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Traditional IRA vs Roth IRA
#1
I've been invested in my ROTH since the beginning, calender year 1998. It's been a fantastic investment tool. I started the ROTH to hedge myself thinking that pensions would eventually disappear for the most part and I wanted something to compliment my 401k plan through my employer. There are many benefits and reasons to be invested in a ROTH plan and it does make sense; however, I've been thinking differently lately and that thinking is making me lean towards the Traditional IRA.

The reason? Taxes.

Assuming your tax rate will be less in your retirement years why pay all the taxes up front at a higher tax rate just to have that money grow tax free when you can contribute to a Traditional IRA, grow your money tax deferred eventually paying less taxes in retirement?

I haven't really researched much about this, but it's been on my mind within the last week.

What's your thoughts on this?
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#2
rayray, that's a tough question because there so many variables and guesstimates involved.

I am assuming you are contributing pre-tax to the 401(k) and getting the full employer match. Considering you can contribute up to 16% of your salary pre-tax, that would be saving you quite a bit of taxes right there.

The big question would be, will you really be in a lower tax bracket when you retire? Those who've done well tax-free throughout their working life may well find that once they reach retirement age and drawing on those accounts they are in the same marginal tax bracket if not higher. Depends on where you fall within the ranges.

If you're not immediately in an equal or greater tax bracket upon retirement may find that 1.) when RMD's kick in for the 401(k) or 2.) RMD's kick in for the traditional IRA (or both), you may well end up paying more taxes when you retire. You also may end up with up to 85% of your Social Security taxable -- you'll need to check the details on this since I haven't looked at SS tax issues for a while.

I would start building a spreadsheet with guesstimates over that time frame and try jiggling the numbers. Also, did you ask your tax advisor when you took your tax info in for preparation this year?

What? You don't have a tax pro? I wouldn't do without one knowing what I know now but that's a story for a different thread and time.
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“While the dividend itself is merely a rearrangement of equity, over time it's more like owning an apple tree. The tree grows the apples back again and again and again, and the theoretical value of the tree doesn't change just because of when the apples are about to fall.” - earthtodan


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#3
Yea, I do have a tax pro but I never really discussed this being I just thought of it within the last week or so, maybe two at most.

Currently my saving tools are 401K tax deferred, Roth IRA and a brokerage account that I consider part of my retirement portfolio.

Not knowing what future taxes will be, I'm assuming most would say use a mix of retirement accounts to hedge yourself. I suppose my way of thinking is that there are many outlets to reduce your tax rate in retirement and if that's a reality then why give the government your taxes now just to contribute to a Roth? Why not defer those taxes while in the higher tax bracket. It's complicated because different investments are taxed differently.

Let's assume two tax brackets, married filing jointly.

Group A: 15% tax bracket 18 450 to 74 900 (Ordinary Dividends taxed at 15%) (Qualified Dividends taxed at 0%)


Group B: 25% tax bracket 74 900 to 151 200 (Ordinary Dividends taxed at 25%) (Qualified Dividends taxed at 15%)



My gut feeling is that most of us will fall into group A during our retirement years. Of course these are current tax rates.


This is something to definitely discuss with a CFP/tax consultant.
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#4
Good on you for a tax pro. All the little gotcha's have been changing so much in the last few years, especially with kids & colleges, I'd rather pay for the knowledge than learn it all myself.

OK, one variable I haven't a clue about is how long before you reach retirement. If you're closer than further, then you can start planning a little easier. I still think either government spending is going to have to adapt or tax rates are going to have to change in the next decade or two.

Also, if the portfolio income is growing faster than inflation (one of my goals), then you may end up in bracket creep anyway because, as of now, the brackets change with inflation.

Lastly, RMDs may be one reason to have a Roth. There aren't any requirements (yet?) so come 70-1/2, do you really want to be forced to add to your taxable income when you don't need the money yet?

As you can tell, it's something I'm still pondering myself and I only have about 10 years before I slow down.
=====

“While the dividend itself is merely a rearrangement of equity, over time it's more like owning an apple tree. The tree grows the apples back again and again and again, and the theoretical value of the tree doesn't change just because of when the apples are about to fall.” - earthtodan


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#5
You're right with the current tax laws the ROTH makes life easier with the ability to withdraw your money when you want it or need it.

I'm still in the accumulation phase and don't plan on retiring till I'm 62, so I have about another 20 years to go yet. I try to prepare myself the best I can and none of us know what we don't know, so I could be in that stage of life that it may be prudent to see a CFP.

My Kplan is just that, I invest with the best choices I have and allocate when necessary. The ROTH and brokerage accounts are geared towards DGI stocks and a couple of mutual funds. I thought I was on auto pilot and would continue as is within these retirement vehicles, but apparently that's not the case since I have questions. I don't want to leave any money on the table, so-to-speak, and that brought me to the Traditional vs ROTH issue.

Now I have to do research on finding a CFP, just great Dodgy lol
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#6
Okay, I did a little research and if anything is incorrect please feel free to do the right thing. Now, the following is directed towards dividend income achievers. Of course, this is with the current tax laws.

Married couples filing jointly will not pay any Federal taxes if earned income is less then 95 500 in QUALIFIED dividend income. This assumes the couple has no other source of income, i.e., pensions, SS, rental income, ect ect ect. Any other income other then QUALIFIED dividend income comes into play and all bets are off, taxes are entering the ballgame. Time for a change up, a new game plan. Back to the subject, in order to pay no Federal taxes on Qualified dividend income the couple has to stay in the 15% tax bracket earning 74 900 or less per calender year. In reality, it's 95 500!! By law the married couple gets a standard deduction of 12 600 plus a personal exemption of 4 000 per person for a total of 8 000, per year. Adding the numbers together, 12 600 + 8 000 = 20 600 + 74 900 = 95 500 per year keeps the couple in the 15% tax bracket. If all income is derived from Qualified income then you pay no federal taxes, pretty sweet deal.

