Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

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fyre4ce
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Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by fyre4ce » Fri May 17, 2019 6:49 pm

BH community,

Some of the other wiki editors and I have been working on major revisions to the Marginal Tax Rate and Traditional vs. Roth articles. We would like to present those to the community and are requesting comment and constructive criticism. The revised articles are here:

Fyre4ce/Marginal tax rate
Fyre4ce/Traditional versus Roth

Goals for making these revisions were:
* Better flow and readability. Existing articles seem a bit patchwork in some places
* Expand the content to cover certain topics that were not previously covered (like straddling brackets)
* Update content to 2019 tax law

To meet these goals, the changes made can be summarized as follows:
* Removed redundant content in a few places
* Updated to 2019 tax law
* Improved flow, by including a brief but comprehensive summary at the top, followed by an explanation of basic concepts, then more advanced concepts further down. The intent was to make it readable from top to bottom to the average BH
* Improved organization, with sub-topics included under their appropriate headers
* Addition of many fully worked and explained examples for different situations. These take up extra space, particularly in the T vs R article, but in my opinion they should be helpful enough to readers to justify their size.
* Addition of content, such as: method for estimating future investment balances and marginal tax rates, method for analyzing straddling brackets, formulas for calculating Social Security taxation "bumps" and how to avoid them, simpler way to compare T vs R when maxing out, two explicit methods for dealing with irregular marginal rate curves, and brief sections on RMD's, tax diversification, Section 199A, marginal take-home pay, very high earners, and estate planning. (I may have missed a couple in this list.)

Overall the articles are longer and more comprehensive than the existing ones. Worked examples definitely contribute to this, but there's also more explanation in general. Rather than referring readers to spreadsheets, the articles try to step readers through the relevant calculations in-line in the text and in tables, and in some cases Excel functions (eg. "=FV") are written out explicitly. Reviewers should let us know whether they think this structure is more effective than what's in the live wiki now, and whether the longer length is justified in terms of helping readers better understand important concepts, or whether it bogs readers down too much.

One area of disagreement that the editing team was not able to resolve is what the stated definition of a "marginal tax rate" should be. My opinion is that the definition should be the tax rate for "small" changes of taxable income - large enough to smooth out any rounding errors to the nearest dollar, or tax table quantization, but small enough to not span multiple tax brackets or phase-out ranges. Other editors correctly point out that when dealing with irregularly shaped marginal rate curves (see irregular marginal rates) that the small-dollar marginal rate doesn't matter - what matters is the "average" marginal rate for a certain size contribution, taking into account any peaks, valleys, and spikes in the curve. Partly to make this point clear, I put in an example worked in detail for a tax situation like that, however I still think that we should stick to the widely-accepted "small" definition. Pretty much every internet source I can find uses the "small" definition, as does my economics textbook from college. In my opinion, as wiki editors our job is to explain concepts as clearly as possible using the terminology in general use. For example, even if we had a REALLY good reason to expand the definition of "capital gains" to include, say, interest (made concepts easier to explain, better dealt with unusual tax cases, etc) I think on balance it would be a bad idea because readers could get confused when comparing the information here to other sources. I think the concept can be adequately explained by using another term, such as an "average marginal" or "incremental" tax rate. Other editors think the value for explaining these cases outweighs the downsides of using a slightly different definition than the most common. If reviewers have an opinion on which definition helps readers most, you can post it here.

Thanks to all the editors who put time into improving these revisions, and thanks to all of you who review and provide feedback. Discuss!

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by rkhusky » Fri May 17, 2019 7:37 pm

Put me down for voting for "marginal" to refer to small additions (<$1000, but preferably <$100) to income and "average" to refer to large additions (>$1000 or when crossing discrete tax boundaries).

Note that Wikipedia articles are not meant to be original research, but are instead supposed to have substantial references to published literature. Not sure if the Bogleheads wiki is supposed to follow that rule or not.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by LadyGeek » Fri May 17, 2019 8:11 pm

rkhusky wrote:
Fri May 17, 2019 7:37 pm
Note that Wikipedia articles are not meant to be original research, but are instead supposed to have substantial references to published literature. Not sure if the Bogleheads wiki is supposed to follow that rule or not.
Yes, we follow Wikipedia policy for No original research. I don't think that rearranging equations would be considered original research - see the section "Routine calculations". If anyone disagrees, let's discuss.

Here's the comparison for marginal rate:
- User:Fyre4ce/Marginal tax rate (draft page)
- Marginal tax rate ("live" page)

Changes: Difference between pages "Marginal tax rate" and "User:Fyre4ce/Marginal tax rate"

Could the calculation example from the "live" page using footnote 3 (spreadsheet) be inserted into the draft page? I understand your intent is to not use spreadsheets, but they add considerable value for readers who are not strong on math. A working spreadsheet drives the point home for investors who may not understand the concept and allows them to experiment on their own.

Here's the comparison for Traditional vs. Roth:
- User:Fyre4ce/Traditional versus Roth (draft page)
- Traditional versus Roth ("live" page)

Changes: Difference between pages "Traditional versus Roth" and "User:Fyre4ce/Traditional versus Roth"

Wiki editors: You can compare any page (any version) to any other page (and version) from Special pages --> Page tools --> Compare pages
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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by JimInIllinois » Fri May 17, 2019 9:16 pm

How about this:
A taxpayer's marginal tax rate is the amount by which tax liability increases due to a small increase in income, expressed as the percentage of the income increase by which the tax liability increases. For example, if earning an additional $20 per year would increase your tax liability by $5 then your marginal tax rate is 25%. The marginal rate will depend on both the total amount and type of income received, with high-income taxpayers generally paying higher marginal rates, and long-term capital gains and qualified dividends taxed at lower marginal rates than earned income. The loss of credits or deductions with increasing income may result in effective marginal rates that are higher than the payer's "tax bracket". When calculating marginal tax rates it is customary to ignore the small jumps in tax liability due to tax tables and rounding and to consider only the underlying rate. The concept of marginal rate is important in calculating the advantage or disadvantage of deferring taxation, as when choosing between a traditional or Roth IRA, preferring to contribute to a Roth IRA at a low marginal rate of 12% but to a traditional IRA at a higher marginal rate of 22%.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by fyre4ce » Sat May 18, 2019 12:54 am

About the spreadsheet note- I'm not anti-spreadsheet; in fact, I like spreadsheets a lot and use them almost every day for either my day job or financial stuff. I took it out because I thought it was redundant and took up too much space. I thought the simpler explanation with text, saying something like "If you have capital gains above and below the 15% threshold, each dollar of earned income gets taxed at 12% and also pushes $1 of capital gains into the 15% bracket, for a total marginal rate of 27%" a clearer and more concise explanation. At least for me and the way I learn, that explanation would help me understand much better than the spreadsheet, and once I have the concept in my head I can easily build a simple spreadsheet to play around with it if I want to. There's also the plot up higher that shows that very effect. I can add it back in but before I do I think I'd prefer to see some more feedback on whether readers find the structure easy to understand. (It also needs to be updated to 2019 taxes.) Reasonable?

I like Jim's definition.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by Glomar » Sat May 18, 2019 6:24 am

I do like the additional guidance to help spreadsheet-savvy folks make their own spreadsheets, but would like to see links to ready-made spreadsheets remain.

In the past, I have at least one of the spreadsheets linked from the current version of this page. I don't think that even with the additional guidance, that I would make my own spreadsheet to run calculations (it is maybe just too much of a hurdle to me).

If possible to include both, that would be my preference.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by Glomar » Sat May 18, 2019 6:35 am

Another comment - I might be misunderstanding this section, but it struck me as odd to say "prefer Roth savings...if one is in retirement". In my understanding if one is retired, it is not possible to contribute to either traditional or Roth since there is no earned income.
Tax considerations:

Prefer traditional savings during higher earning years, and prefer Roth savings and conversions during lower earning years, such as during school and training, early in your career if you expect your income to rise, during lower-income years with disability or sabbatical, while working part-time, or in retirement prior to taking Social Security benefits.
Actually, one last comment - thank you for all your work on the Wiki and especially on this topic!

