Would you roth or traditional in this case?

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BSA44
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Would you roth or traditional in this case?

Post by BSA44 » Sat Sep 29, 2018 9:25 am

Although the normal advice is that a traditional 401k is always better than a Roth, my wife and I have been quite financially lucky and are in a situation where it is less clear if we should make a 403b contribution as roth or traditional. I would appreciate any advice that you might have.

Ages: 30

Assets Total: $1,200,000
Taxable Brokerage Account: $800,000
Traditional 401k/403bs: $250,000
Roth IRAs/401k/403bs: $150,000

Salary His: $205,000
Salary Hers: $0 currently; she just quit her job and is in the process of attempting to start a new career as a fiction author. Given how much authors tend to make, we don't expect her to make much money (likely $10k-$30k a year), although she may end up making more. The savings numbers below assume she makes $0.

Annual Savings Total: $100,794
Backdoor Roths: $11,000
Traditional (pretax) 457b: $18,500
Mandatory pretax 403b retirement contribution: $13,679
Employer 403b match: $17,484
403b (This is the one we are deciding if should be Roth or pre-tax): $18,500
Taxable Brokerage Savings: $21,631

Annual Expenses: ~$77,000
Expense Notes: This doesn't include healthcare as it's mostly covered by the employer. Also, in about 5-10 years, $5000 of those expenses will no longer be needed.
Expense Growth: We are extremely happy with our lifestyle, and neither of us feels much of a need to spend money on material things. We generally only spend extra money on dates and travel, and that expense number already includes a $16,000 travel budget and a $5,000 date budget. We definitely won't be having kids (both medical reasons and strong preferences). When we retire there is a good chance we will move somewhere lower cost of living (we definitely won't be going somewhere more expensive as we dislike big cities). As a result, we don't expect much expense growth. Although, if we continue on our savings trajectory we will end up with massive savings, so we would likely attempt to come up with some ways to spend our money; however, they would likely be experience-related (e.g., rather than buying a massive house), so they wouldn't be forced ongoing costs (e.g., like home maintenance for a huge house).

Salary Protections: We have ~$3 million of life insurance on me, disability insurance that covers 2/3rds of my salary, and a $2 million umbrella policy. I have extremely strong job protections and even if my entire industry were to go down the toilet, my experience is very transferable. Additionally, my wife, who enjoys working hard and has 2 top-tier university degrees, could easily go back to her previous industry and make a minimum of $65,000/year (the main reason she is comfortable trying out being an author full-time is we have so much room to spare with our salary vs expenses).

Projecting future taxes (relevant to the roth vs traditional decisions):
-Our current marginal tax bracket is 24%.
-We currently live in a no income tax state, but may want to retire to a state with income tax.
-There is no guarantee, but there is a very high likelihood that in 10-20 years we will be inheriting about $2-$3 million in today's dollar in a $401k (i.e., we would have to start taking out distributions immediately). This number could also end up being much higher, but the $2-$3 million is conservative.
-We both generally enjoy working and don't like being idle, so although we don't plan on working full-time to 65, it's unlikely we'll retire super-early.
-Given the above, between dividends in a large taxable account, our traditional 457b/401k/403bs, and possible inheritance, it seems like we may have more income at retirement that now (hence a Roth might be useful).
-It seems like a Roth may also be beneficial from a "tax diversification" perspective. Even though we have no idea what taxes will be in the future, having our retirement funds split across traditional and roth would reduce future risk of massive tax rates.

Final Thoughts: Obviously, we have "won the game" by both a combination of a great deal of luck and some hard work, so in the end, this decision won't likely impact our lifestyle much. However, at $18,500 a year, with many years of contributions ahead of us, the tax implications of whether to put it away as Roth or Traditional are quite substantial. We'd prefer to do the "smart" option on taxes, so we end up with more money to spend and if we end up saving more than we need, bestowing the extra tax savings where we see fit at end of life. Any advice would be greatly appreciated!

LeeMKE
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Re: Would you roth or traditional in this case?

Post by LeeMKE » Sat Sep 29, 2018 11:35 am

Put it in a ROTH.

Taxes will probably go up in future years for you, so the more you have in ROTH, the better.
As you already figured out, inherited 401Ks and IRAs are forced out to expose the accounts to taxation. ROTH will not add to the complexity of dealing with RMDs and having your Social Security increase your taxes.

I'll add one more suggestion. Consider converting tIRA amounts to ROTH. Same reasons as above.

