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Old 11-29-2012, 11:08 AM
 
3 posts, read 7,408 times
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Hello Everyone,

I'm a young (22) engineer from New Jersey who recently graduated and started working. I quickly wanted to learn everything about retirement accounts so I could begin saving. I've read many, many articles about Traditional and Roth 401ks and IRAs. After digesting everything, I've come to a solution. I would appreciate any input, criticism, or advice. This post assumes you understand marginal tax rate.

My solution is simple: use both a Traditional and Roth 401k.

In my situation, I'm currently earning less than I will be earning in the future. I can benefit with a Roth 401k by paying taxes while I'm in a lower tax bracket. Once I retire, I will most likely have an income higher than I do now. The tax savings on my retirement income will outweigh the tax savings (via income deductible) of having a Traditional 401k right now.

However, there will come a time when I'm earning significantly more money and I will be taxed more. I may even hit a salary where I am not eligible to participate in a Roth 401k any longer. At this point, I will stop contributing to a Roth 401k (or possibly roll over to a Roth IRA and contribute the maximum $5,000 or so a year). This is when I'll begin to max out my contribution to a Traditional 401k until I hit retirement.

Now, here is where my plan flourishes.

In retirement, I will have my Traditional and Roth accounts. They will be my main source of income. I will withdraw my FIRST dollars from my Traditional account. My first income dollars, up to my total deductible amount, will be taxed at 0%. I will continue withdrawing from my Traditional account, and I will be taxed marginally, up to a tax bracket which I see fit.

My second withdraw will come from my Roth account, which will "top off" my income to a comfortable level. This withdraw will be taxed at 0%, since I've already paid those taxes during my working years.

This part may get confusing. It would only make sense that I withdraw from my Roth account if and only if my retirement income lands me in a tax bracket that is more than the tax bracket I was in while I was contributing to my Roth account. If I paid 25% tax on my Roth contributions, why would I withdraw my tax-free Roth dollars if my retirement income tax bracket is less than 25%? That would just be silly. However, if I withdraw enough money from my Traditional account to land me in the 25% tax bracket, I could then tap into my Roth account and withdraw more - and I'm still locked in the 25% tax bracket.

And there you have it. The answer is not one or the other; have your cake and eat it too. Using my plan, I should be able to 1) significantly reduce the taxes on my Traditional account and thus the taxes I owe during retirement 2) reduce my taxable income during my working years. If anyone can spot flaws in my logic I would love to hear about it.

Also, there are still open ends with my solution that I would like to discuss.

1) Figuring out the ratio of Traditional and Roth withdraws that will make up my retirement income. I have to figure out how much of my retirement income will come from the Traditional account, and how much my Roth account will "top off" my income.

2) Figuring out exactly how much and when to contribute to a Traditional and/or Roth account.

3) Figuring out if there are any negative impacts to starting a Roth 401k now, and say 10 years from, starting a Traditional 401k from scratch.

Thanks for your time. Take care!

-Paul T.
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Old 11-29-2012, 11:39 AM
 
Location: Alaska
5,352 posts, read 15,858,220 times
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Sounds like a good plan to me. Be aware of the Required Minimum Distributions (RMDs), on your traditional IRA at age 70, which can affect your plan. While I don't currently have a Roth, my plan is to convert my traditional to a Roth up to the top of my tax bracket while in retirement. That way I'll have the same flexibility to manage income as in your plan.

As to your point, you'll just need to have the flexibility to vary your withdrawals from each source. You don't know what the tax code will be when you retire so your best bet is to vary your contributions to fit current code at the time.

Always contribute the minimum amount necessary to get an employer match if any. If your employer allows it, have employer's contributions go into a traditional so you won't pay taxes on it now. Also, contribute the maximum allowed now as they will have a better chance of growing. As to when to contribute, the earlier the better, on the assumption you're giving it more time to grow. A case can be made for equal monthly contributions for dollar cost averaging too.

I don't see any negative impacts of a Roth now and traditional later. You can contribute more at age 50, so plan your changeover accordingly. It might mean going a year or two longer with your Roth to make them equivalent.

