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Quick background:
~I'm a 27 y/o female w/ a Corporate Finance degree & I thought I truly understood the ins & outs of ROTH IRA's, 401(k)s, 403(b)s, yadda yadda... then while having a casual convo with my Dad about his investment vehicles he stumped me on something...
My current salary is in the mid $70k annually. My company offers a 401(k), Roth, and Traditional IRA --- they match 50% up to 8%. I decided to go with the ROTH - max it out with 8% contributions to get my employers 4%. I made a comment to my Dad about how my check is eaten by taxes & this 8% contrib. and he made a comment about "well, consider the 401(k) to get the tax benefit"... then I start talking to my Dad (in my 'proud Finance voice') about how Roths are great for young professionals b/c we get taxed now - at a presumably lower tax rate than the rate I'll be at when I retire... then my Dad says "Well, how do you figure you'll be at a higher tax rate at retirement"... then I say "Well - duh, Dad.. I plan to be making far more than $70k when I retire {my goal is to exceed $100k by 35, but thats another story}. Then my Dad stumps me with this - "Well, if you retire you won't be making any income" (assuming I don't work after retirement which is certainly my goal... Now I know there are other benefits and $$ that comes in after retirement (aside from personal investments) - but that doesn't amount to much...
Why have I not thought about this...??? Yes, I'm making mid $70k now.. and yes, by mid 40's or 50's I plan to be making more... but when I retire will I be making anything?? If not (or if very little) I'll be at a lower tax bracket so a 401(k) would be a better option for me now. Why oh why does my Dad always find ways to make me think... lol
-- So I come to you CD Forum... please please help me out on this...
When you pull money out of a tax deferred retirement plan like a 401(k) or Traditional IRA (but not a Roth IRA) it will be taxed at ordinary income. You may not have kids to write off, a mortgage to write off.
I don't think there is a simple way of figuring this out without making some assumptions.
Personally, I max out my 401(k) and contribute to two Roth IRAs (2 X $5000), one for me and one for my non-income earning wife. I also contribute to four college savings accounts (4 X $2000) for my four kids. There isn't much left except beans and franks after all that.
When you pull money out of a tax deferred retirement plan like a 401(k) or Traditional IRA (but not a Roth IRA) it will be taxed at ordinary income. You may not have kids to write off, a mortgage to write off.
I don't think there is a simple way of figuring this out without making some assumptions.
Personally, I max out my 401(k) and contribute to two Roth IRAs (2 X $5000), one for me and one for my non-income earning wife. I also contribute to four college savings accounts (4 X $2000) for my four kids. There isn't much left except beans and franks after all that.
Ahhhhhh!! I didn't think abt the write offs... I do have a mortgage.. no kids. I'd assume that I either (a) wont have kids period or (b) will have kids but wont be writing them off by the time I retire... so with that said.. how would that effect the tax advantage?
Do both, and when you retire pull money up to the stepped tax bracket out from the traditional 401k and then the rest out of the roth. So that way you are deferring taxes in the 25%+ bracket but paying taxes in the 10%-15% bracket. The roth will be a wash because you are now paying taxes in the 25%(ish) bracket and will be paying that tax in the future as well (assuming rates don't change).
In reality the roth only makes sense if you don't make much money (not much tax to defer).
Ahhhhhh!! I didn't think abt the write offs... I do have a mortgage.. no kids. I'd assume that I either (a) wont have kids period or (b) will have kids but wont be writing them off by the time I retire... so with that said.. how would that effect the tax advantage?
there is no answer as to which is better. only hindsite can tell you. want me to argue either way?
i always say that i cant imagine many of us being in a higher tax bracket with no paychecks then we are with them. coupled with the fact many of us will retire to low tax states .im all for getting that tax deduction now...
income taxes have been dropping by about 3% a year now for 40 years as more and more income goes thru at lower and lower tax brackets.
want the pro roth argument? the wild card is this from a planning standpoint.
if you have a mortgage on your house you know exactly what you owe.. well you have a mortgage on your 401k and ira's too only you dont know what you owe. your partner uncle sam has an open ended check book on your money.. you have no clue what will be left down the road for you and your spouse to live on.
if i leave marilyn a million bucks in taxable retirement money i have no clue how much she will have of that to live on.
so why not buyout your partner early in the game .. get rid of uncle same while you know what you owe and go roth. its easier to plan.
roths real strong points are not so much in tax benefits but the fact you can pass whatever is left of this money tax free to your heirs and if the investments earn more then the required distributions then that money can go on tax free from generation to generation actually having each generation end up with more then they started.
why not do a little of both...that way you mix it up.
my plan is not to leave marilyn a big pile of tax infested retirement money with a partner but rather to take some of that money ,purchase a life insurance policy for the same amount and leave marilyn a totaly tax free pile of money with no partner.
whatever is left after paying the life insurance the kids will get and they can pay the taxes over their lifetime not marilyns.
odds are too i will pay in a lot less for the insurance then marilyn will get giving me nice leverage with the money as a benefit.
life insurance and roths are the best way to tax plan and give your uncle as little as possible of your savings.
Last edited by mathjak107; 10-09-2010 at 03:42 AM..