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by rkhusky » Sat May 18, 2019 7:53 am

JimInIllinois wrote:
Fri May 17, 2019 9:16 pm
How about this:
A taxpayer's marginal tax rate is the amount by which tax liability increases due to a small increase in income, expressed as the percentage of the income increase by which the tax liability increases. For example, if earning an additional $20 per year would increase your tax liability by $5 then your marginal tax rate is 25%. The marginal rate will depend on both the total amount and type of income received, with high-income taxpayers generally paying higher marginal rates, and long-term capital gains and qualified dividends taxed at lower marginal rates than earned income. The loss of credits or deductions with increasing income may result in effective marginal rates that are higher than the payer's "tax bracket". When calculating marginal tax rates it is customary to ignore the small jumps in tax liability due to tax tables and rounding and to consider only the underlying rate. The concept of marginal rate is important in calculating the advantage or disadvantage of deferring taxation, as when choosing between a traditional or Roth IRA, preferring to contribute to a Roth IRA at a low marginal rate of 12% but to a traditional IRA at a higher marginal rate of 22%.
To be consistent with the common definition of marginal tax rate, how about:
Marginal Tax Rate is the percent increase (decrease) in tax liability due to adding (subtracting) $1 of income, i.e. it is the tax rate on the "next" ("last") dollar of income. It is customary to ignore changes in the marginal rate that are due to rounding, tax tables, and other periodic step functions in the tax code (e.g. child tax credit) and only consider the underlying rate.

Effective Tax Rate is the average tax rate over an increase (decrease) in income greater than $1, up to and including all income. For small amounts of additional income, marginal and effective tax rates are often the same, and it is customary to use the term marginal tax rate in those cases. One should identify the income in question when quoting an effective or average tax rate (e.g. Adjusted Gross Income, Taxable Income, Adjusted Livesoft Income, next $20K of income, etc).

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by carolinaman » Sat May 18, 2019 9:17 am

Overall, this looks very good. Thanks to you and the team for your hard work in putting this together.

I have only skimmed the article so far. I had a really hard time with this paragraph:
"By inspection of just the tax bracket structure, his future marginal rate would be 22%, the same as today, so it would seem that Traditional and Roth contributions would be equally valuable. His future income would be only slightly above the start of the 22% bracket ($39,475), so he might choose to favor Traditional in case his predictions were off. However, his Social Security income is greater than the $18,236 threshold for the 40.7% "bump" (85% phase-in range in the 22% bracket). With an annual Social Security income of $30,000, the 40.7% bump begins at non-SS income of $35,122 ($42,014 - 0.23 * $30,000) and ends at $43,706 ($28,706 + 0.5 * $30,000), putting his $40,444 Traditional withdrawals right in the middle of the 40.7% bump. If he instead contributes $10,000 per year to his 401(k) as Roth for the next 10 years, his future income from Traditional accounts will be reduced to $34,942 (=FV(6%-3%,10,0,-650000)*4%), keeping him below the 40.7% bump. He will still be in the 85% phase-in range for Social Security, but will be in the 12% bracket, so his marginal tax rate in retirement will be 22.2% (12% * (1 + 85%)). Roth contributions are by far the better choice."

Your points are well made and I understood them but I read it several times and still was not sure of the math. Maybe it is just me, but it seems that more illustrations would be helpful. Digesting something like that only in narrative form was challenging to me and I consider myself pretty good with math calculations, taxes, etc.

I cannot say about other examples but just food for thought.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by JimInIllinois » Sat May 18, 2019 9:23 am

rkhusky wrote:
Sat May 18, 2019 7:53 am
Marginal Tax Rate is the percent increase (decrease) in tax liability due to adding (subtracting) $1 of income, i.e. it is the tax rate on the "next" ("last") dollar of income. It is customary to ignore changes in the marginal rate that are due to rounding, tax tables, and other periodic step functions in the tax code (e.g. child tax credit) and only consider the underlying rate.
When you say "the percent increase (decrease) in tax liability due to adding (subtracting) $1 of income" this means that if my tax liability is $1000 and adding $1 of income increases my tax liability by $.30, then the percent increase in my tax liability due to that last $1 is $.30 / $1000 = .0003 = .03%. This is why I was careful to say "the percentage of the income increase by which the tax liability increases".
rkhusky wrote:
Sat May 18, 2019 7:53 am
Effective Tax Rate is the average tax rate over an increase (decrease) in income greater than $1, up to and including all income. For small amounts of additional income, marginal and effective tax rates are often the same, and it is customary to use the term marginal tax rate in those cases. One should identify the income in question when quoting an effective or average tax rate (e.g. Adjusted Gross Income, Taxable Income, Adjusted Livesoft Income, next $20K of income, etc).
I have come across multiple uses of "effective tax rate". When I hear "effective tax rate" I assume it is an adjustment to some nominal rate, such as a nominal state income tax of 5% being an effective tax rate of 4% if federal taxes are itemized. I think this particular concept is best described as the "average marginal rate" for a change in income, as it is literally the average of the marginal rate for each dollar and emphasizes the connection to the marginal rate.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by LadyGeek » Sat May 18, 2019 9:49 am

fyre4ce wrote:
Sat May 18, 2019 12:54 am
About the spreadsheet note- I'm not anti-spreadsheet; in fact, I like spreadsheets a lot and use them almost every day for either my day job or financial stuff. I took it out because I thought it was redundant and took up too much space. I thought the simpler explanation with text, saying something like "If you have capital gains above and below the 15% threshold, each dollar of earned income gets taxed at 12% and also pushes $1 of capital gains into the 15% bracket, for a total marginal rate of 27%" a clearer and more concise explanation. At least for me and the way I learn, that explanation would help me understand much better than the spreadsheet, and once I have the concept in my head I can easily build a simple spreadsheet to play around with it if I want to. There's also the plot up higher that shows that very effect. I can add it back in but before I do I think I'd prefer to see some more feedback on whether readers find the structure easy to understand. (It also needs to be updated to 2019 taxes.) Reasonable?

I like Jim's definition.
From a new investor perspective: Your explanation forces the reader to visualize how capital gains change, forcing them (me) to read the paragraph several times to understand the concept. Combining six numbers (including "dollar") in the same sentence is very confusing. It's much more clear to have a graph or table to see how the numbers change. The text explains your intent.

As for the concern about space, the wiki (and all web browsers) support "collapsible tables". Here's an example showing a collapsible table as a companion to a spreadsheet. Bloomberg Barclays US Aggregate Bond Index (Index returns)

The spreadsheet's graph conveys the intent clearly. The table remains hidden until the readers clicks "Expand" to see the underlying data. (In this case, the data is also in the spreadsheet.)
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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by rkhusky » Sat May 18, 2019 1:07 pm

JimInIllinois wrote:
Sat May 18, 2019 9:23 am
rkhusky wrote:
Sat May 18, 2019 7:53 am
Marginal Tax Rate is the percent increase (decrease) in tax liability due to adding (subtracting) $1 of income, i.e. it is the tax rate on the "next" ("last") dollar of income. It is customary to ignore changes in the marginal rate that are due to rounding, tax tables, and other periodic step functions in the tax code (e.g. child tax credit) and only consider the underlying rate.
When you say "the percent increase (decrease) in tax liability due to adding (subtracting) $1 of income" this means that if my tax liability is $1000 and adding $1 of income increases my tax liability by $.30, then the percent increase in my tax liability due to that last $1 is $.30 / $1000 = .0003 = .03%. This is why I was careful to say "the percentage of the income increase by which the tax liability increases".
Yes. Perhaps: "Marginal Tax Rate is equivalent to the increase (decrease) in tax liability due to adding (subtracting) $1 of income"
0.30 = 30%
JimInIllinois wrote:
Sat May 18, 2019 9:23 am
rkhusky wrote:
Sat May 18, 2019 7:53 am
Effective Tax Rate is the average tax rate over an increase (decrease) in income greater than $1, up to and including all income. For small amounts of additional income, marginal and effective tax rates are often the same, and it is customary to use the term marginal tax rate in those cases. One should identify the income in question when quoting an effective or average tax rate (e.g. Adjusted Gross Income, Taxable Income, Adjusted Livesoft Income, next $20K of income, etc).
I have come across multiple uses of "effective tax rate". When I hear "effective tax rate" I assume it is an adjustment to some nominal rate, such as a nominal state income tax of 5% being an effective tax rate of 4% if federal taxes are itemized. I think this particular concept is best described as the "average marginal rate" for a change in income, as it is literally the average of the marginal rate for each dollar and emphasizes the connection to the marginal rate.
Perhaps just use average tax rate, since I don't think you will find many references for the term "average marginal rate" and we shouldn't develop new terms in the wiki. I agree that effective tax rate does have existing definitions, including the average tax rate over all your income.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by LadyGeek » Sat May 18, 2019 1:49 pm

The Traditional versus Roth Employer match example may need clarification.