Good luck with your plan.
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Old 11-29-2012, 02:10 PM
 
Location: WA
5,293 posts, read 20,709,725 times
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Quote:
Originally Posted by trianta2 View Post
Hello Everyone,

I'm a young (22) engineer
...
It is great you are thinking about how to use the options available but keep in mind the government will change the regulations and taxes multiple times before you retire. Many of us are living in a very different world than we anticipated in our 20's.
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Old 11-29-2012, 02:41 PM
 
Location: Lexington, SC
4,281 posts, read 10,289,034 times
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I was taught by a wise old CPA to delay paying taxes as long as possible. He said he saw few cases were paying taxes early was an advantage but he saw many cases were delaying paying them was.

Tax avoidance is legal. Tax evasion is illegal.
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Old 11-29-2012, 06:01 PM
 
64,629 posts, read 66,158,228 times
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The biggest bang will come from putting the right assets in the right vehicles.

Equities will do best in a taxable account if you expect to eventually have heirs.

You can benefit from lower capital gains taxes, write off losses,and pass tax free to heirs with no mandatory withdrawals for heirs like a roth.

Things that spin off regular income can be put in a traditional since they are taxed at regular rates anyway.

Roths are a bet tax rates will be higher which may or may not be true with no pay checks coming in.

You cant predict so far in advance as far as the nuts and bolts of your withdrawals as there is so much to eventually consider.
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Old 11-29-2012, 08:31 PM
 
Location: Los Angeles area
14,022 posts, read 16,947,806 times
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Although I have no expertise on the subject matter of this thread - and so I would normally not post here at all - I just have to say that I am favorably impressed by the thoroughness of the OP's research and thinking on the subject. I would say that is very, very rare for a 22-year-old. Many folks do not even begin to think about retirement in a serious fashion until decades later. Well done. (And do continue to keep an open mind by seeking out information and opinions, but don't forget that all of us here are anonymous strangers.)
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Old 11-29-2012, 08:51 PM
 
12,825 posts, read 19,275,714 times
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I started my 401K when I was 23. The one thing I'd do differently is live more monk-like during my 20s and max the thing out from the get go. I did not start maxing until I was in my 30s. I started my IRA a bit late and failed to take advantage of lower income early in my career. Some years later in it I could not do deductible IRA due to income level.

One final bit of stodgy advice I wish I got. Until you are able to fund home ownership, a family nest egg and additional living expenses for another adult, you have no business dating or courting. Far too many people ignore this advice then wonder why they have simultaneous marital and financial problems. Everyone I dated, got intimate with and in a few cases shacked up with prior to getting married made me financially weaker. I wasted too much money trying to impress the ladies. By the time I got married I lacked what I consider now to be a proper portfolio. Made up for it somewhat later, but looking back I did it all bassackwards. People can say what they want about this advice, I know it sounds like Dr. Laura or something. But looking back this advice would have helped me greatly.

Men really do have their brains connected to their you-know-whats in most cases. Learning to overcome that and be fiscally disciplined is one of the best things a man can do.
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Old 11-30-2012, 06:37 AM
 
3 posts, read 7,408 times
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Thank you all for your inputs.
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Old 11-30-2012, 10:06 AM
 
3 posts, read 7,408 times
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Quote:
Originally Posted by accufitgolf View Post
I was taught by a wise old CPA to delay paying taxes as long as possible. He said he saw few cases were paying taxes early was an advantage but he saw many cases were delaying paying them was.

Tax avoidance is legal. Tax evasion is illegal.
I understand. However, if one used a Traditional account as a source of income during retirement up to their total deductible (say $5,950 for a single filer), then that money would have never been taxed either Federally or by the state. I believe this is as close to tax avoidance as you can get legally.

From a practical perspective, no one would be able to live off that low of an income. Nonetheless this illustrates how I plan to use my Traditional account to lessen the blow of taxation during retirement.
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Old 11-30-2012, 11:03 AM
 
4,507 posts, read 6,732,486 times
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You're only 22, by the time you are ready to retire, you will be living in a different financial world entirely. You're basing your system on that fact that things will remain the same (which they won't). But I do commend you for saving at your age.

There is already talk of doing away with the pre-tax benefit of 401k's. I knew eventually the Government would want to get their greedy hands in our money much sooner.
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