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Old 01-09-2017, 02:53 PM
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Originally Posted by willthrill81 View Post
Roth contributions are taxed at your marginal rate (the highest bracket you pay at). Traditional withdrawals are taxed at your effective rate (the percentage of your overall income paid in taxes) .
Sonny, where are you getting this "effective" tax rate stuff? Have you ever seen a form 1040? There is a line for Wages, that's where your Roth money is. There is also a line for traditional IRA withdrawals. They are taxed the SAME. Here, take a look. Then go get a job and learn something about taxes.
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Old 01-09-2017, 03:00 PM
TacticalFarmer TacticalFarmer is offline
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Originally Posted by DuneElliot View Post
I'm lucky if I make $25K a year. Retiring is a LONG way off...if I ever get to that point. I'm only 37. I have a Roth IRA with very little in it!
How much is "Very little"? You can get things rolling with only a few thousand.

Become an Uber driver in your spare time. Save all of the money. Put it in your Roth IRA. Under your IRA, purchase a Primecap Odyssey Stock Fund "POSKX" when you have the minimum buy in required.

http://primecap.com/funds/stock_fund.html
Old 01-09-2017, 04:41 PM
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Originally Posted by puttster View Post
Sonny, where are you getting this "effective" tax rate stuff? Have you ever seen a form 1040? There is a line for Wages, that's where your Roth money is. There is also a line for traditional IRA withdrawals. They are taxed the SAME. Here, take a look. Then go get a job and learn something about taxes.
They are most definitely NOT taxed the same.

Read the OP for a discussion of marginal vs. effective tax rates. Not every dollar is taxed at your highest (marginal) tax rate.

Here's the deal. Let's say that there were only two tax brackets: your first $50,000 of income is taxed at 10%, and everything above that is taxed at 30%. The 30% would be the marginal tax bracket. Now if you made $100,000, it would not all be taxed at 30%. The first $50k would be taxed at 10% ($5,000), and the rest would be taxed at 30% ($15,000). If you add up the total tax paid and divide it by your income, you get the effective tax rate (20% in this case). It's not on a 1040, but it's a very real number that's very important.

Now if you made a Roth contribution in this scenario, your contribution would be taxed at the higher marginal rate (30%). The reason is because if you made a traditional IRA contribution instead, you wouldn't pay any tax on that money.

But when you take out $100,000 from your traditional IRA in retirement, you would only pay 20% of it in taxes (see above for why). That 10% difference is the savings you get with a traditional over a Roth. And if you're like most retirees and need less income than when you were working, you save even more in taxes because your effective rate would drop.

There's no need to be snarky. I already told you that a CPA in this thread (page 1) agrees completely with my analysis.
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Old 01-09-2017, 06:41 PM
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As an accounting/tax professional, I can tell you that these IRA vs. ROTH debates are silly.

IRAs and ROTHs are tools, and like arguing "which is better, a hammer or a screw driver," it's silly to debate the merits of one vs. the other. They're both useful in different scenarios, and for many people it makes sense to have both.

Estate/retirement planning is not like dropping a bomb - you don't pick a lever, pull it, and let it drop. It's like landing an airplane - you make small corrections and adjustments along the way using several different tools as you gently glide to your target.

There are many different factors you should consider when planning for retirement - income and tax rates are only two of them - and you should review and adjust your strategy regularly. Your financial life at 25, 35 and 45 will all be different - your retirement strategy should be different too.

Consider other deductible expenses, and whether they will change year to year. Contribute to a ROTH in years when you have high medical expenses or in the early years of a mortgage when you have high mortgage interest deduction. Contribute to a Traditional IRA when you have extra income or to offset taxable gains. Use a ROTH conversion to control your marginal tax rate at the end of every year.

Also consider the opportunity cost of your cashflow - even if it's more cost effective to pay taxes in retirement, the tax savings may be more impactful in years when cash is tight.

And be mindful of the cost of your investment vehicles - not all plans are built the same. All things being equal (or not), consider investing in the plans and funds with the lowest fees.

Most importantly, when it comes time to retire you'll be able to build your income in the most efficient manners using many different tools at your disposal.