Say your tax bracket is 25% right now, you are being taxed at 25% on the money you are putting into your ROTH. When you retire, lets say your tax bracket will be 30% and you have put all of your money into traditional IRA's or a traditional 401K-when you take that money out you will be taxed at 30%. It is really a guessing game. You are guessing that your tax bracket will be higher when you retire then it is now. Also keep in mind that tax brackets change over time so even if you are in the same tax bracket when you retire as you are now, that tax bracket might be 28% vs 25%. I do think that putting money into a ROTH when you can is a good idea. You are not all that far away from being restricted from putting money into a ROTH. When that happens, you start putting money into a traditional 401K. The idea is to have some of both. We have traditional IRA's, a ROTH, IRA, a 401K, some whole life insurance, a pension and a very small annuity set up for retirement funds. The whole life insurance comes to us tax free in retirement so that combined with the pension is our "fixed" cost money (property taxes, utilities, etc.). The rest of the money is our "fun" money.
A couple other advantages of the ROTH is that you don't have a minimum distribution age and you can take out your cost basis without additional tax consequences for buying a home, loss of a job, etc.
The way I see is this... it may be 25% tax bracket now... but when you pull money out of 401k and Traditional IRAs, the tax bracket may be HIGHER in the future and say you pull out 70k a year during retirement from those investments, you would be paying more in taxes unless you have a ROTH... you are betting that tax rates will go up in the future... I emphasize betting because we don't know and given the government's thirst for stupid spending, it will probably happen unless they get serious about out of control spending... besides that ROTHs allow you to have earnings tax free as long as its a qualified distribution, do you want to pull out 70k and pay possibly 30% taxes in the future or do you want to pull out 70k and pay zero taxes?
Quick background:
~I'm a 27 y/o female w/ a Corporate Finance degree & I thought I truly understood the ins & outs of ROTH IRA's, 401(k)s, 403(b)s, yadda yadda... then while having a casual convo with my Dad about his investment vehicles he stumped me on something...
My current salary is in the mid $70k annually. My company offers a 401(k), Roth, and Traditional IRA --- they match 50% up to 8%. I decided to go with the ROTH - max it out with 8% contributions to get my employers 4%. I made a comment to my Dad about how my check is eaten by taxes & this 8% contrib. and he made a comment about "well, consider the 401(k) to get the tax benefit"... then I start talking to my Dad (in my 'proud Finance voice') about how Roths are great for young professionals b/c we get taxed now - at a presumably lower tax rate than the rate I'll be at when I retire... then my Dad says "Well, how do you figure you'll be at a higher tax rate at retirement"... then I say "Well - duh, Dad.. I plan to be making far more than $70k when I retire {my goal is to exceed $100k by 35, but thats another story}. Then my Dad stumps me with this - "Well, if you retire you won't be making any income" (assuming I don't work after retirement which is certainly my goal... Now I know there are other benefits and $$ that comes in after retirement (aside from personal investments) - but that doesn't amount to much...
Why have I not thought about this...??? Yes, I'm making mid $70k now.. and yes, by mid 40's or 50's I plan to be making more... but when I retire will I be making anything?? If not (or if very little) I'll be at a lower tax bracket so a 401(k) would be a better option for me now. Why oh why does my Dad always find ways to make me think... lol
-- So I come to you CD Forum... please please help me out on this...
~AtlantaGal
The traditional assumption has been that your tax rate would always be lower at retirement than at the peak of your career (which you haven't reached yet).
I don't think this assumption is valid anymore. We have a huge entitlements crisis and huge deficits. It's clear our tax rates will be headed up. It's therefore a very valid position to take that you're better off paying the tax at today's rates, and letting the money grow without tax.
In this case, I think you're smarter than the old man...He's just coming out with old platitudes that people used to go by without thinking. Many of these old platitudes have led us to ruin. Always question them.
I'd go with the Roth IRA for as long as it's available to you. I'd get one, but I make too much money.
80 million voting retiring baby boomers are a good bet income taxes for the masses will remain pretty much as they are which are the lowest in history and going lower each year. for over 40 years..
other taxes will sky rocket but income tax i feel will be sacred ground if the politicians want their jobs.
you think any political party is telling 80 million retirees they are raising their income taxes? i just dont see higher income taxes except on upper incomes playing out .
im also not in favor of any retirement vehicle that makes it easier for folks to tap that money before its time . pulling from one front to shore up another front is a quick way to loose the war
think about why the irs is allowing us to convert to roths and giving us 2 years to pay the taxes. i think they too realize it would take absurd tax increases to put most of america in a higher tax bracket later on with no pay checks. especially when you move to a low or no state tax state.with most families having 2 incomes thats pretty tough to beat tax wise with no pay checks...they want their tax money now...
35 years ago we all worried about the tax rates when we all reached retirement age... no one ever imagined lower tax rates off in the future and yet here we are retiring into rates that are the lowest ever.
things always have a way of playing out different then common sense at that time dictates. we used to laugh at the 5% christmas club account as a savings vehicle.. look at us now, we would die for 5% in a bank.
Last edited by mathjak107; 10-09-2010 at 07:45 AM..
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Yes, I'm making mid $70k now.. and yes, by mid 40's or 50's I plan to be making more... but when I retire will I be making anything?? If not (or if very little) I'll be at a lower tax bracket so a 401(k) would be a better option for me now. 
Why oh why does my Dad always find ways to make me think... lol 
I didn't think abt the write offs... I do have a mortgage.. no kids. I'd assume that I either (a) wont have kids period or (b) will have kids but wont be writing them off by the time I retire... so with that said.. how would that effect the tax advantage?
