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Pretax or Roth 401k or both

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Smiths11

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Still deciding if I should contribute only to pre-tax 401K or to also Roth 401K. Any thoughts ?

Do you have enough cash to cover the taxes to not contribute any less to the Roth than you would to the pre-tax? If so, Roth is the way to go.

Retirement money is more valuable than non retirement money, because it grows tax free. So you're better off paying your taxes from non-retirement money now rather than paying a much larger tax bill when you take distributions. Remember, the retirement money is more valuable, therefore your tax bill at distribution will be higher than the opportunity cost of paying the tax up front with taxable money.

Also, I know this is true for IRAs but not sure about 401k, though I'm sure you'll be rolling over eventually: Traditional IRA has a required distribution starting at age 70 1/2, whereas you never have to take distributions from your Roth. It can grow tax free forever (at least until you die, not sure what the deal is afterwards).

The risk is that your tax bracket in the future is significantly lower than it is today, but assuming you work for many years going forward, build up a nice investment income stream into retirement, it's probably not that high of a risk.

I realize that may sound confusing, so feel free to ask if you want me to explain more.
 

Yellow mellow

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Do you have enough cash to cover the taxes to not contribute any less to the Roth than you would to the pre-tax? If so, Roth is the way to go.

Retirement money is more valuable than non retirement money, because it grows tax free. So you're better off paying your taxes from non-retirement money now rather than paying a much larger tax bill when you take distributions. Remember, the retirement money is more valuable, therefore your tax bill at distribution will be higher than the opportunity cost of paying the tax up front with taxable money.

Also, I know this is true for IRAs but not sure about 401k, though I'm sure you'll be rolling over eventually: Traditional IRA has a required distribution starting at age 70 1/2, whereas you never have to take distributions from your Roth. It can grow tax free forever (at least until you die, not sure what the deal is afterwards).

The risk is that your tax bracket in the future is significantly lower than it is today, but assuming you work for many years going forward, build up a nice investment income stream into retirement, it's probably not that high of a risk.

I realize that may sound confusing, so feel free to ask if you want me to explain more.

I have a ton of student loan so maybe pre-tax is the way to go ? This is all new to me so please bear with me. If I contributed 1500.00 into Roth , tax on that amount would be deducted from my paycheck each month. But because I have student loans, I should go with full pre-tax contribution. I've also elected to invest in Target Date Fund at 100%.
 

Smiths11

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I have a ton of student loan so maybe pre-tax is the way to go ? This is all new to me so please bear with me. If I contributed 1500.00 into Roth , tax on that amount would be deducted from my paycheck each month. But because I have student loans, I should go with full pre-tax contribution. I've also elected to invest in Target Date Fund at 100%.

What is the max you are willing or can contribute to regular 401k and Roth?

If you are putting the same in each, than go with the Roth. If you will end up putting less in a Roth in order to save money to pay for the taxes, than traditional 401k is better. Please share the numbers on how much you'll be contributing in both scenarios.
 

bc65

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The main difference between a Roth and a traditional IRA or 401k is the tax arbitrage. That is, if your tax rate now is lower than it will be in retirement, then pay the (lower) tax now, and use the Roth. This is typically the situation during residency. If you expect that your effective tax rate will be lower in retirement, (eg when you're an attending ) defer the (higher) tax now, and pay it during retirement, when you withdraw the money. If you have maxed out your retirement accounts, but have Roth space you can contribute extra money to, then do that. Examples would be the backdoor Roth, after tax space in 401k plans that allow in-service rollovers, and 529 college plans.

For example, in my case, my marginal rate when working was 39.6 %, but will be about 20% effective in retirement, so I'll save about 20% by using the traditional IRA vs the Roth. However, the Roth gets more tax free growth, because all of that money is yours, whereas in the traditional IRA , part of your contribution and growth (the future tax liability ) will be returned to the government. That eats into benefit of the traditional IRA.

Roths have other advantages though, such as no mandatory distributions, and no tax if you take it out in higher tax years, and easy to take out the contributions before retirement if you need the money, so you should also try to get money into Roths anyway, in addition to IRAs.

Meanwhile, the difference between a Roth and a taxable account is quite small if you use a tax advantaged account. For example, if you put your money in a Total Market Index fund, then the only tax you would pay each year would be on about 2% of dividends and a small amount of capital gains, almost all of which would taxed at the capital gains rate, which maxes out at 28.8% Federal, plus state tax. So, that would be about 30% of 2%, or an annual loss of 0.6%. Add that to the .05% Fidelity and Vanguard charge for that fund, and you have a fairly low annual expense ratio, even including the taxes. Of course, this assumes that you don't try to sell the fund, but instead keep it until death for a step-up in basis, and just use it for the dividend. If you sell, you will have to pay capital gains tax on the entire gain, less re-invested dividends.

Bottom line: If you're a resident, do Roth. If an attending, max out your traditional IRA or 401k, but once you contributed all you can, if you can get additional money into a backdoor Roth , or after-tax into a 401k, do so. After that, if you have kids, fill up your 529, which functions a lot like a Roth, and then use an index fund in a taxable account, which itself is an excellent option so long as you don't sell it.

Play with the numbers yourself and see how it works for you.
 
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Smiths11

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Even if you're an attending with a high tax rate now, it's not necessary that you'll have a much lower rate in retirement. If you're bringing in hundreds of thousands a year, and investing in assets - there is a chance that by the time you retire your investment income + S.S. will generate sufficient income for you to be in a high tax bracket.

Furthermore as I and the above poster said, there is no required distribution in the Roth. And no future tax liability.

I think Roth is better for most people.
 

bc65

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I think Roth is better for most people.

Almost everyone will benefit by having both types of accounts. If you want to do it right, just run the numbers yourself. Calculate the value of a traditional IRA at your age of 70 1/2, assuming maximum contributions from now until then, and the returns you anticipate, see what your required distributions will be at that age ( I believe 3.76%, rising annually by a small percentage) and see if the effective rate on those withdrawals, plus social security and any pension, is higher or lower than your marginal rate. For almost every physician, there will be some benefit to at least a small IRA, because you'll be able to take advantage of the lower tax brackets.

Almost the only way a Roth will be better is if your Social Security and pension fill up the lower brackets until your effective tax rate in retirement reaches your marginal rate at the time of contributions. I maxed out my 401k contributions, and still will benefit a lot by having the IRA. However, I never hit the full 53k because I was an employee, so for someone with 1099 income and multiple retirement accounts, you might indeed be in a higher bracket in retirement. ( Actually, because you're getting more of your money into a Roth than into a traditional account, the break even point is a tax rate slightly lower than your actual contribution rate, but that's a small difference).

Everyone will benefit by having a Roth, especially if it's in addition to the maximum 401k contribution, for example via a "backdoor" Roth, or by an after-tax 401k contribution rolled into a Roth by an in-service conversion ("mega backdoor Roth").

But since a taxable account is almost as good as a Roth if you keep the money in an index fund, most people will do fine by just using the traditional 401k/ IRA, and a taxable account in lieu of a Roth, along with the backdoor option, 529 plan, and HSA if applicable.

The big question is what to do if you're an employer. You have to figure out if providing an employee match costs more or less than the benefits you get in tax deferral, compared to a taxable account or your other available options.
 
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Yellow mellow

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Originally, I wanted to put contribute what I can all into a traditional 401k to lower my income tax and my monthly ibr payments but now I'm confused.
 

bc65

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Originally, I wanted to put contribute what I can all into a traditional 401k to lower my income tax and my monthly ibr payments but now I'm confused.

Are you an attending or resident? i.e. what's your marginal rate now?

If a resident, if you're single, making 50-60k, you're in the 25% bracket now, you should probably go with a traditional IRA. If you're married, you're in the 15% bracket, so you would go with the Roth, but then the IBR payments might make a difference, although probably not a big one. If you're earning more, go with the traditional IRA.

I never considered the IBR issue before. How much will the IBR payments go down? If you plan on refinancing and paying them off then it doesn't matter. If you're going for forgiveness it might make a small difference, maybe not. Let's see the numbers and I'll try to figure it out.
 
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mark-ER

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I agree 100% with bc65, do not overthink it: if you are a resident, single and in the 25% tax bracket go with traditional, but if you are married and in the 15% tax bracket, go with Roth IRA.

However, I would complicate things a tiny bit: if you are single or your spouse earns enough to push you into a 25 or 28% tax bracket, then go with traditional IRA *if* you are in one of the less compensated specialties (family practice, PMNR or some internal medicine specialties); if you are in a subspecialty, highly-compensated field that will soon enough almost certainly push you into top bracket regardless of what you do (subspecialty surg, derm, optho, ER) go with ROTH throughout residency and fellowship.

Last thing to think about: future income tax rates may vary depending on the political climate. Short-term there is a low, but not insignificant "risk" of flat or lower top tax rate, so if a republican gets elected, think about going ROTH now. Longer term, it is almost inevitable that income tax rates rise, with top rates closer to current rates in Canada (45-50%, hopefully not Scandinavia or France at 60+%). I do not forsee US public would ever accept a VAT tax (despite lower income tax), but even if a modified-VAT gets pushed through you will be grateful for any tax-privilidged accounts you have.
 

Smiths11

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Tax brackets should
Almost everyone will benefit by having both types of accounts. If you want to do it right, just run the numbers yourself. Calculate the value of a traditional IRA at your age of 70 1/2, assuming maximum contributions from now until then, and the returns you anticipate, see what your required distributions will be at that age ( I believe 3.76%, rising annually by a small percentage) and see if the effective rate on those withdrawals, plus social security and any pension, is higher or lower than your marginal rate. For almost every physician, there will be some benefit to at least a small IRA, because you'll be able to take advantage of the lower tax brackets.

Almost the only way a Roth will be better is if your Social Security and pension fill up the lower brackets until your effective tax rate in retirement reaches your marginal rate at the time of contributions. I maxed out my 401k contributions, and still will benefit a lot by having the IRA. However, I never hit the full 53k because I was an employee, so for someone with 1099 income and multiple retirement accounts, you might indeed be in a higher bracket in retirement. ( Actually, because you're getting more of your money into a Roth than into a traditional account, the break even point is a tax rate slightly lower than your actual contribution rate, but that's a small difference).

Everyone will benefit by having a Roth, especially if it's in addition to the maximum 401k contribution, for example via a "backdoor" Roth, or by an after-tax 401k contribution rolled into a Roth by an in-service conversion ("mega backdoor Roth").

But since a taxable account is almost as good as a Roth if you keep the money in an index fund, most people will do fine by just using the traditional 401k/ IRA, and a taxable account in lieu of a Roth, along with the backdoor option, 529 plan, and HSA if applicable.

The big question is what to do if you're an employer. You have to figure out if providing an employee match costs more or less than the benefits you get in tax deferral, compared to a taxable account or your other available options.

Why is a taxable account as good as a Roth? In a Roth you pay no taxes ever again after the initial income tax.

Also, when assuming your tax rate during retirement, make sure to account for any investment income you'll be receiving from rental property, dividends, capital gains, etc.

You're right that the estimated growth rate should be calculated. But note that Roth IRAs have no required distribution after 70.5, they never have required distribution which is another benefit (your money can continue to grow tax free for as long as you want).

I still think Roth is better unless your tax rate after retirement will be much much less than it is now, ASSUMING your money grows well and doesn't stay stagnant. If it grows like 10% a year, think about all the tax savings of the final product after 50 years.

And here's the key: the money you spend up front on taxes before a contribution to a Roth is LESS quality money than the present value of money that you save on future taxes in a hypothetical situation where you would contribute to a Traditional.
 