Start with the free tool (extended calculator) at www.I-ORP.com. Your situation has some complexities, so the tool may be just a starting point. I'm expecting that the tool will either tell you to begin conversions immediately (as it did me) or tell you conversions won't help the tax bill coming up. The golden moment is in your 50s, as once RMDs begin the window for conversions closes.
The mightiest Oak is just a nut who stayed the course.

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Re: Would you roth or traditional in this case?

Post by grabiner » Sun Sep 30, 2018 9:03 am

BSA44 wrote:
Sat Sep 29, 2018 9:25 am
Taxable Brokerage Account: $800,000

-Our current marginal tax bracket is 24%.
-We currently live in a no income tax state, but may want to retire to a state with income tax.

-There is no guarantee, but there is a very high likelihood that in 10-20 years we will be inheriting about $2-$3 million in today's dollar in a $401k (i.e., we would have to start taking out distributions immediately). This number could also end up being much higher, but the $2-$3 million is conservative.
These are three indications for Roth.

If you max out a traditional 403(b), you will have to invest the tax savings in a taxable account; therefore, maxing out the Roth is better even if you retire in the same tax bracket.

You may retire in a state with higher tax rates.

You may inherit a huge 401(k) with large RMDs, which will keep you in a high tax bracket in retirement, and will mean that your RMDs are more than you need to spend in retirement. (And once you have taken the RMDs, the money will be in a taxable account, generating taxable dividends that you also don't need to spend.) Having Roth money is valuable because you don't need to take RMDs and can keep the money growing tax-deferred for your heirs.

And I agree with LeeMKE; you might consider converting your traditional IRAs to Roth, up to the top of the 24% tax bracket.
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BSA44
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Re: Would you roth or traditional in this case?

Post by BSA44 » Sun Sep 30, 2018 10:15 am

grabiner wrote:
Sun Sep 30, 2018 9:03 am
And I agree with LeeMKE; you might consider converting your traditional IRAs to Roth, up to the top of the 24% tax bracket.
Thank you both for your comments! It seems like doing a Roth for that 403b is the right call.

That is an interesting suggestion about converting some of our other pre-tax money to Roth up to the top of the 24% tax bracket. I'll have to ponder that one over a bit. Even though I imagine that we would end up better in almost every scenario if we did that, the one scenario where we would end up worse is if BOTH it turns out the inheritance never comes through AND we end up retiring super-early for some reason (as even without the inheritance, our RMDs and dividends will be quite substantial if we work into our late 50's). Not converting would be a hedge against that unlikely, but absolute worst case scenario where it turns out our taxes will go down. I'll have to mull that over a little more as to whether almost guaranteed paying more taxes is worth making our situations in an unlikely "worst-case" scenario a bit better (in which case we'd still likely be fine given our assets as is, anyway).

euroswiss
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Re: Would you roth or traditional in this case?

Post by euroswiss » Sun Sep 30, 2018 10:16 am

BSA44 wrote:
Sat Sep 29, 2018 9:25 am
Although the normal advice is that a traditional 401k is always better than a Roth, my wife and I have been quite financially lucky and are in a situation where it is less clear if we should make a 403b contribution as roth or traditional. I would appreciate any advice that you might have.
I would not consider that “normal advice” - it’s very much situation dependent and in MY opinion, Roth is actually the way to go more often than not.
Yours is one of those cases.

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Re: Would you roth or traditional in this case?

Post by bsteiner » Sun Sep 30, 2018 11:23 am

If you won't be having children, will you be leaving your estates to friends and family, or to charity?

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BSA44
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Re: Would you roth or traditional in this case?

Post by BSA44 » Sun Sep 30, 2018 12:25 pm

bsteiner wrote:
Sun Sep 30, 2018 11:23 am
If you won't be having children, will you be leaving your estates to friends and family, or to charity?
We're not sure yet. We figure our preferences on that will change over the next bunch of years. At this point we figure minimizing taxes for ourselves (should we want to spend most of it at some point) is the most sensible goal.

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Re: Would you roth or traditional in this case?

Post by bsteiner » Sun Sep 30, 2018 1:12 pm

BSA44 wrote:
Sun Sep 30, 2018 12:25 pm
bsteiner wrote:
Sun Sep 30, 2018 11:23 am
If you won't be having children, will you be leaving your estates to friends and family, or to charity?
We're not sure yet. We figure our preferences on that will change over the next bunch of years. At this point we figure minimizing taxes for ourselves (should we want to spend most of it at some point) is the most sensible goal.
The Roth would minimize taxes if you plan to leave the Roth to your future children, or if none then to friends and other family members. But if you don't have children and you plan to leave your retirement benefits to charity, the traditional would minimize taxes.

