Why the Roth IRA Bias?

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Kevin M
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Post by Kevin M » Tue Oct 19, 2010 10:37 pm

the intruder wrote: Could you provide a example as to how delaying RMDs to 70 1/2 would increse one's tax bracket taking into account that tax brackets are adjusted for inflation.
Thought provoking, but if we consider everything in real (as opposed to nominal) terms, perhaps not such a puzzle. Let's turn it around and assume no inflation. I'm in the 15% tax bracket now (retired at 55, now 58 ), but would be in at least the 25% marginal bracket if I were taking distributions from my IRAs now. If projecting into the future with inflation, shouldn't we adjust everything up (e.g., my IRA balance), not just the tax brackets? I hope my IRA at least keeps up with inflation. Thus, thinking in terms of real dollars, it seems to me that if taking RMD now would push me into higher tax brackets, it's likely to do so in the future.

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Post by DickBenson » Wed Oct 20, 2010 12:25 pm

Kevin M wrote:I'm in the 15% tax bracket now (retired at 55, now 58 ), but would be in at least the 25% marginal bracket if I were taking distributions from my IRAs now. ......

it seems to me that if taking RMD now would push me into higher tax brackets, it's likely to do so in the future.
I haven't read all of the discussion, so excuse me if this is not relevant. But the above description of your situation seems to me to be a classic case where, over the next 12 years, one should convert part of one's IRA, up to the 25% bracket, each year.

Not only would you be converting at a lower tax rate, but the eventual RMDs would be smaller and not trigger a higher tax bracket.

Dick

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Post by Kevin M » Wed Oct 20, 2010 1:25 pm

DickBenson wrote:
Kevin M wrote:I'm in the 15% tax bracket now (retired at 55, now 58 ), but would be in at least the 25% marginal bracket if I were taking distributions from my IRAs now. ......

it seems to me that if taking RMD now would push me into higher tax brackets, it's likely to do so in the future.
I haven't read all of the discussion, so excuse me if this is not relevant. But the above description of your situation seems to me to be a classic case where, over the next 12 years, one should convert part of one's IRA, up to the 25% bracket, each year.

Not only would you be converting at a lower tax rate, but the eventual RMDs would be smaller and not trigger a higher tax bracket.

Dick
True, and this is an example of a potential traditional IRA benefit that many have mentioned; i.e., the ability to convert to Roth in lower tax years. What I'm wondering about is whether I should convert to fill only the 15% bracket (which doesn't have much space left) or also the 25%. The analysis is complicated by the fact that I also have CA state taxes, which are high, so there's the potential to move to a no/low income tax state at some point. I've been putting off doing a serious analysis of it, and I'm pretty sure the consensus here would be to fill the 25% federal bracket, but I'd prefer to base the decision on my own analysis (of course benefiting from everything I learn here and elsewhere).

Thanks,

Kevin

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Post by kaneohe » Wed Oct 20, 2010 3:39 pm

Kevin M wrote:
DickBenson wrote:
Kevin M wrote:I'm in the 15% tax bracket now (retired at 55, now 58 ), but would be in at least the 25% marginal bracket if I were taking distributions from my IRAs now. ......

it seems to me that if taking RMD now would push me into higher tax brackets, it's likely to do so in the future.
I haven't read all of the discussion, so excuse me if this is not relevant. But the above description of your situation seems to me to be a classic case where, over the next 12 years, one should convert part of one's IRA, up to the 25% bracket, each year.

Not only would you be converting at a lower tax rate, but the eventual RMDs would be smaller and not trigger a higher tax bracket.

Dick
True, and this is an example of a potential traditional IRA benefit that many have mentioned; i.e., the ability to convert to Roth in lower tax years. What I'm wondering about is whether I should convert to fill only the 15% bracket (which doesn't have much space left) or also the 25%. The analysis is complicated by the fact that I also have CA state taxes, which are high, so there's the potential to move to a no/low income tax state at some point. I've been putting off doing a serious analysis of it, and I'm pretty sure the consensus here would be to fill the 25% federal bracket, but I'd prefer to base the decision on my own analysis (of course benefiting from everything I learn here and elsewhere).