Currently:
If your employer matches 401(k) contributions, this is by far the best investment you can make, as it has an immediate return equal to the match rate. Therefore, regardless of the quality of your employer's plan, you should get the maximum match before investing anywhere else.

If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, if you cannot contribute enough to a Roth to get the maximum match, you should prefer the traditional account. For example, assume you are in a 12% tax bracket and your employer will match 100% of your contributions up to $4,000, and you can only afford to contribute $3,520 out-of-pocket. If you contribute $3,520 to the Roth 401(k), you will only get a $3,520 match. But if you contribute $4,000 to the Traditional 401(k), your after-tax cost is the same ($3,520 = $4,000 * (1 - 12%)), but you get the full $4,000 match.
I have underlined suggested changes. (Consider breaking your text into multiple paragraphs, as I've done here.)
If your employer matches 401(k) contributions, this is by far the best investment you can make, as it has an immediate return equal to the match rate. Therefore, regardless of the quality of your employer's plan, you should get the maximum match before investing anywhere else.

If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, you should contribute an amount to the traditional account that is equal to an (after-tax) amount that would have gone into the Roth.

For example, assume you are in a 12% tax bracket and your employer will match 100% of your contributions up to $4,000, and you can only afford to contribute $3,520 out-of-pocket.

By contributing $4,0000 to the Traditional 401(k), your after-tax cost is the same ($3,520 = $4,000 * (1 - 12%)), but you also get the full $4,000 employer match.
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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by trueblueky » Sat May 18, 2019 2:41 pm

carolinaman wrote:
Sat May 18, 2019 9:17 am
Overall, this looks very good. Thanks to you and the team for your hard work in putting this together.

I have only skimmed the article so far. I had a really hard time with this paragraph:

"By inspection of just the tax bracket structure, his future marginal rate would be 22%, the same as today, so it would seem that Traditional and Roth contributions would be equally valuable. His future income would be only slightly above the start of the 22% bracket ($39,475), so he might choose to favor Traditional in case his predictions were off.

However, his Social Security income is greater than the $18,236 threshold for the 40.7% "bump" (85% phase-in range in the 22% bracket). With an annual Social Security income of $30,000, the 40.7% bump begins at non-SS income of $35,122 ($42,014 - 0.23 * $30,000) and ends at $43,706 ($28,706 + 0.5 * $30,000), putting his $40,444 Traditional withdrawals right in the middle of the 40.7% bump.

If he instead contributes $10,000 per year to his 401(k) as Roth for the next 10 years, his future income from Traditional accounts will be reduced to $34,942 (=FV(6%-3%,10,0,-650000)*4%), keeping him below the 40.7% bump. He will still be in the 85% phase-in range for Social Security, but will be in the 12% bracket, so his marginal tax rate in retirement will be 22.2% (12% * (1 + 85%)). Roth contributions are by far the better choice."


Your points are well made and I understood them but I read it several times and still was not sure of the math. Maybe it is just me, but it seems that more illustrations would be helpful. Digesting something like that only in narrative form was challenging to me and I consider myself pretty good with math calculations, taxes, etc.

I cannot say about other examples but just food for thought.
Agree that many numbers in one paragraph increases reading grade level. I added paragraphs to the bold section. That makes this slightly more readable, while a chart might be much clearer.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by LadyGeek » Sat May 18, 2019 2:57 pm

:arrow: To investors who are learning: Is there anything in these articles that you don't understand? Is the article difficult to read?

If you don't understand something, by all means let us know. These articles are for you. If the point doesn't come across, we haven't done our job. We can't correct the article if we don't know there's a problem.

I would encourage readers to try and reproduce the examples.
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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by JBTX » Sat May 18, 2019 3:02 pm

This is nitpicking, but

"The marginal tax rate is often the same as the individual's tax bracket, but not always.[note 1][note 2]"

I would change "often" to "may be", or "may or may not be".

The reason is that too many people think they are the same but they quite often aren't especially in retirement.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by trueblueky » Sat May 18, 2019 3:11 pm

fyre4ce, This page is great.

Fyre4ce/Marginal tax rate

I believe QBI deserves its own page. REIT dividends and PTP income shown as 199A count.

The 20% QBI deduction is limited to the lesser of:
* 20% of the taxpayer's QBI, plus 20% of the taxpayer's qualified REIT dividends and publicly traded partnership (PTP) income
* 20% of the taxpayer's taxable income minus net capital gain

Cite: https://www.irs.gov/newsroom/tax-cuts-a ... ction-faqs

In AARP TaxAide, we had many clients qualify for some QBI from a the 199A line on a 1099 or K-1. None received this from a job.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sat May 18, 2019 4:16 pm

In Traditional versus Roth - Bogleheads, it says
The main reason to prefer one type of account over the other is the comparison of marginal tax rates. If your marginal tax rate now is higher than your estimated marginal tax rate at retirement
Thus we need an operative definition of "marginal tax rate".

Telling people that "the" marginal rate is the rate on the last dollar is not correct in the context of making a decision on, say, this year's $6K IRA contribution.

Using the following works in all cases:
Marginal tax rate is a tax rate applicable to an income change from some base income. It is calculated by dividing the change in tax by the applicable change in income.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sat May 18, 2019 4:36 pm

LadyGeek wrote:
Fri May 17, 2019 8:11 pm
Could the calculation example from the "live" page using footnote 3 (spreadsheet) be inserted into the draft page? I understand your intent is to not use spreadsheets, but they add considerable value for readers who are not strong on math. A working spreadsheet drives the point home for investors who may not understand the concept and allows them to experiment on their own.
Due to the 2018 tax code change, the Child Tax Credit phase-out moved to much higher incomes. That's one reason a slightly different example (Ordinary income marginal tax rate when causing LTCGs to be taxed) was used. The example still uses footnote 3 (spreadsheet). At least, I think this addresses the question - please advise if not.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by rkhusky » Sat May 18, 2019 4:52 pm

FiveK wrote:
Sat May 18, 2019 4:16 pm
In Traditional versus Roth - Bogleheads, it says
The main reason to prefer one type of account over the other is the comparison of marginal tax rates. If your marginal tax rate now is higher than your estimated marginal tax rate at retirement
Thus we need an operative definition of "marginal tax rate".

Telling people that "the" marginal rate is the rate on the last dollar is not correct in the context of making a decision on, say, this year's $6K IRA contribution.

Using the following works in all cases:
Marginal tax rate is a tax rate applicable to an income change from some base income. It is calculated by dividing the change in tax by the applicable change in income.
One way that I've seen argued is that one should compare each dollar in the $6K and compare its marginal rate on contribution to its marginal rate on withdrawal. In some cases, one may want to do $3K to Traditional and $3K to Roth. This method provides the fine detail to do that.

