus of the account to meet pre-retirement needs or wants. While trades in tax-deferred accounts do not generate any immediate tax consequences trades in taxable accounts do. Taxable accounts may discourage rebalancing due to tax consequences. Taxable accounts discourage the holding of dividend or interest bearing assets because of the tax burden imposed as the positions become large.

The tax-deferred account provides a lot of flexibility. While I do have some regrets about having "too much" of my assets in tax-deferred accounts I realize that without tax-deferred accounts over the long term my assets would be significantly less, even considering all the tax consequences.
The bolded segment is not true, because it ignores the benefit of the tax deduction from contributing to a tax-deferred account. You didn't specify if these were deductible contributions, but I assumed they were.

With equal marginal tax rates at both ends (contribution and withdrawal) tax-deferred and tax-exempt accounts are equivalent. Since tax-exempt Roth accounts are obviously better than taxable accounts, tax-deferred Traditional accounts are also better. On top of that, the taxes at withdrawal are typically much lower than at contribution, making tax-deferred accounts better than tax-exempt accounts.

Large RMDs are only bad to the extent they push you into a higher tax bracket. Most of the RMDs are going to be taxed at far lower rates than the contributions were made.

One exception is if the investor is contributing the max annual amount, which gives Roth accounts an edge of a few percent if the tax rates are equal.

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Re: Does it really make sense to max out tax-deferred?

Post by leonard » Wed Jan 15, 2014 3:05 pm

It depends.

How much money is leftover after the tax advantaged accounts are maxed.
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Re: Does it really make sense to max out tax-deferred?

Post by Bengineer » Wed Jan 15, 2014 3:40 pm

I think of having assets in taxable / deferred / free as tax diversification and increased options.

JV, you might reach financial independence and want to retire (or do less / something else ...) before 58. Flexibility in funding the 5x-6x period would be nice. Tax law will change. Her 403b might offer better ERs than your 401k. As you approach retirement, you might want your allocation to shift more to bonds and desire tax deferred space for their dividends. Reallocation and balancing do become more complex when part is in taxable. Deferred accounts have better protections from liability / creditors.

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Re: Does it really make sense to max out tax-deferred?

Post by bucksfan2 » Wed Jan 15, 2014 4:10 pm

Jeff7 wrote:There is of course balance. For some of us, maxing out a $5500/year IRA and $17500/year in 401ks, and maybe even loading up on $10k in savings bonds, would leave just a few crisp dollars a year to live on, or perhaps much less. So obviously maxing those accounts isn't always feasible. It's that "use it or lose it" feature of the tax advantages that's the motivation.
Isn't this the main question? To me this gets to the biggest issue I have with the bogglehead mantra. I am young, 31, much younger than many people who post on here. I max out both my and my wife's Roth. In the past I had contributed just enough to take full advantage of the company match in my 401K, however I have recently upped that number and probably will continue to do so until I reach the max whenever I feel comfortable in my financial position. My wife and I do not have a strict budge and we probably spend more impulse money than we should. Maxing out all of our retirement accounts is a pretty big chunk of money, especially when you consider that money isn't "available" for another 35 years. To me it was more important to live the lifestyle we wanted to, build up a nice cushion to do the things we wanted to. Two years ago my wife decided she was going to quit work, go back to school and change career paths. If we had maxed out our retirement accounts we would have had to take a loan out to pay for college. As it was we were able to play for her tuition from our savings.

If you do take full advantage of all the tax deferred methods kudos to you. We have just felt that there were more important things to us that saying "look at our retirement account balance!"

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Re: Does it really make sense to max out tax-deferred?

Post by Bacchus01 » Wed Jan 15, 2014 4:25 pm

There are a lot of factors to consider here.

For me, it's about the marginal tax rate that I'm in now versus where I expect to be later. Also, I've been blessed in the past (not current) to have access to Institution-class funds with extremely low fees that I can't get in taxable.