Thanks,

Kevin
Your potential move to another state will certainly complicate the analysis. Perhaps the first step might be, if you're not already convinced , to do the calculation for a conversion assuming the tax brackets are the same.....now for conversion and later when you do withdrawals. I think I've convinced myself mathematically that you always come out the same or better aftertax if you convert. Add in the fact that brackets will probably increase? and that if, like me, you're not 100% Bogleheaded......I have funds that distribute CG/DIV that are temporarily lower now due to bad economy, I probably should be converting into the 25% bracket now. Emotionally, I must admit, I have some trouble with that tho.

Just FYI since you're in CA.....if you had IRAs in the '82-86 period (2K / yr max=10K total), CA did not allow deductions then, so the first 10K you withdraw/convert is potentially not taxable by CA.

In another thread someone suggested this interesting calculator

(might not work since I botched it the first time so just type url)

[/url]http://www.i-orp.com/[url][/url]

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Post by mikep » Mon Nov 22, 2010 1:42 pm

I use traditional 401k, but can't deduct traditional due to income so I use Roth IRA. For my stay at home mom wife though we use traditional IRA since it saves 25% federal income tax, 9.55% state income tax and an additional 5% federal income tax due to child credit phaseouts, and the deduction phaseout for a non working spouse is much higher. Since that effective marginal rate is near 40% we use traditional for the 5k that we can control. I'm ineligible to deduct traditional so I use roth but that doesn't mean we can't use traditional for my wife's IRA. Plus I find it hard to believe the Fed. and state (CA) govt will keep their promise that the roth will always be tax free withdrawals in retirement age in the future. However Roth is better than taxable so still worth it to fill it up.

The other thing we do is since this is a bit of a stretch, take the 2k tax savings that we get and spend on medical expenses and leave the money in our HSA to grow. Therefore the tax savings still grows in tax advantaged. :)

The only thing I worry about is later on this complicates back door Roth's but I'll deal with that when the time comes.. take the tax savings now and don't worry about future tax laws changes. At least I could do backdoor Roth.

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Post by tms » Mon Nov 22, 2010 2:20 pm

a Roth IRA lets one shield more assets than a T-IRA comparative to identical contribution limits. A Roth IRA, in a 25% tax bracket, allows one to shield $6700 in gross income as compared to $5k in a T-IRA.
Exactly. If you are trying to MAX out IRA contributions, then even if your tax rate will be lower in the future, then it still might be worthwhile to fund the ROTH, especially if your time horizon is sufficiently long enough.

At 25% tax rate, a $5000 Roth IRA contribution = $5000 TRADITIONAL IRA contribution + $1250 in savings into a Taxable Account.

If you are not maxing out contributions, then the tax rate now vs tax rate in the future, as well as the tax diversification consideration, become the most important factors.

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Post by mikep » Mon Nov 22, 2010 2:37 pm

tms wrote:
a Roth IRA lets one shield more assets than a T-IRA comparative to identical contribution limits. A Roth IRA, in a 25% tax bracket, allows one to shield $6700 in gross income as compared to $5k in a T-IRA.
Exactly. If you are trying to MAX out IRA contributions, then even if your tax rate will be lower in the future, then it still might be worthwhile to fund the ROTH, especially if your time horizon is sufficiently long enough.

At 25% tax rate, a $5000 Roth IRA contribution = $5000 TRADITIONAL IRA contribution + $1250 in savings into a Taxable Account.

If you are not maxing out contributions, then the tax rate now vs tax rate in the future, as well as the tax diversification consideration, become the most important factors.
Unless you actually withdraw from the Roth IRA in the 25% tax bracket the $1250 savings (along with the state taxes) go poof, and that's assuming the tax laws won't change between now and retirement (40 years for me ).

