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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Does that make sense?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck to you.
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

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

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

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

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

My biggest worry with my plan, if it can even be called that, is that I will hit the year I turn 70.5 (I am approximately at the halfway point from birth to this) and my RMDs will be significantly more than I plan to spend that year. This doesn't seem like such a terrible problem to have.
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

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

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

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

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

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

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

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


I agree with your comments on tax-diversification and planning. I would add that while critical in the accumulation phase, using good judgement in tax diversification/planning should extend into the withdrawal phase as well.
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

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

As much tax-deferred as humanly possible.

It's that simple really.

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

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

I use my order based on likely tax liability

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

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

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

Post by wjhunter » Thu Jan 24, 2019 12:32 pm

marcopolo wrote:
Mon Jan 14, 2019 9:14 am

Where you end up in the ratio is more a result of planning (hopefully) during accumulation phase, and it likely changes over time.
During your high earning (tax rate) years, it probably makes sense to put more into (2), than in to (1). But, if you retire early, during the lower income (tax rate) years, it probably makes sense to move some (a lot) of the money from (2) into (1) via Roth conversions.
Also, if you do retire in your 50s, (i did), there is a lot of flexibility to be gained by having a sizable amount of your portfolio in (3).
I think I need to look at Roth conversions. My wife and I both have Roth accounts but they are only around 40-50K (our 401K\401K Rollover accounts each have around 500K. If I retire in my early 50s, our income will go down by around half - so that would be a good time to do the Roth conversion because our tax rate would be lower, right?

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

Post by FiveK » Thu Jan 24, 2019 12:51 pm

wjhunter wrote:
Thu Jan 24, 2019 12:32 pm
If I retire in my early 50s, our income will go down by around half - so that would be a good time to do the Roth conversion because our tax rate would be lower, right?
Yes.

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

Post by mtmingus » Thu Jan 24, 2019 12:59 pm

One more thing to consider:

As long as not going above your tax bracket, put as much as you can in Roth. By the time you retire ( < 65 yo), your distributions from your Roth accts will not be counted as income for ACA subsidy purpose (let's hope).

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

Post by wjhunter » Thu Jan 24, 2019 1:14 pm

mtmingus wrote:
Thu Jan 24, 2019 12:59 pm
One more thing to consider:

As long as not going above your tax bracket, put as much as you can in Roth. By the time you retire ( < 65 yo), your distributions from your Roth accts will not be counted as income for ACA subsidy purpose (let's hope).
One thing I don't get -- if I convert my rollover IRA (that was funded entirely with pre-tax dollars) to a Roth IRA, then I have to pay taxes on the entire amount. Let's say I convert 500K. That would push us up into a much higher tax bracket. Is the idea to convert some of the of the rollover IRA, but not enough to push us up into the next tax bracket??

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

Post by retiredjg » Thu Jan 24, 2019 1:20 pm

wjhunter wrote:
Thu Jan 24, 2019 1:14 pm
Let's say I convert 500K. That would push us up into a much higher tax bracket. Is the idea to convert some of the of the rollover IRA, but not enough to push us up into the next tax bracket??
Yes or something along that line. Every situation is different.

You may decide to intentionally convert up one bracket. Or you might decide to convert up to the top of the bracket you are already in. It depends on many factors.

There are also limits that you might want to go over that are not related to your tax bracket.

This thread gives some examples of things to consider when doing this kind of planning.

viewtopic.php?t=170477

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

Post by ThrustVectoring » Thu Jan 24, 2019 1:55 pm

The ratio doesn't matter, expected tax brackets now through retirement and RMDs does. The overall goal is to use your tax deferred accounts to "flatten" your income over time, moving income taxed at higher marginal rates into lower ones. If you move $10k of income from this year (where you have taxable income from your job) into the year you and your spouse turn 68 (when you're not working at all), you move income into a lower tax bracket and come out ahead.

So the important question is "given RMDs and planned elective use of tax-deferred accounts to realize income in retirement, and the planned age at which I start taking social security benefits, what tax rate will I end up paying on the marginal dollar that I save today". If having extra money in your 401k means making a larger Roth conversion before you take SS at 70.5 at a lower tax bracket than you're in today, definitely make additional tax-deferred contributions. If your 401k is already large enough that going up to the top of your current tax bracket won't push down the balance enough that RMDs will eventually force withdrawals at a higher rate, you want to prefer Roth contributions and conversions now.