I do the following for us (wife does not work):
- 401K pre-tax $17.5K + $8K match
- HSA $6450
- Roth $11K
- Post-tax 401K to Roth conversion: $29,500
- Taxable: $30K

That's a total of $72,450 in preferential tax accounts, and $30K in taxable for a total of about $100K/yr.

It's doable, but having a big salary sure helps.

I also will have 2 pensions totaling about $60k/year when I'm 65. I'm now 40.

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Re: Does it really make sense to max out tax-deferred?

Post by Marmot » Wed Jan 15, 2014 4:51 pm

We decided back in 1989 to max out both of our 401K's and have stuck with that until now. We have built a pretty sizable amount in tax deferred. I think I can add one persons perspective since I am now 56, so 25 years + on this strategy. We plan to early retire (ER) in May. Our investments (non-taxable and taxable)should generate the required balance needed to cover all expenses (Yes, we Jim Otar'ed this to death). During the last 20 years we have been in the highest tax bracket, so for me it was a no brainer to put the cash in tax deferred vechicles. Our plan is not to make any taxable money for the next 5 years, during that time we plan to Roth over money at a much lower tax rate.
We had debts as any newly married family - house, pool, car, car, student loans, etc. We worked very hard to remove them and stay out of debt. When we did get debt, we were religous on paying it off. Being on the back side of this 25 year experience, i can't tell you how great it is to have total flexibility in terms of working on the asset allocation. We have ample "space" percentage wise for bonds in tax deferred vehicles. There are alot of smart people with great ideas that have commented above. I would max out the employer contribution benefit of the 401K and pay down some of the other bills. Every year that passes reduces your opportunity to add monies in tax deferred space. 50 might seem like it is pretty darn far away...it isn't. Life moves fast.

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Re: Does it really make sense to max out tax-deferred?

Post by FNK » Wed Jan 15, 2014 4:56 pm

The limits on tax-deferred accounts are arbitrarily set by Congress and do not correspond to anything in your life. They may be too high or too low. At this stage in my life, mine are too high (I get to do $51K in my 401).

The real question is not whether you should max them out, but what is the right balance between retirement savings and everything else.

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Re: Does it really make sense to max out tax-deferred?

Post by bhsince87 » Wed Jan 15, 2014 5:01 pm

I’m a big believer in having a taxable investment account. In fact, mine is larger than my tax deferred accts.

I’m planning on retiring around age 52-55, and I plan to rely on my taxable account for as long as possible before tapping IRA or SS funds. We don’t qualify for Roth IRA, and a backdoor doesn’t make sense at this point, so that factors into my decisions.

If used wisely, with current tax laws, a taxable account can actually be better than a Roth in some ways.

I do however try to max out my traditional 401k. We’re currently in the 33% bracket, but I expect to be in the 15% or occasionally 25% when we’re retired (Congress willing...). So there should be some true savings there.
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Re: Does it really make sense to max out tax-deferred?

Post by YttriumNitrate » Wed Jan 15, 2014 5:04 pm

JV wrote:Wouldn't it make more sense to keep money out of tax-advantaged so it can be used for other items, such as...college, etc.
No, definitely not. There are advantages to those retirement accounts other than taxes. For example, if you have a large chunk of money in a taxable account, it is going to count against your kid's eligibility for college financial aid. That money in a 401(k) or IRA is hidden from the colleges. Also, if you were to get sued the money in a 401k retirement account is harder to get at than a taxable account.

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Re: Does it really make sense to max out tax-deferred?

Post by FNK » Wed Jan 15, 2014 5:10 pm

bhsince87 wrote:We don’t qualify for Roth IRA, and a backdoor doesn’t make sense at this point, so that factors into my decisions.
Why doesn't backdoor Roth make sense? Because of Trad IRAs?

If you have savings, it generally makes sense to let them grow tax free, I think...

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Re: Does it really make sense to max out tax-deferred?

