Taxable vs Nontaxable retirement savings: is there an ideal ratio?

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wjhunter
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Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by wjhunter » Thu Jan 10, 2019 4:44 pm

This might be a dumb question, but is there an ideal ratio of taxable to nontaxable retirement savings to shoot for or is it not something to worry about?

For example, in my case (spouse and I are both 51 and working - I plan on retiring before 55, spouse not until 65+). Our savings is 38% taxable and 62% in nontaxable (rollover IRAs, 401Ks, and Roths).

I assume we should continue maxing out our 401k contributions for the tax benefits - any reason not to?

retiredjg
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by retiredjg » Thu Jan 10, 2019 5:10 pm

If you are looking at this, you should probably segregate the groups a little differently.

A taxable account and a Roth IRA account are similar in that the contributions to either one have already been taxed. The others accounts are all tax-deferred, not non-taxable - tax will eventually be paid on this money.

No, there is no ideal ratio. While working, people like tax-deferred because they can take home more money. In retirement, they like Roth IRA best because they can have money and spend it with no taxes.

Also, the ratio you end up with has a lot to do with what types of accounts you have available and the order in which you fill them.

Many people believe it is good to have a combination of tax-deferred (such as a 401k) and already taxed money (such as a Roth IRA). Since one cannot contribute as much to Roth IRA as to 401k, the 401k is usually bigger.

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FiveK
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by FiveK » Thu Jan 10, 2019 7:56 pm

retiredjg wrote:
Thu Jan 10, 2019 5:10 pm
No, there is no ideal ratio.
+1

wjhunter, the ratio is a consequence, not a target. Your target should be to have a traditional account balance from which a 4%/yr (or your chosen %) withdrawal will start to incur a marginal tax rate equal to the marginal tax rate you can save by making a traditional contribution now. Amounts above that should be Roth.

That's a bit of a mouthful, but here's a quick introductory example: if you project having a $1 million balance in your traditional accounts at retirement and expect $10,600/yr in dividends from your taxable investments, withdrawing $40K/yr puts your marginal rate at
- 27% for filing single, or
- 10% for filing MFJ.

Does that make sense?

texasdiver
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by texasdiver » Thu Jan 10, 2019 8:19 pm

Well, obviously you'd rather have $1 million in a Roth than $1 million in a traditional IRA.

The pat answer you often hear from financial advisors is that you want to do tax-deferred savings if you think your tax rate will be lower when you are retired and Roth savings if you think your tax rate will be higher when you retire. But who knows what the tax rates will be when you retire. A whole bunch of people two decades ago were convinced that taxes rates were going up. In fact they have dropped for most people.

For me the answer is to max out tax-deferred savings first before thinking about taxable savings. Because I think of my retirement savings as one part future income and one part future insurance against poverty or disaster. For example, if everything flies off the wheels in your life at age 75, would you rather have $100k in a traditional IRA or $70k in a Roth? I would argue the $100k in a traditional IRA because at that point you are most likely in the zero percent tax bracket and not going to pay any taxes on the $100k in the traditional IRA anyway. In other words, if, God forbid, you wind up poor in retirement you are unlikely to ever owe much if anything on those tax-deferred traditional IRAs and it would have been a waste to have paid all that tax back when you were earning.

Put another way, tilting towards tax-deferred savings is insurance against being poorer than you expect in retirement. Tilting towards a Roth (or taxable) savings is insurance that you will be richer than you expect in retirement. Which eventuality is more important to insure against?

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wjhunter
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by wjhunter » Mon Jan 14, 2019 9:03 am

texasdiver wrote:
Thu Jan 10, 2019 8:19 pm
Put another way, tilting towards tax-deferred savings is insurance against being poorer than you expect in retirement. Tilting towards a Roth (or taxable) savings is insurance that you will be richer than you expect in retirement. Which eventuality is more important to insure against?
Thanks for the reply - this is a good way to frame the issue. I said nontaxable, but of course I meant tax-deferred.

marcopolo
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by marcopolo » Mon Jan 14, 2019 9:14 am

wjhunter wrote:
Thu Jan 10, 2019 4:44 pm
This might be a dumb question, but is there an ideal ratio of taxable to nontaxable retirement savings to shoot for or is it not something to worry about?

For example, in my case (spouse and I are both 51 and working - I plan on retiring before 55, spouse not until 65+). Our savings is 38% taxable and 62% in nontaxable (rollover IRAs, 401Ks, and Roths).

I assume we should continue maxing out our 401k contributions for the tax benefits - any reason not to?
I separate the tax categories a bit differently:

1) Tax-Free: Roth IRA, Roth401k, HSA, 529 plans
2) Tax-deferred: Trad IRA, Trad 401k, 403B.
3) Taxable: Brokerage, Saving.

All things being equal, you would like to have more in 1, then 2, then 3. But, all things are not equal. For example, getting more of your money into (1) has the cost of paying taxes up front, which might not be worth it, based on your situation.