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Post by markcoop » Mon Nov 22, 2010 2:40 pm

mikep wrote:I use traditional 401k, but can't deduct traditional due to income so I use Roth IRA. For my stay at home mom wife though we use traditional IRA since it saves 25% federal income tax, 9.55% state income tax and an additional 5% federal income tax due to child credit phaseouts, and the deduction phaseout for a non working spouse is much higher.
I thought eligibility to deduct a traditional IRA was based on your adjusted gross income, which would be the same for both spouses if married filing jointly. In my case, my wife works part time. We've always maxed out my 401K and ROTHs for both. You got me thinking that maybe she should be contributing to a trad'l IRA that can be deducted.
Mark

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Post by mikep » Mon Nov 22, 2010 2:49 pm

markcoop wrote:
mikep wrote:I use traditional 401k, but can't deduct traditional due to income so I use Roth IRA. For my stay at home mom wife though we use traditional IRA since it saves 25% federal income tax, 9.55% state income tax and an additional 5% federal income tax due to child credit phaseouts, and the deduction phaseout for a non working spouse is much higher.
I thought eligibility to deduct a traditional IRA was based on your adjusted gross income, which would be the same for both spouses if married filing jointly. In my case, my wife works part time. We've always maxed out my 401K and ROTHs for both. You got me thinking that maybe she should be contributing to a trad'l IRA that can be deducted.
See the IRS pub 590, scroll down to table 1-3:

http://www.irs.gov/publications/p590/ch ... 1000230394

For stay at home spouse or spouse that works and doesn't have retirement plan, the deduction limit/phaseout rate is 166K-176K for 2009 (and I think 167K-177K for 2010). Note that CA deduction limit/phaseout remains 150K-160K. (See pg 5 of http://www.ftb.ca.gov/forms/2009/09_540cains.pdf) so check your state for different ranges.
Last edited by mikep on Mon Nov 22, 2010 2:55 pm, edited 1 time in total.

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Post by rob » Mon Nov 22, 2010 2:53 pm

For me... trying not to make this political :-)

IN MY OPINION... I pay less tax now then I will in the future (or did in the past)...... some of this is having kids now and spouse not working.... some of this is the current political climate...... some of this is also having a reasonable balance in trad plans from the past - I want to diversify my tax position by having some in both types....

That is why I have been prioritising Roth (both IRA and 401K in my case) over traditional...... I expect at some point to go back the other way.....
| Rob | Its a dangerous business going out your front door. - J.R.R.Tolkien

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Post by tms » Mon Nov 22, 2010 2:58 pm

Unless you actually withdraw from the Roth IRA in the 25% tax bracket the $1250 savings (along with the state taxes) go poof, and that's assuming the tax laws won't change between now and retirement (40 years for me ).
If your time horizon is 40 years or more (which is not unusual, even for people at retirement age if they plan on leaving the funds to their kids), than even if you are in the 25% bracket at the time of contribution and you assume a 15% rate at the time of withdrawal, it still is worthwhile.

That's because the return on the $1250 inside the taxable account gets eroded over time by taxes - capital gains, and taxes on interest and dividends. And I am assuming a step-up at time of death as well on the unrealized gains.

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Re: Why the Roth IRA Bias?

Post by mptfan » Mon Nov 22, 2010 3:18 pm

Kevin M wrote:I'm puzzled by the apparent bias toward using Roth IRAs, given that the choice between traditional and Roth should be determined by each individual's tax situation. The bias is apparent, for example, in the wiki, which recommends contributing first to 401(k)/403(b) to maximize employer match, then to a Roth IRA, then back to 401/403. I would think the recommended second priority should be traditional or Roth IRA depending on whether or not you expect to be in a lower tax bracket when you retire.
Kevin M
Kevin, I agree with your comments, and the apparent bias in favor of Roths is puzzling. However, take a look at Chapter 10 of the Bogleheads Guide to Retirement Planning, and you will see that the bias is in favor of traditional IRAs over Roths, despite what some posters say.