Smiths11

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Scenario 1:

-You contribute $5,000 to a Traditional.
-Your money grows for 50 years at 8% annualized to a value of $234,508.
-Your retirement tax rate is 25%, so you owe a total tax of $58,627 in 50 years.

Scenario 2:

-You contribute $5,000 to a Roth. If you're in a 33% tax bracket, you pay $1,650 of tax up front.
-Your money grows for 50 years at 8% annualized to a value of $234,508.
-Assuming your taxable rate of return is 7% (it's probably less given your tax free rate is 8%), that $1,650 would have grown to $48,604 in 50 years.
-So, you'll save roughly $10,023 by using a Roth. Assuming an inflation rate of 3%, that's $2,286 present value terms.

Now remember:

1. You don't HAVE to take a distribution in 50 years, or whenever, with a Roth. That's a huge benefit.

2. I'm assuming that your overall rate of return for all the money in your retirement accounts is 8%, and the same for all the money that is not in retirement accounts is 7%. This is conservative assumption, because the frictional costs of taxes is bad. Also, this accounts for all your money: everything in your investment accounts, to rental property, to your home, to the goods you buy, to loose change in your car. Your overall rate of return is surely much more than 1% different than your retirement accounts.

3. If you don't get what the above means - it means, retirement money is much more valuable (in terms of earning potential) than non-retirement money. Therefore, it's better to make it as tax free as possible (choose Roth).

ASSUMING that you're not dipping into the contribution itself to pay the tax up front (the amount you can contribute is not suffering due to the upfront Roth cost), AND assuming you'll have somewhat of a healthy growth rate, AND assuming that your tax rate isn't MUCH less in retirement, Roth > Traditional. Given that you're a doctor, chances are that you'll have a significant tax rate in retirement, and chances are that you won't need to tap into your Roth (you can let it grow tax free since there is no required distribution). Assuming this, Roth is most likely better.
 
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bc65

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Sorry, this is just all wrong. I hardly know where to begin.

I see that I'm repeating some of what I wrote above, but I don't want to leave your misleading statements unchallenged.

assuming that your tax rate isn't MUCH less in retirement, Roth > Traditional.

I still think Roth is better unless your tax rate after retirement will be much much less than it is now,


Yes, but for almost everyone, the effective rate on your withdrawals will be much less than the marginal rate at which you put it in. That's precisely why the traditional IRA is beneficial. If you don't think that's true, run the numbers yourself. Don't make them up, actually do the math. You'll see for yourself. Do annual contributions over a 20 or 25 year career, growth to age 70 1/2, and calculate the RMDs, and see what the tax is on that, plus social security.

In my case, it went in at a marginal rate of 39%, and will come out at 20% effective. That's typical, and represents a big advantage of traditional IRA vs Roth.

the money you spend up front on taxes before a contribution to a Roth is LESS quality money than the present value of money that you save on future taxes in a hypothetical situation where you would contribute to a Traditional.

I have no idea what you're trying to say here, but the present value of money is always much higher than future money, which you have to discount. You seem to have it backwards.

Why is a taxable account as good as a Roth? In a Roth you pay no taxes ever again after the initial income tax.

Not as good, almost as good. It just costs about 47 basis points a year. I pointed this out in an earlier post, but let's try it again.

Let's use a total market index fund, as I do, which might yield 8% a year in gains, 6% growth, and 2% qualified dividends. The annual tax on the dividends would be 23.8% Federal but only on the 2% dividends (plus a little bit on minimal short term gains). So the annual loss to taxes is 2% x .23.8% = 0.476%. Now, that's not nothing, but 47 basis points is the entire difference between a Roth and a traditional, plus state tax, but of course, only if you don't sell the principle. Considering that lots of people buy funds with expense ratios double that amount, or have 401k fees higher than that, it's not a big deal. Now, I plan on eventually spending the dividends from my taxable account, but not the principle,so I will never have to pay any other taxes on that account, and my heirs will get the step up in basis. If I do sell, I will have to pay capital gains on the growth, less the reinvested dividends. That will be a maximum of 23.8% Federal, plus state. So, yes, I could end up paying tax, but only on the growth, and that's entirely avoidable.

You don't HAVE to take a distribution in 50 years, or whenever, with a Roth. That's a huge benefit.

First of all, if you don't plan on taking distributions, then you're just 47 basis points worse off with a taxable account, and never selling. See above. And of course, a taxable account doesn't need to be sold either.

But most people will have to spend some of their savings, so having to take out RMDs from a traditional IRA is not a bad thing. In my case, I put it in at a marginal federal rate of 39%, but I will take it out at an effective rate of about 20%. That's a big savings. And I will still need more money, so I can get that from my taxable account or my Roth. That's why a. I want a traditional IRA and b. I also want a Roth and c. I want a taxable account.

Now, for some reason you want to ignore the fact that I am saving as much as half of my taxes by using a traditional IRA. Go ahead and do what you want, but there are significant savings to using an IRA because almost everyone takes out money from the IRA at a lower income tax rate than they put it in.

Scenario 2:

-You contribute $5,000 to a Roth. If you're in a 33% tax bracket, you pay $1,650 of tax up front.
-Your money grows for 50 years at 8% annualized to a value of $234,508.
-Assuming your taxable rate of return is 7% (it's probably less given your tax free rate is 8%), that $1,650 would have grown to $48,604 in 50 years.

You're not comparing the accounts correctly. You are completely neglecting the fact that if you pay taxes, you have less money to invest elsewhere. You need to account for the money in the Roth/IRA/ 401k, and the money you have outside.

Don't just guess. Use real numbers, and compare one account to another.

SO, here are 3 scenarios:

1. Taxable only. I earn $4,000 at a marginal rate of 25%. I pay 1,000 tax, and invest $3,000 in a total market index fund, as described above.

2. IRA: I earn $4000, I put 2000 in a tax deferred IRA, and pay 25% on the remainder, and invest $1500 in a taxable index fund.

3. Roth: I earn $4,000, I pay 1,000 tax, and I put $2,000 in a Roth and put $1,000 in a taxable account.

Now, run all the numbers, using the same total market index fund, the same 6% + 2% dividends. After you have done that, and accounted for all the taxes, you can get back to me. Try it with different tax rates, and with different rates going in and lower rates coming out.

I can tell you now, having actually done this, that the numbers are not that far apart, UNLESS your federal tax rate is lower when you withdraw the money, which for almost everyone , it will be. In that scenario, you benefit from the traditional IRA. But you can go ahead and put all your money in a Roth and pay more taxes if you want. Just be aware of what you're doing. For everyone else, be careful.

It's actually a bit more complicated than this, but I don't have the energy nor time to go into more detail.
However, the bottom line for almost everyone is:

As a resident, use a Roth.
As an attending, use a traditional IRA or 401k.
IN ADDITION to the 401k, after you have maxed out the tax deferred space , put additional money into a backdoor roth or mega backdoor roth to have tax diversity in retirement. And remember, a Roth is better than a taxable account, but only by about 1/2% a year, if you don't sell, so if you run out of retirement account space, don't worry about saving in a taxable account as long as you use a tax efficient index fund.
 

Smiths11

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Yes, but for almost everyone, the effective rate on your withdrawals will be much less than the marginal rate at which you put it in. That's precisely why the traditional IRA is beneficial. If you don't think that's true, run the numbers yourself. Don't make them up, actually do the math. You'll see for yourself. Do annual contributions over a 20 or 25 year career, growth to age 70 1/2, and calculate the RMDs, and see what the tax is on that, plus social security.

In my case, it went in at a marginal rate of 39%, and will come out at 20% effective. That's typical, and represents a big advantage of traditional IRA vs Roth.

Nope, not making up the numbers. RMD + Social Security is too conservative for assuming your income after retirement. If you're a physician, chances are you will have built up a large investment base. Now let's say you add RMD + SS + Investment Income (Rental, Dividends, Cap Gains, Interest). It's NOT A STRETCH to say assume you will be in the 25% bracket, which is currently for incomes roughly = $75,000-$150,000.

You're assuming that I didn't run the numbers, but surely I did.

Assume:
1. $5,000 contribution
2. Take the distribution 50 years later
3. 8% growth rate in your retirement account, 7% outside of your retirement account
4. 39.6% current tax rate, 25% tax rate during retirement

In this situation, the Roth is slightly better. If you increase the difference between the rate of returns between retirement and non retirement, the Roth will be even better. If your current tax rate is lower or retirement rate is higher, the Roth is better. If you don't want to take the RMD, the Roth is better.

Run the numbers and you'll see; I certainly did. You absolutely positively have to account for the rate of return of ALL of your non retirement assets (including cash that's in your wallet), to calculate whether the Roth is better or not. Why? Because you are comparing the tax paid during distribution (for traditional) vs. the opportunity cost of the cash used to pay taxes on a Roth contribution.

I have no idea what you're trying to say here, but the present value of money is always much higher than future money, which you have to discount. You seem to have it backwards.

No, not at all. Read what I wrote carefully.

What I mean is - your retirement assets are most definitely going to grow faster than your non retirement assets. Better to give up some cash from your non retirement assets to pay taxes on a Roth contribution than it is to pay taxes on your traditional distribution. The reason being because the opportunity cost of the former scenario is less than the cost of the latter scenario. See above hypothetical - 7% vs. 8%. It all depends on the rate of returns for your retirement vs. non retirement assets. And there's no way in hell your non retirement assets will outperform your retirement assets.

Not as good, almost as good. It just costs about 47 basis points a year. I pointed this out in an earlier post, but let's try it again.

Let's use a total market index fund, as I do, which might yield 8% a year in gains, 6% growth, and 2% qualified dividends. The annual tax on the dividends would be 23.8% Federal but only on the 2% dividends (plus a little bit on minimal short term gains). So the annual loss to taxes is 2% x .23.8% = 0.476%. Now, that's not nothing, but 47 basis points is the entire difference between a Roth and a traditional, plus state tax, but of course, only if you don't sell the principle. Considering that lots of people buy funds with expense ratios double that amount, or have 401k fees higher than that, it's not a big deal. Now, I plan on eventually spending the dividends from my taxable account, but not the principle,so I will never have to pay any other taxes on that account, and my heirs will get the step up in basis. If I do sell, I will have to pay capital gains on the growth, less the reinvested dividends. That will be a maximum of 23.8% Federal, plus state. So, yes, I could end up paying tax, but only on the growth, and that's entirely avoidable.

1. First of all, 47 basis points is a HUGE number over time. Really, you can't just say "almost as good", because it's not even close. It's funny that you tell me to run the numbers but it doesn't seem like you have. Let's just say a hypothetical $100,000 portfolio. Over 50 years, an 8% return will give you $4,690,161. Over 50 years, a 7.53% return (difference of 47 bps), will give you $3,771,224. So 47 bps will cost you well over $900,000 on a $100,000 portfolio over the course of 50 years.

2. Secondly, you're giving yourself highly restrictive assumptions. You're assuming to only buy index funds and NEVER sell? Let's say there is another opportunity in a stock or bond or whatever, being in a taxable portfolio will kill you vs. a retirement account. You can't just assume to never sell. But if you really do NEVER sell, then know that 47bps is huge. Or let's just say the market goes into a 1999/2000 or 1929 type of bubble, 50x P/E ratios; and you just want to take some gains and hold cash. Well, good luck paying "just 47 bps" when that happens.

First of all, if you don't plan on taking distributions, then you're just 47 basis points worse off with a taxable account, and never selling. See above. And of course, a taxable account doesn't need to be sold either.