Another way is to consider the average tax rate on an entire year's worth of contributions versus the average tax rate on an entire year's worth of withdrawals. This is simpler and allows one to do long range planning, especially when one isn't sure what future income and tax brackets might be.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by dodecahedron » Sat May 18, 2019 6:05 pm

JimInIllinois wrote:
Fri May 17, 2019 9:16 pm
How about this:
A taxpayer's marginal tax rate is the amount by which tax liability increases due to a small increase in income, expressed as the percentage of the income increase by which the tax liability increases. For example, if earning an additional $20 per year would increase your tax liability by $5 then your marginal tax rate is 25%. The marginal rate will depend on both the total amount and type of income received, with high-income taxpayers generally paying higher marginal rates, and long-term capital gains and qualified dividends taxed at lower marginal rates than earned income. The loss of credits or deductions with increasing income may result in effective marginal rates that are higher than the payer's "tax bracket". Alternatively, the phase-in of refundable credits (e.g., Earned Income Credit, Additional Child Credit) may result in effective marginal rates that are lower than the taxpayer´s tax bracket. When calculating marginal tax rates it is customary to ignore the small jumps in tax liability due to tax tables and rounding and to consider only the underlying rate. The concept of marginal rate is important in calculating the advantage or disadvantage of deferring taxation, as when choosing between a traditional or Roth IRA, preferring to contribute to a Roth IRA at a low marginal rate of 12% but to a traditional IRA at a higher marginal rate of 22%.
Suggested addition in red above. Effective marginal tax rates can be either higher OR lower than the tax bracket rates. Some credits have phase-ins as well as phaseouts. Refundable credits can even lead to negative effective marginal tax rates.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by grabiner » Sat May 18, 2019 6:20 pm

LadyGeek wrote:
Sat May 18, 2019 1:49 pm
The Traditional versus Roth Employer match example may need clarification.

Currently:
If your employer matches 401(k) contributions, this is by far the best investment you can make, as it has an immediate return equal to the match rate. Therefore, regardless of the quality of your employer's plan, you should get the maximum match before investing anywhere else.

If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, if you cannot contribute enough to a Roth to get the maximum match, you should prefer the traditional account. For example, assume you are in a 12% tax bracket and your employer will match 100% of your contributions up to $4,000, and you can only afford to contribute $3,520 out-of-pocket. If you contribute $3,520 to the Roth 401(k), you will only get a $3,520 match. But if you contribute $4,000 to the Traditional 401(k), your after-tax cost is the same ($3,520 = $4,000 * (1 - 12%)), but you get the full $4,000 match.
I have underlined suggested changes. (Consider breaking your text into multiple paragraphs, as I've done here.)
If your employer matches 401(k) contributions, this is by far the best investment you can make, as it has an immediate return equal to the match rate. Therefore, regardless of the quality of your employer's plan, you should get the maximum match before investing anywhere else.

If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, you should contribute an amount to the traditional account that is equal to an (after-tax) amount that would have gone into the Roth.

For example, assume you are in a 12% tax bracket and your employer will match 100% of your contributions up to $4,000, and you can only afford to contribute $3,520 out-of-pocket.

By contributing $4,0000 to the Traditional 401(k), your after-tax cost is the same ($3,520 = $4,000 * (1 - 12%)), but you also get the full $4,000 employer match.
The correction loses the point: a traditional account is better if it allows you to get a larger match. In addition the "any match goes to a traditional account" is not relevant to this point, and should be dropped. The second paragraph should read:

If your employer offers both traditional and Roth accounts, and you cannot contribute enough to a Roth account to get the maximum match, then you should prefer the traditional account because it costs less out of pocket to get the same match.
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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sat May 18, 2019 6:24 pm

rkhusky wrote:
Sat May 18, 2019 4:52 pm
FiveK wrote:
Sat May 18, 2019 4:16 pm
In Traditional versus Roth - Bogleheads, it says
The main reason to prefer one type of account over the other is the comparison of marginal tax rates. If your marginal tax rate now is higher than your estimated marginal tax rate at retirement
Thus we need an operative definition of "marginal tax rate".

Telling people that "the" marginal rate is the rate on the last dollar is not correct in the context of making a decision on, say, this year's $6K IRA contribution.

Using the following works in all cases:
Marginal tax rate is a tax rate applicable to an income change from some base income. It is calculated by dividing the change in tax by the applicable change in income.
One way that I've seen argued is that one should compare each dollar in the $6K and compare its marginal rate on contribution to its marginal rate on withdrawal. In some cases, one may want to do $3K to Traditional and $3K to Roth. This method provides the fine detail to do that.

Another way is to consider the average tax rate on an entire year's worth of contributions versus the average tax rate on an entire year's worth of withdrawals. This is simpler and allows one to do long range planning, especially when one isn't sure what future income and tax brackets might be.
Dividing the change in tax by the change in income works in both of those - actually, all - situations, given a specified income change.

Appropriately specifying the income change requires knowledge of how tax rates change over the entire possible income change. If contributions have diminishing returns (e.g., 22% for the first $3K and 12% for the remaining possible $3K of an individual's IRA), those two $3K increments can be treated separately. In this case, $3K to traditional (to save 22%) and $3K to Roth (not saving 12%) may make good sense.

If contributions have increasing returns then one has to look at "the whole forest" and not go tree by tree. E.g., a HOH filer with $50K gross pay and 2 EIC-eligible dependents will save 12% for the first $1999 of a 401k, then get a $200 spike for the next $1, then back to 12% until jumping to 33.06% at $3300, then back to 21.06% at $17,675 through $19K. If this filer can't afford to contribute more than $3300 (or even $1999), using Roth may be correct. But if more is affordable, using all traditional may instead be correct. One has to use "dividing the change in tax by the change in income" to see that.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sat May 18, 2019 6:30 pm

If we want to change Traditional versus Roth - Bogleheads to say something other than "...the comparison of marginal tax rates" then we can have a wiki entry to explain what that something else is. As long as we are telling people to compare marginal tax rates, it behooves us to give them a useful explanation of what that means in practice.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sun May 19, 2019 12:13 am

Glomar wrote:
Sat May 18, 2019 6:35 am
Another comment - I might be misunderstanding this section, but it struck me as odd to say "prefer Roth savings...if one is in retirement". In my understanding if one is retired, it is not possible to contribute to either traditional or Roth since there is no earned income.
Tax considerations:

Prefer traditional savings during higher earning years, and prefer Roth savings and conversions during lower earning years, such as during school and training, early in your career if you expect your income to rise, during lower-income years with disability or sabbatical, while working part-time, or in retirement prior to taking Social Security benefits.
Actually, one last comment - thank you for all your work on the Wiki and especially on this topic!
Probably the intent is to read it as "prefer Roth...conversions...during lower income years...in retirement prior to taking Social Security benefits."

There may be too many "and"s and "or"s in the current wording. Suggestions for rewording?

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by carolinaman » Sun May 19, 2019 6:35 am

trueblueky wrote:
Sat May 18, 2019 2:41 pm
carolinaman wrote:
Sat May 18, 2019 9:17 am
Overall, this looks very good. Thanks to you and the team for your hard work in putting this together.

I have only skimmed the article so far. I had a really hard time with this paragraph:

"By inspection of just the tax bracket structure, his future marginal rate would be 22%, the same as today, so it would seem that Traditional and Roth contributions would be equally valuable. His future income would be only slightly above the start of the 22% bracket ($39,475), so he might choose to favor Traditional in case his predictions were off.

However, his Social Security income is greater than the $18,236 threshold for the 40.7% "bump" (85% phase-in range in the 22% bracket). With an annual Social Security income of $30,000, the 40.7% bump begins at non-SS income of $35,122 ($42,014 - 0.23 * $30,000) and ends at $43,706 ($28,706 + 0.5 * $30,000), putting his $40,444 Traditional withdrawals right in the middle of the 40.7% bump.

If he instead contributes $10,000 per year to his 401(k) as Roth for the next 10 years, his future income from Traditional accounts will be reduced to $34,942 (=FV(6%-3%,10,0,-650000)*4%), keeping him below the 40.7% bump. He will still be in the 85% phase-in range for Social Security, but will be in the 12% bracket, so his marginal tax rate in retirement will be 22.2% (12% * (1 + 85%)). Roth contributions are by far the better choice."


