nolesrule wrote: ↑
Wed Jun 05, 2019 7:19 am
Lee_WSP wrote: ↑
Tue Jun 04, 2019 10:33 pm
nolesrule wrote: ↑
Tue Jun 04, 2019 8:35 pm
Lee_WSP wrote: ↑
Tue Jun 04, 2019 2:56 pm
I see what your saying now.
I still don't think the cake analogy is correct since what you're doing is increasing the size of the cake rather than adding on another layer. Although the layer visual can adequately depict the brackets. Sort of like volume markers in a beaker.
You are increasing the size of the cake by adding another layer if you make a Traditional contribution. If you make a Roth contribution, then no layer gets added to the cake and ultimately the cake is smaller.
So for example, you are in the 22% bracket now, all of the this year's contribution is 22%. You look at the size of your cake currently and also with the additional layer of the potential contribution added in and take a slice of each cake (withdrawal) and use that to estimate your future taxes. Without that layer the top rate on your withdrawal may be 12%. But by adding another layer, maybe the top rate is 22%. That's the decision point one is trying to make with each year's contributions.
I'm not following this logic.
That's why I think we need a visual.
Previous contributions effect the withdrawal rate on future contributions, but not vice versa. That's where the layers come in. And because most people don't pull everything out in one withdrawal, that's why the withdrawal is a slice of all the layers. You have to look at where the slices line up with the tax brackets when income stacking.
Let's say for example you contribute $10k to Traditional for 20 years (I'm ignoring growth for simple illustration). You have $200k. What's the tax rate going to be upon withdrawal in retirement? You're not withdrawing all at once. Let's say you withdraw 4% in retirement. Your withdrawal is $8k.
Now, in year 21 you want to add another $10k. If you add to traditional, your 4% withdrawal in retirement becomes $8.4k. It's the tax rate on that $400 that you are comparing to the marginal rate on the $10k going in. The other $8k is only relevant to the decision because the $400 sits on top of it in the income stack for determining the in and out rates on the contribution.
The dollars may be fungible, but the effects of the contribution decision of those dollars is not fungible.
Let me try and understand the parameters:
- There will be X% withdrawal rate off the total retirement pool
- We're going to ignore Roth for the purposes of this illustration
- We're trying to illustrate how much current contributions will be taxed upon withdrawal
If I've got that right, let me propose the following.
I still disagree that it is a cake because the money is fungible and there is no specific basis with retirement accounts. The government currently does not care when you deposited it or what the basis is. So, it's more of a homogenous mix.
I propose thinking of it like a balloon which will expel X% each time period. As the balloon gets bigger, the total amount exiting each time period gets bigger as it is a portion of the total amount in the balloon.
So, each time you put more air into the balloon, the balloon gets bigger and the amount exiting gets bigger.
Knowing this, we can then surmise that by putting more air into the balloon will necessitate a larger expelling upon deflation time. However, the total amount expelled per period will continually decrease as the balloon shrinks in size (assuming no growth or at least assume withdrawals > growth).
The effect of putting in more trad contributions thus becomes:
You will increase the total amount of withdrawals each year as you will be withdrawing x%, however, if the percentage of withdrawals is > % growth, your amount of withdrawals per year will decrease over time. Likewise if %withdrawals < %growth your withdrawals will increase with time up until RMD's kick in.
If the trad account is at the margin & one more contribution will push it over into the next tax bracket, we can therefore say:
Some of this contribution will be taxed at the higher rate, but not all of it. And only a small portion will be taxed at the higher rate during retirement because that's how tax brackets work. In the next year, it is entirely possible and probable that the total withdrawals will be below the bracket margin and thus the contribution will not be taxed at a higher bracket.
But saying that that particular contribution ignores the fact that money is fungible, but for the purposes of this thought experiment, let's just say you can track it via specific basis. It's more accurate to say that Y% of the withdrawal (regardless of where the original contribution came from) will be taxed at the higher rate.