See above. 47 bps is a lot. Never selling is a terrible restriction.

But most people will have to spend some of their savings, so having to take out RMDs from a traditional IRA is not a bad thing. In my case, I put it in at a marginal federal rate of 39%, but I will take it out at an effective rate of about 20%. That's a big savings. And I will still need more money, so I can get that from my taxable account or my Roth. That's why a. I want a traditional IRA and b. I also want a Roth and c. I want a taxable account.

Now, for some reason you want to ignore the fact that I am saving as much as half of my taxes by using a traditional IRA. Go ahead and do what you want, but there are significant savings to using an IRA because almost everyone takes out money from the IRA at a lower income tax rate than they put it in.

The advice is specifically geared towards doctors, who might have plenty of savings outside retirement accounts. Really, the last money you ever want to touch is your retirement money because it is the most advantageous. Plough through your non retirement savings first and then touch your golden retirement money. (Why touch something that is growing tax free?).


You're not comparing the accounts correctly. You are completely neglecting the fact that if you pay taxes, you have less money to invest elsewhere. You need to account for the money in the Roth/IRA/ 401k, and the money you have outside.

Clearly I am accounting for that opportunity cost. What I'm saying is that the opportunity cost of paying taxes with non retirement money is not as bad as paying taxes on the gains. The bare bones simple explanation is that the rate of return is absolutely going to be lower with your non retirement money. (Okay, I shouldn't say absolutely. Maybe one day you come up with an opportunity to buy something with your non retirement cash which is not available to you in your 401k or Roth, and that is bound to grow super fast, and therefore your non retirement cash is more valuable. But 99% of the time, the rate of return is higher with retirement money, and that's what matters the most.

Don't just guess. Use real numbers, and compare one account to another.

SO, here are 3 scenarios:

1. Taxable only. I earn $4,000 at a marginal rate of 25%. I pay 1,000 tax, and invest $3,000 in a total market index fund, as described above.

2. IRA: I earn $4000, I put 2000 in a tax deferred IRA, and pay 25% on the remainder, and invest $1500 in a taxable index fund.

3. Roth: I earn $4,000, I pay 1,000 tax, and I put $2,000 in a Roth and put $1,000 in a taxable account.

Now, run all the numbers, using the same total market index fund, the same 6% + 2% dividends. After you have done that, and accounted for all the taxes, you can get back to me. Try it with different tax rates, and with different rates going in and lower rates coming out.

See, the key here is something I said several times: I am assuming that you are NOT dipping into that actual contribution to pay the tax. Obviously if the contribution itself is taking a hit for you to pay the roth taxes up front, that changes all the math. In my case, you contribute $4,000 total to an IRA, or to a Roth. The $1,000 in taxes you pay comes from outside this number. Don't say that I'm changing my assumptions. This is something I specified several times in above posts, please go back and read.




My advice to everyone is:

1. Look at the current tax brackets and assume the same going forward.

2. If you're dipping into the contribution itself to pay the whole tax bill, then Traditional is better. If you're using outside money to pay the tax up front for a Roth, then there's a good chance Roth is better.

3. Figure that if you're making like $200,000+ a year, that you'll have income other than just your S.S. and your RMD during retirement. So don't automatically assume that you'll be in some ultra low tax bracket. Maybe you will be, but there's a good chance you won't. (Because you'll have so much money saved and invested by retirement that you'll be generating a lot of interest, dividends, rental income, business income, etc.)

4. Figure out 4 numbers: a) your current tax bracket, b) your retirement tax bracket, c) your retirement account rate of return, d) your taxable rate of return.


Everyone talks about tax brackets, but nobody talks about rate of return, and particularly rate of return differential between retirement vs. taxable.

Run the numbers to see that it makes all the difference.
 

bc65

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You keep fudging your assumptions and ignoring your own arguments.


IRA vs Roth

First, when you compare Roth vs traditional IRA, if tax brackets are the same, there's no difference in net proceeds. However, that isn't usually the case. You admit as much yourself:
. It's NOT A STRETCH to say assume you will be in the 25% bracket, which is currently for incomes roughly = $75,000-$150,000.

Do you not see that the 39% that you pay when you're working is higher than the 20% effective rate you'll pay when you take it out? Someone taking out 180K , plus 50 k from social security, will pay a 25% marginal rate which will be a 20% effective rate. Surely you won't disagree that it's better to pay 20% in taxes than 39%?

You might find exceptions to this, but as I said above, I personally paid a marginal rate of up to 39% while working, but will pay an effective rate of 20% when I take RMDs.

That's the bottom line. That's why having at least some money in a traditional IRA will give you the best results.

According to Medscape, only 10% of physicians retire with a net worth of greater than $5 million. If all of that 5 million was in an IRA, the RMD would be only $182,481. At that rate, you would probably be paying 20% effective, vs 33% to 39% you would have paid while earning.

If you have a reasonable argument as to why you would forgo the tax arbitrage opportunity that this represents, please do so. Otherwise, please stop misleading others.

Sorry, but I get the sense that you don't have a lot of real world investing experience yet. In my experience, the only people who recommend against using traditional IRAs preferentially are scammers trying to get you to invest in their indexed annuity, whole life insurance products, or real estate scheme.


Roth vs Taxable

Of course a Roth is generally better than a taxable account. I never said otherwise. I'm just pointing out that the differences are small, and you need to keep that in mind when you make your decisions. Don't make bad investment decisions to avoid paying taxes when the benefit will be less than the cost.

You keep keep assuming 8% in retirement accounts and 7% in taxable. But it would be 8% vs 7.53%. and I'm just pointing out that the difference can be calculated, and should be, when you make your decisions.

For example, if you're running a private practice, if you set up a 401k you have to pay a match for your employees, and you have other additional administrative costs. Calculate how much those are, because if they are more than 1/2%, it may not pay to do it. Another alternative you may be offered is an indexed annuity or other life insurance product. The costs for those will far exceed 1/2%, so don't let the tax tail wag the dog. You might want to set up a defined benefit or defined contribution plan. Again, run the numbers and see what the costs would be vs the extra taxes of a taxable account. You might have to pay 3%, 5%, or more in total costs to get the tax deferral. It's often not worth the costs.

See, the key here is something I said several times: I am assuming that you are NOT dipping into that actual contribution to pay the tax. Obviously if the contribution itself is taking a hit for you to pay the roth taxes up front, that changes all the math. In my case, you contribute $4,000 total to an IRA, or to a Roth. The $1,000 in taxes you pay comes from outside this number. Don't say that I'm changing my assumptions. This is something I specified several times in above posts, please go back and read.

You don't realize what you're doing here. "The $1,000 in taxes is coming from outside this number". But it's still coming from your money. You can't wave a magic wand and just conjure the $1000 in taxes out of thin air. It's coming from your income. That's why you have to calculate all your projections starting from your gross. You can't just compare a $2,000 Roth to a $2,000 IRA. If in a 25% bracket, you need to compare a { $2,000 Roth plus a $1,000 taxable } to a { $2,000 IRA and a $2,000 taxable. }

Now let's say you add RMD + SS + Investment Income (Rental, Dividends, Cap Gains, Interest).

A perfect example of where you're trying to have it both ways. You say you'll be in a higher tax bracket because of additional investment income, dividends, rental, etc. All of that money of yours is obviously in taxable accounts. So first you say taxable accounts are bad, don't use them, but your argument for why they are bad is because you have too much income from your taxable accounts. Obviously, you agree that you will have some taxable investments. So why are you arguing otherwise?
 
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Smiths11

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I'm not sure whether you choose to ignore very real points that I raise on purpose or because you truly don't understand. Rather than spend another 20 minutes refuting most of which you've written, I'll just point one thing out that is blatantly wrong.

Of course a Roth is generally better than a taxable account. I never said otherwise. I'm just pointing out that the differences are small, and you need to keep that in mind when you make your decisions. Don't make bad investment decisions to avoid paying taxes when the benefit will be less than the cost.

You keep keep assuming 8% in retirement accounts and 7% in taxable. But it would be 8% vs 7.53%. and I'm just pointing out that the difference can be calculated, and should be, when you make your decisions.

As pointed out in my above post, this is grossly misleading. You conveniently choose to ignore what I said and continue to say "the differences are small".

1. .47% is a huge number over time, due to the affects of compounding. Once again, .47% over 50 years on a hypothetical $100,000 portfolio makes a difference of over $900,000. On top of this you have state taxes which you yourself pointed out. So please don't loosely use the words "the differences are small". It's so unbelievably misleading.

2. Another major requirement of yours to arrive at the "47 bps" argument is to buy an index fund, and NEVER SELL. This is really a severe restriction that shouldn't be ignored. Just imagine when we see another bubble, and the investor wants to sell his stock fund and reinvest in a bond fund. Well right then and there, the cost of the taxes shoot a hell of a lot above 47 bps due to capital gains taxes.

Do you agree with me on this, or are you going to continue with the whole "taxable vs non-taxable isn't much of a difference" argument? Because if you still refuse to admit to this, I won't waste anymore energy refuting the rest of your points.

You don't realize what you're doing here. "The $1,000 in taxes is coming from outside this number". But it's still coming from your money. You can't wave a magic wand and just conjure the $1000 in taxes out of thin air. It's coming from your income. That's why you have to calculate all your projections starting from your gross. You can't just compare a $2,000 Roth to a $2,000 IRA. If in a 25% bracket, you need to compare a { $2,000 Roth plus a $1,000 taxable } to a { $2,000 IRA and a $2,000 taxable. }

Ok I'll comment on this too. Again, you conveniently choose to ignore what I wrote. I made it very clear that I am accounting for the opportunity cost of the taxes paid for a Roth investment. I made it clear that "outside this number" means that as long as you're not dipping into the contribution itself to pay the tax, Roth is generally better. Meaning, you're investing the same amount in either a Roth or a Traditional, and for Roth you're paying the taxes from other funds that you own.

A perfect example of where you're trying to have it both ways. You say you'll be in a higher tax bracket because of additional investment income, dividends, rental, etc. All of that money of yours is obviously in taxable accounts. So first you say taxable accounts are bad, don't use them, but your argument for why they are bad is because you have too much income from your taxable accounts. Obviously, you agree that you will have some taxable investments. So why are you arguing otherwise?

Huh? When did I ever say I never use taxable accounts? Obviously we can't put unlimited funds in retirement accounts, so all savings after maxing out your 401k/IRA must go into taxable accounts. Given we are doctors, we're likely to have plenty of savings even after maxing that out - hence accounting for other income - rental, investment income, etc. Couldn't help but reply to this either.

If you have a reasonable argument as to why you would forgo the tax arbitrage opportunity that this represents, please do so. Otherwise, please stop misleading others.

Sorry, but I get the sense that you don't have a lot of real world investing experience yet. In my experience, the only people who recommend against using traditional IRAs preferentially are scammers trying to get you to invest in their indexed annuity, whole life insurance products, or real estate scheme.

No sir, you're the one misleading. Either you're severely misinformed or you're just so stubborn to back down.

Oh, and I have 15 years of investing experience. I worked for a major Investment Banking firm prior to Medicine, and currently work part time for a Investment Management company. And no, none of the business I do involves selling IRAs, annuities, life insurance, or any retirement products.

Not that it matters, I'd rather people judge me from the content I've written than assume I know all this just because I have extensive history in the industry. But you asked, so I told you.
 

bc65

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Oh, and I have 15 years of investing experience. I worked for a major Investment Banking firm prior to Medicine, and currently work part time for a Investment Management company. And no, none of the business I do involves selling IRAs, annuities, life insurance, or any retirement products.

