traditional IRA vs Roth - how to figure out

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Sahara
Posts: 332
Joined: Tue Dec 04, 2018 6:21 pm

Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

I agree.

I don't think you can do Solo 401K and also deduct a Traditional IRA contribution. You could contribute to the Traditional IRA, but it would not be deductible so there is really no advantage.

If the Solo 401K is a go, you would invest what you are allowed for 2021 in the Solo 401K. Your accountant can provide the contribution limit, and there are also online calculators for a rough estimate if you have the data they require such as this one: https://obliviousinvestor.com/solo-401k ... alculator/

If you have more than your Solo 401K limit to invest for 2021, then you could also utilize a taxable account. 3 buckets!

Hopefully other posters will be able to help with the 401k setup if you go that route. It's not something I have experience with but there are many here who are knowledgeable in that area. If you poke around on the Wiki or the forum you will see what people commonly recommend.
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FiveK
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Re: traditional IRA vs Roth - how to figure out

Post by FiveK »

Sahara wrote: Thu Apr 01, 2021 5:52 pm I don't think you can do Solo 401K and also deduct a Traditional IRA contribution. You could contribute to the Traditional IRA, but it would not be deductible so there is really no advantage.
With $80K gross income, contributing $14K or more to a solo 401k (so AGI is $66K or less) will allow a full $7K tIRA deduction.

With a solo 401k in effect, AGI < $66K (see IRA Deduction Limits) is the key to full tIRA deductibility, so if there is some other taxable income (income, dividends, etc.) that must be considered also.
Sahara
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Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

Aha. So the options increase. Possibly 19,500 in the Solo 401k and 7,000 in the Traditional IRA for 2021 depending on her profit. Thank you.

By the way FiveK, I attended your Zoom presentation regarding the personal finance toolbox. Thanks for making it make sense! Could you explain the IRMMA spikes though? I was wondering why they are spikes. Does the tax rate go back down?
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FiveK
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Re: traditional IRA vs Roth - how to figure out

Post by FiveK »

Sahara wrote: Thu Apr 01, 2021 9:37 pm By the way FiveK, I attended your Zoom presentation regarding the personal finance toolbox. Thanks for making it make sense! Could you explain the IRMMA spikes though? I was wondering why they are spikes. Does the tax rate go back down?
The chart shows marginal tax rates, not tax amounts. E.g., if one were to plot the Illinois state tax only, the chart would show a flat line at 4.95%.

The Medicare premium Income Related Monthly Adjustment Amounts (IRMAA) are fixed amounts that change step-wise: see tfb's chart labeled "Annual Medicare Part B Premium Per Person" in 2021 2022 Medicare Part B Part D IRMAA Premium Brackets.

Thus the IRMAA marginal tax rate, (change in premium)/(change in income), on some income amount, if that amount causes one to move to a higher IRMAA tier, can be huge. That's what causes the spikes. But then the IRMAA marginal tax rate does indeed go back down to 0% (because the premium amount doesn't change), until one reaches the next tier, etc. Does that help?
Sahara
Posts: 332
Joined: Tue Dec 04, 2018 6:21 pm

Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

FiveK wrote: Thu Apr 01, 2021 10:16 pm
Sahara wrote: Thu Apr 01, 2021 9:37 pm By the way FiveK, I attended your Zoom presentation regarding the personal finance toolbox. Thanks for making it make sense! Could you explain the IRMMA spikes though? I was wondering why they are spikes. Does the tax rate go back down?
The chart shows marginal tax rates, not tax amounts. E.g., if one were to plot the Illinois state tax only, the chart would show a flat line at 4.95%.

The Medicare premium Income Related Monthly Adjustment Amounts (IRMAA) are fixed amounts that change step-wise: see tfb's chart labeled "Annual Medicare Part B Premium Per Person" in 2021 2022 Medicare Part B Part D IRMAA Premium Brackets.

Thus the IRMAA marginal tax rate, (change in premium)/(change in income), on some income amount, if that amount causes one to move to a higher IRMAA tier, can be huge. That's what causes the spikes. But then the IRMAA marginal tax rate does indeed go back down to 0% (because the premium amount doesn't change), until one reaches the next tier, etc. Does that help?
Yes. I think. What’s being represented visually by the spike is that when the income hits 87,001 the individual has to pay the higher premium. Then it occurs again at 109,001 etc.

Not to derail this thread. Thank you.
Topic Author
hartista
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Joined: Fri Mar 19, 2021 2:50 pm

Re: traditional IRA vs Roth - how to figure out

Post by hartista »

FiveK wrote: Thu Apr 01, 2021 9:08 pm
Sahara wrote: Thu Apr 01, 2021 5:52 pm I don't think you can do Solo 401K and also deduct a Traditional IRA contribution. You could contribute to the Traditional IRA, but it would not be deductible so there is really no advantage.
With $80K gross income, contributing $14K or more to a solo 401k (so AGI is $66K or less) will allow a full $7K tIRA deduction.

With a solo 401k in effect, AGI < $66K (see IRA Deduction Limits) is the key to full tIRA deductibility, so if there is some other taxable income (income, dividends, etc.) that must be considered also.
Hello thanks for chiming in here. So sounds like you're saying that if the 401K is possible for me that's the best way to go as it allows for the 401K + the full IRA contributions to be tax deferred. Correct? If so I'll check with my account and see if that is possible. Thank you!
Topic Author
hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Sahara wrote: Thu Apr 01, 2021 9:37 pm Aha. So the options increase. Possibly 19,500 in the Solo 401k and 7,000 in the Traditional IRA for 2021 depending on her profit. Thank you.