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Post by markcoop » Mon Nov 22, 2010 3:19 pm

mikep wrote:
markcoop wrote:
mikep wrote:I use traditional 401k, but can't deduct traditional due to income so I use Roth IRA. For my stay at home mom wife though we use traditional IRA since it saves 25% federal income tax, 9.55% state income tax and an additional 5% federal income tax due to child credit phaseouts, and the deduction phaseout for a non working spouse is much higher.
I thought eligibility to deduct a traditional IRA was based on your adjusted gross income, which would be the same for both spouses if married filing jointly. In my case, my wife works part time. We've always maxed out my 401K and ROTHs for both. You got me thinking that maybe she should be contributing to a trad'l IRA that can be deducted.
See the IRS pub 590, scroll down to table 1-3:

http://www.irs.gov/publications/p590/ch ... 1000230394

For stay at home spouse or spouse that works and doesn't have retirement plan, the deduction limit/phaseout rate is 166K-176K for 2009 (and I think 167K-177K for 2010). Note that CA deduction limit/phaseout remains 150K-160K. (See pg 5 of http://www.ftb.ca.gov/forms/2009/09_540cains.pdf) so check your state for different ranges.
Thanks Mike. Yes, now I remember. My wife works part time but has a plan available to her (a very bad one). That's why it's not deductible in our case.
Mark

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Post by the intruder » Mon Nov 22, 2010 4:26 pm

Kevin M wrote:
the intruder wrote: Could you provide a example as to how delaying RMDs to 70 1/2 would increse one's tax bracket taking into account that tax brackets are adjusted for inflation.
Thought provoking, but if we consider everything in real (as opposed to nominal) terms, perhaps not such a puzzle. Let's turn it around and assume no inflation. I'm in the 15% tax bracket now (retired at 55, now 58 ), but would be in at least the 25% marginal bracket if I were taking distributions from my IRAs now. If projecting into the future with inflation, shouldn't we adjust everything up (e.g., my IRA balance), not just the tax brackets? I hope my IRA at least keeps up with inflation. Thus, thinking in terms of real dollars, it seems to me that if taking RMD now would push me into higher tax brackets, it's likely to do so in the future.
Using no inflation is not realistic because the historical inflation for the last 35 years has averaged about 4%. If you assume 4% inflation and a 4% return on the IRA for the next 12 years you would get the following result on a 500k investment:

500k @4% (12) = $800.5 which at the MRD rate of .0365% at age 70.5 would equal a payment of about $29k.

Assume that IRA owner and spouse have taxable income of 86K at 58 (2010) which places them in the 15% bracket and the annual increase in inflation is also 4%. In 12 years the 15% bracket would increase to $137.7k or $51.7k over max income in the 15% bracket 12 years earlier. In other words if inflation and earnings on the IRA advance at the same rate the increase in the MRD payment at 70.5 would be only 56% of the increase in the max incomew allowed fo rhte 15% tax bracket. This of course assumes that there would be no decline in the value of the IRA over the investment period due to deflation or market upheavals such as the 50% decline from 2000-2003 and the 50% decline from 2007-2009.

While unlikely it is possible for the MRDs to push a taxpayer into a higher bracket. In the above scenario the taxpayer would be pushed into the 25% bracket if the value of the IRA was more than $1,416,000 at 70.5.
At a constant 4% interest rate for 12 years the IRA would have to be worth $884k at 58 to increase to $1,416,000.

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Post by sls239 » Mon Nov 22, 2010 7:15 pm

I assumed it was a basic bias for diversification, including tax diversification, especially for people who have not hit their peak earning years and so won't get very far past the max the Roth.

Because the longer the assets are going to be there, the more of the account will be earnings, so the greater advantage to the Roth.

So switching to the TIRA in later years when you have a better approximation of probable tax rates, and probably more of your portfolio in bonds with less expected return is less costly than trying to bulk up the Roth in the end.