Where you end up in the ratio is more a result of planning (hopefully) during accumulation phase, and it likely changes over time.
During your high earning (tax rate) years, it probably makes sense to put more into (2), than in to (1). But, if you retire early, during the lower income (tax rate) years, it probably makes sense to move some (a lot) of the money from (2) into (1) via Roth conversions.
Also, if you do retire in your 50s, (i did), there is a lot of flexibility to be gained by having a sizable amount of your portfolio in (3).

Good luck to you.
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Clever_Username
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by Clever_Username » Mon Jan 14, 2019 11:29 am

My belief has generally been to max out tax-advantaged space first, unless saving for something that those vehicles aren't appropriate for.

In my case, I'll max out my 403(b), make any Roth IRA contributions I can make for the year (if any), get my $10K worth of Series I Bonds. Only after that will I invest in a non-tax-advantaged account. When I qualify for my 457, I will prioritize that over the non-tax-advantaged account.

Then again, I am not saving up for a house and have no desire to purchase investment property, so YMMV.

My biggest worry with my plan, if it can even be called that, is that I will hit the year I turn 70.5 (I am approximately at the halfway point from birth to this) and my RMDs will be significantly more than I plan to spend that year. This doesn't seem like such a terrible problem to have.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_ | | I survived my first downturn and all I got was this signature line.

Spirit Rider
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by Spirit Rider » Mon Jan 14, 2019 2:20 pm

marcopolo wrote:
Mon Jan 14, 2019 9:14 am
1) Tax-Free: Roth IRA, Roth401k, HSA, 529 plans
2) Tax-deferred: Trad IRA, Trad 401k, 403B.
3) Taxable: Brokerage, Saving.
I re-order by potential tax liability and delineate a little further:
  1. Potentially Tax-Free
    1. Tax-Free (Roth IRA and Roth 401k)
    2. Tax-deferred/likely Tax-Free (HSA and 529)
  2. Potentially Taxable
    1. Tax-Loss carry-forward with short-term Tax-Free redemption
    2. Taxable for legacy inheritance with step-up future Tax-Free redemption
    3. Taxable near/far term redemption
  3. Tax-deferred
I think ideally you should have 20% - 50% in each of the three buckets by age 65. I think you should use good tax diversification judgement during the accumulation phase, but should not let it wag the actual tax benefit dog. I.e. I might choose a Roth IRA before maxing traditional deferrals to an employer plan after getting the full employer match., but I certainly wouldn't make taxable investments in place of tax-deferred in the two highest tax brackets.

marcopolo
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by marcopolo » Mon Jan 14, 2019 5:15 pm

Spirit Rider wrote:
Mon Jan 14, 2019 2:20 pm
marcopolo wrote:
Mon Jan 14, 2019 9:14 am
1) Tax-Free: Roth IRA, Roth401k, HSA, 529 plans
2) Tax-deferred: Trad IRA, Trad 401k, 403B.
3) Taxable: Brokerage, Saving.
I re-order by potential tax liability and delineate a little further:
  1. Potentially Tax-Free
    1. Tax-Free (Roth IRA and Roth 401k)
    2. Tax-deferred/likely Tax-Free (HSA and 529)
  2. Potentially Taxable
    1. Tax-Loss carry-forward with short-term Tax-Free redemption
    2. Taxable for legacy inheritance with step-up future Tax-Free redemption
    3. Taxable near/far term redemption
  3. Tax-deferred
I think ideally you should have 20% - 50% in each of the three buckets by age 65. I think you should use good tax diversification judgement during the accumulation phase, but should not let it wag the actual tax benefit dog. I.e. I might choose a Roth IRA before maxing traditional deferrals to an employer plan after getting the full employer match., but I certainly wouldn't make taxable investments in place of tax-deferred in the two highest tax brackets.
I like your additional delineation. I will have to start thinking about it that way. As an example, it appears we have probably over-funded our kids 529 plans. Those funds (we may need to use them someday rather than passing to next generation for education) should definitely transition to the "Potentially" tax-free bucket; I used to think of them as tax-free.

I am curious about your change in ordering. I kind of think of them in order of value to me. tax-free, tax-deferred, then taxable.
I think what you are saying is that the taxable is only potentially taxable (and you give some example where tax could be avoided).
But, the tax deferred is going to get taxed at some point. So, that ranks below the potentially taxable category.

Is that a fair description of your thinking? I will have to give that some thought.


I agree with your comments on tax-diversification and planning. I would add that while critical in the accumulation phase, using good judgement in tax diversification/planning should extend into the withdrawal phase as well.
Once in a while you get shown the light, in the strangest of places if you look at it right.

JustinR
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by JustinR » Mon Jan 14, 2019 5:59 pm

As much tax-deferred as humanly possible.

It's that simple really.

Spirit Rider
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by Spirit Rider » Mon Jan 14, 2019 6:23 pm

I use my order based on likely tax liability

Equities will taxable on dividends and capital gains. Qualified dividends and capital gains are subject to much lower capital gains tax rates. Capital gains from sales are only on the gains.

Taxes on tax-deferred distributions are on the entire amount and subject to the much higher ordinary income taxes.

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