Post by bhsince87 » Wed Jan 15, 2014 5:22 pm

FNK wrote:
bhsince87 wrote:We don’t qualify for Roth IRA, and a backdoor doesn’t make sense at this point, so that factors into my decisions.
Why doesn't backdoor Roth make sense? Because of Trad IRAs?

If you have savings, it generally makes sense to let them grow tax free, I think...
Yes, because of about $200k in traditional IRAs. And my 401k plan won't allow transfers into it. It's been a while since I've run the numbers though. Maybe it does make sense.

But anyway, most of the funds in my taxable account are growing tax free too! Some munies, but mostly individual stocks that pay little to no dividends.

I'm mostly buy and hold. There are no taxes on unrealized capital gains. I plan to take the capital gains when I'm retired and I will hopefully be in the 0% tax bracket. I will also consider converting Trad IRA/401k to Roth then.
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Re: Does it really make sense to max out tax-deferred?

Post by White Coat Investor » Wed Jan 15, 2014 5:54 pm

The Wizard wrote:
EmergDoc wrote:
Lots of docs I know of would love to put $150K or even more into tax-advantaged space, they just aren't able to. But if you only need to save $40K a year toward retirement to meet your goals, then yes, $55K is high.
In the other thread on High Incomes, one doc mentioned that in retirement, his RMD is double what he made when he was working.
While that's "nice" from an income point of view, tax-wise it's not so nice.
Probably would've been better to have put more in after-tax investments in the later working years, no?
Absolutely. I had an email this week about an orthodontist who retired on $16 Million. Really a first world problem there. I agree with the above comment, that once your RMDs fill more than perhaps the 25 or 28% bracket, perhaps the rest ought to go to Roth conversions. However, keep in mind how much income we're talking about here. For a married couple, we're talking about $200K of RMDs. A 70 year old's RMD is 3.6%, an 80 year old's is 5.3%. So we're talking about a tax-deferred portfolio of $4M+ now, more in the future (since brackets will also go up with inflation.) Most people, including doctors, will retire with a tax-deferred portfolio much lower than that. If you are one of the rare few who will have more, then I think the obvious solution is Roth conversions.

$50K contributed from age 35 to 55, growing at 5% real a year until age 70, grows to $3.6M.

It's not impossible, but I think it's a pretty rare situation where someone is going to be pulling money out of retirement accounts at a higher effective rate than the marginal rate at which they put money into the retirement account, and most of these situations are going to involve significant pensions.
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Re: Does it really make sense to max out tax-deferred?

Post by Watty » Wed Jan 15, 2014 6:03 pm

Since so much can change in retirement, and it is so difficult to know what your "number" will be at that stage, it seems like $55k every year is ridiculously high. Wouldn't it make more sense to keep money out of tax-advantaged so it can be used for other items, such as paying down debt (mortgage, credit card, etc.), building up a liquid portfolio for future purchases like cars, home repairs, etc., and whatever else life throws your way (vacation, college, etc.)?
Your net worth goes up by the same amount (adjusted for taxes) if $1,000 goes into a retirement account or is used to pay down your mortgage by $1,000 so using money for something like this is an "it depends" question if you want to know what is best for you.

I'm not retired yet but a few years ago within a year I went to three funerals for people I knew who were roughly my age. That was an eye-opener and helped me reevaluate my "now vs later" balance and I have started doing things like traveling more .

My retirement savings were just about at the point where I have would enough to support a very modest retirement if I had to so I am now contributing just enough to my 401k to get an employer match which combined is 9% of my salary.

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Re: Does it really make sense to max out tax-deferred?

Post by dotnet » Wed Jan 15, 2014 6:32 pm

It seems like people have answered by talking about what will give you the most money on the day you retire.

It, also, seems like you're not really interested in that. You have plenty of money for retirement (or you're on pace to), and want to know if its crazy to keep some of the money for use now.