So better to choose wrong and choose Roth than to choose wrong and choose traditional.

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Post by Bob's not my name » Mon Nov 22, 2010 7:23 pm

sls239 wrote:Because the longer the assets are going to be there, the more of the account will be earnings, so the greater advantage to the Roth.
Why?

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Post by Doc » Mon Nov 22, 2010 9:06 pm

sls239 wrote: ...

Because the longer the assets are going to be there, the more of the account will be earnings, so the greater advantage to the Roth.

So switching to the TIRA in later years when you have a better approximation of probable tax rates, and probably more of your portfolio in bonds with less expected return is less costly than trying to bulk up the Roth in the end.

...
OK, I don't know for sure what my tax rate is going to be then.

1) RMD from a tIRA may raise my future tax rate - better to convert now. The use your powder now before it gets wet option.

2) Stick with the tIRA until I know more. The keep your powder dry option.

:(

If you can't get a good handle on the tax rates you have to guess. Best way to handle is:

1) If you are in low bracket convert since taxes are unlikely to go down much.

2) If you are in a high bracket then wait since taxes are not likely to go up much.

This is the false positive/negative problem in statistics. You have to asess the consequences of making the wrong choice even if your choice is not the most probable result.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Post by ThePrune » Mon Nov 22, 2010 9:17 pm

sls239 wrote:Because the longer the assets are going to be there, the more of the account will be earnings, so the greater advantage to the Roth.
I, too, am intrigued by this statement. Perhaps it's just a vague, "top of the head" impression of a Roth IRA's advantage over a traditional IRA.

Here's an often overlooked fact: if you (1) are in the same marginal tax bracket while depositing into and withdrawing out of either type of IRA (e.g. the 25% bracket while depositing and withdrawing), and (2) use the same investments within either type of IRA, then ---> there will be no difference in the net, after-tax funds you end up with. Prof. William Reichenstein's text "Integrating Investments and the Tax Code" (John Wiley & Sons, 2003) goes through the math explaining why.

Of course the condition (1) above is pretty strict. Many retirees can reasonable expect to be in a lower marginal tax bracket in retirement; for them this would make a deductable traditional IRA (or 401k / 403b) more attractive than a Roth IRA.

On the other hand, many folks expect Congress to increase taxes in the future through some combination of actions that will effectively make marginal taxes in retirement higher than their current marginal tax rate. This would make current Roth IRA contributions more attractive.

This whole area of tax planning is so complicated, with so many moving parts, that I felt compelled to made a personalized, integrated retirement budget + retirement income + retirement taxes Excel spreadsheet model for my family. I use this tool to try out new strategies based on future tax "what ifs", Roth conversions, etc., etc.

Truly optimizing someone's after-tax retirement income potential can be extremely complicated. But starting with "generic rules of thumb" can get most people heading in roughly the best direction. Good luck in finding your best strategy.
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Post by bdpb » Mon Nov 22, 2010 11:17 pm

ThePrune wrote:
sls239 wrote:Because the longer the assets are going to be there, the more of the account will be earnings, so the greater advantage to the Roth.
I, too, am intrigued by this statement. Perhaps it's just a vague, "top of the head" impression of a Roth IRA's advantage over a traditional IRA.

Here's an often overlooked fact: if you (1) are in the same marginal tax bracket while depositing into and withdrawing out of either type of IRA (e.g. the 25% bracket while depositing and withdrawing), and (2) use the same investments within either type of IRA, then ---> there will be no difference in the net, after-tax funds you end up with. Prof. William Reichenstein's text "Integrating Investments and the Tax Code" (John Wiley & Sons, 2003) goes through the math explaining why.
This is only true up to the max tIRA contribution. Any amount above the
tIRA limit put in a taxable account (which could have been put in a Roth)
loses value to taxes every year and eventually the Roth will surpass the
tIRA plus taxable. It will overcome any tax bracket differences, although it
may take a long time depending on the differences and taxable inefficiencies.