Your points are well made and I understood them but I read it several times and still was not sure of the math. Maybe it is just me, but it seems that more illustrations would be helpful. Digesting something like that only in narrative form was challenging to me and I consider myself pretty good with math calculations, taxes, etc.

I cannot say about other examples but just food for thought.
Agree that many numbers in one paragraph increases reading grade level. I added paragraphs to the bold section. That makes this slightly more readable, while a chart might be much clearer.
Your point is clear from the wording but I still have trouble following the numbers (maybe that is not so important). I favor some form of illustration. Again, this may just be my difficulty, but I suspect others will have difficulty too.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sun May 19, 2019 9:32 am

FiveK wrote:
Sat May 18, 2019 4:36 pm
LadyGeek wrote:
Fri May 17, 2019 8:11 pm
Could the calculation example from the "live" page using footnote 3 (spreadsheet) be inserted into the draft page? I understand your intent is to not use spreadsheets, but they add considerable value for readers who are not strong on math. A working spreadsheet drives the point home for investors who may not understand the concept and allows them to experiment on their own.
Due to the 2018 tax code change, the Child Tax Credit phase-out moved to much higher incomes. That's one reason a slightly different example (Ordinary income marginal tax rate when causing LTCGs to be taxed) was used. The example still uses footnote 3 (spreadsheet). At least, I think this addresses the question - please advise if not.
OK, I mistook "reference" #3 for "notes" #3. Both refer to downloadable spreadsheets. Personally I prefer seeing the charts of marginal rates and wouldn't miss the one that merely calculates a single number, but others may have a different perspective.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by dbr » Sun May 19, 2019 9:44 am

My comment about marginal tax rate is that it might be better to just advise people to calculate the actual difference in tax costs between two alternatives rather than taking the detour of computing a rate which is then used to estimate a cost that one already knows. The reason for this is that the amount of the income increment may be large and the marginal rate is not a constant over the entire difference. This is affected by when one hits phase outs and how brackets are straddled.

I suppose, of course, that marginal rate is mentioned so often that there has to be a discussion somewhere, and surely the confusion between marginal and average or effective rate needs to be made clear.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by dbr » Sun May 19, 2019 9:47 am

OK, also, isn't the discussion about Trad vs Roth a discussion of tax cost rather than tax rate and the same comment as above applies.

But I have always been an advocate of dummy tax computation to get costs rather than to use rates to estimate costs. Maybe that is too much work and people can ballpark it using rates.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sun May 19, 2019 12:44 pm

dbr wrote:
Sun May 19, 2019 9:47 am
OK, also, isn't the discussion about Trad vs Roth a discussion of tax cost rather than tax rate and the same comment as above applies.
It's the tax rate that matters, not the absolute tax cost.

"Minimizing tax cost" is an incorrect way to say Roth is better than traditional, just as "compare marginal vs. effective" is an incorrect way to say traditional is better than Roth.

What matters is the amount left after all taxes are paid, and the commutative property of multiplication tells us that it's the tax rates that matter.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by Phil DeMuth » Sun May 19, 2019 1:03 pm

Thank you for your hard work putting together this wiki.

I do not understand the advice under Very High Earners to the effect that they should generally prefer Roth accounts. Do we mean that they should prefer to own Roth accounts? That would be true. Do we mean that they should prefer to contribute to Roth accounts? That is a more complicated question because the value of any hypothetical tax benefits later needs to be weighed against the certain value of the tax deduction today.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sun May 19, 2019 1:45 pm

Phil DeMuth wrote:
Sun May 19, 2019 1:03 pm
I do not understand the advice under Very High Earners to the effect that they should generally prefer Roth accounts. Do we mean that they should prefer to own Roth accounts? That would be true. Do we mean that they should prefer to contribute to Roth accounts? That is a more complicated question because the value of any hypothetical tax benefits later needs to be weighed against the certain value of the tax deduction today.
I think you are correct that Very High Earners aren't different enough from anyone else who can make a maximum contribution to retirement accounts to warrant a separate section.

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Employer match

Post by LadyGeek » Sun May 19, 2019 1:56 pm

grabiner wrote:
Sat May 18, 2019 6:20 pm
LadyGeek wrote:
Sat May 18, 2019 1:49 pm
The Traditional versus Roth Employer match example may need clarification.

...I have underlined suggested changes. (Consider breaking your text into multiple paragraphs, as I've done here.)
If your employer matches 401(k) contributions, this is by far the best investment you can make, as it has an immediate return equal to the match rate. Therefore, regardless of the quality of your employer's plan, you should get the maximum match before investing anywhere else.

If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, you should contribute an amount to the traditional account that is equal to an (after-tax) amount that would have gone into the Roth.

For example, assume you are in a 12% tax bracket and your employer will match 100% of your contributions up to $4,000, and you can only afford to contribute $3,520 out-of-pocket.

By contributing $4,0000 to the Traditional 401(k), your after-tax cost is the same ($3,520 = $4,000 * (1 - 12%)), but you also get the full $4,000 employer match.
The correction loses the point: a traditional account is better if it allows you to get a larger match. In addition the "any match goes to a traditional account" is not relevant to this point, and should be dropped. The second paragraph should read:

If your employer offers both traditional and Roth accounts, and you cannot contribute enough to a Roth account to get the maximum match, then you should prefer the traditional account because it costs less out of pocket to get the same match.
Your suggestion assumes that employer matches are available in a Roth account. I do not believe that is accurate. My employer only matches traditional accounts, as does the Thrift Savings Plan. I propose to keep my suggestion.

============
FYI - The wiki is a collaborative effort. We have several wiki editors contributing to this discussion, and are addressing multiple aspects. Once each section has a consensus, I recommend the wiki editor update the draft page (User:Fyre4ce/Traditional versus Roth) and report back here that the change has been made.

I changed the title of my post (the Subject: line above the post edit area) to indicate the section I'm addressing.
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Re: Employer match

Post by grabiner » Sun May 19, 2019 6:51 pm

LadyGeek wrote:
Sun May 19, 2019 1:56 pm
grabiner wrote:
Sat May 18, 2019 6:20 pm
LadyGeek wrote:
Sat May 18, 2019 1:49 pm
If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, you should contribute an amount to the traditional account that is equal to an (after-tax) amount that would have gone into the Roth.
The correction loses the point: a traditional account is better if it allows you to get a larger match. In addition the "any match goes to a traditional account" is not relevant to this point, and should be dropped. The second paragraph should read:

If your employer offers both traditional and Roth accounts, and you cannot contribute enough to a Roth account to get the maximum match, then you should prefer the traditional account because it costs less out of pocket to get the same match.
Your suggestion assumes that employer matches are available in a Roth account. I do not believe that is accurate.
The problem I had is with the "therefore"; the fact that the match goes to a traditional account did not seem to be relevant to the importance of getting the full match. However, I now realize that the "therefore" is correct; if you could get a Roth match, then $880 matched in the Roth would be as good as $1000 matched in the traditional 401(k) in a 12% bracket. Since I didn't get the point the first time, I believe it needs clarifying. Therefore, I suggest the following wording.

If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, if you cannot contribute enough to a Roth account to get the maximum match, then you should prefer traditional contributions because you can get a larger match for the same out-of-pocket (after-tax) cost.
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Re: General ordering

Post by FiveK » Sun May 19, 2019 7:11 pm

LadyGeek wrote:
Sun May 19, 2019 1:56 pm
FYI - The wiki is a collaborative effort. We have several wiki editors contributing to this discussion, and are addressing multiple aspects. Once each section has a consensus, I recommend the wiki editor update the draft page (User:Fyre4ce/Traditional versus Roth) and report back here that the change has been made.

I changed the title of my post (the Subject: line above the post edit area) to indicate the section I'm addressing.
Made a few changes that (I think) are outside the unsettled scope. In short, the intent is to tell the reader
1. In most cases, the simple comparison of tax rates is either exactly correct or close enough.
2. When contributing the maximum, the breakeven rate shifts a few percent in favor of the Roth, and some useful spreadsheets are available to define "a few".
3. How to evaluate the situation when a Roth contribution causes a tax reduction (saver's credit).