This all is highly specific to your current income and planned retirement dates and activities, so it's really hard to give generic advice. If you're good with Excel or other spreadsheeting software, this is a great place to use those skills.
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by MikeG62 » Thu Jan 24, 2019 6:48 pm

FiveK wrote:
Thu Jan 10, 2019 7:56 pm


wjhunter, the ratio is a consequence, not a target.
I agree with this.

Generally speaking, it is usually a good idea to put as much as possible into tax deferred retirement accounts while working (as one's tax rate is typically higher while working than what would reasonably be expected in retirement). Backdoor into a Roth IRA a good idea if you have extra cash once funding your 401K and HSA too if you are in a high deductible plan. If you have more excess cash flow, then fund a brokerage account and save as much as you can there. The numbers will be what the numbers will be once you retire.

For my DW and I, about 80% of our financial assets are in taxable brokerage accounts. This despite funding the maximum amount into my 401K pretty much every year that I worked (most certainly for the last two decades before retirement). We funded backdoor Roth at maximum amount every year that this was an option too and I recently have been funding an HSA as last year was my first year in a HD plan.

This split is working out great for us so far (starting our fourth full year of early retirement in 2019) as we are able to manage our tax rate to be quite low, while also doing partial systematic Roth conversions.
Last edited by MikeG62 on Sat Jan 26, 2019 9:45 am, edited 2 times in total.
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by michaeljc70 » Thu Jan 24, 2019 7:06 pm

Even if there were an ideal ratio, I'm not sure it would be smart to achieve that. I maxed out retirement accounts throughout my life and whatever was left I put into taxable. I was not going to give up the tax break or tax-free gains over my working life.

There probably would be too many factors to give a general ideal ratio. Off the top of my head, what age you retire at, what tax brackets you will be in working vs at retirement vs after ss starts, if you might be eligible for ACA subsidies, if you will be able to do Roth conversions in retirement at a low rate, etc.

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

Post by PatrickA5 » Thu Jan 24, 2019 10:47 pm

Currently, we're sitting at 77% tax deferred and 23% tax free (Roth). I plan on doing conversions over the next several years to get closer to 50/50. That should give us more options once RMDs and SS start (in 10 years) to manipulate what our tax outcome will be. At least that's the plan. Lots of moving parts. Right now, we have very little in taxable accounts (but that could change).

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

Post by FinancialDave » Fri Jan 25, 2019 12:20 am

wjhunter wrote:
Mon Jan 14, 2019 9:03 am
texasdiver wrote:
Thu Jan 10, 2019 8:19 pm
Put another way, tilting towards tax-deferred savings is insurance against being poorer than you expect in retirement. Tilting towards a Roth (or taxable) savings is insurance that you will be richer than you expect in retirement. Which eventuality is more important to insure against?
Thanks for the reply - this is a good way to frame the issue. I said nontaxable, but of course I meant tax-deferred.
I agree with the "texasdiver" viewpoint -- it is more important not to run out of tax-deferred money, because that is the money that "can" fill up the lower tax brackets, in retirement, no matter what the tax brackets are.

As far as tax preference there are really 4 levels:

1. HSA on the top, at 2 levels of tax avoidance - both in and out (if you have enough medical receipts to spend against).
2. Traditional IRA (or 401k) & Roth IRA (or 401k) at 1 level of tax avoidance - either in or out (IRA "could" function at level 2 with money spent at 0%) - Roth could get to level 2 as well (I know some doing it) but it is harder.
3. Taxable brokerage account, which I call level 1/2, as long term capital gains get a partial tax break.
4. Savings accounts & short term capital gains essentially get no tax break and are treated as ordinary income (could fall in 0% bracket for very low income)

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

Post by FinancialDave » Fri Jan 25, 2019 12:41 am

FiveK wrote:
Thu Jan 24, 2019 12:51 pm
wjhunter wrote:
Thu Jan 24, 2019 12:32 pm
If I retire in my early 50s, our income will go down by around half - so that would be a good time to do the Roth conversion because our tax rate would be lower, right?
Yes.
I think this is "Yes" with a qualifier.

One of the questions deals with "do you need more Roth?" Ponder the following:

1. Say your tax bracket drops from 24% to 12% -- but the question is how much of the 12% bracket do you have "free" to do the conversions? As it turns out it is very possible that the amount you have "free" to do conversions is probably close to the amount you will still have free after conversions are done before you fill up the 12% bracket with RMDs -- ie - maybe there is no need to do the conversion because you will still be in the same tax bracket and have not gained anything, but "paid more tax before its time."