If you're comfortable you'll have enough for retirement, then you've won. I'd keep putting money away because it is smart, but at some point you have to make a personal decision on your quality of life. If you have enough in retirement and it'll give you more utils (a measurement of utility) to keep money liquid to fix up the house or go on a great vacation, then by all means...

The investing that money in a taxable account is a different story. I am prone to invest money I have plans to use in the next 5-10 years in a taxable account too (ie. I plan to buy another house, go on a big vacation eventually, etc.). But it probably isn't the smartest thing. You're probably better off investing in a CD or something.

Personally, I understand the risk that the money could go away, have a larger than necessary "emergency" fund, and I'm okay with putting off those expenses if something bad happened. Still not sure that my move is the absolute smartest when you consider risk vs reward... but to each his own.

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Re: Does it really make sense to max out tax-deferred?

Post by SGM » Wed Jan 15, 2014 6:58 pm

I have always maxed out tax deferred and increased my taxable accounts. Years ago limits for tax deferred accounts were much lower so taxable is higher. I have converted some tIRAs to ROTHs since 2010 in an effort to decrease future RMDs. I don't expect my taxes to go down in retirement. I continue to add to a tax deferred 401k while converting to ROTHs. I have about 4 more years of much smaller conversions.
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Re: Does it really make sense to max out tax-deferred?

Post by tphp99 » Wed Jan 15, 2014 7:24 pm

EmergDoc wrote: It's not impossible, but I think it's a pretty rare situation where someone is going to be pulling money out of retirement accounts at a higher effective rate than the marginal rate at which they put money into the retirement account, and most of these situations are going to involve significant pensions.
I agree. Right now I'd rather save the 39.6% and see what will happen in a few decades.

I suppose if an individual were in a low tax braket, it might make sense to forgo the current tax savings. The risk of rates going up might muck it all up. Roth IRA might be best.

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Re: Does it really make sense to max out tax-deferred?

Post by TMQ206 » Wed Jan 15, 2014 7:30 pm

My first post, so apologies if out of bounds, but my calculus for tax deferred versus taxable saving also includes asset protection. There are professions and life circumstances where liability protection in personal finance can be as important as the tax implications. Tax advantaged accounts, 401k/403b, and to a lesser extent IRAs depending on state of residence, offer some degree of creditor protection.

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Re: Does it really make sense to max out tax-deferred?

Post by grabiner » Wed Jan 15, 2014 8:02 pm

bhsince87 wrote:But anyway, most of the funds in my taxable account are growing tax free too! Some munies, but mostly individual stocks that pay little to no dividends.
Munis have a hidden tax cost. If a muni has a 3% yield and a corporate bond of comparable risk has a 4% yield, then you are paying 1% per year to avoid the taxes.
I'm mostly buy and hold. There are no taxes on unrealized capital gains. I plan to take the capital gains when I'm retired and I will hopefully be in the 0% tax bracket. I will also consider converting Trad IRA/401k to Roth then.
If you expect to have a 0% tax cost on capital gains in retirement, then you will have a negative tax cost for maxing out your 401(k). If you are in a 28% bracket now (which presumably you are since you are ineligible to contribute to the Roth) and will retire in a 15% bracket, then $720 contributed out of pocket becomes $1000 in the 401(k) and $850 when you withdraw it.
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Re: Does it really make sense to max out tax-deferred?

Post by bhsince87 » Wed Jan 15, 2014 8:47 pm

grabiner wrote:
bhsince87 wrote:But anyway, most of the funds in my taxable account are growing tax free too! Some munies, but mostly individual stocks that pay little to no dividends.
Munis have a hidden tax cost. If a muni has a 3% yield and a corporate bond of comparable risk has a 4% yield, then you are paying 1% per year to avoid the taxes.