By the way FiveK, I attended your Zoom presentation regarding the personal finance toolbox. Thanks for making it make sense! Could you explain the IRMMA spikes though? I was wondering why they are spikes. Does the tax rate go back down?
Ok, so sounds like you're both saying that the 401K would be the first choice for another bucket if I'm able, is that how you're seeing it now? That way I'd make all my contributions for the year ($7000 IRA + $14,000 or so) in a tax deferred bucket. If you think this is best possible choice I'll go ahead and discuss with accountant. Glad you got some good info from your buddy here on another topic!
Sahara
Posts: 332
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Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

hartista wrote: Fri Apr 02, 2021 7:15 pm Glad you got some good info from your buddy here on another topic!
Yue, FiveK is one of the more knowledgeable members of the forum. You are lucky to have him helping you here.
Sahara
Posts: 332
Joined: Tue Dec 04, 2018 6:21 pm

Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

hartista wrote: Fri Apr 02, 2021 7:11 pm
FiveK wrote: Thu Apr 01, 2021 9:08 pm
Sahara wrote: Thu Apr 01, 2021 5:52 pm I don't think you can do Solo 401K and also deduct a Traditional IRA contribution. You could contribute to the Traditional IRA, but it would not be deductible so there is really no advantage.
With $80K gross income, contributing $14K or more to a solo 401k (so AGI is $66K or less) will allow a full $7K tIRA deduction.

With a solo 401k in effect, AGI < $66K (see IRA Deduction Limits) is the key to full tIRA deductibility, so if there is some other taxable income (income, dividends, etc.) that must be considered also.
Hello thanks for chiming in here. So sounds like you're saying that if the 401K is possible for me that's the best way to go as it allows for the 401K + the full IRA contributions to be tax deferred. Correct? If so I'll check with my account and see if that is possible. Thank you!
Hartista, there are usually a number of good options and rarely an “optimal plan” when it comes to retirement planning and investing. When we involve our intellect, our emotions, finances and the IRS, things get complicated. Personally, I tend to strive for the least complexity or complication. Others are fine with complexity and multiple accounts and transactions.

So to return to the issue at hand. Are you a sole proprietor?

A sole proprietor over 50 years of age can contribute up to $25,500 to a Solo 401K as “employee contributions” depending upon their profit. There is an additional provision for “employer contributions.” More details on this can be found here https://www.bogleheads.org/wiki/Solo_401(k)_plan

The sum of these allowable contributions to a Solo 401K max out at $57,000 per year.

To return to your question of what FiveK and I are recommending.
I (Sahara) was unclear as to whether an individual could contribute to a Solo 401K and also deduct a contribution to a Traditional IRA. FiveK clarified that it is allowed if your AGI is under $56,000. So now we know that we can include that in the list of options to choose from.

Next comes the complicated part. Your Solo 401K allowance for 2021 will be based upon your profit for 2021. Your accountant may be able to make a projection based upon your 2020 profit, but will not be able to tell you exactly how much you will be able to contribute until your 2021 taxes are done. Many people are in this situation and handle it by regular contributions below the limit they expect and/or waiting until the deadline to contribute or top off the account to its limit. It’s important not to exceed IRS limits, as I know you understand.

Now comes the intellectual vs emotion vs financial vs IRS part.

You have $25,000 and more coming this year that you want to invest. You are in the 22% tax bracket. You are excited about getting started. The “optimal” thing to do would be to use tax deferred vehicles such as the Solo 401K or/and Traditional IRA for as many dollars as allowed. What is the advantage? You are saving 10% in Federal Income tax when you do that. So, if we look at just the employee contribution of 25,500 you are saving $2,550 in Federal Income tax. What is the disadvantage? It’s complicated, you have some learning to do, and you need to rely upon the generous strangers here on the internet and your accountant and the person on the phone at Vanguard to make these complex decisions. So, my point here is to remember that it is your money and your life and we can give you suggestions and facts to steer you away from terrible mistakes. But we probably can’t come up with an “optimal” scenario for you.

What would someone else do in your situation?

One, with $25,000 in hand, one might plop $7,000 in a Traditional IRA, 18,000 in a taxable account, and explore the Solo 401k options. The understanding would be that he or she gets the money in the market now and gets moving on the Solo 401K path, and the Traditional IRA would definitely be deductible if there were no big changes in employment or income for 2021.

Another might spend hours on the BH forum and other internet sites, email his or her accountant, and compare index funds to the Balanced Index, wondering which is optimal. Then the individual would put the decision off until he or she had someone authoritative to answer the question, relying on them to provide the “optimal solution” that doesn’t exist.

A third might work with her accountant to calculate the probable 2021 Solo 401K contribution. She would set up the plan over the next few months, gather the projected amount in a savings account until next April, repeating on an annual basis with precision.

As you can see, you’ve waded into an area of life without 100% clarity and you may have to accept that, like the rest of us, you may never achieve an ideal. As you continue to learn and make decisions about your investing, please let us know how we can help you make the best decisions for you.
Topic Author
hartista
Posts: 37
Joined: Fri Mar 19, 2021 2:50 pm

Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Sahara wrote: Sat Apr 03, 2021 7:27 am
hartista wrote: Fri Apr 02, 2021 7:15 pm Glad you got some good info from your buddy here on another topic!
Yue, FiveK is one of the more knowledgeable members of the forum. You are lucky to have him helping you here.
Wow, I love that and yes I have felt fortunate from the start, for you both!! My lucky stars were lined up haha!
Topic Author
hartista
Posts: 37
Joined: Fri Mar 19, 2021 2:50 pm

Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Sahara wrote: Sat Apr 03, 2021 7:39 am
hartista wrote: Fri Apr 02, 2021 7:11 pm
FiveK wrote: Thu Apr 01, 2021 9:08 pm
Sahara wrote: Thu Apr 01, 2021 5:52 pm I don't think you can do Solo 401K and also deduct a Traditional IRA contribution. You could contribute to the Traditional IRA, but it would not be deductible so there is really no advantage.
With $80K gross income, contributing $14K or more to a solo 401k (so AGI is $66K or less) will allow a full $7K tIRA deduction.