2. If you error in how much tIRA you need and you run out of traditional tax-deferred money you could very likely be in the zero or 10% tax bracket and the "taxperson" very happy you paid your taxes early in life -- you however won't be so happy because you paid more taxes than you had to.

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

Post by Ben Mathew » Fri Jan 25, 2019 2:07 am

For retirement, tax-advantaged accounts (both traditional and Roth) beats taxable. So no reason to contribute to taxable until you've run out of tax-advantaged space. So, to answer your question, given a certain total savings, the ideal ratio would be 100% tax-advantaged/0% taxable = + infinity (or undefined?).

But within tax-advantaged, traditional vs Roth depends on the specific circumstances. But both are better than taxable.

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

Post by SGM » Fri Jan 25, 2019 5:14 am

I liked the tax deferred growth and maximized tax deferred contributions during my accumulation period. We weren't eligible for Roth conversions until 2010 when the law changed. We paid our taxes out of the taxable account and the purchasing power at the time of conversion was unchanged. We converted all of the tax deferred accounts over a 5 year period with lower or no earned income.

Our tax rates have remained about the same in retirement as we have additional sources of retirement income outside of the Roth. Another consideration was that tax rates would go higher for a widow or widower. Soon I will be able to see the benefits in lower taxes and lower IRMAA fees when I have no RMDs.

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

Post by wjhunter » Fri Jan 25, 2019 11:22 am

FinancialDave wrote:
Fri Jan 25, 2019 12:41 am
FiveK wrote:
Thu Jan 24, 2019 12:51 pm
wjhunter wrote:
Thu Jan 24, 2019 12:32 pm
If I retire in my early 50s, our income will go down by around half - so that would be a good time to do the Roth conversion because our tax rate would be lower, right?
Yes.
I think this is "Yes" with a qualifier.

One of the questions deals with "do you need more Roth?" Ponder the following:

1. Say your tax bracket drops from 24% to 12% -- but the question is how much of the 12% bracket do you have "free" to do the conversions? As it turns out it is very possible that the amount you have "free" to do conversions is probably close to the amount you will still have free after conversions are done before you fill up the 12% bracket with RMDs -- ie - maybe there is no need to do the conversion because you will still be in the same tax bracket and have not gained anything, but "paid more tax before its time."

2. If you error in how much tIRA you need and you run out of traditional tax-deferred money you could very likely be in the zero or 10% tax bracket and the "taxperson" very happy you paid your taxes early in life -- you however won't be so happy because you paid more taxes than you had to.

Dave
These concepts are new to me, so I don't completely follow. Are you basically saying that if our tax bracket is lower in retirement than it is when we do the conversion, then there is no advantage to doing a Roth conversion? Our tax bracket *probably* will be lower in retirement (or at least equal), because we generally live on about half of our current income. However, I thought part of the reason for the Roth conversion was insurance for the possibility that taxes are higher in retirement than expected - either because we need more income or rates are higher. in that case, you would have more flexibility\options with more Roth?

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

Post by FiveK » Fri Jan 25, 2019 12:35 pm

wjhunter wrote:
Fri Jan 25, 2019 11:22 am
Are you basically saying that if our tax bracket is lower in retirement than it is when we do the conversion, then there is no advantage to doing a Roth conversion?
The answer to "which is better, traditional or Roth?" always depends on the marginal benefit one could (or did) gain by making a traditional contribution, compared with the marginal cost one would (or did) pay when withdrawing that contribution and its gains.

So yes, if it will cost less to withdraw later, don't withdraw now, if you don't need the money now. And if it will cost more to withdraw later, e.g., due to taxation of Social Security benefits), then do withdraw an appropriate amount now.

Polish your crystal ball, and good luck!

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

Post by FinancialDave » Fri Jan 25, 2019 1:56 pm

wjhunter wrote:
Fri Jan 25, 2019 11:22 am
FinancialDave wrote:
Fri Jan 25, 2019 12:41 am


I think this is "Yes" with a qualifier.

One of the questions deals with "do you need more Roth?" Ponder the following:

1. Say your tax bracket drops from 24% to 12% -- but the question is how much of the 12% bracket do you have "free" to do the conversions? As it turns out it is very possible that the amount you have "free" to do conversions is probably close to the amount you will still have free after conversions are done before you fill up the 12% bracket with RMDs -- ie - maybe there is no need to do the conversion because you will still be in the same tax bracket and have not gained anything, but "paid more tax before its time."

