what percent of retirement should be invested in tax deferred vs tax free accounts?

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zetsui
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what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by zetsui »

As a younger person my asset allocation is 30% bonds and 70% stocks. However as I get older that [shifts] towards a more bond heavy profile closer to retirement

Can I think of tax defered and tax free accounts (ie Roth) as the same around my retirement age? Should my retirement accoutns be maxed out regardless every year 1) or should i tend to invest that money more towards tax deffered (ie roth 401k instead of 401k) as I get older and closer to retirmeent?

This seem sto be a complex problem as I dont know much about historical tax rates, whether they will go up, what percent of retirees retire into a higher tax bracket or what major costs can increase your tax bill in retirement, how to account for this when investing initially?

[Typo correction by moderator oldcomputerguy]
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WoodSpinner
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by WoodSpinner »

zetsui wrote: Wed Sep 16, 2020 9:04 pm As a younger person my asset allocation is 30% bonds and 70% stocks. However as I get older that [shifts] towards a more bond heavy profile closer to retirement

Can I think of tax defered and tax free accounts (ie Roth) as the same around my retirement age? Should my retirement accoutns be maxed out regardless every year 1) or should i tend to invest that money more towards tax deffered (ie roth 401k instead of 401k) as I get older and closer to retirmeent?

This seem sto be a complex problem as I dont know much about historical tax rates, whether they will go up, what percent of retirees retire into a higher tax bracket or what major costs can increase your tax bill in retirement, how to account for this when investing initially?
There have been several threads on when to use a Tax Deferrd (e.g. 401K) vs. a Roth, you can use the Search box in the upper Right hand corner.

Quick summary is that if you are in the 24% Marginal bracket or above go for the Tax Deferred. If you are in the 12% or below, go for the Roth. 22% bracket is a tossup, you are probably better off doing a bit of both.

Later in the game, (when you are closer to Retirement) you could consider more funds in Roth and use that as a ladder before SS.

Glad to see this question, it means you are thinking things through and look8ng at the long ga,e!

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FiveK
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by FiveK »

It's a reasonable question, but it turns out the answer is best couched in absolute terms instead of percentages.

In short, you want to fill the traditional (tax deferred) accounts up to the point that withdrawals from them (at, say, a 4%/yr or 5%/yr rate) would have a marginal tax rate equal to what you would save on contributions today. Beyond that, use Roth (tax free) accounts.

See Traditional versus Roth - Bogleheads for a longer version.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by aristotelian »

Completely depends on your tax bracket now and in retirement. You need to provide a lot more info. Generally you should max your pretax accounts.
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teen persuasion
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by teen persuasion »

FiveK wrote: Wed Sep 16, 2020 10:18 pm It's a reasonable question, but it turns out the answer is best couched in absolute terms instead of percentages.

In short, you want to fill the traditional (tax deferred) accounts up to the point that withdrawals from them (at, say, a 4%/yr or 5%/yr rate) would have a marginal tax rate equal to what you would save on contributions today. Beyond that, use Roth (tax free) accounts.

See Traditional versus Roth - Bogleheads for a longer version.
Taking this discussion slightly off-topic - I've been thinking thru different scenarios for Roth conversion ladder execution when we retire early. While we'd be withdrawing 4% of our overall retirement account totals, we'd in reality be converting 6% of the traditional account totals to Roth, and withdrawing an equivalent amount from Roth contributions (we are currently at roughly 1/3 Roth to 2/3 traditional).

So it seems that for tax purposes, the size of combined account totals doesn't matter, only the size of the traditional totals, since the Roth portion won't incur tax.

Am I thinking about this correctly? Does it shift the thought process any?
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by retiredjg »

zetsui wrote: Wed Sep 16, 2020 9:04 pm Can I think of tax defered and tax free accounts (ie Roth) as the same around my retirement age?
Not sure what this means. They are not the same, but most people agree that it is good to have some of both when you reach/are in retirement.

Should my retirement accoutns be maxed out regardless every year 1) or should i tend to invest that money more towards tax deffered (ie roth 401k instead of 401k) as I get older and closer to retirmeent?
These questions are not connected to each other. I wonder if something got left out in an edit?