Hmm, I'm not sure about that. By my way of thinking, I'm still better off with 3% tax free than 4% taxed. You might have missed my later post, but I'm in the 33% bracket. At 4% taxed, I'm earning 2.67% after tax, right?
I'm mostly buy and hold. There are no taxes on unrealized capital gains. I plan to take the capital gains when I'm retired and I will hopefully be in the 0% tax bracket. I will also consider converting Trad IRA/401k to Roth then.
If you expect to have a 0% tax cost on capital gains in retirement, then you will have a negative tax cost for maxing out your 401(k). If you are in a 28% bracket now (which presumably you are since you are ineligible to contribute to the Roth) and will retire in a 15% bracket, then $720 contributed out of pocket becomes $1000 in the 401(k) and $850 when you withdraw it.
Agree completely. I do max out my traditional 401k. Since I'm in the 33% bracket now, I'm pretty sure I'm making the right bet there.
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Re: Does it really make sense to max out tax-deferred?

Post by VictoriaF » Wed Jan 15, 2014 8:58 pm

JV wrote:I'm 41, and plan on retiring (if everything falls into place) at 58. My wife will have a solid pension, which also factors into my decision to not max out tax-advantaged space.
If you retire at 58, you can have 12 years of low income before you start taking Social Security and RMDs at the age of 70. During these 12 years you will be able to convert your traditional retirement accounts into Roth at a relatively low tax rate. If now you live in a state with income tax, you are paying state tax on your taxable investment income. In retirement, you can relocate to a state without state income tax, which will make your Roth conversions not taxable at the state level.

Thus, maximizing your tax-deferred assets may be financially advantageous.

Victoria
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Re: Does it really make sense to max out tax-deferred?

Post by Watty » Wed Jan 15, 2014 9:10 pm

[quote="EmergDoc} It's not impossible, but I think it's a pretty rare situation where someone is going to be pulling money out of retirement accounts at a higher effective rate than the marginal rate at which they put money into the retirement account, and most of these situations are going to involve significant pensions.[/quote]

Three other common situations where this might happen.

1) You retire in a state with higher income taxes.

2) You are in the income range where each dollar of additional income causes more of your Social Security to be taxed.
http://www.bogleheads.org/wiki/Taxation ... y_benefits

3) You were married and filing joint returns when you were working but are widowed or divorced and filing as single when you are retired.

Future tax rate increases could also be a factor.

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Re: Does it really make sense to max out tax-deferred?

Post by grabiner » Thu Jan 16, 2014 9:34 pm

bhsince87 wrote:
grabiner wrote:
Munis have a hidden tax cost. If a muni has a 3% yield and a corporate bond of comparable risk has a 4% yield, then you are paying 1% per year to avoid the taxes.
Hmm, I'm not sure about that. By my way of thinking, I'm still better off with 3% tax free than 4% taxed. You might have missed my later post, but I'm in the 33% bracket. At 4% taxed, I'm earning 2.67% after tax, right?
Your goal is to optimize after-tax returns, not to minimize taxes. If you hold a muni earning 3% in a taxable account when you could hold a corporate bond earning 4% in a Roth IRA, your after-tax returns will be 1% less; this is the cost you pay to avoid paying taxes, so it should be considered as a cost imposed by the tax laws both in the decision whether to invest in a tax-deferred account and in the decision of what to put in your taxable account.

If you retire and drop to a 15% tax bracket, you can swap the muni for the corporate bond then; you will increase your after-tax returns from 3% to 3.4% but you are now paying a direct tax cost of 0.6% rather than a hidden tax cost of 1%. If you put the corporate bond in the Roth, it would continue to pay 4%.
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Re: Does it really make sense to max out tax-deferred?

Post by YDNAL » Fri Jan 17, 2014 6:13 am

JV wrote:I currently contribute 6% to my 401(k) to capture the employer match and max out our Roth IRAs. I don't contribute to my wife's 403(b) any longer since there is no employer match. Does it truly make sense for a couple, if they have the means, to max out every tax-advantaged account they have?
Unless you know something about the future that tells you otherwise, yes it does "make sense."