I find it hard to believe that you have investment experience, given what you have written here. However, if you do, it's clear why you needed to change careers. Honestly, I don't believe that you have any financial experience at all. Either that, or you're a troll.

You never addressed the tax arbitrage of an IRA, which is the only benefit that IRAs convey. Among other errors you made is that you recommend trading in a taxable account, rather than in your tax deferred account,and you also recommended market timing. Good luck with that.

My credential is that after finishing residency with no assets and owing all of my tuition in loans, my only financial concern now is dealing with my estate tax problem. You, on the other hand, if you're telling the truth, seem to need two jobs to get by.

I won't address you any further, but for anyone else reading this, let me assure you that the following advice is otherwise universally accepted:

1. A traditional IRA is better than a Roth because of the tax arbitrage. So use a Roth when your marginal rate is low or equal to what it will be in retirement, ( e.g. in residency ) and invest in a traditional IRA when your marginal rate is higher than the effective rate will be in retirement. This will save most doctors about 20%.

2. Fill the Roth space next as much as possible. This can be done via a backdoor Roth, or by a 401k with in service roll-overs. Similar tax advantages can be achieved by using a 457 if you feel the risk of creditors is low. A 529 will give you similar benefits, as will an HSA account.

3. Finally, use a taxable account, but use index funds and hold for the long term. Taxable bonds and funds that will have high turnover go in your tax advantaged accounts. If you don't sell, and utilize the step-up at death, it will cost only 0.5% per year over a Roth. If you do sell, it will cost you an additional 1 1/2%. That will leave you with an expected return of 6 to 7 1/2%. This cost is very low compared to what you will pay for any tax deferred annuities, insurance products,, and even the cost of many retirement plans you might set up yourself if you have to provide a match, so be sure to compare the costs of those plans to the minimal costs of index funds before investing in any of those alternatives.
 
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Smiths11

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I find it hard to believe that you have investment experience, given what you have written here. However, if you do, it's clear why you needed to change careers. Honestly, I don't believe that you have any financial experience at all. Either that, or you're a troll.

My credential is that after finishing residency with no assets and owing all of my tuition in loans, my only financial concern now is dealing with my estate tax problem. You, on the other hand, if you're telling the truth, seem to need two jobs to get by.

When one doesn't have valid points, they attack the messenger.

I won't dip down to your level of patronizing and pretentiousness. Good luck to you.

You never addressed the tax arbitrage of an IRA, which is the only benefit that IRAs convey. Among other errors you made is that you recommend trading in a taxable account, rather than in your tax deferred account,and you also recommended market timing. Good luck with that.

Time and time again I've mentioned that you need to consider the tax arbitrage was well as the rate of return differential. The former makes the traditional better, the latter makes the roth better. It takes some number crunching and assumptions to figure out which one overall is more beneficial. However, generally, that is the Roth.

What's wrong with trading in your taxable account sir? Nope never recommended market timing - I'm a value investor. Just saying that sometimes the valuation gets so absurd that a bond fund may be better than a stock. Or sometimes one index is better than another. At any rate, it's foolish to assume that buying and holding an index forever is the only right thing to do.

And you continue to refuse to admit that 47 bps a year (even though it would actually cost you much more) is really a hell of a lot of money due to compounding. I ran the calculation, you dodged the question.

I won't address you any further, but for anyone else reading this, let me assure you that the following advice is otherwise universally accepted:

1. A traditional IRA is better than a Roth because of the tax arbitrage. So use a Roth when your marginal rate is low or equal to what it will be in retirement, ( e.g. in residency ) and invest in a traditional IRA when your marginal rate is higher than the effective rate will be in retirement. This will save most doctors about 20%.

2. Fill the Roth space next as much as possible. This can be done via a backdoor Roth, or by a 401k with in service roll-overs. Similar tax advantages can be achieved by using a 457 if you feel the risk of creditors is low. A 529 will give you similar benefits, as will an HSA account.

3. Finally, use a taxable account, but use index funds and hold for the long term. Taxable bonds and funds that will have high turnover go in your tax advantaged accounts. If you don't sell, and utilize the step-up at death, it will cost only 0.5% per year over a Roth. If you do sell, it will cost you an additional 1 1/2%. That will leave you with an expected return of 6 to 7 1/2%. This cost is very low compared to what you will pay for any tax deferred annuities, insurance products,, and even the cost of many retirement plans you might set up yourself if you have to provide a match, so be sure to compare the costs of those plans to the minimal costs of index funds before investing in any of those alternatives.


There is so much nonsense here, so I'll address just one thing. A backdoor Roth IRA is a way to invest in a Roth IRA if you exceed the income limit to invest in one. Given the advantages a Roth IRA presents over a traditional, the government has a ceiling on the income you earn for you to be allowed to invest in one. For example, for 2015 tax year, a married couple filing jointly can't invest in a Roth IRA directly if their income exceeds $193,000

(This should give you a hint right there that the Roth is more advantageous - because there is a limit on your income level to even qualify to invest in one, as opposed to the traditional which has no such income limits)


However, there is a loophole to be able to invest in a Roth, which surprisingly the government allows. If you make more than $193,000, you can put your money in a traditional IRA, and then convert to a Roth IRA the very next day. This is called a backdoor conversion. You don't seem to know what a backdoor conversion is even.


Folks- please read all the advice here carefully and judge for yourself. I know it's very complicated, but it really boils down to two points: a) your marginal rate in retirement vs. now, and b) your rate of return in your taxable portfolio vs. retirement.

If anyone wants to PM me or has any questions, please feel free. I would hate to see someone making the wrong decision based on faulty advice they receive. I will try to explain the best I can. It really really isn't that complicated. This gentleman has decided to make it personal against me to make himself look smarter. I won't argue with him any further, but I am more than happy to help anyone interested.
 
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mvenus929

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Scenario 1:

-You contribute $5,000 to a Traditional.
-Your money grows for 50 years at 8% annualized to a value of $234,508.
-Your retirement tax rate is 25%, so you owe a total tax of $58,627 in 50 years.

Scenario 2:

-You contribute $5,000 to a Roth. If you're in a 33% tax bracket, you pay $1,650 of tax up front.
-Your money grows for 50 years at 8% annualized to a value of $234,508.
-Assuming your taxable rate of return is 7% (it's probably less given your tax free rate is 8%), that $1,650 would have grown to $48,604 in 50 years.
-So, you'll save roughly $10,023 by using a Roth. Assuming an inflation rate of 3%, that's $2,286 present value terms.

Now remember:

1. You don't HAVE to take a distribution in 50 years, or whenever, with a Roth. That's a huge benefit.

2. I'm assuming that your overall rate of return for all the money in your retirement accounts is 8%, and the same for all the money that is not in retirement accounts is 7%. This is conservative assumption, because the frictional costs of taxes is bad. Also, this accounts for all your money: everything in your investment accounts, to rental property, to your home, to the goods you buy, to loose change in your car. Your overall rate of return is surely much more than 1% different than your retirement accounts.

3. If you don't get what the above means - it means, retirement money is much more valuable (in terms of earning potential) than non-retirement money. Therefore, it's better to make it as tax free as possible (choose Roth).

ASSUMING that you're not dipping into the contribution itself to pay the tax up front (the amount you can contribute is not suffering due to the upfront Roth cost), AND assuming you'll have somewhat of a healthy growth rate, AND assuming that your tax rate isn't MUCH less in retirement, Roth > Traditional. Given that you're a doctor, chances are that you'll have a significant tax rate in retirement, and chances are that you won't need to tap into your Roth (you can let it grow tax free since there is no required distribution). Assuming this, Roth is most likely better.

Off hand, your numbers don't take into account that by investing in a Roth, you're actually putting in more money up front. By your numbers, if you put 5K into a Roth IRA, you've put $6650 of your gross into the Roth (but are only getting returns on 5k), but only $5000 into a traditional. Math is not my strong suit, so I'm sure I'd mess up if I tried to run the numbers again, but it seems like the difference would be much smaller if you made the numbers more comparable (since you aren't paying those taxes on the traditional side up front).

Or maybe I am conceptually thinking about it wrong.
 
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Smiths11

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Off hand, your numbers don't take into account that by investing in a Roth, you're actually putting in more money up front. By your numbers, if you put 5K into a Roth IRA, you've put $6650 of your gross into the Roth (but are only getting returns on 5k), but only $5000 into a traditional. Math is not my strong suit, so I'm sure I'd mess up if I tried to run the numbers again, but it seems like the difference would be much smaller if you made the numbers more comparable (since you aren't paying those taxes on the traditional side up front).

Or maybe I am conceptually thinking about it wrong.

Hi mvenus929,

Note I did say that the assumption is that you are maxing out on your contribution. In other words, the amount you put into the IRA (or 401k) is not suffering due to the upfront cost of the tax. For example, the IRA contribution limit (if you're under 50) is currently $5,500 for both Traditional and Roth IRAs. You cannot put in more than this number. So the assumption is that you either:

a) put in $5,500 in a Traditional
b) put in $5,500 in a Roth and have cash on hand to pay the taxes on this

Let's just say for simplicity sake that you are in a 30% bracket. So that means the tax would be $1,650 on this contribution. So, my assumption is that you are able to contribute the full $5,500 to the Roth AND pay the $1,650 tax bill on it (instead of contributing only $3,850 because of the tax hit).

Edit:

So what you want to do is compare the $1,650 up front cost of the Roth vs. the future cost of taxes on the Traditional. On the surface it would seem the only thing you need to look at is the marginal rate now vs. the marginal rate in retirement. But that is flawed.

The other aspect that you need to look at is the total number of dollars of growth of that $1,650 that you are giving up (in the case of a Roth) vs. the total number of dollars in taxes that you would owe in the future (in the case of the Traditional). The latter dollar amount is most likely higher, purely because tax free accounts grow faster than taxable accounts (because of the frictional cost of taxes).

So, even though your marginal rate may be lower in retirement, the cost of paying the taxes when taking the distribution on all that tax free growth in the IRA may very well be > cost of giving up $1,650 of taxable money up front.
 
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bc65

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Off hand, your numbers don't take into account that by investing in a Roth, you're actually putting in more money up front. By your numbers, if you put 5K into a Roth IRA, you've put $6650 of your gross into the Roth (but are only getting returns on 5k), but only $5000 into a traditional. Math is not my strong suit, so I'm sure I'd mess up if I tried to run the numbers again, but it seems like the difference would be much smaller if you made the numbers more comparable (since you aren't paying those taxes on the traditional side up front).

Or maybe I am conceptually thinking about it wrong.

Of course you're right. That guy is completely clueless. I suspect he's a premed who took a finance course.

Please read on for complete calculation, but if you want to see additional discussions, please see these links:

http://whitecoatinvestor.com/3-ways-your-401k-lowers-your-tax-bill/

http://whitecoatinvestor.com/should-you-make-roth-or-traditional-401k-contributions/

Here are the complete calculations you can look at, which take into account precisely the issue you raised: the money that you spent on taxes. I also include the capital gains tax if you sell the entire amount, but most investors will hold on and get the step up in basis at death. Of course, this only shows the result after one year, but you get the idea. If you have any questions, just ask.

===============================================

In the following example, I will assume that all the money will be invested in a Total Market Index Fund, there’s a total of $4,000 income, and you are placing $2,000 into either a Roth IRA or a traditional IRA.

Also assume a marginal rate of 33% going in, and 25% coming out. Most physicians will pay 33% in, and 20% effective coming out, so in reality there will be larger benefits in real life.