Yes, if you can you should max out your retirement accounts each year. But this I mean a plan at work (if you have one) and an IRA. Whether you use tax-deferred contributions or Roth contributions depends on your situation and your preferences.


Unless there is an edit/typo problem, it appears you are confused about what "tax-deferred" is - a traditional 401k contribution would be tax-deferred (meaning you are putting off the tax till a later time). A Roth 401k contribution is not tax-deferred - you pay taxes on that money the year it is earned.


This seem sto be a complex problem as I dont know much about historical tax rates, whether they will go up, what percent of retirees retire into a higher tax bracket or what major costs can increase your tax bill in retirement, how to account for this when investing initially?
It is complex. Sometimes the "best" choice is clear but I'd say this is the exception rather than the rule. Most of the time, this is a best guess decision. For this reason, some people have just decided to use half and half if they have that option.

Most people are in a lower tax bracket in retirement, not everyone.

If you want help with your own situation, you need to tell us what it is.
Greenman72
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Greenman72 »

WoodSpinner wrote: Wed Sep 16, 2020 9:47 pm
There have been several threads on when to use a Tax Deferrd (e.g. 401K) vs. a Roth, you can use the Search box in the upper Right hand corner.
[OT comment removed by admin LadyGeek]

Nonetheless--in the absence of tax rate arbitrage (which is virtually impossible to know in advance), there is no advantage to one account over another. The Roth does offer some benefits that a Traditional doesn't offer, but not much. Basically, you just have to pick and stick.
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Kintora
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Kintora »

OP, here is my take on it.

I am currently in the 22% tax bracket. In retirement, I may be in the 12% tax bracket. However, we do not know what tax brackets will look like in the future. The current 12% bracket could be 15-20%+ when I retire. Or not. We just don't know. I personally feel like they are more likely to go up than down in the future.

I contribute to my work 401k as Roth 401k. I like to get my tax payment "over and done with" and look forward to enjoying everything being tax free on the back end. With pre-tax 401k, I may or may not be disciplined enough to invest the current year tax savings elsewhere. I also like the idea of not worrying about RMDs as much in the future. I already have a traditional IRA account from previous years as well, so I do have diversity as far as investments in all 3 buckets (taxable, tax deferred, tax free).

I would also consider a Roth IRA (outside your 401k) as you can withdraw your contributions at any time tax/penalty free. If you decide to go tax deferred in your 401k, this will give you some diversity and flexibility with your investments when the time comes to start withdrawing.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by willthrill81 »

We're currently in the 22% bracket but expect to be in the 12% bracket during retirement. Therefore, it is to our significant advantage to put everything into tax-deferred accounts right now. If/when our tax-deferred contributions effectively bring us down into the 12% bracket, we'll then do Roth contributions and conversions.

Generally, most people are better off with tax-deferred contributions because they will be in a lower tax bracket when they withdraw the funds than they were when they made the contributions. But those with significant pensions and/or significant non-portfolio income (e.g. rental properties) are often better off with Roth contributions.
Last edited by willthrill81 on Thu Sep 17, 2020 10:34 am, edited 1 time in total.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by smitcat »

Greenman72 wrote: Thu Sep 17, 2020 10:12 am
WoodSpinner wrote: Wed Sep 16, 2020 9:47 pm
There have been several threads on when to use a Tax Deferrd (e.g. 401K) vs. a Roth, you can use the Search box in the upper Right hand corner.
[OT comment removed by admin LadyGeek]

Nonetheless--in the absence of tax rate arbitrage (which is virtually impossible to know in advance), there is no advantage to one account over another. The Roth does offer some benefits that a Traditional doesn't offer, but not much. Basically, you just have to pick and stick.
"Nonetheless--in the absence of tax rate arbitrage (which is virtually impossible to know in advance), there is no advantage to one account over another."
In many cases it is fairly easy to know that a traditional account will have advantages if you are a higher earner - due to matching, due to taxes, do to future plans.

"Basically, you just have to pick and stick."
You really need to do a quick reevalution as time moves forward and perhaps your income, location and/or tax situation changes.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by KlangFool »

OP,


It is very simple.


A) Max out your Trad. 401K and put the tax savings into the Roth IRAs. It works 90+% of the time.

<<what percent of retirement should be invested in tax deferred vs tax free accounts?>>

This is the wrong question. If you ask this question, you do not know enough to do something other than (A).