With a solo 401k in effect, AGI < $66K (see IRA Deduction Limits) is the key to full tIRA deductibility, so if there is some other taxable income (income, dividends, etc.) that must be considered also.
Hello thanks for chiming in here. So sounds like you're saying that if the 401K is possible for me that's the best way to go as it allows for the 401K + the full IRA contributions to be tax deferred. Correct? If so I'll check with my account and see if that is possible. Thank you!
Hartista, there are usually a number of good options and rarely an “optimal plan” when it comes to retirement planning and investing. When we involve our intellect, our emotions, finances and the IRS, things get complicated. Personally, I tend to strive for the least complexity or complication. Others are fine with complexity and multiple accounts and transactions.

So to return to the issue at hand. Are you a sole proprietor?

A sole proprietor over 50 years of age can contribute up to $25,500 to a Solo 401K as “employee contributions” depending upon their profit. There is an additional provision for “employer contributions.” More details on this can be found here https://www.bogleheads.org/wiki/Solo_401(k)_plan

The sum of these allowable contributions to a Solo 401K max out at $57,000 per year.

To return to your question of what FiveK and I are recommending.
I (Sahara) was unclear as to whether an individual could contribute to a Solo 401K and also deduct a contribution to a Traditional IRA. FiveK clarified that it is allowed if your AGI is under $56,000. So now we know that we can include that in the list of options to choose from.

Next comes the complicated part. Your Solo 401K allowance for 2021 will be based upon your profit for 2021. Your accountant may be able to make a projection based upon your 2020 profit, but will not be able to tell you exactly how much you will be able to contribute until your 2021 taxes are done. Many people are in this situation and handle it by regular contributions below the limit they expect and/or waiting until the deadline to contribute or top off the account to its limit. It’s important not to exceed IRS limits, as I know you understand.

Now comes the intellectual vs emotion vs financial vs IRS part.

You have $25,000 and more coming this year that you want to invest. You are in the 22% tax bracket. You are excited about getting started. The “optimal” thing to do would be to use tax deferred vehicles such as the Solo 401K or/and Traditional IRA for as many dollars as allowed. What is the advantage? You are saving 10% in Federal Income tax when you do that. So, if we look at just the employee contribution of 25,500 you are saving $2,550 in Federal Income tax. What is the disadvantage? It’s complicated, you have some learning to do, and you need to rely upon the generous strangers here on the internet and your accountant and the person on the phone at Vanguard to make these complex decisions. So, my point here is to remember that it is your money and your life and we can give you suggestions and facts to steer you away from terrible mistakes. But we probably can’t come up with an “optimal” scenario for you.

What would someone else do in your situation?

One, with $25,000 in hand, one might plop $7,000 in a Traditional IRA, 18,000 in a taxable account, and explore the Solo 401k options. The understanding would be that he or she gets the money in the market now and gets moving on the Solo 401K path, and the Traditional IRA would definitely be deductible if there were no big changes in employment or income for 2021.

Another might spend hours on the BH forum and other internet sites, email his or her accountant, and compare index funds to the Balanced Index, wondering which is optimal. Then the individual would put the decision off until he or she had someone authoritative to answer the question, relying on them to provide the “optimal solution” that doesn’t exist.

A third might work with her accountant to calculate the probable 2021 Solo 401K contribution. She would set up the plan over the next few months, gather the projected amount in a savings account until next April, repeating on an annual basis with precision.

As you can see, you’ve waded into an area of life without 100% clarity and you may have to accept that, like the rest of us, you may never achieve an ideal. As you continue to learn and make decisions about your investing, please let us know how we can help you make the best decisions for you.
To answer your question - yes I am a sole proprietor, just me, myself and I run this show.

Next this is great! I do "human development" for a living and it's always better to help people learn how to think about things, rather than give them an exact way. So you are on the same track as I am, however you are shortening my learning curve quite a bit because I don't plan to be on the internet or forum for endless hours. I plan to make the best, most reasonable choice I can with the info I have, and then learn and adjust from there! I don't wring my hands or lie awake at night (haha), I find good helpers in life (thank you!), then I trust my own instincts and learn best as I can.

My impulse is to go as far as I can with the 401K if that's a possibility, that plus the IRA seems like it would take up much of the buik of my current investments anyway and then I can grow and learn from there. If there'anything I'm not seeing here, you're welcome to say so.

You mentioned awhile back not to put the same asset allocations in different buckets. What did you mean by this? If I chose the type of AA that you laid out on the spreadsheet for the IRA, how would I figure out the allocations for the 401K (or other bucket) route?

Lastly I apologize if pasting the whole discussion back in here is not correct but any time I tried to edit it, it doesn't show up in different colors (for your reading ease), so still learning on this front.

Last but not least, I really thank my lucky stars for finding two very helpful helpers right off the bat. I could have gotten discouraged easily and given up but you made my experience quite great!
Sahara
Posts: 332
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Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

hartista wrote: Mon Apr 05, 2021 7:40 pm
To answer your question - yes I am a sole proprietor, just me, myself and I run this show.

My impulse is to go as far as I can with the 401K if that's a possibility, that plus the IRA seems like it would take up much of the buik of my current investments anyway and then I can grow and learn from there. If there's anything I'm not seeing here, you're welcome to say so.

You mentioned a while back not to put the same asset allocations in different buckets. What did you mean by this? If I chose the type of AA that you laid out on the spreadsheet for the IRA, how would I figure out the allocations for the 401K (or other bucket) route?