If you know your tax brackets will be the same and you contribute
more than the tIRA limit then almost certainly Roth is better than tIRA plus taxable.

Initially, I wrote this thinking sls239 may be the thinking of the value
of a Roth being effectively larger tax free space, but after rereading his
statements, I'm not sure any more. He may just be fooled by the
common thought that Roth is tax free and tIRA is only tax deferred (that
Reichenstein explains).

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Post by Bob's not my name » Tue Nov 23, 2010 4:52 am

Exactly my thought, which is why I asked the question. Every thread (and there are many) on Roth vs. tIRA ends up in this ditch. The first thing to get straight is that the math is the same (by the commutative property of multiplication) if the tax rate doesn't change. sls239 may understand that, but lots of posters don't. The issue gets confused quickly when the effective larger size of the Roth is introduced -- it's a very good point, and important for people who are maxing out all tax-advantaged space. However, people who are maxing out all tax-advantaged space are often high earners in high brackets, so the "more space" advantage of the Roth increases with income as does the "pay later" advantage of the tIRA, leaving the dilemma unresolved.

A second common error, in my view, is over-simplifying the tax rate issue, viz., broad statements about how taxes can only go up. It's way more complicated than that, e.g.:
-- For many in their peak earning years, credit phaseouts have huge effects on their marginal rate. Consider the AOC, which creates an incremental marginal rate of 12.5% per child in college, or financial aid, an effective tax that takes 47% of your income net after federal taxes.
-- Changing state of residence can change your marginal rate by up to 10%.
-- You have more ability to manipulate your tax bracket in retirement than while working.
-- Major changes in tax policy are probable as the population tilts into retirement, and it's impossible to predict how these will affect the relative value of Roth vs. tIRA (and I'm including accidents of the tax code here; perhaps in the future in addition to the back door Roth we'll have the side door Roth and the doggie flap Roth and the mail slot Roth).
-- Your tax burden could go up while your top marginal rate goes down.

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Post by tms » Tue Nov 23, 2010 11:36 am

This is only true up to the max tIRA contribution. Any amount above the tIRA limit put in a taxable account (which could have been put in a Roth)
loses value to taxes every year and eventually the Roth will surpass the
tIRA plus taxable. It will overcome any tax bracket differences, although it
may take a long time depending on the differences and taxable inefficiencies.
Even with fairly favorable tax conditions on a taxable account (low turnover for example), a time horizon of 40 plus years can overcome 10 drop in tax rates from the time of contribution/conversion to the time of withdrawal.

40 years is not that long when we are talking about multiple generations.

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Post by sls239 » Tue Nov 23, 2010 3:00 pm

I said it with respect to making the decision to convert a TIRA to a Roth, as conversion seemed to be a convenient way of measuring the likely effects of choosing wrong.

If you chose TIRA, and chose wrong, by the time you have realized that you chose wrong, you are probably in a higher tax bracket because if you hadn't had a significant increase in earnings, you wouldn't be wrong. In other words, you'd be paying a lot of tax to convert. I guess I worded it poorly because earnings don't have much to do with it except it makes the account grow over time, increasing the cost of choosing wrong.

So putting it in a Roth when young and then finding out you didn't really need to is not as expensive as putting it in a TIRA and then trying to convert once you realized you are wrong.

In other words, the negative consequences are most likely asymmetrical, and the longer it is until the person realized they chose wrong, the more asymmetrical in favor of the Roth becomes.

However, if you are in your peak earning years, obviously the cost of choosing wrong and choosing Roth is higher but the uncertainty about tax brackets in retirement should be lower and uncertainly about future earning potential should be drastically lower. In other words, you aren't likely to even have to ask the question in the first place.

I'm certainly open to counter arguments about that, but none that are predicated on the assumption that you already know what your tax rate will be in retirement, because hardly anyone in their 30's has any freaking clue, not just because of what may happen to tax brackets, but also what may happen in their careers.
Last edited by sls239 on Tue Nov 23, 2010 3:58 pm, edited 2 times in total.