<<(ie roth 401k instead of 401k)>>


90+% of the time that people made a mistake by contributing to Roth 401K.

<<This seem sto be a complex problem>>

It is not a complex problem for 90+% of people. It is only a problem for someone with a very big tax-deferred account and/or very good pension.

KlangFool
Last edited by KlangFool on Thu Sep 17, 2020 10:42 am, edited 1 time in total.
livesoft
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by livesoft »

There is no definitive answer to "should be invested."

The way tax laws are nowadays, it does look like even folks in low tax brackets could benefit from tax-deferred accounts and not everyone needs to do Roth accounts. There are two reasons for this:

(a) One may not be in a low tax bracket unless they contribute enough to a tax-deferred account and thus have income that is deductible and not showing up on their tax return.

(b) in retirement, the standard deduction can be significant and one can consider that withdrawals from a tax-deferred account that get included in gross income could actually be offset by the standard deduction and not taxed. So they could be tax-free going in and tax-free coming out.

My advice is save and invest in tax-deferred as much as possible, then put the rest in Roth, then put the rest in a taxable account. Then when you are pleasantly surprised that you have enough money to retire at age 45, 50, 55, or whatever, then retire.

However, I wish to add that Roth IRAs have the peculiar property that one can withdraw contributions from them at any time without paying tax nor IRS penalty. I do not believe that holds for Roth 401(k) and Roth 403(b) contributions. Some folks might need the mental backstop of this withdrawal feature to get started with investing for retirement.
Last edited by livesoft on Thu Sep 17, 2020 10:48 am, edited 1 time in total.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by willthrill81 »

smitcat wrote: Thu Sep 17, 2020 10:33 am
Greenman72 wrote: Thu Sep 17, 2020 10:12 am
WoodSpinner wrote: Wed Sep 16, 2020 9:47 pm
There have been several threads on when to use a Tax Deferrd (e.g. 401K) vs. a Roth, you can use the Search box in the upper Right hand corner.
[OT comment removed by admin LadyGeek]

Nonetheless--in the absence of tax rate arbitrage (which is virtually impossible to know in advance), there is no advantage to one account over another. The Roth does offer some benefits that a Traditional doesn't offer, but not much. Basically, you just have to pick and stick.
"Nonetheless--in the absence of tax rate arbitrage (which is virtually impossible to know in advance), there is no advantage to one account over another."
In many cases it is fairly easy to know that a traditional account will have advantages if you are a higher earner - due to matching, due to taxes, do to future plans.
Agreed. And in some situations, even significant changes to the tax code wouldn't change the choice between tax-deferred vs. Roth. For instance, we're currently in the 22% bracket but expect to be in the 12% bracket during retirement. Even if the 12% bracket is changed to 18%, a 50% increase, we'd still be better off with tax-deferred contributions.

Also, tax-deferred accounts can have some significant advantages over Roth, especially in the case of significant healthcare expenses in retirement. Healthcare expenses exceeding 10% of your AGI are tax-deductible, meaning that expenses beyond that point can be paid for tax-free from tax-deferred accounts.

There is significant asymmetric risk in the decision as to which type of contribution to make. The short explanation is that if you wind up under-saving, you'll be better off with tax-deferred contributions, whereas if you over-save, you'll have enough money no matter which type of contribution you made.

Further, you can do Roth conversions of tax-deferred balances whenever you wish, but you cannot convert Roth balances into tax-deferred (i.e. one-way trip). Ergo, there is greater optionality with tax-deferred accounts.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Kintora »

Well, leave it to the excellent minds on this forum to guide me in a hopefully better direction yet again. After reading all the replies so far, I think it would be best for me to switch back to traditional before-tax contributions to my 401k instead of Roth 401k (while still maxing my Roth IRA each year). I only did Roth 401k for about 6 months and have about 8 years ahead of me until retirement, so certainly not too late to change course!
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by FiveK »

teen persuasion wrote: Thu Sep 17, 2020 6:58 am So it seems that for tax purposes, the size of combined account totals doesn't matter, only the size of the traditional totals, since the Roth portion won't incur tax.