First, let’s look at the traditional IRA.

Assume a 33% tax rate, marginal, and a capital gains rate of 18.8% ( 15% bracket plus 3.8% medicare surtax )

You Earn $4,000, and invest $2,000 tax deferred

The IRA grows by 10% ( 8% plus 2% dividends ). After one year, there is $2200.

If this is then withdrawn, it will be taxed at an effective rate of 25%, so there will be $1,650 left.

The remaining $2,000 is taxed at 33%, and that leaves $1,340 to be invested in a taxable account.

The principle grows by 8%, and the 2% dividends are taxed at 18.8%.
The principle grows by 107.20, and the dividends will be 26.80.
The dividends will be subject to a tax of 18.8%, so that will leave 21.76, which will be added to the basis to determine capital gains.

So, the total will be 1468.96.

If there is an effective rate of 25%, the total after one year would be:

1650 + 1468.96= $3,118.96.

If this were sold, capital gains tax of 20.15 would be due, leaving $3,098.85

---------------------------------------------------

Now, let’s look at the Roth IRA.

You earn $4,000.

All of it is taxed at 33%, leaving $ 2680

$2,000 is invested in the Roth IRA.

The remaining $ 680 is invested in a taxable account.

After one year, the Roth IRA is worth $2200.

The $680 has grown to $745.44. If sold, capital gains of $10.23 would be due.

The total would be 2,945.44. If the entire account were sold, after capital gains on the taxable account, you would have $2,935.21


Notice that there will be more money using the traditional IRA than the Roth. Using a more realistic effective rate of 20% on withdrawal will show even greater benefit for the traditional IRA.

-==============================


Now let’s look at the same money put into a taxable account instead of a Roth IRA.

You earn $4,000.

All of it is taxed leaving $ 2680.

It grows by 8% , plus 2% dividends.

The result is 214.4 in growth, plus dividends of 53.60, which after taxes leaves 43.52.

It this were sold, capital gains tax of 40.30 would be due.


The total after one year is 2,937.92. After capital gains, 2,897.62

This is definitely less than using a Roth, but there's only a minimal difference, especially if you don't sell and avoid capital gains. Of course, you only use taxable accounts when you have exhausted all the other alternatives. But you can see that the difference between a Roth and a taxable account is small, compared to the differences between a Roth and a traditional IRA.

You might also want to see this article:

http://whitecoatinvestor.com/some-more-thoughts-on-roth-401k-contributions/

http://whitecoatinvestor.com/comparing-retirement-accounts/

From the above articles, there are additional useful links, but those are the most relevant to the discussion above.
 

Smiths11

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Of course you're right. That guy is completely clueless. I suspect he's a premed who took a finance course.

The personal attacks continue. Thanks again.



mvenus929 - I have an excel spreadsheet that I use for this. I'm more than happy to send it to you (or anyone else) if you want to see for yourself. I would rather not post it here but feel free to ask and I'll share.

There are a number of assumptions bc65 is using that are misleading and/or wrong:

1. Effective rate is not what you use to calculate this - marginal rate is.

2. He's showing the results after 1 year - first of all, nobody here is retiring after 1 year. I suspect most are retiring after several decades. This makes a difference because it is only over time where the effects of compounding make a difference. Yes, if you are retiring next year, then Traditional is way better than Roth. But, after several decades, the math changes due to the effects of compounding.

3. The 'traditional vs. roth' examples assume the growth of $4,000 even though he only contributes $2,000 to the ira. The real way to compare them would be to compare the growth of: ($4,000 in the IRA minus the cost of taxes when withdrawing) vs. (the growth of $4,000 in a Roth minus the lost growth of the tax paid up front for a Roth)

4. He assumes you'll buy an index fund and transfer to your heirs without ever selling or making any trades or changing investments.

At this point I would be happy to talk to anyone on PM or even on the phone, if they would like for me to explain exactly what I'm saying in these posts. It really angers me that someone can be spewing such false statements to his/her peers when real money is involved. Once again, I have an excel model that lays everything out - I'll be more than happy to share, just PM me.

Let me try to explain what I mean just one more time for everyone.

I'll start with a simple definition. A deferred tax liability is when you owe taxes that you haven't yet paid. It applies in the case of a Traditional IRA/401k. You put your money in, it grows for years and years. Each year your deferred tax liability also grows as the size of your account grows. When you finally take your money out, you pay off that liability. There are two factors that will determine the value of a Traditional IRA's deferred tax liability:

i. Your marginal tax rate at retirement: If you're in the 25% marginal tax bracket at retirement, you will pay 25% of the account size when you withdraw.

ii*. The rate at which your account grows: If you're account grows by 1,000% by the time you retire, the amount you owe taxes on also grows by 1,000%.
A Roth IRA has no deferred tax liability because the tax is paid up front. So, if you're in the 33% bracket, you owe 33% of that contribution. Now I cannot stress this point enough, and that is:

A Roth IRA ONLY makes sense as long as you are not paying the upfront tax bill out of the contribution itself.

Meaning, you are contributing just as much to a Roth as you will to a Traditional. $5,500 is the max you can put into each, so let's say you are putting that amount into either account. And that you have enough money to pay the tax of that $5,500 Roth without dipping into the contribution itself. So if you owe $1,650 in this case, you have the funds to pay it off AND deposit the full $5,500 into the Roth. Cannot stress this enough.
Anyway, back to my explanation. At first glance it seems obvious that you're better off owing 25% in the future (Traditional) than 33% presently (Roth).

But there is an issue, and that is 'ii*' (see above): the growth part of your deferred tax liability. You see, the benefit of a retirement account is that it grows without the tax headwind. Obviously this means that it will grow faster than any taxable account that you have. But, with this benefit comes the very real cost, which is that the deferred tax liability of a Traditional IRA also grows faster than your taxable account.

So the question is, given this fast growing deferred tax liability, is a Traditional still better than a Roth despite the lower marginal rate at retirement?

Well, there is only one way to figure that out - you need to figure out the opportunity cost of the $1,650 you paid for the Roth. In other words, what is the lost benefit of paying that $1,650 up front and giving up the chance of paying nothing at all with a Traditional IRA? The proper way to calculate that lost benefit is by figuring out what that $1,650 would have turned into had you not spent it on this tax bill. So, you need put a growth rate on it. Now here is another point that I can't stress enough:

The growth rate of your taxable money will most likely (99.99% of the time) be less than the growth rate of your tax free money, and therefore by definition - it will also be less than the growth rate of the deferred tax liability.

Meaning, the rate you put on the lost growth of $1,650 should be less than the rate you put on the growth of the deferred tax liability of your hypothetical Traditional IRA.
Here is where the equation becomes not so simple as "33% vs. 25%". Because now you have to figure out which of these two is more expensive:

the lost growth of the upfront tax
OR
the growth in the deferred tax liability

Everybody knows that 33% > 25%. However a very important but not so obvious question is:

What are we applying those percentages to?

Now, if we only have the retirement account for 1 year, most likely the 33% up front cost of a Roth would be more expensive than the 25% cost of the distribution you take next year for a Traditional.

However, over long periods of time compounding works its charm. The accelerated growth of the deferred tax liability at 25% laps the opportunity cost of paying a tax bill at 33%.

If you don't believe me, plug the numbers into a spreadsheet, or better yet, ask me for my spreadsheet. Even a tiny cost of .47% such as the one bc65 mentioned (which is wrong btw, as your tax headwind would most likely be higher than that - feel free to ask why) adds up over long periods of time. And of course, I speak of 25% in retirement vs. 33% now as if its set in stone for all of us. The reality is that you as a physician may very well be generating enough income even in retirement that your tax rate will still be 33% then; but that's a separate discussion.

The point is this. If you didn't get anything from the many pages worth of material I have written on this thread thus far - just try to understand this:

It is not as simple as taking the difference between the two marginal rates (current and retirement). You must consider opportunity cost and deferred tax liability if you truly want to know which of these two IRAs are better.
Thanks

 
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mvenus929

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Hi mvenus929,

Note I did say that the assumption is that you are maxing out on your contribution. In other words, the amount you put into the IRA (or 401k) is not suffering due to the upfront cost of the tax. For example, the IRA contribution limit (if you're under 50) is currently $5,500 for both Traditional and Roth IRAs. You cannot put in more than this number. So the assumption is that you either:

a) put in $5,500 in a Traditional
b) put in $5,500 in a Roth and have cash on hand to pay the taxes on this

Let's just say for simplicity sake that you are in a 30% bracket. So that means the tax would be $1,650 on this contribution. So, my assumption is that you are able to contribute the full $5,500 to the Roth AND pay the $1,650 tax bill on it (instead of contributing only $3,850 because of the tax hit)

But this is what I'm getting at. As I see it, if you have $5500 to invest in a Roth, you've already paid taxes on it (unless you are the business owner or a contractor that has to pay quarterly taxes because they are not already taken out by the time they are in your bank account). So, contributing the full amount to a Roth is equivalent to contributing $5500 plus the taxes you paid on that to a traditional. You end up with the same cash in hand at the end of the day. Since there are maximum contribution limits to both, they are not an even comparison unless you contribute less to the Roth.


So the question is, given this fast growing deferred tax liability, is a Traditional still better than a Roth despite the lower marginal rate at retirement?

Well, there is only one way to figure that out - you need to figure out the opportunity cost of the $1,650 you paid for the Roth. In other words, what is the lost benefit of paying that $1,650 up front and giving up the chance of paying nothing at all with a Traditional IRA? The proper way to calculate that lost benefit is by figuring out what that $1,650 would have turned into had you not spent it on this tax bill. So, you need put a growth rate on it. Now here is another point that I can't stress enough:

.

The growth rate of your taxable money will most likely (99.99% of the time) be less than the growth rate of your tax free money, and therefore by definition - it will also be less than the growth rate of the deferred tax liability.

Meaning, the rate you put on the lost growth of $1,650 should be less than the rate you put on the growth of the deferred tax liability of your hypothetical Traditional IRA.

.
Here is where the equation becomes not so simple as "33% vs. 25%". Because now you have to figure out which of these two is more expensive:

the lost growth of the upfront tax
OR
the growth in the deferred tax liability

Everybody knows that 33% > 25%. However a very important but not so obvious question is:

What are we applying those percentages to?

Now, if we only have the retirement account for 1 year, most likely the 33% up front cost of a Roth would be more expensive than the 25% cost of the distribution you take next year for a Traditional.

However, over long periods of time compounding works its charm. The accelerated growth of the deferred tax liability at 25% laps the opportunity cost of paying a tax bill at 33%.

If you don't believe me, plug the numbers into a spreadsheet, or better yet, ask me for my spreadsheet. Even a tiny cost of .47% such as the one bc65 mentioned (which is wrong btw, as your tax headwind would most likely be higher than that - feel free to ask why) adds up over long periods of time. And of course, I speak of 25% in retirement vs. 33% now as if its set in stone for all of us. The reality is that you as a physician may very well be generating enough income even in retirement that your tax rate will still be 33% then; but that's a separate discussion.

The point is this. If you didn't get anything from the many pages worth of material I have written on this thread thus far - just try to understand this:

It is not as simple as taking the difference between the two marginal rates (current and retirement). You must consider opportunity cost and deferred tax liability if you truly want to know which of these two IRAs are better.
.
Thanks

.