Lastly I apologize if pasting the whole discussion back in here is not correct but any time I tried to edit it, it doesn't show up in different colors (for your reading ease), so still learning on this front.

Last but not least, I really thank my lucky stars for finding two very helpful helpers right off the bat. I could have gotten discouraged easily and given up but you made my experience quite great!
I’m glad you feel that you are learning how to apply this yourself. I spent 30 years teaching Spanish to adolescents, and I always had better results being the “guide on the side” than the “sage on the stage.” The goal here is to empower you. There are many roads you can take, support and guidance are good, but you don’t want to be in a position of needing “permission.”

Yes, I agree with your choice to pursue the Solo 401K option. I think the main factor will be the net income from your most recent tax return, in terms of what your allowable contribution is. You could always start another thread “Solo 401k advice” with a link to this thread if you want specific advice. Some forum members tend to be drawn to posts where their interests or expertise lie.

To answer your question about asset allocation. The term asset allocation refers to which assets (ie: funds) you place (ie: allocate) in which buckets (ie: accounts.) The Bogleheads way is that when you have more than one “bucket/account” you always go back to the basic math of the overall portfolio to determine the proportions of the funds. Then you "allocate" them to the buckets/accounts. Somehow life always boils down to language doesn't it?

STEP 1
If you want a simple 3 fund portfolio with 70% stock and 30% bonds it would look like this
Assets 100,000 (insert any amount here and follow the math)
30% Bonds = $30,000 VBTLX Vanguard Total Bond Index
70% Stock = $70,000
>> 80% US = $56,000 VTSAX Vanguard Total Stock Market Index
>> 20% International = 14,000 VTIAX Vanguard Total International Stock Index

STEP 2 Divide the dollars among the accounts as you wish. Sometimes it can be easiest to have the International Fund in only one account, and that would be the account you use for rebalancing. And, since contributions are one good way to rebalance or maintain your allocation, you might place the International Fund in the Solo 401K. For example, in your Rollover IRA you might have Total Bond Index and Total Stock Index and in your Solo 401K you might have Total Bond Index, Total Stock Index and Total International Index. If things get out of proportion you don't have to touch the Rollover IRA, just move what's needed to get back in proportion in the Solo 401K or contribute more/less to one fund. But that's getting ahead of things and should not be a major issue. I'll try to plot it out a bit on a tab in the spreadsheet and see what it would look like as well.

STEP 3 if necessary You want to pay more attention to which funds go in which buckets when you have Roth accounts and Taxable Accounts. You do not want Bonds to go in those accounts. I can explain that if you’d like but it’s not relevant for you at this point so I will spare you.

Regarding posting, it can be tricky due to the formatting. You don’t always need to reference a previous post if you are continuing the conversation. If you want to reference a previous post - but not the whole thing - you could either

a) use the quote function, then place your cursor in the text and delete the parts that aren’t relevant. This isn’t easy and I usually end up erasing the portion of the text that turns it yellow which I think is what you are referring to. To avoid that you have to make sure you don’t delete the first and last portion of the formatting as shown below >> with the brackets around them. Make sure to leave those at the top and bottom and that portion should show up yellow.
First: quote=hartista post_id=5926348 time=1617669614 user_id=173251
Last: /quote

b) you can always simply say “Hey Sahara, remember you said “XYZ,” why is that, etc.?
Topic Author
hartista
Posts: 37
Joined: Fri Mar 19, 2021 2:50 pm

Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Sahara wrote: Mon Apr 05, 2021 9:06 pm
hartista wrote: Mon Apr 05, 2021 7:40 pm
To answer your question - yes I am a sole proprietor, just me, myself and I run this show.

My impulse is to go as far as I can with the 401K if that's a possibility, that plus the IRA seems like it would take up much of the buik of my current investments anyway and then I can grow and learn from there. If there's anything I'm not seeing here, you're welcome to say so.
I’m glad you feel that you are learning how to apply this yourself. I spent 30 years teaching Spanish to adolescents, and I always had better results being the “guide on the side” than the “sage on the stage.” The goal here is to empower you. There are many roads you can take, support and guidance are good, but you don’t want to be in a position of needing “permission.”

Yes, I agree with your choice to pursue the Solo 401K option. I think the main factor will be the net income from your most recent tax return, in terms of what your allowable contribution is. You could always start another thread “Solo 401k advice” with a link to this thread if you want specific advice. Some forum members tend to be drawn to posts where their interests or expertise lie.

To answer your question about asset allocation. The term asset allocation refers to which assets (ie: funds) you place (ie: allocate) in which buckets (ie: accounts.) The Bogleheads way is that when you have more than one “bucket/account” you always go back to the basic math of the overall portfolio to determine the proportions of the funds. Then you "allocate" them to the buckets/accounts. Somehow life always boils down to language doesn't it?

STEP 1
If you want a simple 3 fund portfolio with 70% stock and 30% bonds it would look like this
Assets 100,000 (insert any amount here and follow the math)
30% Bonds = $30,000 VBTLX Vanguard Total Bond Index
70% Stock = $70,000
>> 80% US = $56,000 VTSAX Vanguard Total Stock Market Index
>> 20% International = 14,000 VTIAX Vanguard Total International Stock Index

STEP 2 Divide the dollars among the accounts as you wish. Sometimes it can be easiest to have the International Fund in only one account, and that would be the account you use for rebalancing. And, since contributions are one good way to rebalance or maintain your allocation, you might place the International Fund in the Solo 401K. For example, in your Rollover IRA you might have Total Bond Index and Total Stock Index and in your Solo 401K you might have Total Bond Index, Total Stock Index and Total International Index. If things get out of proportion you don't have to touch the Rollover IRA, just move what's needed to get back in proportion in the Solo 401K or contribute more/less to one fund. But that's getting ahead of things and should not be a major issue. I'll try to plot it out a bit on a tab in the spreadsheet and see what it would look like as well.