Am I thinking about this correctly? Does it shift the thought process any?
Seems correct to me. The percent per year withdrawal amount may indeed vary from person to person, and from year to year, depending on the rest of the finances.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Jefferson »

There are other factors besides math and tax rates. I am in the highest federal tax bracket and I max out my 401k as Roth.

My income is likely much higher now than it will be in retirement. Put simply, paying the tax now hurts less than it will in the future. Plus, my taxable account is many times larger than my tax-advantaged account. I’m willing to take the tax hit now to lessen it in the future.
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FiveK
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by FiveK »

Jefferson wrote: Thu Sep 17, 2020 5:19 pm There are other factors besides math and tax rates. I am in the highest federal tax bracket and I max out my 401k as Roth.

My income is likely much higher now than it will be in retirement. Put simply, paying the tax now hurts less than it will in the future. Plus, my taxable account is many times larger than my tax-advantaged account. I’m willing to take the tax hit now to lessen it in the future.
If you understand your strategy will likely provide less spendable after-tax income in retirement, but are willing to pay that price for happiness, have at it.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by stuper1 »

Jefferson wrote: Thu Sep 17, 2020 5:19 pm There are other factors besides math and tax rates. I am in the highest federal tax bracket and I max out my 401k as Roth.

My income is likely much higher now than it will be in retirement. Put simply, paying the tax now hurts less than it will in the future. Plus, my taxable account is many times larger than my tax-advantaged account. I’m willing to take the tax hit now to lessen it in the future.
Say what? You're in the highest federal tax bracket (37%), your income is much higher now than it will be in retirement, and you are maxing out a Roth 401k?

Why pay 37% now, when you will have a lower income and lower tax bracket later? Maybe you'd only pay 22% later. You'd have 15% more money.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by smitcat »

Jefferson wrote: Thu Sep 17, 2020 5:19 pm There are other factors besides math and tax rates. I am in the highest federal tax bracket and I max out my 401k as Roth.

My income is likely much higher now than it will be in retirement. Put simply, paying the tax now hurts less than it will in the future. Plus, my taxable account is many times larger than my tax-advantaged account. I’m willing to take the tax hit now to lessen it in the future.
I do not understand - why would anyone purposely do something like this?
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Greenman72 »

^Because the government limits how much you can invest in non-taxable or tax-deferred accounts. There is no limit on how much you can save in a taxable brokerage account.

If you want to save $1,000,000 per year and you can only put $6,000 in an IRA, then by definition, $994,000 will go into a taxable brokerage account.

(edit - I think I answered the question of "why would your taxable account be larger than your tax-deferred account, when you were really asking "why would you contribute to a Roth when you know your current tax rate is higher than it will be in retirement". Sorry about the confusion. But I wanted to leave the answer up because....well....no good reason.)
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Greenman72 »

Jefferson wrote: Thu Sep 17, 2020 5:19 pm There are other factors besides math and tax rates. I am in the highest federal tax bracket and I max out my 401k as Roth.

I’m willing to take the tax hit now to lessen it in the future.
This doesn't make financial or economic sense, but most of the decisions we make do not make financial or economic sense. However, it may make perfect "emotional" sense.

This guy is saying, "I know I can pay the tax now, so I choose to pay the tax now." Since he does not know what his situation will be when he retires, he chooses to maximize his tax free income at a later date.

It's kinda like Pascal's wager--just in a financial setting instead of a religious one.
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teen persuasion
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by teen persuasion »

Greenman72 wrote: Fri Sep 18, 2020 9:31 am ^Because the government limits how much you can invest in non-taxable or tax-deferred accounts. There is no limit on how much you can save in a taxable brokerage account.

If you want to save $1,000,000 per year and you can only put $6,000 in an IRA, then by definition, $994,000 will go into a taxable brokerage account.

(edit - I think I answered the question of "why would your taxable account be larger than your tax-deferred account, when you were really asking "why would you contribute to a Roth when you know your current tax rate is higher than it will be in retirement". Sorry about the confusion. But I wanted to leave the answer up because....well....no good reason.)
Well, your perspective does point out that there's more than one way to view the issue.

Some of us are looking at the tax side - why would you willingly pay more tax now, when you could pay less tax later?

Perhaps the poster was viewing it from an income POV: he mentioned having plenty of income now to essentially prepay the tax (and not have to pay that expense later).