Based on the above, it seems to me that the simplest way to calculate it would be to include the tax loss in the calculation for the tax deferred account. That is, if you were going to contribute $5500 to the Roth, the equivalent would be the $5500 plus whatever taxes you paid to get that, then contribute all that to the tax deferred account and see where you end up after 30 years. Or, take the taxes out of the same amount and contribute the lower number to the Roth. I know this doesn't necessarily reflect real life situations, but it would demonstrate the difference more clearly.
 

bc65

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But this is what I'm getting at. As I see it, if you have $5500 to invest in a Roth, you've already paid taxes on it (unless you are the business owner or a contractor that has to pay quarterly taxes because they are not already taken out by the time they are in your bank account). So, contributing the full amount to a Roth is equivalent to contributing $5500 plus the taxes you paid on that to a traditional. You end up with the same cash in hand at the end of the day. Since there are maximum contribution limits to both, they are not an even comparison unless you contribute less to the Roth.

Of course you're right.
He either doesn't understand the basics of how these accounts work, or just won't admit that he's wrong.
Don't feed the troll.

I accounted for your concern in my numbers, where I start with $4,000 of income, and contribute $2,000 to either a Roth or a traditional IRA, and pay any taxes due on the balance. Then I let the Roth/IRA grow, plus the remaining after tax money. That's why the IRA has a companion taxable balance of $1,340, but the Roth only has $680 in the companion taxable account.

I showed the results after one year because I don't want to do more calculations, but the benefits of the IRA / 401k will of course only be magnified over time.

Note that the other poster doesn't understand the basics of how marginal and effective tax rates work. That's why I really don't think that he has any finance experience or even ever paid income taxes.
When you put the money in, you're paying, or saving, at the highest, or marginal rate. However, when the IRA /401k money comes out, it will spill over several brackets. For most married physicians, even after accounting for social security income, your withdrawal will correspond to the 15%, 25%, and perhaps even part of the 28% brackets. After deductions, most will top out at 25%, and after you average that out, most physicians will be pay about 20% effective or even less.
In my case, I deferred at the 33% and 39% marginal rates, but I will withdraw at the effective rate of 20%.
So to summarize, for IRA and 401k accounts, compare marginal rates going in, to effective rates coming out.

Note that this assumes that you don't have a pension, or win the lottery, or have a large income from royalties, etc. If you do, then you will be in the minority of physicians (or anyone) who is paying a higher rate effective rate in retirement than their marginal rate when working. But that's why I, and everyone else, suggests that when you're a resident, and earning a lower salary, of about 60k, and are in the lower tax brackets, that you use a Roth, since you'll be withdrawing at a higher effective rate. So you always need to look at your current marginal rate and compare it to your income and tax brackets in retirement to know where to put your money.

Note a minor interesting point: If you compare a Roth to an IRA, and use the exact same tax rate going in and coming out,then there is a fraction of a percent advantage to a Roth, because there's more tax free money in a Roth than an IRA. However, since in practice, your IRA is taxed at the effective tax rate, and not the marginal tax rate, then the Roth only has an advantage if your withdrawal marginal tax rate is higher in retirement, and not the same. Again, that is very unlikely to happen, and if you were going to be in that category, you would realize it many years in advance and at that point you could adjust your contributions accordingly.

The reality is that for most physicians, you will have mostly pre-tax 401k or IRA space, and less Roth or other after tax space, and most physicians should use both. That's because when you withdraw, if you need more money that your RMD, you might spill up into the next tax bracket. So to give yourself the option of withdrawing more money if you need it, after you max out your pre-tax contributions, you contribute after tax money to your backdoor Roth, your 401k in-service rollover if available, your 403b, a 457, a 529, your HSA, etc. There are several other accounts that allow you to shelter after tax money and get tax free growth, but that should come after you have contributed to the tax deferred accounts.

Also, pretty much everyone else who talks about investing recommends putting index funds in your taxable account and getting the step up in basis at death. That guy is the only person I ever heard of who seems to suggest otherwise.

For anyone who wants corroboration with my recommendations, or still has questions, please see the links I provided in my earlier post above.
 

Smiths11

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But this is what I'm getting at. As I see it, if you have $5500 to invest in a Roth, you've already paid taxes on it (unless you are the business owner or a contractor that has to pay quarterly taxes because they are not already taken out by the time they are in your bank account). So, contributing the full amount to a Roth is equivalent to contributing $5500 plus the taxes you paid on that to a traditional. You end up with the same cash in hand at the end of the day. Since there are maximum contribution limits to both, they are not an even comparison unless you contribute less to the Roth.



Based on the above, it seems to me that the simplest way to calculate it would be to include the tax loss in the calculation for the tax deferred account. That is, if you were going to contribute $5500 to the Roth, the equivalent would be the $5500 plus whatever taxes you paid to get that, then contribute all that to the tax deferred account and see where you end up after 30 years. Or, take the taxes out of the same amount and contribute the lower number to the Roth. I know this doesn't necessarily reflect real life situations, but it would demonstrate the difference more clearly.

I know what you're saying, but you can't calculate it like that.

You can't calculate a number of >$5,500 for a tax deferred account, simply because it would be impossible to contribute >$5,500 to a tax deferred account. You must assume that were you to go for a Traditional instead of the Roth, that you will put $5,500 in tax deferred AND put $1,650 in taxable (opportunity cost).

What you're saying is that if you were to go for Traditional instead of Roth, that you put BOTH $5,500 + $1,650 in a Traditional - something that is not legally allowed. You can't assume the alternative reality of what you'd do without a Roth would be to put that $1,650 in the Traditional, because that would give you a falsely higher value for the Traditional route.

To make it easier to see, picture two universes:

Universe 1: Capital gains and Dividend taxes are 99.99% (instead of the current 15-20%). Your marginal rate now is 33%, and 25% at retirement.

At that point, the opportunity cost of the lost $1,650 (its future growth) is almost nothing. What that $1,650 is "missing out on" by being paid as taxes up front rather than not being kept in your taxable savings/investments is next to nothing. Here, Roth >>>>>>>>> Traditional

Universe 2: Capital gains and Dividend taxes are .01% (instead of the current 15-20%). Your marginal rate now is 33%, and 25% at retirement.

At this point, the opportunity cost of the lost $1,650 (its future growth) is HUGE. The $1,650 is "missing out on" a hell of a lot of future returns if it were to be used to pay up front taxes. Here, Traditional >>>>>>>>>>>>> Roth


You see, you can't simply compare $5,500 in a Roth vs. $5,500 + $1,650 in a Traditional, as you're suggesting.

You must value the $1,650 separately, to figure out its opportunity cost when investing in a Roth. At the same time, you must value the deferred tax liability separately, to figure out its cost when investing in a Traditional.

One of these valuations depends on capital gains/dividend tax rates, the other depends on marginal income tax rates. Hence the reason you separate the two.

Do you kind of get what I'm saying? If not, feel free to ask again. I will talk about it as much as anyone wants to. I love this stuff and I'm more than happy to help! :)
 

Smiths11

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Of course you're right.
He either doesn't understand the basics of how these accounts work, or just won't admit that he's wrong.
Don't feed the troll.

Note that the other poster doesn't understand the basics of how marginal and effective tax rates work. That's why I really don't think that he has any finance experience or even ever paid income taxes.
When you put the money in, you're paying, or saving, at the highest, or marginal rate. However, when the IRA /401k money comes out, it will spill over several brackets. For most married physicians, even after accounting for social security income, your withdrawal will correspond to the 15%, 25%, and perhaps even part of the 28% brackets. After deductions, most will top out at 25%, and after you average that out, most physicians will be pay about 20% effective or even less.

So to summarize, for IRA and 401k accounts, compare marginal rates going in, to effective rates coming out.

Dead wrong. Straight from Investopedia: http://www.investopedia.com/articles/personal-finance/021015/how-much-are-taxes-ira-withdrawal.asp

If it's a Roth IRA, you won't owe any income tax. If it's not you will. If the money is deposited in a traditional IRA, SEP IRA, Simple IRA or SARSEP IRA you will owe taxes at your current tax rate on the amount you take out. For example, if you are in the 15% tax bracket, your withdrawal will be taxed at 15%

Straight from CNN Money: http://money.cnn.com/retirement/guide/IRA_Basics.moneymag/index11.htm

Your withdrawals from a Roth IRA are tax free as long as you are 59 ½ or older and your account is at least five years old. Withdrawals from traditional IRAs are taxed as regular income, based on your tax bracket for the year in which you make the withdrawal.




No sir, you are taxed at your marginal rate when taking distribution, not effective. :)
P.s. keep the personal attacks coming
 

bc65

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You're taxed at the effective rate because your RMDs will span several tax brackets , which I demonstrated. If you had ever actually paid taxes yourself you would understand that. As I showed you, while I saved taxes at a 39% marginal rate, and withdraw at a marginal rate of 25%, my effective rate on my RMDs, even excluding social security income, is 20%. I showed the numbers, plain as day. Numbers don't lie. Explain the numbers or be quiet.

Some people might be confused by your blabbering. Otherwise I wouldn't care what you thought.
 

Smiths11

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You're taxed at the effective rate because your RMDs will span several tax brackets , which I demonstrated. If you had ever actually paid taxes yourself you would understand that. As I showed you, while I saved taxes at a 39% marginal rate, and withdraw at a marginal rate of 25%, my effective rate on my RMDs, even excluding social security income, is 20%. I showed the numbers, plain as day. Numbers don't lie. Explain the numbers or be quiet.

Some people might be confused by your blabbering. Otherwise I wouldn't care what you thought.

Lol, the marginal rate that you start withdrawing at is your BASE rate, the effective rate (if it spans several brackets) would be higher.

If you start withdrawing at a 20% bracket, then you pay 20%. Then your withdrawals go so high that you spill into the 25% bracket. That would bring your effective rate higher, not lower. But effective rate is average of all types of income. All that matters to you is the rate at which the IRA is withdrawn, and that rate certainly is the marginal rate, and then if the withdrawals go higher into the next bracket, it will be the next higher marginal rate.

Effective rate of your full income is meaningless here - all that matters is the amount and rate you pay off the IRA withdrawals. So you may withdraw your IRA at 25%, meaning you'd pay $25 for each $100 you withdraw. Period. That's the cost - $25/$100. Your effective rate may be 20% or 18%, but that makes no difference at all. You are only comparing the direct cost of the IRA (in this case $25/$100) vs. the cost of the alternative (Roth).

It's absurd that you recognize this concept when contributing, where you use the marginal rate, but when distributing you use an average rate of your whole income. Absurd.
 

bc65

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Again, if you had ever calculated your income tax, you wouldn't make this mistake. So here are some real numbers for you. Do the math and post the results. My income, married filing jointly, in the mid to high 6 figures. By the time I turn 71 the maximum social security income will be 36,000 a year, I estimate. I will have 4.5 million in my IRA. RMD on that is $169,811. Let's ignore the deductions. Why don't you do the math, tell me what my marginal rate was going in, my marginal rate on distribution, and my effective rate on distribution on my taxable gross upon distribution of $206,000. Please post those 3 numbers for us. If the marginal on contribution is higher than the marginal on withdrawal, and the marginal on withdrawal is higher than the effective rate on withdrawal, you owe this forum an apology for misleading them. If not, I will apologize. Please do the math and get back to me.
 