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Re: Would you roth or traditional in this case?

Post by applejack123 » Sun Sep 30, 2018 2:08 pm

Question. I don’t understand your annual savings total. How do you do two backdoor Roth’s for 11k? Your wife don’t work. And if you do this, how can you still contribute another 18,500 to a 403b or roth(you highlighted this spot) for 18,500? Then you added it all up to get 100,794? And one last thing, how does your employer match more than you put in? That must be nice.

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BSA44
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Re: Would you roth or traditional in this case?

Post by BSA44 » Sun Sep 30, 2018 2:16 pm

applejack123 wrote:
Sun Sep 30, 2018 2:08 pm
Question. I don’t understand your annual savings total. How do you do two backdoor Roth’s for 11k? Your wife don’t work. And if you do this, how can you still contribute another 18,500 to a 403b or roth(you highlighted this spot) for 18,500? Then you added it all up to get 100,794? And one last thing, how does your employer match more than you put in? That must be nice.
1) From my understanding, for any annual IRA/Roth/backdoor Roth contribution ($5500 per person) one spouse can contribute on behalf of the other spouse as long as one of the spouses has enough income to cover both (even if the other spouse isn't working).

2) From my understanding, the $5,500 IRA/Backdoor Roth contribution per person doesn't count against your $18,500 403b/401k limit (in this case given the responses we'd likely make that a Roth 403b).

3) When I joined my US state employer I had a choice of either a pension or a retirement plan where I make a little over 6% contribution and my employer makes a little over a 8% contribution. The pension payout wasn't great in the first place and I doubt I'd stay with the employer long enough to realize it, so I chose the retirement plan.

4) To get to the >$100k savings, I listed some other savings sources in my original post (e.g., 457b, taxable brokerage) on top of everything you noted.

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Re: Would you roth or traditional in this case?

Post by FiveK » Sun Sep 30, 2018 2:18 pm

applejack123 wrote:
Sun Sep 30, 2018 2:08 pm
How do you do two backdoor Roth’s for 11k? Your wife don’t work. And if you do this, how can you still contribute another 18,500 to a 403b or roth(you highlighted this spot) for 18,500?
Because that's the way the law is written. E.g., look up "spousal IRA." IRA and 4xyz contribution limits are independent of each other.

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Re: Would you roth or traditional in this case?

Post by grabiner » Sun Sep 30, 2018 3:38 pm

BSA44 wrote:
Sun Sep 30, 2018 10:15 am
That is an interesting suggestion about converting some of our other pre-tax money to Roth up to the top of the 24% tax bracket. I'll have to ponder that one over a bit. Even though I imagine that we would end up better in almost every scenario if we did that, the one scenario where we would end up worse is if BOTH it turns out the inheritance never comes through AND we end up retiring super-early for some reason (as even without the inheritance, our RMDs and dividends will be quite substantial if we work into our late 50's).
It is an equivalent decision to the decision whether to invest in the traditional or Roth 403(b). If you contribute $1000 to a Roth 403(b) rather than a traditional 403(b), you pay $240 in tax, and jabe $1000 in the Roth rather than the traditional account. If you convert $1000, you also pay $240 in tax, and have $1000 in a Roth rather than a traditional account. (Before 2018, they were not quite equivalent, because you could undo a conversion through October 15 of the next year, but that recharacterization option was removed in the new tax law.)

But this doesn't mean that the decision must be all-or-none. While you pay the same amount of extra tax for every $1000 you move to a Roth, the more you move, the lower your taxable income will be in retirement, which might result in avoiding future taxation on income that would be taxed at a lower rate.

You can try to estimate your marginal tax rate under the no-inhertance scenario. 85% of your Social Security will be taxable, but you can wait until age 70 to take that, which will give you years to convert traditional to Roth accounts before 70 to reduce RMDs on your own accounts.
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BSA44
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Re: Would you roth or traditional in this case?

Post by BSA44 » Sun Sep 30, 2018 4:15 pm

grabiner wrote:
Sun Sep 30, 2018 3:38 pm

It is an equivalent decision to the decision whether to invest in the traditional or Roth 403(b). If you contribute $1000 to a Roth 403(b) rather than a traditional 403(b), you pay $240 in tax, and jabe $1000 in the Roth rather than the traditional account. If you convert $1000, you also pay $240 in tax, and have $1000 in a Roth rather than a traditional account. (Before 2018, they were not quite equivalent, because you could undo a conversion through October 15 of the next year, but that recharacterization option was removed in the new tax law.)