Your focus on the taxable vs non-taxable/tax deferred leads to at least 2 ways to view it. If comparing non-taxable to tax deferred, non-taxable lets you effectively contribute more (because it's post tax). If comparing taxable to non-taxable, non-taxable is obviously preferable and both are post tax (so equivalent at contribution).
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Greenman72 »

teen persuasion wrote: Fri Sep 18, 2020 9:57 am Your focus on the taxable vs non-taxable/tax deferred leads to at least 2 ways to view it. If comparing non-taxable to tax deferred, non-taxable lets you effectively contribute more (because it's post tax). If comparing taxable to non-taxable, non-taxable is obviously preferable and both are post tax (so equivalent at contribution).
Yes, this is another way to look at it. All things equal, a dollar in a Roth IRA is worth more than a dollar in a Traditional IRA.

If you don't need the money now, and have the ability to pay the tax now, why not contribute to the Roth? That way you have "more" money later, when you may need the money and not have the ability to pay tax.

You won't find this in any textbook. It reminds me of the old aphorism, "In theory, there's no difference between theory and reality. In reality, there is."
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by sailaway »

Greenman72 wrote: Fri Sep 18, 2020 10:11 am
teen persuasion wrote: Fri Sep 18, 2020 9:57 am Your focus on the taxable vs non-taxable/tax deferred leads to at least 2 ways to view it. If comparing non-taxable to tax deferred, non-taxable lets you effectively contribute more (because it's post tax). If comparing taxable to non-taxable, non-taxable is obviously preferable and both are post tax (so equivalent at contribution).
Yes, this is another way to look at it. All things equal, a dollar in a Roth IRA is worth more than a dollar in a Traditional IRA.

If you don't need the money now, and have the ability to pay the tax now, why not contribute to the Roth? That way you have "more" money later, when you may need the money and not have the ability to pay tax.

You won't find this in any textbook. It reminds me of the old aphorism, "In theory, there's no difference between theory and reality. In reality, there is."
And in reality, there is a third type of account, where you can put your tax savings now and end up with more money to spend overall in the future.
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teen persuasion
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by teen persuasion »

Greenman72 wrote: Fri Sep 18, 2020 10:11 am
teen persuasion wrote: Fri Sep 18, 2020 9:57 am Your focus on the taxable vs non-taxable/tax deferred leads to at least 2 ways to view it. If comparing non-taxable to tax deferred, non-taxable lets you effectively contribute more (because it's post tax). If comparing taxable to non-taxable, non-taxable is obviously preferable and both are post tax (so equivalent at contribution).
Yes, this is another way to look at it. All things equal, a dollar in a Roth IRA is worth more than a dollar in a Traditional IRA.

If you don't need the money now, and have the ability to pay the tax now, why not contribute to the Roth? That way you have "more" money later, when you may need the money and not have the ability to pay tax.

You won't find this in any textbook. It reminds me of the old aphorism, "In theory, there's no difference between theory and reality. In reality, there is."
"All things equal"
Therein lies the rub - rarely are all things equal. I suspect the poster here IS working more on emotion than on logic. If he's currently doing Roth in the highest bracket, is his future retirement bracket really likely to be higher? Only if his income remains high (but some income like SS has reduced taxation, taxable account income is not ordinary income like wages, and all Roth income is zero tax) and tax brackets increase (speculation).

But maybe he has some special collection of conditions that aren't immediately obvious and upend the usual rules of thumb.

The rules of thumb say I should go all Roth (low tax bracket). But my marginal tax rate is high, due to tax credit phaseouts, so even with a negative tax burden we are much better doing traditional employer accounts. IRAs are Roth, though, because there's no further tax advantage to be gleaned. Bonus points for effects on FAFSA EFC, too. Roth conversions in the future should be low or no cost over time, so no future disadvantage to using traditional over Roth.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Greenman72 »

With the "all things equal", I intentionally omitted a detail:

Sure, $5000 in a Roth is more than $5000 in a Traditional. The astute person would note that $5000 in a Roth equal $7000 in a Traditional. (Technically, it's $6,849.31 at a 37% tax rate, but I digress....) So in theory, you could contribute $5k to a Roth and put the extra $2k in a taxable account. But in practice, I NEVER see anybody contribute $5k to a Roth, then contribute an additonal $2k to a taxable account so they can "equalize" or "normalize" their savings because they've done the math down to the 5th decimal point.