Retirement planning isn't about gambling whether tax rates will go up and down. It's about proactively providing yourself the tools so that you have choices and can respond effectively, no matter what the future may bring.
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Old 01-09-2017, 07:10 PM
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Originally Posted by puttster View Post
Sonny, where are you getting this "effective" tax rate stuff? Have you ever seen a form 1040? There is a line for Wages, that's where your Roth money is. There is also a line for traditional IRA withdrawals. They are taxed the SAME. Here, take a look. Then go get a job and learn something about taxes.
puttster, you clearly don't understand how a progressive tax system works.

It's one thing to be an ******* and be correct. It's another to be an ******* and have no idea what you're talking about...
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Old 01-10-2017, 01:02 PM
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One more thing to keep in mind with regards to tax deferred accounts like the IRA/401K is that the government can always adjust the amount of tax collected by changing the minimum withdrawal and forcing you into a higher tax bracket.
Old 01-10-2017, 01:07 PM
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Originally Posted by TonyDedo View Post
Use a ROTH conversion to control your marginal tax rate at the end of every year.
I've never paid much attention to Roths because of the W2 limit, but this mention of controlling your marginal tax rate at the end of every year caught my eye. Could you explain that a bit?
Old 01-10-2017, 01:44 PM
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I thought your Roth contributions were never taxed again
Old 01-10-2017, 01:55 PM
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Originally Posted by 3cyl View Post
I thought your Roth contributions were never taxed again
Never taxed again, no required distributions and you can leave it to a beneficiary tax free.
Old 01-10-2017, 02:38 PM
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Originally Posted by Watchingtheweasels View Post
I've never paid much attention to Roths because of the W2 limit, but this mention of controlling your marginal tax rate at the end of every year caught my eye. Could you explain that a bit?
I assume he is referrng to the modified AGI on deductible contributions on IRAs.
Old 01-10-2017, 03:12 PM
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Originally Posted by Watchingtheweasels View Post
One more thing to keep in mind with regards to tax deferred accounts like the IRA/401K is that the government can always adjust the amount of tax collected by changing the minimum withdrawal and forcing you into a higher tax bracket.
Congress can do whatever they want to do. Don't assume that they'll never find a way to tax Roth withdrawals. They can change any rules anytime they want to. All we can do is plan with the knowledge we have available to us now, knowing that nothing is guaranteed.

That being said, the IRS specifies required minimum distributions on the basis of your life expectancy. If life expectancies continue to increase, RMDs will eventually come down a bit. But as I said, they can change anything at any time.

Personally, I would rather take a guaranteed benefit now (no taxes on contributions with a traditional) than a likely but uncertain benefit that's likely to be smaller (for me at least) far into the future.

Quote:
Originally Posted by Watchingtheweasels View Post
I've never paid much attention to Roths because of the W2 limit, but this mention of controlling your marginal tax rate at the end of every year caught my eye. Could you explain that a bit?
Basically, you see at the end of the year which marginal tax bracket you ended up in, and if you could take on enough extra dollars of taxable income, you convert funds from a traditional IRA into a Roth IRA. Generally, you would only do this to (1) avoid paying even higher taxes on the converted funds when you retire or (2) to minimize the impact of required minimum distributions later on.

If I retire at around age 55, I plan on converting enough funds to a Roth IRA to keep me in the 15% marginal tax bracket for both of the above reasons.
Old 01-10-2017, 05:48 PM
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Originally Posted by Watchingtheweasels View Post
I've never paid much attention to Roths because of the W2 limit, but this mention of controlling your marginal tax rate at the end of every year caught my eye. Could you explain that a bit?
High level explanation: You can control/manipulate your marginal tax rate by doing a tax projection before the end of the year and shifting money into the appropriate investment vehicle.

The idea is that your marginal tax rate is rarely the same every year. We have good years and bad years. We experience things that temporarily increase our marginal tax rate (bonuses, one time capital gains from selling stock or a house) and temporarily decrease our marginal tax rate (periods of unemployment, deductible interest in the early years of a mortgage, tuition deductions for sending your kids to college, capital losses, one time tax credits). And the tax laws are constantly changing.