Smiths11

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Again, if you had ever calculated your income tax, you wouldn't make this mistake. So here are some real numbers for you. Do the math and post the results. My income, married filing jointly, in the mid to high 6 figures. By the time I turn 71 the maximum social security income will be 36,000 a year, I estimate. I will have 4.5 million in my IRA. RMD on that is $169,811. Let's ignore the deductions. Why don't you do the math, tell me what my marginal rate was going in, my marginal rate on distribution, and my effective rate on distribution on my taxable gross upon distribution of $206,000. Please post those 3 numbers for us. If the marginal on contribution is higher than the marginal on withdrawal, and the marginal on withdrawal is higher than the effective rate on withdrawal, you owe this forum an apology for misleading them. If not, I will apologize. Please do the math and get back to me.

1) Nope, I never said that the marginal on contribution is NOT higher than the one at withdrawal. In all my posts I keep referring to 33% on contribution vs. 25% on withdrawal. Perhaps the retirement rate may be higher if you generate a lot of passive income (rental, etc.) but in all my posts I'm simply assuming 33% vs 25%. So don't put words in my mouth.

2) I AGREE that the marginal on withdrawal will be greater than the effective if including your S.S. income. However, what I DISAGREE with is that this matters. All that matters is the rate you're paying on the withdrawals themselves (the marginal rate).

3) The effective rate is a direct effect of all sources of income (S.S. included in this case); this is not what you're really paying on the distributions - it's the result, not the cause.

4) There's nothing for me to apologize for. Everyone and their mother's can see that 33% is greater than 25%. The whole other side of the argument is the rate of return differential - I will not argue with you on this. But as I said hundreds of times - income tax rates are NOT the only thing people should look at, because they also should look at opportunity cost on the lost rate of return and growth of the deferred tax liability.

5) I'm done with you. Anyone else, feel free to ask me questions/comments on my posts. Also if anyone wants to see my excel model on this topic, I'll send it to you, just PM me.
 
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bc65

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"However, what I DISAGREE with is that this matters. All that matters is the rate you're paying on the withdrawals themselves (the marginal rate). "

And again you're ignoring reality. The tax you pay on the withdrawal is not the marginal rate. It's the sum of the tax you pay on the withdrawals, divided by the amount of withdrawals. Surely you understand that math, don't you? Take away the SS income, and the tax you paid on that. The remaining tax, divided by the RMD, is the tax you paid on the IRA money. That will clearly be less than the marginal rate on that money because it spans several brackets below the marginal bracket. That's why it's the effective rate on that money that counts and not the marginal.
 

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"However, what I DISAGREE with is that this matters. All that matters is the rate you're paying on the withdrawals themselves (the marginal rate). "

And again you're ignoring reality. The tax you pay on the withdrawal is not the marginal rate. It's the sum of the tax you pay on the withdrawals, divided by the amount of withdrawals. Surely you understand that math, don't you? Take away the SS income, and the tax you paid on that. The remaining tax, divided by the RMD, is the tax you paid on the IRA money. That will clearly be less than the marginal rate on that money because it spans several brackets below the marginal bracket. That's why it's the effective rate on that money that counts and not the marginal.

Agreed! Exclude the S.S.

So let's say the rates you withdraw at are 15%, 20%, 25%. Yes look at the effective of those.

So, what I want to say is that
a) S.S. may not be the only other source of income (therefore the starting rate on your withdrawals may be higher than you think)

b) regardless of what rate is when, the rate of return differential (opportunity cost vs. deferred tax liability) still matters and must be calculated

But yes, if your withdrawals span several brackets - you must look at the rate on all those brackets, not just the top one.
 
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Who ever thought that a Finance forum debate would get so heated? Good grief.

OP, if you're still there, I agree with what bc65 said in post 5 that the best thing to do depends on your current training status/income level, as well as on your discretionary income. As a resident, I did BOTH a pretax retirement account contribution and a Roth IRA contribution because I had enough cash to fund both. But if you can't afford to do both as a current resident, doing the Roth right now likely makes more sense, for a couple of reasons. 1) There is a good chance that your tax bracket at retirement will be around what it is now, so there is minimal harm in paying the taxes up front; and 2) you are probably young (late 20s/early 30s), which means you have a lot of time to take advantage of the tax-free growth that occurs in a Roth compared to us older folks. However, you made a good point regarding your loan payments. Realize that most of us who are Gen Xers or older can't advise you too well here, because loan rates are much higher now than they were 10+ years ago (and loan amounts are much higher these days as well). You will have to run the numbers yourself for your specific case (or get your financial planner/accountant to help you with it).

If you're already an attending, then minimizing taxable income becomes the bigger concern because your current income is usually so much higher than your retirement income is likely to be. I am in the 33% bracket now, but I don't expect to be here as a retiree, especially since I anticipate retiring early. So I want to defer as much income as possible at this point. I do also take advantage of the back door Roth, and I buy US savings bonds, which are tax-deferred as well (though you have to buy them using post-tax money, so it's not quite equivalent to investing in bonds through an IRA). As bc65 said, the leftover money is in a taxable account, invested in tax-efficient equity funds with low turnover.

All in all, the biggest obstacle that most people face as new grads is that they aren't saving or investing anything in any account. So regardless of what you end up deciding to do, the most important decision you need to make is to start investing, period. If you're not comfortable coming up with your own plan, then hire someone to help you, but regardless, get started. Sooner is always better when it comes to saving/investing.

Best of luck. :)
 
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Smiths11

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Who ever thought that a Finance forum debate would get so heated? Good grief.

OP, if you're still there, I agree with what bc65 said in post 5 that the best thing to do depends on your current training status/income level, as well as on your discretionary income. As a resident, I did BOTH a pretax retirement account contribution and a Roth IRA contribution because I had enough cash to fund both. But if you can't afford to do both as a current resident, doing the Roth right now likely makes more sense, for a couple of reasons. 1) There is a good chance that your tax bracket at retirement will be around what it is now, so there is minimal harm in paying the taxes up front; and 2) you are probably young (late 20s/early 30s), which means you have a lot of time to take advantage of the tax-free growth that occurs in a Roth compared to us older folks. However, you made a good point regarding your loan payments. Realize that most of us who are Gen Xers or older can't advise you too well here, because loan rates are much higher now than they were 10+ years ago (and loan amounts are much higher these days as well). You will have to run the numbers yourself for your specific case (or get your financial planner/accountant to help you with it).

If you're already an attending, then minimizing taxable income becomes the bigger concern because your current income is usually so much higher than your retirement income is likely to be. I am in the 33% bracket now, but I don't expect to be here as a retiree, especially since I anticipate retiring early. So I want to defer as much income as possible at this point. I do also take advantage of the back door Roth, and I buy US savings bonds, which are tax-deferred as well (though you have to buy them using post-tax money, so it's not quite equivalent to investing in bonds through an IRA). As bc65 said, the leftover money is in a taxable account, invested in tax-efficient equity funds with low turnover.

All in all, the biggest obstacle that most people face as new grads is that they aren't saving or investing anything in any account. So regardless of what you end up deciding to do, the most important decision you need to make is to start investing, period. If you're not comfortable coming up with your own plan, then hire someone to help you, but regardless, get started. Sooner is always better when it comes to saving/investing.

Best of luck. :)

The first bolded statement (my emphasis) is something I've been saying when I say over long periods of time the power of compounding may very well mean that despite the lower tax bracket in retirement, paying off the tax right now at a higher tax bracket makes sense.

The second bolded statement - yes, if you retiring fairly soon, then perhaps the advantage for you is Traditional > Roth.

I'll just say this - my firm has clients who are doctors, and I have family who is doctors. Most of them have substantial assets outside their retirement portfolios - so that even after retiring from medicine, they would be generating income beyond just S.S. and IRA/401k distributions. So just think about how much you're making, what you're doing with your money, and how long you'll work. Of course if you live a very expensive lifestyle, maybe you're not saving anything outside your IRA, and perhaps all you'll have in retirement is S.S. + distributions. But I've seen different.

My point continues to be this: purely looking at the tax rate on the surface is not enough. One must think of that as well as the cost of what they are giving up in each scenario (opportunity cost vs. growth in deferred tax liability).

Best ! :)
 

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I know what you're saying, but you can't calculate it like that.

You can't calculate a number of >$5,500 for a tax deferred account, simply because it would be impossible to contribute >$5,500 to a tax deferred account. You must assume that were you to go for a Traditional instead of the Roth, that you will put $5,500 in tax deferred AND put $1,650 in taxable (opportunity cost).

What you're saying is that if you were to go for Traditional instead of Roth, that you put BOTH $5,500 + $1,650 in a Traditional - something that is not legally allowed. You can't assume the alternative reality of what you'd do without a Roth would be to put that $1,650 in the Traditional, because that would give you a falsely higher value for the Traditional route.

My understanding is that these limits only apply to IRA accounts (and you can only contribute if you make below a certain income, which many attendings don't qualify for). If you're contributing to a 401k or a 403b or similar account (which is why I changed the terminology in my post to 'tax deferred account'), you are not bound by such limits. Which I feel is the choice that I have in residency--either contribute to a 403b sponsored by my employer (and roll over to an IRA later, after I leave residency), or contribute to a Roth IRA. In that case and your example, contributing $7150 to a pre-tax retirement account is equivalent to contributing $5500 to a Roth IRA.

But please, correct me if I am wrong in my thinking.
 

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My understanding is that these limits only apply to IRA accounts (and you can only contribute if you make below a certain income, which many attendings don't qualify for). If you're contributing to a 401k or a 403b or similar account (which is why I changed the terminology in my post to 'tax deferred account'), you are not bound by such limits. Which I feel is the choice that I have in residency--either contribute to a 403b sponsored by my employer (and roll over to an IRA later, after I leave residency), or contribute to a Roth IRA. In that case and your example, contributing $7150 to a pre-tax retirement account is equivalent to contributing $5500 to a Roth IRA.

But please, correct me if I am wrong in my thinking.

You are correct that the $5,500 limit is only for the IRA accounts. But I believe 401k accounts also have a limit, albeit much higher. I think it's $18,000-$24,000ish, depending on your income.

In this case, the same principle applies though: as long as you can afford to make the contribution without dipping into the contribution itself to pay the tax, Roth may very well be better than Traditional. Obviously with much higher contribution limits in a 401k, most residents cannot do a Roth at the same amount they would do a Traditional, so generally for them it's not worth it.

The part of your post that I bolded, is referring to only Roth IRAs (I'm not sure about the Roth 401k). But yes, Roth IRA has an income limit. Given its potential lucrative advantages over a Traditional, the government doesn't offer the chance to people making very high incomes.

However there is a loophole, which I'm surprised the government hasn't shut. And that is that even if you make too much money to be allowed to contribute to a Roth, you can always put your money in a Traditional and the very same day roll it over to a Roth (while paying the tax). This is referred to as the "backdoor Roth contribution".
 

bc65

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But please, correct me if I am wrong in my thinking.

Your mistake is talking to that guy. Please search on his other posts to see who you're dealing with. Read all his posts. He claims 15 years experience in finance, but he is 29 years old and has spent the last 3 or 4 years in DO school, so his 15 years experience with his "family business" was apparently in elementary and high school, just as I suspected earlier. He's a troll. You're taking financial advice from someone with no financial knowledge or experience. If anyone listens to him, they deserve what they get.

The first bolded statement (my emphasis) is something I've been saying when I say over long periods of time the power of compounding may very well mean that despite the lower tax bracket in retirement, paying off the tax right now at a higher tax bracket makes sense.

He already admitted that he was wrong about this. If you come out ahead one year with a tax deferred account, as I demonstrated you will, over time it works even better. It won't magically change.

You are correct that the $5,500 limit is only for the IRA accounts. But I believe 401k accounts also have a limit, albeit much higher. I think it's $18,000-$24,000ish, depending on your income.