The average (about 50%) of people say, "How much will the IRS allow me to deduct? That's how much I want to save." THe other half say "How much does my employer match? That's how much I want to save." Their savings rates are dictated by the government or their employer--not by any common sense, rationale, or expectation of future expenses.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by FIREchief »

It is impossible to determine optimal because of the three great unknowns:

a) you don't know what the market is going to do
b) you don't know what Washington is going to do
c) you don't know how long you are going to live

That said, I'll agree with another poster that making Roth contributions while in the 12% or less bracket is somewhat of a no-brainer. Beyond that, I've got nothing.... :twisted:
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by sailaway »

Greenman72 wrote: Fri Sep 18, 2020 11:32 am With the "all things equal", I intentionally omitted a detail:

Sure, $5000 in a Roth is more than $5000 in a Traditional. The astute person would note that $5000 in a Roth equal $7000 in a Traditional. (Technically, it's $6,849.31 at a 37% tax rate, but I digress....) So in theory, you could contribute $5k to a Roth and put the extra $2k in a taxable account. But in practice, I NEVER see anybody contribute $5k to a Roth, then contribute an additonal $2k to a taxable account so they can "equalize" or "normalize" their savings because they've done the math down to the 5th decimal point.

The average (about 50%) of people say, "How much will the IRS allow me to deduct? That's how much I want to save." THe other half say "How much does my employer match? That's how much I want to save." Their savings rates are dictated by the government or their employer--not by any common sense, rationale, or expectation of future expenses.
Average, yes.

However, the whole point of asking a question like this on a personal finance forum is to put more thought into it than average.
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teen persuasion
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by teen persuasion »

Greenman72 wrote: Fri Sep 18, 2020 11:32 am With the "all things equal", I intentionally omitted a detail:

Sure, $5000 in a Roth is more than $5000 in a Traditional. The astute person would note that $5000 in a Roth equal $7000 in a Traditional. (Technically, it's $6,849.31 at a 37% tax rate, but I digress....) So in theory, you could contribute $5k to a Roth and put the extra $2k in a taxable account. But in practice, I NEVER see anybody contribute $5k to a Roth, then contribute an additonal $2k to a taxable account so they can "equalize" or "normalize" their savings because they've done the math down to the 5th decimal point.

The average (about 50%) of people say, "How much will the IRS allow me to deduct? That's how much I want to save." THe other half say "How much does my employer match? That's how much I want to save." Their savings rates are dictated by the government or their employer--not by any common sense, rationale, or expectation of future expenses.
$7,936.51

Yeah, I do the math.

I figure out how much contributing an extra $1k to an employer account nets us in refundable EITC (21% phaseout, so extra $210). Then I figure out how much THAT credit nets us on the state EITC (30% match of federal EITC, which is thus another 6.3% phaseout, or another $63). Then there's the state tax avoided by reduced AGI (somewhere in the 4-5.x% range). I've actually stopped considering the avoidance of federal tax (10-12% brackets), because we rapidly get to the point of burning nonrefundable tax credits (which erase any federal tax owed). I've also set our withholding allowances as high as possible (per our state) to usually result in zero federal tax withheld, because it's unnecessary.

Anyhow, all tax refunds are used to fund our Roth IRAs. As it's all refundable credits (also CTC, state CTC, and AOTC), it's free money we wouldn't have received if I didn't contribute to traditional employer plans. I do top the Roth IRAs off from income now, but in past years our refunds were large enough to fully fund 2 Roth IRAs.

So now you've met someone who does the math, AND puts the tax savings in Roth IRAs.

ETA: I just reread your post, more closely, and realized you've got it backwards. You get the tax break from contributions to traditional accounts, not Roth. You'd want to save the tax break extra money. Roth costs MORE upfront.
RAchip
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by RAchip »

Since you cannot know what tax rates will be when you retire, how can anyone know if Roth or 401k would be better?
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by LadyGeek »

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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by changingtimes »

I see some posts in this thread talking about what "our" income will be in retirement.