So you can use tax planning and retirement investment vehicles to shift income out of the high tax years and into the low tax years.

This is just one of many examples, all of which are going to vary at a detail level depending on your situation.

Reducing your marginal tax rate:

Let's say you're single and you project your taxable income is going to be $100,000 for this year. Your marginal tax rate is 28%, and $8,100 will be taxed at that rate. So you choose to put $8,100 into a tax deferred investment vehicle (IRA, 401k, SEP, etc). Your marginal tax rate is now 25%.

Increasing your marginal tax rate:

Let's say the following year you get laid off, or you buy a big house or have quintuplets, and your taxable income is only $29,850 for the year. That puts you in the 15% tax bracket by exactly $8,100. So you do a ROTH conversion - take that $8,100 out of your tax deferred investment vehicle (IRA, 401k, SEP), pay taxes on it at your marginal rate (15%), and park it in your ROTH IRA. Your marginal tax rate is now 25%, but all your income was taxed at 15% or lower (does that make sense).

As a result that $8,100 that was originally going to be taxed at 28% was instead taxed at 15%, and will sit in your ROTH and grow tax free.

This is just an example of basic tax planning, but the key is that you project your tax liability BEFORE the end of the year, and you have multiple tools at your disposal to make adjustments as you go.
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Old 01-10-2017, 09:20 PM
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To survive the 2/3 drop in income after her husband's death for the decade until her death the below is exactly what my grandma did.

She sold her stocks, some highly-appreciated (acquired 1940s-1970s), which were taxed 0% federally and 2-3% effectively (by the state).

Married in the late 1930s, they paid federal taxes on the first dollar of their AGI for nearly all of their working life.
(e.g. lowest bracket was 20% in the 1950s, dropping to 14% in the 1960s. iirc, not until the mid-1970s was there a 0% federal bracket)

The above strategy allowed grandma to leave six figures in equities (stepped up basis, of course) to her children.

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Originally Posted by willthrill81 View Post
And even apart from a Roth, you can get tax deferred growth and tax free income (before age 59.5 too) by simply buying and holding equities, then selling them when the long-term capital gains rate is zero. Granted, your taxable income cannot currently exceed $75,300 to achieve this, but that's significantly higher than the U.S. median household income anyway.
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Old 01-10-2017, 11:22 PM
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To survive the 2/3 drop in income after her husband's death for the decade until her death the below is exactly what my grandma did.

She sold her stocks, some highly-appreciated (acquired 1940s-1970s), which were taxed 0% federally and 2-3% effectively (by the state).

Married in the late 1930s, they paid federal taxes on the first dollar of their AGI for nearly all of their working life.
(e.g. lowest bracket was 20% in the 1950s, dropping to 14% in the 1960s. iirc, not until the mid-1970s was there a 0% federal bracket)

The above strategy allowed grandma to leave six figures in equities (stepped up basis, of course) to her children.
Your example is a perfect illustration of the fact that the statement "taxes always go up" is simply false. The situation is far more nuanced than that.

I believe that it's easier to pay very low, even zero, taxes with a respectable income today than just about at any other time since the development of the U.S. income tax.
Old 01-11-2017, 09:40 AM
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If I retire at around age 55, I plan on converting enough funds to a Roth IRA to keep me in the 15% marginal tax bracket for both of the above reasons.
No one should be taking financial advice from a person whose dream is to get into the 15% tax bracket
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Old 01-11-2017, 12:44 PM
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No one should be taking financial advice from a person whose dream is to get into the 15% tax bracket
Reduced to insults are we?

Never take financial advice from someone who doesn't understand tax law 101.

Do you know what taxes Warren Buffet pays? In 2011, he reported to the NYT that his effective tax rate was only 17.4%. And he's reported to be the second wealthiest person in the country.

Wealth is not measured in how much taxes you pay.

ForestBeeKeeper, a fellow here on SB who made a lot of money in real estate, went for many years without paying any income taxes at all.
Old 01-11-2017, 12:59 PM
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Reduced to insults are we?