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Re: Employer match

Post by LadyGeek » Sun May 19, 2019 7:38 pm

grabiner wrote:
Sun May 19, 2019 6:51 pm
LadyGeek wrote:
Sun May 19, 2019 1:56 pm
grabiner wrote:
Sat May 18, 2019 6:20 pm
LadyGeek wrote:
Sat May 18, 2019 1:49 pm
If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, you should contribute an amount to the traditional account that is equal to an (after-tax) amount that would have gone into the Roth.
The correction loses the point: a traditional account is better if it allows you to get a larger match. In addition the "any match goes to a traditional account" is not relevant to this point, and should be dropped. The second paragraph should read:

If your employer offers both traditional and Roth accounts, and you cannot contribute enough to a Roth account to get the maximum match, then you should prefer the traditional account because it costs less out of pocket to get the same match.
Your suggestion assumes that employer matches are available in a Roth account. I do not believe that is accurate.
The problem I had is with the "therefore"; the fact that the match goes to a traditional account did not seem to be relevant to the importance of getting the full match. However, I now realize that the "therefore" is correct; if you could get a Roth match, then $880 matched in the Roth would be as good as $1000 matched in the traditional 401(k) in a 12% bracket. Since I didn't get the point the first time, I believe it needs clarifying. Therefore, I suggest the following wording.

If your employer offers both traditional and Roth accounts, any match goes to a traditional account. Therefore, if you cannot contribute enough to a Roth account to get the maximum match, then you should prefer traditional contributions because you can get a larger match for the same out-of-pocket (after-tax) cost.
I concur on the revised wording and have updated the section: User:Fyre4ce/Traditional versus Roth (Employer match)
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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by trueblueky » Sun May 19, 2019 7:53 pm

Section entitled "Social Security" last paragraph, should where it says "18%" be " 10%"?

Great effort.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by fyre4ce » Sun May 19, 2019 9:07 pm

trueblueky wrote:
Sun May 19, 2019 7:53 pm
Section entitled "Social Security" last paragraph, should where it says "18%" be " 10%"?

Great effort.
I don't think so. Take a look at the "heat map" plots I posted to the Social Security taxation page. The 22.2% bump has either 18% (single) or 18.5% (married) rate below it, when you're either in the 12% bracket and benefit taxation is phased in at 50% (12% * (1 + 50%)) or are in the 10% bracket and benefit taxation is phased in at 85% (10% * (1 + 85%)). If you still see a mistake, let me know.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by fyre4ce » Sun May 19, 2019 9:34 pm

Thanks again to all those helping improve these articles, by edits, feedback, or both.

Here's some comments on specific points:

-The match description threw me off the first time I read it too (that language was in the current "live" version), but as I thought about it again it made more sense - the same trajectory Grabiner took :-) I think it's good with the edits that were made.

-I agree the first bullet under General Guidelines, Tax Considerations got a bit long. I was trying to cover contributions and conversions in one swing. I edited it to remove references to conversions in that section, and put one sentence about when to do conversions at the bottom of that section. It's arguably extraneous to the topic, but it's good advice and so closely related to this article's topic that I think it deserves a sentence and a link to the Roth conversion article. If people disagree, they can discuss here or just remove the conversion link.

-For Social Security bump, I thought it might be helpful to work out the simple formulas where people can directly calculate where their bumps begin and end, based on their SS income. I can see how putting all that calculation in-line got hard to read. I edited it to break those calculations out in a small separate table; hopefully that helps. I still hope that the simple begin/end formulas that can easily be calculated by hand are more useful to some than using a big spreadsheet or online calculator, but maybe this is wrong. If the consensus is still that the begin/end formulas are not useful, I'm OK taking them out, but in either case I still like the idea of showing a worked example where someone can switch to Roth and avoid the bump.

-I think the section on Very High Earners is justified (I'm not one of them by the way... I wish). We have a small but important contingent of readers who will definitely be in the top bracket for the rest of their lives, and I think the advice of going for Roth as a baseline for these people is worth the small amount of space. I expanded slightly the section toward the bottom to make the reasoning more clear, and also added a bullet to the top in the general guidelines because upon reflection I think it's general enough advice to put up there. If people disagree with these changes we can discuss here.

-Regarding terminology, I'm thinking we keep "marginal" to refer just to "small" changes (this has always been my preference for the reasons I stated above) and use the term "average savings rate" for the increments used in the irregular analysis. I agree we should avoid inventing terminology to the maximum extent practical; maybe this is the minimum level of "invention" while still getting the point across.

-Understood about the spreadsheet note. I don't have time to add this back in tonight but I can over the next week.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Sun May 19, 2019 10:36 pm

fyre4ce wrote:
Sun May 19, 2019 9:34 pm
-Regarding terminology, I'm thinking we keep "marginal" to refer just to "small" changes (this has always been my preference for the reasons I stated above) and use the term "average savings rate" for the increments used in the irregular analysis. I agree we should avoid inventing terminology to the maximum extent practical; maybe this is the minimum level of "invention" while still getting the point across.
In a PM exchange, you mentioned the difficulty of communicating "over text where the reader can't tell tone, etc." Please keep that in mind here: you may not have enough experience dealing with questions that arise in this forum to be making a correct judgment.

E.g., see today's discussion starting with viewtopic.php?f=10&t=280254&start=50#p4552058: unfortunately the idea that one can save at a marginal rate while withdrawing at an effective rate persists. The more we use "average" or "effective" the more likely we reinforce that erroneous idea.

Kevin M's thoughts three years ago seem pertinent today:
Kevin M wrote:
Sun May 15, 2016 8:06 pm
The problem with "marginal rate" is that it can be different depending on the incremental value you're using. I think the standard definition is the rate on an extra $1 of income. But grabiner used $1,000 in his example. If we're looking at an annual IRA contribution the incremental amount is $5,500 (or $6,500 if age 50 or older). For a 401k contribution it's even larger.

This is not the same issue as distinguishing between tax bracket and marginal rate. Regardless of impact of deduction and credit phaseouts, social security taxation, etc., the tax rate you use in a particular analysis should be the one that applies to the amount you are analyzing, not the last $1, $10, $100 or $1,000.

So if your $5,500 IRA contribution (or distribution) is all in the 15% tax bracket except for the last $1, ignoring impacts of phaseouts, etc., your marginal tax rate is 25%, but that would be a silly number to use in your analysis. The marginal rate that's more applicable to this analysis is 15%.

If you use Kitce's definition, cited as a reference in the Wiki article under development, it makes perfect sense to me:
A marginal tax rate is the tax rate that will apply to the next marginal – or incremental – amount of income (or deductions). It is calculated by dividing the amount of additional taxes that will be due based on some decision (e.g., to take an IRA withdrawal) by the amount of income involved.
(Highlight mine).

This is the way I do it. However, this is not consistent with statements like this:
The smaller the amount the more precise the result <snip>
This is true for determining the theoretical marginal rate, but it may not be a useful number for the analysis at hand.

Similar issue with using the derivative concept. The derivative is essentially the slope of the curve at a certain point on the curve of tax vs. income. But the slope could be very different on the last $1 of income vs. the incremental $1 of income a bit to the left on the graph, or more importantly the average slope applicable to the analysis at hand.

Kevin
We have already discussed cases in which using small increments leads to an incorrect choice. Are there any examples in which using (change in tax)/(change in income) leads to an incorrect choice for that change in income? If not, I suggest we put this to bed and go back to the consensus reached three years ago.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by fyre4ce » Mon May 20, 2019 2:52 am

What does the group think about the following addition to the match section to make it crystal-clear?

If your employer offers both traditional and Roth accounts, any match goes to a traditional account and is without regard to whether the matched contributions are traditional or Roth. Therefore, if you cannot contribute enough to a Roth account to get the maximum match, then you should prefer traditional contributions because you can get a larger match for the same out-of-pocket (after-tax) cost.
FiveK wrote:
Sun May 19, 2019 10:36 pm
fyre4ce wrote:
Sun May 19, 2019 9:34 pm
-Regarding terminology, I'm thinking we keep "marginal" to refer just to "small" changes (this has always been my preference for the reasons I stated above) and use the term "average savings rate" for the increments used in the irregular analysis. I agree we should avoid inventing terminology to the maximum extent practical; maybe this is the minimum level of "invention" while still getting the point across.
In a PM exchange, you mentioned the difficulty of communicating "over text where the reader can't tell tone, etc." Please keep that in mind here: you may not have enough experience dealing with questions that arise in this forum to be making a correct judgment.