You might want to run some numbers to see what RMDs and taxes look like if only one of you survives and is paying taxes on withdrawals from tax-deferred monies that were enough to support two people in retirement.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Lars_2013 »

willthrill81 wrote: Thu Sep 17, 2020 10:47 am There is significant asymmetric risk in the decision as to which type of contribution to make. The short explanation is that if you wind up under-saving, you'll be better off with tax-deferred contributions, whereas if you over-save, you'll have enough money no matter which type of contribution you made.
This asymmetry is why I do traditional (pre-tax) in my employment-based retirement account. If I stay healthy, stay employed, and keep up with inflation in my market returns, I'll have more than enough money for retirement, and my pre-tax money will mostly go to charity (and never be taxed) while I primarily live on my taxable account, roth IRA, and (eventually) social security income. If things don't go well, then I'm likely to end up in a low tax bracket. (Doing pre-tax in the employment-based retirement accounts also keeps me in the 12% ordinary income federal tax bracket and keeps my LTCGs and dividends in the 0% federal bracket, which is nice.)
Greenman72 wrote: Fri Sep 18, 2020 11:32 am The average (about 50%) of people say, "How much will the IRS allow me to deduct? That's how much I want to save." THe other half say "How much does my employer match? That's how much I want to save." Their savings rates are dictated by the government or their employer--not by any common sense, rationale, or expectation of future expenses.
I don't think this is true. I think only about 70% or 80% of employees who have access to a plan participate at all (https://www.researchgate.net/profile/Ho ... Update.pdf and https://www.researchgate.net/profile/Ch ... curity.pdf). The median contribution rate among participants is perhaps 5%, which is perhaps the median amount to get the full match, but even among high-income participants it's unusual to max out contributions.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by smitcat »

RAchip wrote: Fri Sep 18, 2020 2:05 pm Since you cannot know what tax rates will be when you retire, how can anyone know if Roth or 401k would be better?
You have your tax rates now, you have your plans for the future, and you have historical data for past taxes.
In our case that was more than sufficient to make a very good call.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by smitcat »

teen persuasion wrote: Fri Sep 18, 2020 1:17 pm
Greenman72 wrote: Fri Sep 18, 2020 11:32 am With the "all things equal", I intentionally omitted a detail:

Sure, $5000 in a Roth is more than $5000 in a Traditional. The astute person would note that $5000 in a Roth equal $7000 in a Traditional. (Technically, it's $6,849.31 at a 37% tax rate, but I digress....) So in theory, you could contribute $5k to a Roth and put the extra $2k in a taxable account. But in practice, I NEVER see anybody contribute $5k to a Roth, then contribute an additonal $2k to a taxable account so they can "equalize" or "normalize" their savings because they've done the math down to the 5th decimal point.

The average (about 50%) of people say, "How much will the IRS allow me to deduct? That's how much I want to save." THe other half say "How much does my employer match? That's how much I want to save." Their savings rates are dictated by the government or their employer--not by any common sense, rationale, or expectation of future expenses.
$7,936.51

Yeah, I do the math.

I figure out how much contributing an extra $1k to an employer account nets us in refundable EITC (21% phaseout, so extra $210). Then I figure out how much THAT credit nets us on the state EITC (30% match of federal EITC, which is thus another 6.3% phaseout, or another $63). Then there's the state tax avoided by reduced AGI (somewhere in the 4-5.x% range). I've actually stopped considering the avoidance of federal tax (10-12% brackets), because we rapidly get to the point of burning nonrefundable tax credits (which erase any federal tax owed). I've also set our withholding allowances as high as possible (per our state) to usually result in zero federal tax withheld, because it's unnecessary.

Anyhow, all tax refunds are used to fund our Roth IRAs. As it's all refundable credits (also CTC, state CTC, and AOTC), it's free money we wouldn't have received if I didn't contribute to traditional employer plans. I do top the Roth IRAs off from income now, but in past years our refunds were large enough to fully fund 2 Roth IRAs.

So now you've met someone who does the math, AND puts the tax savings in Roth IRAs.

ETA: I just reread your post, more closely, and realized you've got it backwards. You get the tax break from contributions to traditional accounts, not Roth. You'd want to save the tax break extra money. Roth costs MORE upfront.
"ETA: I just reread your post, more closely, and realized you've got it backwards. You get the tax break from contributions to traditional accounts, not Roth. You'd want to save the tax break extra money. Roth costs MORE upfront."