STEP 3 if necessary You want to pay more attention to which funds go in which buckets when you have Roth accounts and Taxable Accounts. You do not want Bonds to go in those accounts. I can explain that if you’d like but it’s not relevant for you at this point so I will spare you.

Regarding posting, it can be tricky due to the formatting. You don’t always need to reference a previous post if you are continuing the conversation. If you want to reference a previous post - but not the whole thing - you could either

First: quote=hartista post_id=5926348 time=1617669614 user_id=173251
Last: /quote

b) you can always simply say “Hey Sahara, remember you said “XYZ,” why is that, etc.?
Hello, thanks for the help on posting, I'm still learning but did a slight trim on this one! Ah now on to my next major task is to study asset allocation and the tax buckets but thanks to your head start, I'm beginning! I am looking at it as a whole picture and then start to lay out which taxable, non taxable or tax deferred buckets are best for each type of investment. Thats the overall idea and I don't want to make it too complicated but would like to understand it. I'm also reading the book Power of Zero and he has quite an in depth discussion of why to use the Roth, so more learning here. Any thoughts on this or easiest way to succeed? Overall I'm still proceeding with all of our above ideas, I probably need to wait until after tax season to get the ear of my accountant but I imagine there's no hurry here now that my funds are in an IRA, correct? Best to take my time I imagine. Thanks again, I printed out my notes to study haha! You're a true educator :>)
User avatar
FiveK
Posts: 11103
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Re: traditional IRA vs Roth - how to figure out

Post by FiveK »

hartista wrote: Wed Apr 07, 2021 11:50 amI'm also reading the book Power of Zero and he has quite an in depth discussion of why to use the Roth, so more learning here. Any thoughts on this or easiest way to succeed?
As several posts in The Power of Zero (0% tax bracket in retirement) book - Bogleheads.org note, it isn't "minimize how much one pays in taxes" that always provides the best result. Instead, it's "maximize how much one has to spend after paying taxes."

While those amounts may be two sides of the same coin for any one year, looking across many years they can differ. To see this, compare traditional vs. Roth (both taxes paid and amount left to spend) for
- 22% tax bracket at contribution
- 12% tax bracket at withdrawal
- investment value doubles between contribution and withdrawal.

You should find that using traditional in those circumstances
- causes more tax paid, but
- provides more to spend after taxes.
Sahara
Posts: 332
Joined: Tue Dec 04, 2018 6:21 pm

Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

Hartista,

This is a much debated topic. One can use software such as EMoney or Pralana Gold, or Excel spreadsheet calculators such as Personal Finance Toolbox, or one's own spreadsheet to see how it plays out in their individual situation.

For me, the light bulb went on when I calculated the potential growth of the money I would spend in taxes. If that money is not taken into consideration, Roth appears to be a big win. However, if that money is invested it makes up for the perceived benefit. Below is how I have learned to frame the issue.

The goal should not be to pay as little tax as possible. The goal should be to have as much money left over after taxes as possible. Comparing marginal rates between contribution (or conversion now) and withdrawal in the future is the most direct way to achieve this goal.

Suppose you're in a 10% marginal tax bracket now and in retirement (Just to make the math easy). You have $1000 to invest, you're retiring next year, and you'll get a 10% return (again to make the math easy). So, you could invest all $1000 in traditional, it will grow to $1100 next year and when you withdraw it you'll owe $110 in taxes leaving $990 to spend.

Or you could pay $100 taxes now and invest the remaining $900 in Roth, which will grow to $990 next year all of which you'll be able to spend.

Do this for however many years, whatever rate of return, whatever marginal tax bracket, and however much money and the results will always be the same because of the commutative property. As long as your marginal tax bracket is equal when investing and in retirement and you invest any tax savings in traditional then traditional and Roth will be exactly the same. A lower marginal tax bracket when investing than in retirement favors Roth and vice versa.
Sahara
Posts: 332
Joined: Tue Dec 04, 2018 6:21 pm

Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

hartista wrote: Wed Apr 07, 2021 11:50 am Overall I'm still proceeding with all of our above ideas, I probably need to wait until after tax season to get the ear of my accountant but I imagine there's no hurry here now that my funds are in an IRA, correct? Best to take my time I imagine. Thanks again, I printed out my notes to study haha! You're a true educator :>)
You're a good student! That's what I've done here as well - take lots of notes.

Since your funds are in an IRA, there is no hurry. Of course, they are in a money market fund and not a stock or bond mutual fund where they might make a higher return, which is the goal. Of course, they might also lose money in a stock or bond mutual fund and the hope is that in the long term you come out ahead.

One thought I did have was that a simple solution for you if all of your accounts are tax deferred would be to use the Balanced Index Fund in all of them. That way the rebalancing is automatic. Your contributions are easy as well, no calculations. I would not recommend that for a Roth or Taxable account.
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hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

FiveK wrote: Wed Apr 07, 2021 1:28 pm
hartista wrote: Wed Apr 07, 2021 11:50 amI'm also reading the book Power of Zero and he has quite an in depth discussion of why to use the Roth, so more learning here. Any thoughts on this or easiest way to succeed?
As several posts in The Power of Zero (0% tax bracket in retirement) book - Bogleheads.org note, it isn't "minimize how much one pays in taxes" that always provides the best result. Instead, it's "maximize how much one has to spend after paying taxes."

While those amounts may be two sides of the same coin for any one year, looking across many years they can differ. To see this, compare traditional vs. Roth (both taxes paid and amount left to spend) for
- 22% tax bracket at contribution
- 12% tax bracket at withdrawal
- investment value doubles between contribution and withdrawal.