E.g., see today's discussion starting with viewtopic.php?f=10&t=280254&start=50#p4552058: unfortunately the idea that one can save at a marginal rate while withdrawing at an effective rate persists. The more we use "average" or "effective" the more likely we reinforce that erroneous idea.

Kevin M's thoughts three years ago seem pertinent today:
Kevin M wrote:
Sun May 15, 2016 8:06 pm
The problem with "marginal rate" is that it can be different depending on the incremental value you're using. I think the standard definition is the rate on an extra $1 of income. But grabiner used $1,000 in his example. If we're looking at an annual IRA contribution the incremental amount is $5,500 (or $6,500 if age 50 or older). For a 401k contribution it's even larger.

This is not the same issue as distinguishing between tax bracket and marginal rate. Regardless of impact of deduction and credit phaseouts, social security taxation, etc., the tax rate you use in a particular analysis should be the one that applies to the amount you are analyzing, not the last $1, $10, $100 or $1,000.

So if your $5,500 IRA contribution (or distribution) is all in the 15% tax bracket except for the last $1, ignoring impacts of phaseouts, etc., your marginal tax rate is 25%, but that would be a silly number to use in your analysis. The marginal rate that's more applicable to this analysis is 15%.

If you use Kitce's definition, cited as a reference in the Wiki article under development, it makes perfect sense to me:
A marginal tax rate is the tax rate that will apply to the next marginal – or incremental – amount of income (or deductions). It is calculated by dividing the amount of additional taxes that will be due based on some decision (e.g., to take an IRA withdrawal) by the amount of income involved.
(Highlight mine).

This is the way I do it. However, this is not consistent with statements like this:
The smaller the amount the more precise the result <snip>
This is true for determining the theoretical marginal rate, but it may not be a useful number for the analysis at hand.

Similar issue with using the derivative concept. The derivative is essentially the slope of the curve at a certain point on the curve of tax vs. income. But the slope could be very different on the last $1 of income vs. the incremental $1 of income a bit to the left on the graph, or more importantly the average slope applicable to the analysis at hand.

Kevin
We have already discussed cases in which using small increments leads to an incorrect choice. Are there any examples in which using (change in tax)/(change in income) leads to an incorrect choice for that change in income? If not, I suggest we put this to bed and go back to the consensus reached three years ago.
It's definitely true that I don't have as much experience explaining to forum members the traditional vs Roth analysis. You are probably right there is some value in using the more flexible definition. My only point is that there's also a "cost" associated with deviating from standard terminology, and that has to be balanced against the pedagogical value of what you're proposing. I think the concepts can still be clearly explained while using the more common definition of marginal. Furthermore, if people are routinely getting confused about marginal vs average, it seems to me like sticking to the "small" definition would actually help explain the simple case, before adding the complexity of irregular cases where averaging is required. Based on the comments here, it doesn't seem to me like there's a consensus; several people have expressed preference for the "small" definition. In any case, this is clearly a controversial topic and I'm going to leave the editing on this point to more senior editors (I'm relatively new here). For the time being I won't make any edits to the proposed article related to this definition and will focus on evaluating the value of the new content.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by rkhusky » Mon May 20, 2019 6:38 am

fyre4ce wrote:
Mon May 20, 2019 2:52 am
My only point is that there's also a "cost" associated with deviating from standard terminology, and that has to be balanced against the pedagogical value of what you're proposing.
And, as noted previously, the wiki is not supposed to engage in original research. And creating new definitions for existing phrases is original research. Kitces used a larger increment in one article. In many subsequent articles he used the "last dollar" or "next dollar" definitions. And the video in Ref 2 also uses the "additional dollar" definition of marginal rate.

Incidentally, each article could use some additional references. This post has some references for the "last" or "next" dollar definitions of marginal tax rate: viewtopic.php?f=2&t=279430&p=4514209#p4514536

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Mon May 20, 2019 8:54 am

rkhusky wrote:
Mon May 20, 2019 6:38 am
fyre4ce wrote:
Mon May 20, 2019 2:52 am
My only point is that there's also a "cost" associated with deviating from standard terminology, and that has to be balanced against the pedagogical value of what you're proposing.
And, as noted previously, the wiki is not supposed to engage in original research. And creating new definitions for existing phrases is original research. Kitces used a larger increment in one article. In many subsequent articles he used the "last dollar" or "next dollar" definitions. And the video in Ref 2 also uses the "additional dollar" definition of marginal rate.

Incidentally, each article could use some additional references. This post has some references for the "last" or "next" dollar definitions of marginal tax rate: viewtopic.php?f=2&t=279430&p=4514209#p4514536
Sure, there are plenty of references in which "marginal" is used in place of "first derivative". By and large, academic references are discussing smooth functions. The tax code is not a smooth function.

Again, we have already discussed cases in which using small increments leads to an incorrect choice.
Are there any examples in which using (change in tax)/(change in income) leads to an incorrect choice for that change in income?
If so, let's discuss. If not, let's put this to bed and go back to the consensus reached three years ago.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by rkhusky » Mon May 20, 2019 9:58 am

FiveK wrote:
Mon May 20, 2019 8:54 am
Are there any examples in which using (change in tax)/(change in income) leads to an incorrect choice for that change in income?
If so, let's discuss. If not, let's put this to bed and go back to the consensus reached three years ago.
I disagree that that is the deciding factor. The wiki should use the overwhelmingly common definition and write the articles on that basis, working around any issues that may arise. The consensus of a few people on Bogleheads is not sufficient to redefine common expressions.

I suggest that the article says something such as: One should generally compare the marginal rate on each dollar of contribution versus the marginal rate on withdrawing that dollar when making a Traditional vs Roth decision. However, there are a few situations where that may cause an incorrect choice to be made and where comparing the average tax rate of a larger contribution versus the average tax rate when withdrawing that contribution would yield a better choice. Examples of those situations are describe below:

...

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by MrBeaver » Mon May 20, 2019 1:31 pm

Fair warning: I've always been somewhat confused by the 'negative marginal rate' graphs showing tax savings as a function of contributions toward tax-differed vehicles. But these articles don't help me grasp those any better. I grasp paying taxes based on how much income I have just fine, but I don't automatically grasp these negative rate graphs as 'saving' taxes I would have paid had I made other decisions.
https://www.bogleheads.org/wiki/User:Fy ... inal_rates

I feel like I have a good understanding of marginal rates, tax policy, and tax-advantaged accounts. I prefer the traditional definition of 'marginal rate' as what happens to the next few dollars until the rate changes on the next dollar of income. But I find the following quote from the analysis section of the link above to muddle that definition and confuse the reader. It almost seems like it is using the latter proposed definition of marginal rate even though the former is stated to be the agreed method:
In the chart above, the "Cumulative" curve shows that calculation for the given starting point. For example, even though the marginal savings rate is 43% for contributions between $1,500 and $2,000, this couple would have to contribute $1,500 at only 22% in order to achieve that benefit. A $2,000 401(k) contribution would result in a tax savings of $543.83, for a marginal savings rate of ~27.19% ($543.83 / $2,000).
Is the bolded section (my bolding) just a typo and should instead be 'average savings rate'? Or is there something more I'm just not grasping?

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Mon May 20, 2019 1:51 pm

MrBeaver wrote:
Mon May 20, 2019 1:31 pm
Fair warning: I've always been somewhat confused by the 'negative marginal rate' graphs showing tax savings as a function of contributions toward tax-differed vehicles.
Those are just the convention used by that Excel tool: it is plotting "change in tax" vs. "something".