But this doesn't mean that the decision must be all-or-none. While you pay the same amount of extra tax for every $1000 you move to a Roth, the more you move, the lower your taxable income will be in retirement, which might result in avoiding future taxation on income that would be taxed at a lower rate.

You can try to estimate your marginal tax rate under the no-inhertance scenario. 85% of your Social Security will be taxable, but you can wait until age 70 to take that, which will give you years to convert traditional to Roth accounts before 70 to reduce RMDs on your own accounts.
That's a good point about it being equivalent; I guess I just had a mental block about conversion and contributions being different.

Yeah, I think in most any case, our tax rate will be high in retirement inheritance or not. Even in the no inheritance situation, if we decided to stop saving any money today and more than double our annual expenses from $77k to >$150k, at 6% real return (I know many others use more conservative numbers), our current assets alone would compound to $6.5 million by age 60. We feel no need to double our expenses and plan to save as we are, so if we continue our current savings trajectory, which seems plausible (especially as there is room for growth in my income and my wife's current $0 income will almost guaranteed go up at least somewhat), we'd end up with almost $14 mill in today's dollars spread across our accounts at 60. That said, I'm guessing once we hit $4 million (in about 10-16 years depending on the market), which is what we consider our extremely safe retirement number (even though we definitely don't plan on retiring then as we enjoy working), we'll likely start making an effort of upping our spending (there is no point in being buried with our money). Anyway, it would seem that due to the magic of compounding and the luck of being able to save a lot early, in almost no scenario does it seem like converting to the Roth is a worse decision.

I guess the only thing that is giving me pause on the conversion is that even though we have very good protections in place (life/disability/umbrella insurance and very stable career/credentials/experience that is relatively low stress, with lots of time off, and I enjoy), if for some reason everything were to fall apart in the next 10 years and neither of us wanted to (or were unable to due to non-disability reasons) work, it would have made more sense to stick the to pre-tax/traditional rather than Roth. I guess that's just the somewhat irrational risk averse/conservative side of my brain thinking, though.

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Re: Would you roth or traditional in this case?

Post by FiveK » Sun Sep 30, 2018 6:54 pm

BSA44 wrote:
Sun Sep 30, 2018 4:15 pm
I guess that's just the somewhat irrational risk averse/conservative side of my brain thinking, though.
Doesn't seem at all irrational to hedge against an early (forced or unforced) retirement, when if said early retirement doesn't occur you will still have more money than you will know what to do with. ;)

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Re: Would you roth or traditional in this case?

Post by T-Wrench » Mon Oct 01, 2018 1:00 pm

BSA44 wrote:
Sat Sep 29, 2018 9:25 am

Salary His: $205,000
Salary Hers: $0 currently; she just quit her job and is in the process of attempting to start a new career as a fiction author. Given how much authors tend to make, we don't expect her to make much money (likely $10k-$30k a year), although she may end up making more. The savings numbers below assume she makes $0.

Mandatory pretax 403b retirement contribution: $13,679
Employer 403b match: $17,484
403b (This is the one we are deciding if should be Roth or pre-tax): $18,500
Taxable Brokerage Savings: $21,631
My understanding is that the 403b is an individual account (i.e., it's your account, not your wife's, and so you can't contribute $18,500 in addition to your mandatory amount) and therefore you are dealing with the $18,500 limit for this year. That tells me that we're quibbling about:

$18,500 - $13,679 mandatory contribution = $4821 that you can make a decision on per year.

At 24%, you would save $1157.04 in tax this year (deferred until later) or pay that tax to have just under $5000 in a Roth.

I would put it in the Roth for tax diversification since that is open to you at your salary and because it makes things a little less complicated when you receive that inheritance (when, if I'm guessing correctly, you'll already be grieving and need to start making different tax-related decisions).

Just my .02.

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BSA44
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Re: Would you roth or traditional in this case?

Post by BSA44 » Mon Oct 01, 2018 1:34 pm

T-Wrench wrote:
Mon Oct 01, 2018 1:00 pm
My understanding is that the 403b is an individual account (i.e., it's your account, not your wife's, and so you can't contribute $18,500 in addition to your mandatory amount) and therefore you are dealing with the $18,500 limit for this year. That tells me that we're quibbling about:

$18,500 - $13,679 mandatory contribution = $4821 that you can make a decision on per year.
I believe that is incorrect. The $18500 is only a limit for elective deferrals not mandatory ones.

For reference, see:

viewtopic.php?t=234355
viewtopic.php?t=156731

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Re: Would you roth or traditional in this case?

Post by T-Wrench » Thu Oct 04, 2018 5:59 pm

Huh. Learn something new everyday. Thanks.

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