You should find that using traditional in those circumstances
- causes more tax paid, but
- provides more to spend after taxes.
I'm glad I asked about this. It didn't quite make sense to me and now I see why, it's fairly off of the Boglehead philosophy as well, so I'll put that idea aside and stick to what I have. Thanks for clarifying this point which makes sense. It seems to me that the traditional IRA is the best path for me now.
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hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Sahara wrote: Wed Apr 07, 2021 2:28 pm Hartista,

This is a much debated topic. One can use software such as EMoney or Pralana Gold, or Excel spreadsheet calculators such as Personal Finance Toolbox, or one's own spreadsheet to see how it plays out in their individual situation.

For me, the light bulb went on when I calculated the potential growth of the money I would spend in taxes. If that money is not taken into consideration, Roth appears to be a big win. However, if that money is invested it makes up for the perceived benefit. Below is how I have learned to frame the issue.

The goal should not be to pay as little tax as possible. The goal should be to have as much money left over after taxes as possible. Comparing marginal rates between contribution (or conversion now) and withdrawal in the future is the most direct way to achieve this goal.

Suppose you're in a 10% marginal tax bracket now and in retirement (Just to make the math easy). You have $1000 to invest, you're retiring next year, and you'll get a 10% return (again to make the math easy). So, you could invest all $1000 in traditional, it will grow to $1100 next year and when you withdraw it you'll owe $110 in taxes leaving $990 to spend.

Or you could pay $100 taxes now and invest the remaining $900 in Roth, which will grow to $990 next year all of which you'll be able to spend.

Do this for however many years, whatever rate of return, whatever marginal tax bracket, and however much money and the results will always be the same because of the commutative property. As long as your marginal tax bracket is equal when investing and in retirement and you invest any tax savings in traditional then traditional and Roth will be exactly the same. A lower marginal tax bracket when investing than in retirement favors Roth and vice versa.
I did have the wondering when I saw this book if it was (another one) of those books on money with a catchy title (you know what I mean). Given what you said, "The goal should not be to pay as little tax as possible. The goal should be to have as much money left over after taxes as possible," I think I'm already on the right track and not going down this "0" rabbit hole!
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hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Sahara you said:
If you want a simple 3 fund portfolio with 70% stock and 30% bonds it would look like this
Assets 100,000 (insert any amount here and follow the math)
30% Bonds = $30,000 VBTLX Vanguard Total Bond Index
70% Stock = $70,000
>> 80% US = $56,000 VTSAX Vanguard Total Stock Market Index
>> 20% International = 14,000 VTIAX Vanguard Total International Stock Index


Yes this is what I want. I've laid this out and also printed out the spreadsheet. This part seems very clear to me and I thought it would be simple. Where I'm getting confused is on where and how to allocate this. Seems like keeping the $55,000 in traditional IRA is fine, I have another $7000 to add for this year. BUT here is where I get confused - if I need another bucket, for further contributions (say a 401K or something else), then how do I allocate that for the 2 funds? I thought you said I wouldn't want to replicate this in both? I am also wondering if I could or should proceed on my own without my accountant? He is snowed under by tax season and I would like to get this all moving if possible.

You also mention "if all of your accounts are tax deferred would be to use the Balanced Index Fund in all of them" - might this idea simplify my overall process here? I do not want to overcomplicate or confuse myself (very easy to do)! Thanks for cheering me on and like you I do love to learn! I also love simplicity haha!
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hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

One other idea I wondered about is to put my $15,000 Emergency fund that’s in a bank money market account into the Roth IRA since they’re both taxable accounts but I could withdraw without penalty I believe. Possible idea?
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Re: traditional IRA vs Roth - how to figure out

Post by FiveK »

hartista wrote: Wed Apr 07, 2021 11:19 pm One other idea I wondered about is to put my $15,000 Emergency fund that’s in a bank money market account into the Roth IRA since they’re both taxable accounts but I could withdraw without penalty I believe. Possible idea?
You can't just move all $15K into a Roth IRA in one go, but the use of Roth IRA as an emergency fund is certainly possible. :)
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Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

hartista wrote: Wed Apr 07, 2021 11:07 pm Sahara you said:
If you want a simple 3 fund portfolio with 70% stock and 30% bonds it would look like this
Assets 100,000 (insert any amount here and follow the math)
30% Bonds = $30,000 VBTLX Vanguard Total Bond Index
70% Stock = $70,000
>> 80% US = $56,000 VTSAX Vanguard Total Stock Market Index
>> 20% International = 14,000 VTIAX Vanguard Total International Stock Index


Yes this is what I want. I've laid this out and also printed out the spreadsheet. This part seems very clear to me and I thought it would be simple. Where I'm getting confused is on where and how to allocate this. Seems like keeping the $55,000 in traditional IRA is fine, I have another $7000 to add for this year.

BUT here is where I get confused - if I need another bucket, for further contributions (say a 401K or something else), then how do I allocate that for the 2 funds? I thought you said I wouldn't want to replicate this in both? I am also wondering if I could or should proceed on my own without my accountant? He is snowed under by tax season and I would like to get this all moving if possible.

You also mention "if all of your accounts are tax deferred would be to use the Balanced Index Fund in all of them" - might this idea simplify my overall process here? I do not want to overcomplicate or confuse myself (very easy to do)! Thanks for cheering me on and like you I do love to learn! I also love simplicity haha!
Good morning.