2. If you error in how much tIRA you need and you run out of traditional tax-deferred money you could very likely be in the zero or 10% tax bracket and the "taxperson" very happy you paid your taxes early in life -- you however won't be so happy because you paid more taxes than you had to.

Dave
These concepts are new to me, so I don't completely follow. Are you basically saying that if our tax bracket is lower in retirement than it is when we do the conversion, then there is no advantage to doing a Roth conversion? Our tax bracket *probably* will be lower in retirement (or at least equal), because we generally live on about half of our current income. However, I thought part of the reason for the Roth conversion was insurance for the possibility that taxes are higher in retirement than expected - either because we need more income or rates are higher. in that case, you would have more flexibility\options with more Roth?
What I was responding to was the notion that your tax bracket was going to drop in the early years of retirement and that was the time you were going to do the conversions. In that case it really doesn't matter at all that your tax bracket has dropped in retirement. What matters is the marginal tax rate on the Roth conversions you do, as compared to the marginal rate of money spent. My assumption was that if you had enough room in your lower tax bracket to do the conversion, then your retirement tax bracket without conversions is the same - meaning little to no advantage doing the conversion.

Obviously doing the conversions in the "lower retirement tax bracket" is much better than doing them while you are working, if you have already decided you need more Roth funds.

Part of having SOME Roth funds is absolutely insurance against large lump sum payments that raise your tax bracket in retirement, but as FiveK points out, only to the extent that that "marginal" Roth money is keeping you out of a higher tax bracket.

As someone pointed out farther up this thread, if you have any kind of risk of not having enough money in retirement - ie your budget is tight and so are your savings, then spending "a lot" (somewhat nebulous term left up to you to decide) of money on taxes for Roth contributions and taxes probably is not your best use of your funds. Once you send those taxes to the IRS and put the money in the Roth you can't change your mind. While under the right circumstance spending Roth money can lower taxes on your SS, this is a narrow window, which because the crossover point has so far not been indexed to inflation becomes less and less of a factor as time goes on.

The Boglehead Wiki makes the point that in the 12% bracket you can hardly go wrong doing conversions, which as a general rule of thumb is something I would agree with, but just caution against going overboard with this idea because, especially for a married couple, there is currently roughly $46,400 that can be spent in lower tax brackets ( 0%-$27,000 if both over 65 + $19,400 in 10%). Then add to that another $59,550 that can be spent in the 12% bracket and you get a total of $105,950 of taxable income you can spend in retirement before you need any Roth at all. Of course for the single person that number is $52,775.

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

Post by wjhunter » Fri Jan 25, 2019 2:21 pm

FinancialDave wrote:
Fri Jan 25, 2019 1:56 pm
wjhunter wrote:
Fri Jan 25, 2019 11:22 am
FinancialDave wrote:
Fri Jan 25, 2019 12:41 am


I think this is "Yes" with a qualifier.

One of the questions deals with "do you need more Roth?" Ponder the following:

1. Say your tax bracket drops from 24% to 12% -- but the question is how much of the 12% bracket do you have "free" to do the conversions? As it turns out it is very possible that the amount you have "free" to do conversions is probably close to the amount you will still have free after conversions are done before you fill up the 12% bracket with RMDs -- ie - maybe there is no need to do the conversion because you will still be in the same tax bracket and have not gained anything, but "paid more tax before its time."

2. If you error in how much tIRA you need and you run out of traditional tax-deferred money you could very likely be in the zero or 10% tax bracket and the "taxperson" very happy you paid your taxes early in life -- you however won't be so happy because you paid more taxes than you had to.

Dave
These concepts are new to me, so I don't completely follow. Are you basically saying that if our tax bracket is lower in retirement than it is when we do the conversion, then there is no advantage to doing a Roth conversion? Our tax bracket *probably* will be lower in retirement (or at least equal), because we generally live on about half of our current income. However, I thought part of the reason for the Roth conversion was insurance for the possibility that taxes are higher in retirement than expected - either because we need more income or rates are higher. in that case, you would have more flexibility\options with more Roth?

The Boglehead Wiki makes the point that in the 12% bracket you can hardly go wrong doing conversions, which as a general rule of thumb is something I would agree with, but just caution against going overboard with this idea because, especially for a married couple, there is currently roughly $46,400 that can be spent in lower tax brackets ( 0%-$27,000 if both over 65 + $19,400 in 10%). Then add to that another $59,550 that can be spent in the 12% bracket and you get a total of $105,950 of taxable income you can spend in retirement before you need any Roth at all. Of course for the single person that number is $52,775.