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Post by Wagnerjb » Tue Nov 23, 2010 3:33 pm

tms wrote:Even with fairly favorable tax conditions on a taxable account (low turnover for example), a time horizon of 40 plus years can overcome 10 drop in tax rates from the time of contribution/conversion to the time of withdrawal.

40 years is not that long when we are talking about multiple generations.
I am struggling to replicate your conclusion. I assumed a 33% tax rate today and a 25% tax rate in 40 years. I assumed a 15% rate on both dividends and capital gains for the taxable account, along with an 8% appreciation, of which 1.5% comes from dividends. With these assumptions, I found that it didn't make sense to convert. You indicate that 40+ years can overcome a 10% gap, but I don't see it overcoming an 8% gap. Did I make a mistake in my calculations? Or are your assumptions dramatically different from mine?

Thanks.
Andy

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Post by Noobvestor » Tue Nov 23, 2010 3:50 pm

As a 'hedge as much as possible' person, I think it's far simpler than many of these nuanced arguments either way: there isn't that much Roth space available to most of us, in the long term, relative to other space. Therefore it is at most a small 'side bet' - so why not make it to diversify risk/reward?
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Post by Bob's not my name » Tue Nov 23, 2010 4:12 pm

noobvester wrote:As a 'hedge as much as possible' person, I think it's far simpler than many of these nuanced arguments either way: there isn't that much Roth space available to most of us, in the long term, relative to other space. Therefore it is at most a small 'side bet' - so why not make it to diversify risk/reward?
I think you're assuming traditional 401k and Roth IRA contributions, but the debate gets most heated when we're discussing going all Roth in contributions (Roth 401k + Roth IRA) and/or converting a massive tIRA to a Roth. I do agree with you, though, on hedging with a Roth IRA; I am able to start doing this in 2010 (still going traditional 403b and traditional spouse IRA, though).

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Post by Noobvestor » Tue Nov 23, 2010 4:39 pm

Bob's not my name wrote:
noobvester wrote:As a 'hedge as much as possible' person, I think it's far simpler than many of these nuanced arguments either way: there isn't that much Roth space available to most of us, in the long term, relative to other space. Therefore it is at most a small 'side bet' - so why not make it to diversify risk/reward?
I think you're assuming traditional 401k and Roth IRA contributions, but the debate gets most heated when we're discussing going all Roth in contributions (Roth 401k + Roth IRA) and/or converting a massive tIRA to a Roth. I do agree with you, though, on hedging with a Roth IRA; I am able to start doing this in 2010 (still going traditional 403b and traditional spouse IRA, though).
Thanks Notbob (can I call you that? Your name confuses the heck out of me!). You're absolutely right, and I definitely oversimplified things upon reflection - those kinds of options do make it more complicated. I strive for *ultra* simple investing where at all possible, so I decided on inaction regarding those other options, which indeed require deeper thought and more calculations to decide upon. For me, well, I'm just going to make out Roth IRA space when I can and ignore the rest, since my research into Roth401Ks, pros/cons, etc... just produced a migraine :)
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Post by mikep » Wed Nov 24, 2010 3:10 pm

Chuck has some good comments in this thread that are applicable to this debate.. http://www.bogleheads.org/forum/viewtopic.php?t=41292

It's exactly what I do as well. The effect is even greater for me when I figure in child tax credits 5% phaseout and state taxes at high marginal brackets. One must compare their marginal tax rate from today (since that is what is saved) vs the average tax rate in retirement (since that is what is paid) and draw their own conclusion. For me, saving close to $2K on taxes from a $5K TIRA contribution is a slam dunk decision. We still get some tax diversification since I as the working spouse can't deduct TIRA, so I use Roth.

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Re: Investing priority after 410K match ?