Please review this previous reply, STEP 2:

STEP 1

If you want a simple 3 fund portfolio with 70% stock and 30% bonds it would look like this
Assets 100,000 (insert any amount here and follow the math)
30% Bonds = $30,000 VBTLX Vanguard Total Bond Index
70% Stock = $70,000
>> 80% US = $56,000 VTSAX Vanguard Total Stock Market Index
>> 20% International = 14,000 VTIAX Vanguard Total International Stock Index

STEP 2 Divide the dollars among the accounts as you wish. Sometimes it can be easiest to have the International Fund in only one account, and that would be the account you use for rebalancing. And, since contributions are one good way to rebalance or maintain your allocation, you might place the International Fund in the Solo 401K. For example, in your Rollover IRA you might have Total Bond Index and Total Stock Index and in your Solo 401K you might have Total Bond Index, Total Stock Index and Total International Index. If things get out of proportion you don't have to touch the Rollover IRA, just move what's needed to get back in proportion in the Solo 401K or contribute more/less to one fund. But that's getting ahead of things and should not be a major issue. I'll try to plot it out a bit on a tab in the spreadsheet and see what it would look like as well.

STEP 3 if necessary You want to pay more attention to which funds go in which buckets when you have Roth accounts and Taxable Accounts. You do not want Bonds to go in those accounts. I can explain that if you’d like but it’s not relevant for you at this point so I will spare you.

I hear you about the accountant. I work part-time in an accounting firm and it's very hectic this time of year. We mailed out around 50 tax returns yesterday and E-filed another 50 or so.

Here's what I suggest. Contribute $7,000 to the Traditional IRA. Once that has settled, go online (otherwise you will pay a fee) and "exchange" from the money market fund to the Balanced Index Fund. Speak with your accountant prior to making your next move.

Why do I recommend the Balanced Index? Isn't the 3 Fund Portfolio the best?
The 3 Fund portfolio is a purist portfolio. It requires some management. For someone without experience in the market, seeing individual funds gain or lose money can have a psychological effect, resulting in buying or selling when one should just hold on. The Balanced Index will react more slowly to market changes and the overall effect will be muted to the eye, resulting in less reactivity. I do have friends in their 50's with only the Total Stock Market Index. They lose thousands in a day and don't blink. I am not one of those people. You don't know if you're one of those people until you are in that situation. I am not going to be the person to recommend you go out on that ledge.

Isn't that going to make you less money because it is only 60/40?
The 60/40 portfolio has returned 8.8% historically, the 70/30 portfolio has returned 9.2% historically (based upon the Vanguard document I shared earlier.) The 70/30 also has more risk, thus the higher return. You have to decide whether the higher return is worth the effort and risk of the 3 Fund Portfolio.

Isn't the ER higher? Yes, the Balanced Index has an ER of .07. The Balanced Index has returned 9.82 over the past 10 years, after accounting for the fee. We don't know what it will return in the future.

If you want to stick with the 3 Fund Portfolio you will have to get comfortable with steps 1 and 2 above. I've made some changes to the spreadsheet to illustrate what it could look like with the Traditional IRA and the Solo 401. It's a work in process!

Let us know what you think.
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hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Updated post - after “enough” research I think the solo 401K is the way to go. I was hesitant because I’d never heard of it but from my research that’s because it’s still a fairly “new” structure for folks like me. If I’d been up in these things (or had help) I might have done this earlier but alas it’s never too late. My questions are these - do you suggest I research any of this further (in this forum or beyond)? Do I need to consult my accountant (from my research seems like it may not even be something they know allot about). Seems to me like I meet the requirements easily (sole proprietor and independent contractor). So can I go ahead on my own? I’m pretty clear on the terms and amounts I can contribute which fall well within my range. Then lastly if his works I would have two tax deferred buckets and I can potentially get started with my asset allocation to them as one collective whole. What do you think friends? Ideally I want to learn/do as much/all of this on my own. This journey has inspired me to create a program on money for the community I work with (we all need some basics!). Thanks as always, so helpful to have some helping hands here!
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Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

hartista wrote: Thu Apr 08, 2021 10:33 am Updated post - after “enough” research I think the solo 401K is the way to go. I was hesitant because I’d never heard of it but from my research that’s because it’s still a fairly “new” structure for folks like me. If I’d been up in these things (or had help) I might have done this earlier but alas it’s never too late. My questions are these - do you suggest I research any of this further (in this forum or beyond)? Do I need to consult my accountant (from my research seems like it may not even be something they know allot about). Seems to me like I meet the requirements easily (sole proprietor and independent contractor). So can I go ahead on my own? I’m pretty clear on the terms and amounts I can contribute which fall well within my range. Then lastly if his works I would have two tax deferred buckets and I can potentially get started with my asset allocation to them as one collective whole. What do you think friends? Ideally I want to learn/do as much/all of this on my own. This journey has inspired me to create a program on money for the community I work with (we all need some basics!). Thanks as always, so helpful to have some helping hands here!
Makes sense to me. My only concern is matching the $ amount of income for your business qualifies you for the $ amount you contribute. From my experience in an accounting firm with 5 CPAs, the investment knowledge is minimal and often incorrect. I would count on the accountant to prepare the tax return. The tax return will include the figure upon which the 401K contribution is based.

How about giving Vanguard a call and discussing this with them? You might want to have a copy of your most recent tax return available when you do.

Edit: apostrophe.
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hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Sahara wrote: Thu Apr 08, 2021 10:54 am
hartista wrote: Thu Apr 08, 2021 10:33 am Updated post - after “enough” research I think the solo 401K is the way to go. I was hesitant because I’d never heard of it but from my research that’s because it’s still a fairly “new” structure for folks like me. If I’d been up in these things (or had help) I might have done this earlier but alas it’s never too late. My questions are these - do you suggest I research any of this further (in this forum or beyond)? Do I need to consult my accountant (from my research seems like it may not even be something they know allot about). Seems to me like I meet the requirements easily (sole proprietor and independent contractor). So can I go ahead on my own? I’m pretty clear on the terms and amounts I can contribute which fall well within my range. Then lastly if his works I would have two tax deferred buckets and I can potentially get started with my asset allocation to them as one collective whole. What do you think friends? Ideally I want to learn/do as much/all of this on my own. This journey has inspired me to create a program on money for the community I work with (we all need some basics!). Thanks as always, so helpful to have some helping hands here!
Makes sense to me. My only concern is matching the $ amount of income for your business qualifies you for the $ amount you contribute. From my experience in an accounting firm with 5 CPAs, the investment knowledge is minimal and often incorrect. I would count on the accountant to prepare the tax return. The tax return will include the figure upon which the 401K contribution is based.