Dave
This last paragraph I get. Very good. Thank your for the explanation. This thread has been very educational for me. Given our modest spending (right now 65K per year) and no reason to expect higher in retirement (more likely lower), it is hard to see us exceeding the 12% tax bracket in retirement, so the small amount of Roth we have now is probably good enough "insurance", assuming no drastic change in future tax rates.

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

Post by FiveK » Fri Jan 25, 2019 2:28 pm

wjhunter wrote:
Fri Jan 25, 2019 2:21 pm
Given our modest spending (right now 65K per year) and no reason to expect higher in retirement (more likely lower), it is hard to see us exceeding the 12% tax bracket in retirement, so the small amount of Roth we have now is probably good enough "insurance", assuming no drastic change in future tax rates.
Might be worth checking the marginal rate you'll pay on traditional withdrawals once you are receiving SS benefits. It's easily possible to be "in the 12% bracket" but be paying a 22.2% marginal rate.

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

Post by FinancialDave » Fri Jan 25, 2019 3:46 pm

FiveK wrote:
Fri Jan 25, 2019 2:28 pm
wjhunter wrote:
Fri Jan 25, 2019 2:21 pm
Given our modest spending (right now 65K per year) and no reason to expect higher in retirement (more likely lower), it is hard to see us exceeding the 12% tax bracket in retirement, so the small amount of Roth we have now is probably good enough "insurance", assuming no drastic change in future tax rates.
Might be worth checking the marginal rate you'll pay on traditional withdrawals once you are receiving SS benefits. It's easily possible to be "in the 12% bracket" but be paying a 22.2% marginal rate.
Five,
Wouldn't you say it depends on what a person puts in that taxable account and whether they are spending from it.

If I was concerned about the income thrown off I would certainly consider something like BRK.B or even a basket of non-dividend investments. I was also thinking municipals, but I believe those do add to your MAGI for SS, so not as good an idea.

In the 12% bracket, I would suggest a person could save the taxable account as an inheritance for future generations, or use it similar to a Roth. As an example I drained mine the first two years of retirement to pay off the mortgage.
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by FiveK » Fri Jan 25, 2019 4:04 pm

FinancialDave wrote:
Fri Jan 25, 2019 3:46 pm
FiveK wrote:
Fri Jan 25, 2019 2:28 pm
wjhunter wrote:
Fri Jan 25, 2019 2:21 pm
Given our modest spending (right now 65K per year) and no reason to expect higher in retirement (more likely lower), it is hard to see us exceeding the 12% tax bracket in retirement, so the small amount of Roth we have now is probably good enough "insurance", assuming no drastic change in future tax rates.
Might be worth checking the marginal rate you'll pay on traditional withdrawals once you are receiving SS benefits. It's easily possible to be "in the 12% bracket" but be paying a 22.2% marginal rate.
Five,
Wouldn't you say it depends on what a person puts in that taxable account and whether they are spending from it.
If you are saying that a person isn't required to withdraw from a traditional account, and could instead withdraw spending money from a taxable account - yes, that could work. Up until the year one turns 70.5, at which time traditional withdrawals are not optional.

And that gets us back to the question of "what is the marginal cost to withdraw earlier vs. the marginal cost to withdraw later?" By age 70.5, SS benefits will presumably be occurring.

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

Post by DesertMan » Fri Jan 25, 2019 4:20 pm

If retiring early (pre Medicare) one will need significant high basis taxable account assets to draw on in order to avoid going off the ACA subsidy cliff. Or one could convert TIRA to Roth 5 years or more before retirement into a separate conversion Roth IRA to draw on. Maybe someone here can explain this better.

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

Post by FinancialDave » Fri Jan 25, 2019 4:37 pm

FiveK wrote:
Fri Jan 25, 2019 4:04 pm
FinancialDave wrote:
Fri Jan 25, 2019 3:46 pm
FiveK wrote:
Fri Jan 25, 2019 2:28 pm
wjhunter wrote:
Fri Jan 25, 2019 2:21 pm
Given our modest spending (right now 65K per year) and no reason to expect higher in retirement (more likely lower), it is hard to see us exceeding the 12% tax bracket in retirement, so the small amount of Roth we have now is probably good enough "insurance", assuming no drastic change in future tax rates.
Might be worth checking the marginal rate you'll pay on traditional withdrawals once you are receiving SS benefits. It's easily possible to be "in the 12% bracket" but be paying a 22.2% marginal rate.
Five,
Wouldn't you say it depends on what a person puts in that taxable account and whether they are spending from it.
If you are saying that a person isn't required to withdraw from a traditional account, and could instead withdraw spending money from a taxable account - yes, that could work. Up until the year one turns 70.5, at which time traditional withdrawals are not optional.

