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Opus 17
Level 15

Having second thoughts about my retirement contributions

Right now, about 90% of my qualified retirement money is pre-tax, but my new contributions are going 50/50 to pre-tax and Roth (both a Roth IRA and a designated Roth 403b).  I like the idea of Roth money because there are no taxes in the future, no RMD, and I can use the contributions from the Roth IRA as an emergency cash reserve if something bad happens.  But in thinking about my tax position, it seems that this is an expensive option.  By making Roth contributions, I am foregoing a 22% tax deduction now.  But my pre-tax money will mostly be taxed at 12% when I retire.  (Even if I withdraw enough plus taxable SS to be in the 22% bracket, the pre-tax money will have an average tax rate of 15% or so.)  Even if Congress raises taxes "on the middle class" (which they always promise not to do), I doubt they would double the marginal rates from 10/12 to 20/24, so it seems I am losing money in the long run by making the Roth contributions now instead of pre-tax contributions.

 

Any thoughts?

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
6 Replies
Critter-3
Level 15

Having second thoughts about my retirement contributions

This is something you have to decide for yourself and it will depend a lot on how long you have to go until you retire and start taking distributions so a talk with a financial planner and or a local tax pro so you can get personal suggestions for your individual situation. 

 

Just  some  general info: 

 

>contribute $100,000  to a traditional IRA get 22% tax savings now  ... later the account may be worth $150,000 and every penny of the distribution is taxable at your current tax rate  ... so 100K x 22% = 22,000 saved now  but if the tax rates do not change and your income remains the same $150,000 x 22% = 33,000. 

 

>contribute $100,000 to a ROTH and pay the 22% taxes now  ... later the account may  be worth $150,000 and all of the distributions are tax free.  A difference of $11,000 if nothing changes.   

 

If you contribute more over the years and the account does well and earns a lot then the tax savings could be much larger.  Also the tax savings to your beneficiaries need to be considered if you don't spend it all yourself. 

 

Opus 17
Level 15

Having second thoughts about my retirement contributions


@Critter-3 wrote:

This is something you have to decide for yourself and it will depend a lot on how long you have to go until you retire and start taking distributions so a talk with a financial planner and or a local tax pro so you can get personal suggestions for your individual situation. 

 

Just  some  general info: 

 

>contribute $100,000  to a traditional IRA get 22% tax savings now  ... later the account may be worth $150,000 and every penny of the distribution is taxable at your current tax rate  ... so 100K x 22% = 22,000 saved now  but if the tax rates do not change and your income remains the same $150,000 x 22% = 33,000. 

 

>contribute $100,000 to a ROTH and pay the 22% taxes now  ... later the account may  be worth $150,000 and all of the distributions are tax free.  A difference of $11,000 if nothing changes.   

 


I know that's the standard thinking, but if we assume my income now is $100,000 per year, anything I put in pre-tax saves 22%, because it comes off the top.  However, in retirement, let's say I want an income of $70,000, and $30,000 is (partly-taxable) social security.  My IRA draw ($40,000) would be mostly taxed at 12%, thanks to the standard deduction and partial social security exclusion.

 

In other words, the deduction is off the top, but the tax owed is calculated from the bottom up.

 

But on the other other hand, if all my retirement income was Roth, SS would not be taxable at all, which is yet another factor that confuses me further.

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Critter-3
Level 15

Having second thoughts about my retirement contributions

This is where a sit down with a knowledgeable  financial planner would be wise because there are too many variables to consider.  Everyone's situation is different and you can never know what tax law changes will happen in  the future. 

 

Such as if you really want to take out $40K from the pension then 85% of your SS benefits will be taxable  and every dollar you take out of the 401K or IRA is taxed.   If you split up your deduction to a 401K and a ROTH 401K then you can take out some from each account and keep the taxable portion below the range where your SS benefits become taxed.   And you have to consider the RMD you will need to take ... if your 401K grows a lot over the years then this could be costly as you will not have a choice on how much to take out.  I have a couple of doctors who invested wisely and contributed the max allowed every year  to the SEP IRA  and now their RMD each year is actually more than they ever made when they were still working so they are actually paying taxes at a higher rate AND their SS benefits are 85% taxable as well.

SouthShore
Level 2

Having second thoughts about my retirement contributions

Well ... as most everyone says "it all depends" on one's personal situation.  If you anticipate being in a lower future bracket ... The following is my personal view.

 

Some things you may consider:  IMHO only, always maximize 401k (for company matches and deductibility) and traditional IRAs (for the deductions) and then add to Roths with "surplus" after tax income.  Also, add to a regular brokerage account with low cost index ETFs if there's still $$ left over.

 

If retired tax brackets are sure to be lower, then consider (full or partial) IRA to Roth conversions at that time , which require "ordinary income" taxation on the amount converted.  After that the Roth growth and income withdrawals are not taxed.  There are online calculators that can give you the number of years to break even with similar rates of return in both types of accounts.  If you like MS Excel, there are .xlsx files around for that too or build your own.

 

A side benefit here is that doing the conversion(s) also reduces the future IRA amount subject to RMDs.

 

There's also the "back-door" IRA to Roth conversion to consider.  Search for that too for the requirements and the mechanics.

 

Just remember, one way or another, the IRS always gets its dough, it's just a matter of timing.  😉

 

A good "Fee-Based" (only) CFP can help here.

 

Retirement planning is too important to not get unbiased expertise in developing the plan.  Do not work with any commissioned based "professionals" (conflicts of interest) or people that want to create their own income annuity based on quarterly fees for managing your assets (more conflicts of interest), "fiduciaries" or not.

 

Or consider joining AAII if you are a do it yourself type, you'll have a lot of like minded folks to communicate with along with unbiased information.

 

Best wishes ...

 

/ss

 

Critter-3
Level 15

Having second thoughts about my retirement contributions

And the standard rule is that you need time in the market to make a ROTH contribution  really worth while so doing them when you are younger is best.

 

Say you put  the max you can into a ROTH  for 10 years (say $6000 x 10) when you are in your 20s (pay the tax on the contributions)  and don't touch it and invest wisely the amount in the by the time you reach 65 it could be worth $4 million ... so you paid taxes on $60K  but have $4 million to withdraw tax free later ... not a bad trade off. 

 

So it is back to the "it depends on your complete situation" since there are too many variables to give any meaningful answer in this forum.  Your age, other assets, income, time to retirement, other investments/retirements, possible inheritances, your health, when you will retire, etc all must be taken into consideration when tax planning for the future.

 

 

TomD8
Level 15

Having second thoughts about my retirement contributions

And of course if you're married you need to take your wife's age, income, retirement plans, etc, into consideration when you do your planning.  Remember that if you file jointly the taxability of your SS benefits will be determined by your combined incomes.

**Answers are correct to the best of my ability but do not constitute tax or legal advice.
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