How about giving Vanguard a call and discussing this with them? You might want to have a copy of your most recent tax return available when you do.

Edit: apostrophe.
Ah that makes total sense, glad I asked! I had that instinct too that it's not really something an accountant may be knowledgeable about (which you confirm). I don't have my 2020 return back yet (coming soon), should I wait for that and base it from that, or from the previous year (or does it matter). I think giving Vanguard a call is a great idea! Lastly are there anything more complex with the Solo 401K that I will run into (like much extra record keeping etc)? I really want simple! And is there a second best option or is this really the icing I'd want my cake to have? As always super helpful and thank you. You must feel good that you are helping others.
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Re: traditional IRA vs Roth - how to figure out

Post by FiveK »

Do check the various links in the solo 401k wiki article that discuss pros/cons of the major solo 401k providers. Different providers can be the best choice for different people, depending on what features are desired.
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Re: traditional IRA vs Roth - how to figure out

Post by Sahara »

FiveK wrote: Thu Apr 08, 2021 9:20 pm Do check the various links in the solo 401k wiki article that discuss pros/cons of the major solo 401k providers. Different providers can be the best choice for different people, depending on what features are desired.
I agree. We don't know if Vanguard will be the best for your Solo 401K.

The WIki also explains the contribution limit. I would have the 2019 tax return handy when calling the provider. As long as your income has remained steadily above $30,000 you should clear the bar for a contribution of $19,500 + $6,000 for those over age 50. My brief reading leads me to believe that your limit would be the amount on Schedule 1, line 3 minus 50% of your self-employment tax. Self-employment tax would be on schedule 2 line 4. Verify that with your chosen provider.

I enjoy helping. I wish I could be more helpful. Unfortunately, the financial services industry is more focused on profit and doesn’t really have roles that empower clients.
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Re: traditional IRA vs Roth - how to figure out

Post by abuss368 »

There is a lot of flexibility with Roth IRAs. There are no required minimum distributions. Contributions can be removed any time without tax penalties.

Another little known advantage is that your income would be lower from a Roth as the distributions are not taxable. The result is lower Medicare premiums.

Tony
John C. Bogle: “Simplicity is the master key to financial success."
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hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

FiveK wrote: Thu Apr 08, 2021 9:20 pm Do check the various links in the solo 401k wiki article that discuss pros/cons of the major solo 401k providers. Different providers can be the best choice for different people, depending on what features are desired.
Thank you for the idea, for ease I'm using Vanguard and will keep all my growing investments together. I have appreciated all of your ideas.
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hartista
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

Sahara wrote: Fri Apr 09, 2021 5:54 am
FiveK wrote: Thu Apr 08, 2021 9:20 pm Do check the various links in the solo 401k wiki article that discuss pros/cons of the major solo 401k providers. Different providers can be the best choice for different people, depending on what features are desired.
I agree. We don't know if Vanguard will be the best for your Solo 401K.

The WIki also explains the contribution limit. I would have the 2019 tax return handy when calling the provider. As long as your income has remained steadily above $30,000 you should clear the bar for a contribution of $19,500 + $6,000 for those over age 50. My brief reading leads me to believe that your limit would be the amount on Schedule 1, line 3 minus 50% of your self-employment tax. Self-employment tax would be on schedule 2 line 4. Verify that with your chosen provider.

I enjoy helping. I wish I could be more helpful. Unfortunately, the financial services industry is more focused on profit and doesn’t really have roles that empower clients.
Hello again, yes that is a sad current fact about the financial world but please know your assistance here has made a world of difference! I've sorted out my buckets and even my asset allocations and I'm ready to start putting everything in its place, leaving it and going out to celebrate! It's almost my birthday and this learning has been a major milestone for me. Thanks for all of your efforts. I've appreciate it all very much.
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Re: traditional IRA vs Roth - how to figure out

Post by hartista »

abuss368 wrote: Fri Apr 09, 2021 6:18 am There is a lot of flexibility with Roth IRAs. There are no required minimum distributions. Contributions can be removed any time without tax penalties.

Another little known advantage is that your income would be lower from a Roth as the distributions are not taxable. The result is lower Medicare premiums.

Tony
Hello Tony, thanks for chiming in here. I've decided to stick with the traditional IRA. It took a lot of research but that's my best conclusion for myself. Alas, one has to make the best choice for the moment, then learn from there. Thanks a bunch!
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Re: traditional IRA vs Roth - how to figure out

Post by abuss368 »

hartista wrote: Fri Apr 09, 2021 5:00 pm
abuss368 wrote: Fri Apr 09, 2021 6:18 am There is a lot of flexibility with Roth IRAs. There are no required minimum distributions. Contributions can be removed any time without tax penalties.

Another little known advantage is that your income would be lower from a Roth as the distributions are not taxable. The result is lower Medicare premiums.

Tony
Hello Tony, thanks for chiming in here. I've decided to stick with the traditional IRA. It took a lot of research but that's my best conclusion for myself. Alas, one has to make the best choice for the moment, then learn from there. Thanks a bunch!
That works. Keep in mind over time as the account compounds, it may be that much costlier to convert to a Roth IRA should you decide too.

Tony
John C. Bogle: “Simplicity is the master key to financial success."
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