That said, I wish I had $10 per word written on this subject in the Forum. I would be sitting on the deck of my 200 foot yacht in Bali, sipping margaritas. And, likely paying lower percent in taxes than the captain of my yatch... a la Warren Buffett vs. his assistant. :)
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Re: Does it really make sense to max out tax-deferred?

Post by JV » Fri Jan 17, 2014 10:36 am

Love the feedback here.

I decided to max out my 401(k) in 2014 and continue that going forward, in addition to maxing out our Roth IRAs. I'm leaving my wife's 403(b) alone for now as there's no match and she is eligible for a decent pension at 57. I'm using any leftover cash in two ways: 1) using half to save in taxable, either via a NY tax-free muni bond fund, or VG TM Balanced, and 2) using half to pay down my mortgage, which only has $61k left. Once the mortgage is done, hopefully by late 2015 or 2016, and provided my income remains as is, I'll begin re-adding to my 529 plans for both kids and possibly amping up the 403(b) due to the extra cash now that the mortgage is paid.

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Re: Does it really make sense to max out tax-deferred?

Post by pancake19 » Fri Jan 17, 2014 10:48 am

VictoriaF wrote:
JV wrote:I'm 41, and plan on retiring (if everything falls into place) at 58. My wife will have a solid pension, which also factors into my decision to not max out tax-advantaged space.
If you retire at 58, you can have 12 years of low income before you start taking Social Security and RMDs at the age of 70. During these 12 years you will be able to convert your traditional retirement accounts into Roth at a relatively low tax rate. If now you live in a state with income tax, you are paying state tax on your taxable investment income. In retirement, you can relocate to a state without state income tax, which will make your Roth conversions not taxable at the state level.

Thus, maximizing your tax-deferred assets may be financially advantageous.

Victoria
I'm fairly new to thinking about these things, can you clarify for me why you would have 12 years of low income. I understand the mandatory minimum distributions and SS, but assuming my expenses are the same at age 65 vs 75, why would my tax rate be lower while 65?

Are you suggesting that betwee those 12 years people fund themselves with post-tax $?

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Re: Does it really make sense to max out tax-deferred?

Post by kaudrey » Fri Jan 17, 2014 11:04 am

pancake - my thinking follows Victoria's. From age 57 to 70, income in this case will just be coming from the pension and taxable investments (assuming they wait on SS and don't touch their retirement accounts until they have to). So the income number is lower than when SS starts and the RMDs hit. I plan to do Roth conversions during those years as well, as my scenario will be similar to JV's.

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Re: Does it really make sense to max out tax-deferred?

Post by zed » Fri Jan 17, 2014 11:08 am

pancake19 wrote:
VictoriaF wrote:
JV wrote:I'm 41, and plan on retiring (if everything falls into place) at 58. My wife will have a solid pension, which also factors into my decision to not max out tax-advantaged space.
If you retire at 58, you can have 12 years of low income before you start taking Social Security and RMDs at the age of 70. During these 12 years you will be able to convert your traditional retirement accounts into Roth at a relatively low tax rate. If now you live in a state with income tax, you are paying state tax on your taxable investment income. In retirement, you can relocate to a state without state income tax, which will make your Roth conversions not taxable at the state level.

Thus, maximizing your tax-deferred assets may be financially advantageous.

Victoria
I'm fairly new to thinking about these things, can you clarify for me why you would have 12 years of low income. I understand the mandatory minimum distributions and SS, but assuming my expenses are the same at age 65 vs 75, why would my tax rate be lower while 65?

Are you suggesting that between those 12 years people fund themselves with post-tax $?
That's our strategy. Use the funds from post-tax accounts to cover living expenses, then do ROTH conversions up to the top of the optimal tax bracket. In our case the 15% federal tax bracket.

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Re: Does it really make sense to max out tax-deferred?