Exactly - and we are another one that does the math as well.
withrye
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by withrye »

As you have seen, there is vigorous debate regarding pre-tax vs Roth savings.

If you are in the camp that favors an approach of saving enough in pre-tax such that your anticipated withdrawals remain under your current marginal bracket (as I do), I came across Google speadsheet developed by a user on Reddit: https://www.reddit.com/r/financialindep ... roth_some/

You can current account balances and anticipated future account flows to determine a *rough* estimate of your future marginal bracket. This can help you anticipate when you'll have "filled up" your pre-tax accounts such that a switch to full Roth may be necessary.

Keep in mind that if you plan on retiring quite close to your SS benefit and/or RMD age, you may have limited time in which to spend/convert your pre-tax dollars. As a result, I would not necessarily go full bore on pre-tax until your anticipated marginal rate in retirement exceeds your marginal rate now if you won't have a lot of time to do staged withdrawals.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by tibbitts »

smitcat wrote: Fri Sep 18, 2020 3:06 pm
RAchip wrote: Fri Sep 18, 2020 2:05 pm Since you cannot know what tax rates will be when you retire, how can anyone know if Roth or 401k would be better?
You have your tax rates now, you have your plans for the future, and you have historical data for past taxes.
In our case that was more than sufficient to make a very good call.
I had the same data and did not make what has turned out to be a very good call so far. There is a large amount of unpredictability involved. I'd have to have tax rates roughly cut in half for my excessive deferrals to work out.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by Greenman72 »

teen persuasion wrote: Fri Sep 18, 2020 1:17 pm
Greenman72 wrote: Fri Sep 18, 2020 11:32 am (Technically, it's $6,849.31 at a 37% tax rate, but I digress....)
$7,936.51

Yeah, I do the math.
As it turns out, 5000 / .73 is not correct. Shoulda been 5000/.63. My bad.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by smitcat »

tibbitts wrote: Fri Sep 18, 2020 3:18 pm
smitcat wrote: Fri Sep 18, 2020 3:06 pm
RAchip wrote: Fri Sep 18, 2020 2:05 pm Since you cannot know what tax rates will be when you retire, how can anyone know if Roth or 401k would be better?
You have your tax rates now, you have your plans for the future, and you have historical data for past taxes.
In our case that was more than sufficient to make a very good call.
I had the same data and did not make what has turned out to be a very good call so far. There is a large amount of unpredictability involved. I'd have to have tax rates roughly cut in half for my excessive deferrals to work out.
I cannot imagine what your situation is and maybe it was not avoidable but for us it was certainly not perfect but worked out very well.
We have time to do some Roth conversions , we will switch states to a no state tax, we will be well ahead.
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Re: what percent of retirement should be invested in tax deferred vs tax free accounts?

Post by UpsetRaptor »

zetsui wrote: Wed Sep 16, 2020 9:04 pm Can I think of tax defered and tax free accounts (ie Roth) as the same around my retirement age? Should my retirement accoutns be maxed out regardless every year 1) or should i tend to invest that money more towards tax defered (ie roth 401k instead of 401k) as I get older and closer to retirmeent?
OP,

Your various questions are a little tough to parse, but
1) If you're asking if you should max out all tax advantaged retirement accounts, then yes, if it's feasible for you and you have the choice, any tax advantaged account is almost always better than investing in taxable.
2) Whether Tax Deferred (401k) or Tax Free (Roth) will be better in the end will depend on your present vs future tax rates, which involves making an educated guess.
3) Generally, more people tend to have lower tax rates after they retire which would favor Tax Deferred over Roth, but this isn't universal. One could have a large pension plus Social Security plus high amounts of Tax Deferred savings when RMDs hit at age 72 leaving a tax time bomb, or overall tax rates could be raised.
4) Because of the unknowns, it's often advised to have some mix of both Tax Deferred and Tax Free heading into retirement.

There's a lot you didn't tell us which would help. What's your current tax bracket? Also, are you expecting your income to go down when you retire, and will this be before you take Social Security? If so, it may make sense focus on pretax for now, with targeting Roth conversions during low-income retirement years. Or maybe not. We would need more info.
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