When an increase in "something" (e.g., tIRA withdrawals) causes an increase in tax, the plot shows positive values.

When an increase in "something" (e.g., 401k contributions) causes a decrease in tax, the plot shows negative values.

Does that make sense?

Note that plotting the absolute value, to make all curves have positive y-values, would not be appropriate in some cases. E.g., tax rate vs. income actually is negative at low income due to the earned income credit, then positive at higher incomes due to the "usual" tax brackets.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by MrBeaver » Mon May 20, 2019 2:04 pm

FiveK wrote:
Mon May 20, 2019 1:51 pm
MrBeaver wrote:
Mon May 20, 2019 1:31 pm
Fair warning: I've always been somewhat confused by the 'negative marginal rate' graphs showing tax savings as a function of contributions toward tax-differed vehicles.
Those are just the convention used by that Excel tool: it is plotting "change in tax" vs. "something".

When an increase in "something" (e.g., tIRA withdrawals) causes an increase in tax, the plot shows positive values.

When an increase in "something" (e.g., 401k contributions) causes a decrease in tax, the plot shows negative values.

Does that make sense?
Yes it does, it's just something that I had to learn by reading and thinking while not looking at the graph, and then later go look at the graph and interpret it. It may have something to do with inconsistent / sloppy axis labels and descriptions. In these pages, the negative graph is titled "Total Tax Rate vs 401k contribution", but the subtitle says "Marginal Savings Rate vs. 401(k) Contribution". I don't view this as a marginal savings rate, but rather the tax rate I would have paid if I had not contributed that dollar to a tax-deductible account.

I guess for me, the positive graphs immediately made several things click for me: marginal vs cumulative, social security tax humps, IRMAA, ACA credit and other phaseouts, etc. I had no such similar reaction when I viewed the negative graphs so they seem less intuitive. That doesn't mean they are wrong, I just think they require more explanation.
FiveK wrote:
Mon May 20, 2019 1:51 pm
Note that plotting the absolute value, to make all curves have positive y-values, would not be appropriate in some cases. E.g., tax rate vs. income actually is negative at low income due to the earned income credit, then positive at higher incomes due to the "usual" tax brackets.
Agreed.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Mon May 20, 2019 2:07 pm

rkhusky wrote:
Mon May 20, 2019 9:58 am
I suggest that the article says something such as:
One should generally compare the marginal rate on each dollar of contribution versus the marginal rate on withdrawing that dollar when making a Traditional vs Roth decision.

However, there are a few situations where that may cause an incorrect choice to be made and where comparing the average tax rate of a larger contribution versus the average tax rate when withdrawing that contribution would yield a better choice. Examples of those situations are describe below:...
Agreed in principle on the first sentence (especially if we add "plus its growth" to the withdrawal part)! Good to see we can leave the "marginal vs. effective" horse to rest in peace. :sharebeer

For the second paragraph, at one point the phrase "effective marginal" was considered but was not used. A reasonable case can be made to use it, but it is not without its drawbacks as well (and the same applies to "average marginal").

Because of the multiple meanings of average, effective, marginal, etc., we should provide the reader an operative definition of terms used in the "Traditional vs. Roth" wiki. Because the T vs. R wiki is written the way it is (using the phrase "marginal tax rate", that is why the User:Fyre4ce/Marginal tax rate article is written the way it is: to provide a definition that fits all cases.
FiveK wrote:
Mon May 20, 2019 8:54 am
Are there any examples in which using (change in tax)/(change in income) leads to an incorrect choice for that change in income?
If so, let's discuss. If not, let's put this to bed and go back to the consensus reached three years ago.
I disagree that that is the deciding factor. The wiki should use the overwhelmingly common definition and write the articles on that basis, working around any issues that may arise. The consensus of a few people on Bogleheads is not sufficient to redefine common expressions.
I can see how one might feel that way. If this were an apples to apples comparison, calling an apple an orange would indeed be confusing and inappropriate.

The smooth curves one finds in a Economics 101 textbook, however, often bear little resemblance to a plot of tax vs. income. The "overwhelmingly common definition" is thus defining something other than the what traditional vs. Roth chooser encounters. We have already agreed that $1 increments are too small to calculate marginal tax rate. When we discuss whether to use $100, $200, $1000, the generic "amount of income involved", etc., as the joke goes, now we're just haggling over price.

Kitces' language (which he still references in 2019 posts) remains the most useful definition, covering both the Economics 101 academic smooth curves and the real life tax code: marginal tax rate "is calculated by dividing the amount of additional taxes that will be due based on some decision (e.g., to take an IRA withdrawal) by the amount of income involved."

If, in the T vs. R article, we want to say "sometimes use 'marginal tax rate' and sometimes use 'something else'" then it would be fine if both "marginal tax rate" and "something else" are appropriately defined.


It does seem the most significant bone of contention, "marginal vs. marginal" vs. "marginal vs. effective" is behind us and we are dealing with semantic issues, with all concurring on the underlying math.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by fyre4ce » Mon May 20, 2019 2:34 pm

MrBeaver wrote:
Mon May 20, 2019 1:31 pm
Fair warning: I've always been somewhat confused by the 'negative marginal rate' graphs showing tax savings as a function of contributions toward tax-differed vehicles. But these articles don't help me grasp those any better. I grasp paying taxes based on how much income I have just fine, but I don't automatically grasp these negative rate graphs as 'saving' taxes I would have paid had I made other decisions.
https://www.bogleheads.org/wiki/User:Fy ... inal_rates

I feel like I have a good understanding of marginal rates, tax policy, and tax-advantaged accounts. I prefer the traditional definition of 'marginal rate' as what happens to the next few dollars until the rate changes on the next dollar of income. But I find the following quote from the analysis section of the link above to muddle that definition and confuse the reader. It almost seems like it is using the latter proposed definition of marginal rate even though the former is stated to be the agreed method:
In the chart above, the "Cumulative" curve shows that calculation for the given starting point. For example, even though the marginal savings rate is 43% for contributions between $1,500 and $2,000, this couple would have to contribute $1,500 at only 22% in order to achieve that benefit. A $2,000 401(k) contribution would result in a tax savings of $543.83, for a marginal savings rate of ~27.19% ($543.83 / $2,000).
Is the bolded section (my bolding) just a typo and should instead be 'average savings rate'? Or is there something more I'm just not grasping?
The negative sign from the Personal Finance Toolbox just refers to the fact that the tax due is going down while the contribution goes up. It's just a sign convention thing. In my analysis I prefer to flip the sign such that tax rates are positive on both ends - makes the comparison easier. It's probably worth including a note about the sign convention attached to the plot. A "true" negative marginal tax rate would mean that your total tax liability goes DOWN the more you earn, so the government would effectively subsidize your income. I'm not aware of cases where this happens, although there might be some out there.

To your second comment, I think the problem is the terminology is not consistent. Whatever is decided on the definitions, it needs to be consistent throughout the article. Once a decision is reached, we can help scrub it. Sorry for the confusion.

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Re: Seeking comment on proposed revisions to Marginal Tax Rate and Traditional v. Roth wiki articles

Post by FiveK » Mon May 20, 2019 3:09 pm

MrBeaver wrote:
Mon May 20, 2019 2:04 pm
Yes it does, it's just something that I had to learn by reading and thinking while not looking at the graph, and then later go look at the graph and interpret it. It may have something to do with inconsistent / sloppy axis labels and descriptions. In these pages, the negative graph is titled "Total Tax Rate vs 401k contribution", but the subtitle says "Marginal Savings Rate vs. 401(k) Contribution". I don't view this as a marginal savings rate, but rather the tax rate I would have paid if I had not contributed that dollar to a tax-deductible account.

I guess for me, the positive graphs immediately made several things click for me: marginal vs cumulative, social security tax humps, IRMAA, ACA credit and other phaseouts, etc. I had no such similar reaction when I viewed the negative graphs so they seem less intuitive. That doesn't mean they are wrong, I just think they require more explanation.
All good points. Please look at the latest version of Irregular marginal rates and see if that looks better to you. If good enough, great. If still lacking, suggestions appreciated!

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