And that gets us back to the question of "what is the marginal cost to withdraw earlier vs. the marginal cost to withdraw later?" By age 70.5, SS benefits will presumably be occurring.
No I was saying just the opposite - don't draw from the taxable at all, save it and use as a Roth for later.

In my viewpoint I am not going to spend my Roth money to defer 10.2% of extra tax on my SS, because it is such a narrow window of opportunity for most people and the risk is then you will spend down too much of the Roth for very little gain.

Let's say you are MFJ 65 for both with $50k of SS - you get roughly $20k of tIRA withdrawals for zero tax. My next $42k takes me about to the top of the 12% bracket with roughly $9000 tax. This $42k withdrawal from your tIRA costs you roughly 14.5% marginal rate. I am quite happy with that and from any withdrawals above that the SS taxable is already maxed out at 85%, so that is where you could use the Roth or taxable account for tax still between 0% (Roth) to 15% (taxable). Nowhere am I worried some incremental dollars are spent at 22%, because my effective retirement taxes are still very low. Where I want to spend my Roth money is where my taxes are much higher.

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

Post by FiveK » Fri Jan 25, 2019 5:03 pm

FinancialDave wrote:
Fri Jan 25, 2019 4:37 pm
No I was saying just the opposite - don't draw from the taxable at all, save it and use as a Roth for later.

In my viewpoint I am not going to spend my Roth money to defer 10.2% of extra tax on my SS, because it is such a narrow window of opportunity for most people and the risk is then you will spend down too much of the Roth for very little gain.

Let's say you are MFJ 65 for both with $50k of SS - you get roughly $20k of tIRA withdrawals for zero tax. My next $42k takes me about to the top of the 12% bracket with roughly $9000 tax. This $42k withdrawal from your tIRA costs you roughly 14.5% marginal rate. I am quite happy with that and from any withdrawals above that the SS taxable is already maxed out at 85%, so that is where you could use the Roth or taxable account for tax still between 0% (Roth) to 15% (taxable). Nowhere am I worried some incremental dollars are spent at 22%, because my effective retirement taxes are still very low. Where I want to spend my Roth money is where my taxes are much higher.

Dave
Tax rates for MFJ 65 for both with $50k of SS vs. tIRA withdrawals shown below.

If one wants to be withdrawing ~$62K/yr from accounts in the future to supplement the $50K of SS, the more one could have converted from traditional to Roth at 12% before SS started, the better. At least, up to the point at which traditional withdrawals would be <$20K/yr.

It's better to pay 12% than 18% or 22.2%. One may decide that paying a cumulative 14.5% is acceptable, but paying 18% and 22.2% marginal is still worse than paying 12% marginal.

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

Post by FinancialDave » Fri Jan 25, 2019 5:24 pm

I agree with your math, just not your method. Mainly because future tax rates are unknown over a 30 year retirement so I just don't favor spending Roth money to avoid 10% tax, when I could use the money to avoid 12% or more later. What you should be doing is spending down the tIRA early in retirement to avoid larger RMD's later, not spending down your Roth early in retirement to avoid an extra 5-10% of tax. Don't like the possible risk reward. So far in 7 years of retirement I have used my Roth sparingly to avoid the 24% tax bracket.

It is of course sometimes a balancing act. There are always going to be a few isolated cases where this could make sense, but like I said, it is a narrow window and getting narrower every year on an inflation adjusted basis.
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Re: Taxable vs Nontaxable retirement savings: is there an ideal ratio?

Post by FiveK » Fri Jan 25, 2019 6:09 pm

FinancialDave wrote:
Fri Jan 25, 2019 5:24 pm
I just don't favor spending Roth money to avoid 10% tax, when I could use the money to avoid 12% or more later.
I agree.

But where did "spending Roth money to avoid 10% tax" come from? Don't recall that being an explicit or implicit assumption...?

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

Post by FinancialDave » Fri Jan 25, 2019 6:27 pm

The assumption that was being talked about was converting to a Roth in a 12% bracket. So if you spend that money later to avoid 12% tax it is a break even transaction. If you spend it to avoid anywhere from about 14% to 22% marginal on the SS curve as you show it (like the graph by the way) it's a benefit to you of 2% to 12%. 10% is just a good round number. What I am talking about is the delta to the break-even line on the original Roth investment.
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