This still brings me to the Roth vs Traditional IRA debacle.

Through current tax laws, assuming I'm not understanding this wrong, we can convert monies from Traditional IRA's and tax deferred Kplans to Roth IRA's as long as that amount is equal to or less then the STANDARD deduction of 20 600. So, every year one can transfer 20 600 from tax deferred IRA/Kplan to a Roth IRA and pay no taxes in the process. That's a huge loophole in order to avoid taxes. This makes me think that 401k plans and Traditional IRA's in the accumulation phase is the way to go. Then use the tax laws accordingly to save massive amounts of dollars.

This is directed towards future Qualified Dividend Income.
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#7
(04-12-2015, 10:44 AM)rayray Wrote: Married couples filing jointly will not pay any Federal taxes if earned income is less then 95 500 in QUALIFIED dividend income. This assumes the couple has no other source of income, i.e., pensions, SS, rental income, ect ect ect. Any other income other then QUALIFIED dividend income comes into play and all bets are off, taxes are entering the ballgame.

So, you're going to forgo Social Security? That amount would be more than the savings you would've realized if you took no income.

(04-12-2015, 10:44 AM)rayray Wrote: This still brings me to the Roth vs Traditional IRA debacle.

Through current tax laws, assuming I'm not understanding this wrong, we can convert monies from Traditional IRA's and tax deferred Kplans to Roth IRA's as long as that amount is equal to or less then the STANDARD deduction of 20 600. So, every year one can transfer 20 600 from tax deferred IRA/Kplan to a Roth IRA and pay no taxes in the process. That's a huge loophole in order to avoid taxes.

All distributions from a pre-tax 401(k) and traditional IRA are considered taxable income, and NOT qualified dividend income, regardless of the source. That includes custodian-to-custodian transfers. So, this is added to any income you make for the year to live on and taxed accordingly.

Two pitfalls here. Unless you have money under the mattress to live on so you don't have to report any other income, you're going to have to file a 1040 to take advantage of the standard deduction & exemptions. Red Flag for the IRS #1 is you've filed 1040s in the past and all of a sudden you don't file or file with no tax due. Expect a letter from the IRS within 2-4 years asking you to prove you didn't have to file or are indeed a 'no tax due' filer but still had a source of money to live on.

This brings us to Red Flag #2 which is even worse, in my opinion. Yes, you had cash laying around to pay all your living expenses. Where did it come from? The IRS hates lots of cash sitting around and you can expect your name to get flagged both within the IRS records and also the FBI, DEA and the rest of Homeland Security. You may never hear from them but they'll be snooping around to find out why you have all that cash. Drug dealing? Terrorist? Organized crime?

But let's say you go around picking up scrap to live off of and you tell the IRS that's where it's coming from. Normally, unless it's large amounts at a time, no one will be the wiser unless you self-report. But tell the IRS it's your source of income so you don't have to file and all of a sudden they're NOT going to consider that a hobby and expect you to now file Schedule C as an unincorporated business in addition to the 1040. Ooops.

(04-12-2015, 10:44 AM)rayray Wrote: This makes me think that 401k plans and Traditional IRA's in the accumulation phase is the way to go. Then use the tax laws accordingly to save massive amounts of dollars.
.

Ben Franklin had it right ... “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”

The best that can be done is to minimize it with judicious planning. I don't recommend letting the tax tail wag the investing dog.
=====

“While the dividend itself is merely a rearrangement of equity, over time it's more like owning an apple tree. The tree grows the apples back again and again and again, and the theoretical value of the tree doesn't change just because of when the apples are about to fall.” - earthtodan


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#8
Yea, Ben Franklin was a smart man!

I should have started this retirement planning when I was 12 lol.
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#9
I don't think I can add to the quality of this discussion, but I will add some quantity. I decided to go full Roth, and the excess of what I can contribute goes to a taxable account, for these reasons.

1. The idea of RMDs appeals to me not a bit. When I retire I should be able to decide when, if, and how much I withdraw.

2. I use my Roth IRA to hold REITs, and other securities that pay out distributions with mixed classifications, including ordinary income, capital gains and Return of Capital (which adjusts your cost basis). I like the fact that I will never have to sort out the tax implications of these distributions. With a traditional IRA, at some point I imagine you'd have to tabulate decades of mixed classifications, each of which is different for each security each year. Sure it can be tracked over time, but there's still something comforting about having all tax implications behind me.

3. Ordinary income from REIT distributions could really add up, if you are successful enough to retire with a large account balance, and if you rotate into higher yield at that time. Enough ordinary income could realistically put you in a higher tax bracket if it's not in a Roth IRA, forcing you to look for income elsewhere.

4. The argument that your tax bracket should be low in retirement applies equally to a taxable account as to a traditional IRA. Given that I use a Roth for the reasons above, I'm hoping that in 30 years I will be able to realize gains and dividends from my taxable account in retirement with little consequence.
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#10
(04-12-2015, 03:42 PM)earthtodan Wrote: I'm hoping that in 30 years I will be able to realize gains and dividends from my taxable account in retirement with little consequence.
I applaud your optimism. RMD's are already taxed and that ROTH windfall will surely catch the eye of the revenuers. But then what do I know, except I sure don't want to live 'til I'm 93...
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