Post by Sunny Sarkar » Wed Nov 24, 2010 5:13 pm

Taylor Larimore wrote:Hi Kevin:
I would think the recommended second priority (after the 401K match) should be traditional or Roth IRA depending on whether or not you expect to be in a lower tax bracket when you retire.
In most cases, I would agree with you.

Nice catch.
But... if you have a 401k, you are not eligible for a traditional IRA - isn't that the case?
"Cost matters". "Stay the course". "Press on, regardless". ― John C. Bogle

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Re: Investing priority after 410K match ?

Post by tfb » Wed Nov 24, 2010 5:31 pm

Sunny Sarkar wrote:But... if you have a 401k, you are not eligible for a traditional IRA - isn't that the case?
No it's not the case. There is an income limit for taking a deduction but the limit is well above median income: 66k single 109k married.
Harry Sit, taking a break from the forums.

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Re: Why the Roth IRA Bias?

Post by jmndu99 » Tue Jan 02, 2018 9:52 pm

Bringing up older thread that I came to from
thefinancebuff.com

Fast forward to 2018 and tax rates are lowered.


Mine lowered 3%. Should I still favor ROTH IRA & Roth 401 (k)?

Remember this new law expires in 2025

Thanks J

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Re: Why the Roth IRA Bias?

Post by gouverneur » Wed Jan 03, 2018 8:14 am

Confused by the question, although there are other threads out there with more detail. You ask if you should “still” prefer Roth after tax rates go down? But the reduction of rates increases the desirability of Roth because you’re paying less in taxes today and get it tax free whenever you use it in the future. If you preferred Roth while paying say marginal 25% you’ll certainly prefer it paying marginal 22%.

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Re: Why the Roth IRA Bias?

Post by Longdog » Wed Jan 03, 2018 9:35 am

I think the end game is to get as much in a Roth as possible, but the path to getting to that point is either to contribute initially to a Roth if you are in a low tax bracket or to contribute to pre-tax accounts initially if you are in a high tax bracket, then to eventually convert to Roth if you find yourself in a lower tax bracket at some point prior to RMDs.
Steve

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Re: Why the Roth IRA Bias?

Post by jmndu99 » Wed Jan 03, 2018 7:21 pm

gouveneur and Longdog,

Thank you for the replies. Yes, I was in a low marginal tax bracket preferring ROTH. Now my marginal tax bracket is lowered and will still prefer ROTH.

The above preference is the reason for my ROTH bias, relating to the OP question.

J

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Re: Why the Roth IRA Bias?

Post by Kevin M » Wed Jan 03, 2018 9:00 pm

Longdog wrote:
Wed Jan 03, 2018 9:35 am
I think the end game is to get as much in a Roth as possible <snip>
Not necessarily, and this is typical of the confusion I was trying to explore in starting this thread more than seven years ago.

The end game is not to get as much in a Roth as possible, but to maximize your after-tax wealth and income, and it's quite likely that for many people this will be better accomplished with a traditional IRA. This is because many people will pay little or no income tax on distributions from their traditional IRA accounts, so they are much better off getting a 15% or 25% (now 12% or 22%) tax deduction on the contribution, and paying no tax or a much lower tax rate on the distributions.

Of course this may not be true for the typical Boglehead, but the point of the thread was to emphasize that you should evaluate your own tax situation, and not just favor a Roth because the qualified distributions will always be tax free. Distributions from a traditional IRA might also be tax free for some people, and for others they might be taxed at a rate significantly lower than the tax savings rate they got on the contributions.

If you are in a low tax bracket now and expect to be in a low tax bracket for the rest of your working life, then it's quite likely that you'll be in an even lower tax bracket in retirement, in which case a traditional IRA could make more sense. If you're in a low tax bracket now and expect to be in a higher tax bracket for quite a few working years in the future, then sure, Roth could well be the better choice for you during your earlier working years.

And of course if you have some low income years, say in early retirement, and expect to be in a higher tax bracket when RMDs kick in, then Roth conversions during the lower income years probably make sense.

Kevin
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