Never take financial advice from someone who doesn't understand what effective tax rates are.

Do you know what taxes Warren Buffet pays? In 2011, he reported to the NYT that his effective tax rate was only 17.4%. And he's reported to be the second wealthiest person in the country.

Wealth is not measured in how much taxes you pay.

ForestBeeKeeper, a fellow here on SB who made a lot of money in real estate, went for many years without paying any income taxes at all.
As has Trump

Using the tax system to your advantage is what this thread is about
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Old 01-12-2017, 01:41 PM
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The OP is stating numbers as if you have to choose one over the other. That's simply not the case.
You should be very diverse in your investments.

In my case, investments (outside of RE) are in four categories.
1)Traditional Qualified retirement accounts - IRA, 401K
2)After Tax retirement accounts - ROTH IRA
3)529 savings (Similar to 401K regarding state taxes but grows tax free like a ROTH)
4)Ordinary non-retirement brokerage account (Liquid and unrestricted)

This is in addition to any checking, savings or liquid cash on hand. These are investments for the future.

I really like ROTH and currently put all of my 401K contribution in ROTH 401k. I really like the thought of taking income down the road that will not be added to my taxable income. Keep in mind that when you are eligible for SSA, you are taxed on your SSA money if your taxable income is above a certain level. Through planning, you manipulate your "taxable income" through withdrawals from your ROTH accounts. You can, in reality have much more retirement income without the possible tax on your SSA income.

in short, you should have both pre-tax and after-tax contributions available once you retire.
Old 01-12-2017, 01:50 PM
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I really like ROTH and currently put all of my 401K contribution in ROTH 401k. I really like the thought of taking income down the road that will not be added to my taxable income.
That's really the crux of the issue as to why people like Roth IRAs: they like the idea of not having to pay taxes in the future, even at the expense of paying taxes today. The problem is that this does not always (probably not even usually) make the most financial sense. However, that's why it's called personal finance. I'm paying off my mortgage early, which doesn't make the most financial sense, but it gives me a sense of security that I value above the money.

If you've been informed regarding how the two IRA types actually work, then at least you're making an informed decision. Unfortunately, most people are not making informed decisions and are simply listening to what they've been told by someone who isn't usually informed either.

As I've said over and over throughout this thread, unless your effective tax rate in retirement (potentially a function of SS, IRA withdrawals, and other sources) will be higher than your marginal tax rate when you make your IRA contributions, then the traditional IRA is better; otherwise, the Roth is better. That is a mathematical truth that is not my opinion.

The element of subjectivity to the topic comes in when trying to determine what your effective tax rate will be. All we can do is use history as our guide. Some say that income taxes always go up, but history has shown that notion to be false.

And remember that nothing is guaranteed either way: tax rates may go up substantially in the future (a plus for the Roth) and/or Congress may find a way to tax Roth withdrawals (a plus for the traditional IRA).
Old 01-13-2017, 12:33 PM
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As I've said over and over throughout this thread, unless your effective tax rate in retirement (potentially a function of SS, IRA withdrawals, and other sources) will be higher than your marginal tax rate when you make your IRA contributions, then the traditional IRA is better; otherwise, the Roth is better. That is a mathematical truth that is not my opinion.
The only thing that you left out of the equation is growth. Your "effective" tax rate in retirement may very well end up being 100% of your initial contribution. In other words, if you initially deposit $100, it grows to $400 and you withdraw $400, a 25% tax rate would mean you pay $100. You would get $300 from your initial investment. That is the entire amount of your initial investment. At the same tax rate initially (assuming like this entire topic) you saved $25 in taxes initially.
That same $100, invested in a ROTH, if grown to $400 will allow you to withdraw the entire $400, use the entire $400 and pay no taxes. Or, if you like the math this way, take out $300, your entire gain, and use it all, pay no taxes and you still have your ENTIRE initial investment.

Another thing I like about having some money in ROTH is that you are not required to start taking distributions at age 70 1/2. With a traditional IRA, you are required to take money and pay taxes, as soon as you turn 70 1/2.
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