Post by VictoriaF » Fri Jan 17, 2014 11:15 am

pancake19 wrote:
VictoriaF wrote:
JV wrote:I'm 41, and plan on retiring (if everything falls into place) at 58. My wife will have a solid pension, which also factors into my decision to not max out tax-advantaged space.
If you retire at 58, you can have 12 years of low income before you start taking Social Security and RMDs at the age of 70. During these 12 years you will be able to convert your traditional retirement accounts into Roth at a relatively low tax rate. If now you live in a state with income tax, you are paying state tax on your taxable investment income. In retirement, you can relocate to a state without state income tax, which will make your Roth conversions not taxable at the state level.

Thus, maximizing your tax-deferred assets may be financially advantageous.

Victoria
I'm fairly new to thinking about these things, can you clarify for me why you would have 12 years of low income. I understand the mandatory minimum distributions and SS, but assuming my expenses are the same at age 65 vs 75, why would my tax rate be lower while 65?

Are you suggesting that betwee those 12 years people fund themselves with post-tax $?
Let's say your expenses are approximately $100k per year. When you work, you fund your expenses from your employment income (e.g., $200k), and your entire employment income is fully taxable at the Federal and State income tax rates.

As an illustrative example(*), in retirement, you may have a $1.2m stock portfolio in a taxable account, 30% of which are long-term capital gains. For 12 years you will take $100k/year, of which only $30k are taxed at 15%, or $4.5k, at the Federal level. You can also make Roth conversions, while remaining in the 15% tax bracket--which is much lower than the 25% bracket you will be in when you start collecting Social Security and RMDs at the age of 70.

(*) The numbers are for illustration only. They don't account for possible previous tax losses from TLH, the growth (or decline) of the $1.2m stock portfolio during these 12 years, tax deductions and exemptions, any other assets, or changes in expenses. Moving to a no-income-tax state would eliminate State-level taxes.

Victoria
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Re: Does it really make sense to max out tax-deferred?

Post by pancake19 » Fri Jan 17, 2014 11:52 am

VictoriaF wrote:
pancake19 wrote:
VictoriaF wrote:
JV wrote:I'm 41, and plan on retiring (if everything falls into place) at 58. My wife will have a solid pension, which also factors into my decision to not max out tax-advantaged space.
If you retire at 58, you can have 12 years of low income before you start taking Social Security and RMDs at the age of 70. During these 12 years you will be able to convert your traditional retirement accounts into Roth at a relatively low tax rate. If now you live in a state with income tax, you are paying state tax on your taxable investment income. In retirement, you can relocate to a state without state income tax, which will make your Roth conversions not taxable at the state level.

Thus, maximizing your tax-deferred assets may be financially advantageous.

Victoria
I'm fairly new to thinking about these things, can you clarify for me why you would have 12 years of low income. I understand the mandatory minimum distributions and SS, but assuming my expenses are the same at age 65 vs 75, why would my tax rate be lower while 65?

Are you suggesting that betwee those 12 years people fund themselves with post-tax $?
Let's say your expenses are approximately $100k per year. When you work, you fund your expenses from your employment income (e.g., $200k), and your entire employment income is fully taxable at the Federal and State income tax rates.

As an illustrative example(*), in retirement, you may have a $1.2m stock portfolio in a taxable account, 30% of which are long-term capital gains. For 12 years you will take $100k/year, of which only $30k are taxed at 15%, or $4.5k, at the Federal level. You can also make Roth conversions, while remaining in the 15% tax bracket--which is much lower than the 25% bracket you will be in when you start collecting Social Security and RMDs at the age of 70.

(*) The numbers are for illustration only. They don't account for possible previous tax losses from TLH, the growth (or decline) of the $1.2m stock portfolio during these 12 years, tax deductions and exemptions, any other assets, or changes in expenses. Moving to a no-income-tax state would eliminate State-level taxes.

Victoria
Okay yes that makes complete sense and is what I was planning to do also, was just confused if people were suggesting that actual gross income would be higher age 70+.

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