The employee contribution to a 401k is $18,000 if you are under age 50, $24,000 if over the age of 50.
It's not income based. Anyone with the most rudimentary knowledge about personal finance would know that.

In this case, the same principle applies though: as long as you can afford to make the contribution without dipping into the contribution itself to pay the tax, Roth may very well be better than Traditional.

No, we painstakingly looked at those numbers. A Roth is better if you will withdraw at the same or higher tax rate than you paid when you put it in. If you withdraw at a lower tax rate, as almost all will, you will be better with a tax deferred account. It has nothing to do with dipping into the contribution.

However there is a loophole, which I'm surprised the government hasn't shut. And that is that even if you make too much money to be allowed to contribute to a Roth, you can always put your money in a Traditional and the very same day roll it over to a Roth (while paying the tax). This is referred to as the "backdoor Roth contribution".

Once again, he doesn't know what he's talking about. You don't roll it over and pay the tax. The IRA contribution was already an after tax contribution, because you only do this if you can't make a pre-tax contribution, or a direct Roth contribution. So what you do is you make an after-tax IRA contribution, which has no income limit. Then, after waiting a while, you do a conversion to a Roth. You don't owe any tax because the initial IRA contribution was already after tax, of necessity.

Also, most advisers suggest making the contribution at the end of one year, and doing the rollover the following year, for fear that the IRS will eventually crack down on this. By doing it in different years it makes the transactions potentially look better to the IRS.

More importantly, this only works if you don't have any other traditional IRAs, due to the pro-rata rule. So it's best if you have a 401k to accept regular pre-tax contributions, and then an empty IRA in which you put the $5500 contribution, ($6500 if over 50) which you then roll over into a Roth IRA. You then keep the IRA empty until next year.


However, a resident can usually contribute directly to a Roth, because their income is low, so they don't need a backdoor Roth. If they're married, both can contribute.

You can contribute to a Roth IRA directly if your income is under 113k single, and 183k married. Single phases out between 116k-131k. Married phases out 183-193. So all housestaff, and some practicing physicians will be able to contribute directly to a Roth without doing the backdoor method. However, if you are over those limits, you can make an after tax contribution to a traditional IRA and do the rollover.

My understanding is that these limits only apply to IRA accounts (and you can only contribute if you make below a certain income, which many attendings don't qualify for). If you're contributing to a 401k or a 403b or similar account (which is why I changed the terminology in my post to 'tax deferred account'), you are not bound by such limits. Which I feel is the choice that I have in residency--either contribute to a 403b sponsored by my employer (and roll over to an IRA later, after I leave residency), or contribute to a Roth IRA. In that case and your example, contributing $7150 to a pre-tax retirement account is equivalent to contributing $5500 to a Roth IRA.

If you have enough money, you can do both. That will solve the problem for you! So, maximize the Roth contribution, and then contribute whatever else you can to the 403b.

To address your specific question:

Yes, in terms of how much effective money you're getting into the account, you need more in the 403b to get the same money working tax free. However, right now as a resident you might be paying 5% or 10% effective in federal tax. When you take money out of the account at retirement, you'll pay more tax on it than you're paying now, say, 20% effective. So you'll lose an extra 10 to 15%. That's why you probably want to pay the tax now and put it in a Roth. But do the math and see what your marginal rate is now. If it's less than 20%, you should probably do the Roth. If it's 20% or more, go for the 403b, but if it's close, it's your call.
If you have extra money you can use it to build an emergency fund or to use it to help you start a practice, or to pay down your loans.

Remember, while there's more of your money in a Roth, with a tax deferred account, you have the lower tax rate on withdrawal, plus, a lot more money in your taxable account, which more than makes up for having less working money in the IRA.
 
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bc65

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All in all, the biggest obstacle that most people face as new grads is that they aren't saving or investing anything in any account. So regardless of what you end up deciding to do, the most important decision you need to make is to start investing, period. If you're not comfortable coming up with your own plan, then hire someone to help you, but regardless, get started. Sooner is always better when it comes to saving/investing.

This is so true. In my opinion, the real benefit of retirement accounts is the incentive to save, rather than the tax incentives alone. But the next problem is getting people to invest, and not just stay in cash. I have friends with 600k in cash, and more cash in a SEP-IRA that's been there for 10 years, but they remain frozen with indecision, waiting for the market to correct. Of course, now that it has, they're waiting some more, and they'll keep waiting until it goes back up again. Then they'll wait for the correction once again.

That's why the default option target date funds that so many retirement plans have now are so good.
 

Smiths11

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Your mistake is talking to that guy. Please search on his other posts to see who you're dealing with. Read all his posts. He claims 15 years experience in finance, but he is 29 years old and has spent the last 3 or 4 years in DO school, so his 15 years experience with his "family business" was apparently in elementary and high school, just as I suspected earlier. He's a troll. You're taking financial advice from someone with no financial knowledge or experience. If anyone listens to him, they deserve what they get.

Listen, I'm getting tired of the personal attacks. Especially since much of what you say isn't even true. No, I'm not 29 years old - I don't have to tell you my age but I will say you're not even close. You're a jerk for going through my posts and implying that being a DO makes me any less qualified.

And yes absolutely I have 15 years of investing experience. In addition I have substantial experience working as an investment banker and I currently work part time in distressed debt. So **** off.

I have been nothing but civil and polite to you but you insist on attacking me personally and in a desperate attempt to soothe your bruised ego you go through my posts and imply that as DO I'm less credible.


He already admitted that he was wrong about this. If you come out ahead one year with a tax deferred account, as I demonstrated you will, over time it works even better. It won't magically change.

Nope, I stand 100% by what I said, never said I was wrong.

And one year is not enough - because compound interest over time accounts for lower rate of withdrawal. Make a model and see for yourself.


The employee contribution to a 401k is $18,000 if you are under age 50, $24,000 if over the age of 50.
It's not income based. Anyone with the most rudimentary knowledge about personal finance would know that.

Doesn't matter - the fundamental point of the argument still stands.


No, we painstakingly looked at those numbers. A Roth is better if you will withdraw at the same or higher tax rate than you paid when you put it in. If you withdraw at a lower tax rate, as almost all will, you will be better with a tax deferred account. It has nothing to do with dipping into the contribution.

Wrong. Rate of return matters too.




If anyone would like to see my excel model proving this, feel free to ask. I'd be more than happy to send it to you. And I'll do my best to answer any questions you may have. I won't respond anymore to this jerk's garbage, but I'll stick around to answer anyone who would like to know more, either here or through PM.
 

QofQuimica

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The second bolded statement - yes, if you retiring fairly soon, then perhaps the advantage for you is Traditional > Roth.
I'm not retiring altogether. However, I will be quitting my FT attending job in about 13 months and doing a fellowship, after which I intend to work on a more limited basis when/because I feel like it. So no, I am not thinking in terms of hypotheticals that are decades off into the future here. I'm planning for "retirement" starting next year, in the sense that I do not ever anticipate earning this much money again for the rest of my life.

This is so true. In my opinion, the real benefit of retirement accounts is the incentive to save, rather than the tax incentives alone. But the next problem is getting people to invest, and not just stay in cash. I have friends with 600k in cash, and more cash in a SEP-IRA that's been there for 10 years, but they remain frozen with indecision, waiting for the market to correct. Of course, now that it has, they're waiting some more, and they'll keep waiting until it goes back up again. Then they'll wait for the correction once again.
Sounds like your friends need a financial plan and should maybe consider DCAing so they can get started slowly. This is a great time to buy. If I had my entire 2016 year's salary right now, I'd invest it all right now. As it is, I'm waiting on tenterhooks to get paid on Friday so I can do my back door Roth for this year. :p
 

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Sounds like your friends need a financial plan and should maybe consider DCAing so they can get started slowly. This is a great time to buy. If I had my entire 2016 year's salary right now, I'd invest it all right now. As it is, I'm waiting on tenterhooks to get paid on Friday so I can do my back door Roth for this year

I tried to get them to dollar cost average, to no avail. They still are waiting for a divine message to tell them when the time is right. People just don't take good advice, and there are lots of people giving bad advice, due to ignorance or malicious intent, as in this thread.

All my money is invested, so all I can do is watch, but my horizon is 20 years, so I can just enjoy the ride.
 

QofQuimica

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I tried to get them to dollar cost average, to no avail. They still are waiting for a divine message to tell them when the time is right. People just don't take good advice, and there are lots of people giving bad advice, due to ignorance or malicious intent, as in this thread.

All my money is invested, so all I can do is watch, but my horizon is 20 years, so I can just enjoy the ride.
Probably best to just leave them to their own devices, then. I think I told you that I've been taking CFP classes. While there is a part of me that fantasizes about working as a CFP, I know that the counseling aspect of it would be just as frustrating and thankless of a job as the counseling aspect of being a physician. Instead of telling people who don't want to hear it to stop smoking, lose weight, and exercise, I would be telling people who don't want to hear it to stop spending so much money, save/invest more, and avoid trying to time the market. (Interestingly, the CFP text even went through the same "stages of change" literature that I remember learning in medical school for the purpose of counseling patients on smoking cessation.) I would be the kind of CFP who would be telling my clients with six figure incomes to save half their incomes or more, not 10-15%! (Or alternatively, to devote the same percentage toward paying off their debt if they have debt, since I see that as being two sides of the same coin.)

For both physical health and financial health, people tend to underestimate how much their small daily decisions add up over time to make an overall trajectory toward a good outcome or a bad one....
 
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bc65

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I know that the counseling aspect of it would be just as frustrating and thankless of a job as the counseling aspect of being a physician.

That's precisely the conclusion I came to after talking with them several times. It's just like being a physician, but with a different set of liabilities and frustrations, but much less money.

However, I still looked into getting a CFP designation. I even bought a couple of older edition textbooks to see what the work entails, and I found a few inexpensive online courses, one cheaper than the others. However, the big problem seems to be that you need 2 or 3 years of real experience to get the certification, and that doesn't seem easy to do without actually going to work for an advisory firm. And in the end, there's little that I think I would learn that would be of use in the real world.

So, have you learned anything useful, how hard have the courses been, and how many have you taken so far, and do you plan on getting experience in order to get the certification, and if so, how will you do it? I know teaching for 3 years in a university will do it. Is that your plan?
 

QofQuimica

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So, have you learned anything useful, how hard have the courses been, and how many have you taken so far, and do you plan on getting experience in order to get the certification, and if so, how will you do it? I know teaching for 3 years in a university will do it. Is that your plan?
Have definitely learned some useful things. At this point I do all my own financial planning, from taxes to wealth management to kids' college funds (for my niece and nephew) to risk management/insurance. The courses are not particularly hard if you have basic math skills, which any physician should have. I'm talking high school algebra and college stats here, not differential equations and linear algebra. But I'm not going to get the actual certification. Besides the three years' apprenticeship experience, which you mentioned, it is also necessary to study for and take a board exam, which I don't particularly feel like doing. Learning about these subjects for my own interest and edification is one thing. Going through what is essentially like a second residency for a day job I don't really want is quite another!
 

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Have definitely learned some useful things. At this point I do all my own financial planning, from taxes to wealth management to kids' college funds (for my niece and nephew) to risk management/insurance. The courses are not particularly hard if you have basic math skills, which any physician should have. I'm talking high school algebra and college stats here, not differential equations and linear algebra. But I'm not going to get the actual certification. Besides the three years' apprenticeship experience, which you mentioned, it is also necessary to study for and take a board exam, which I don't particularly feel like doing. Learning about these subjects for my own interest and edification is one thing. Going through what is essentially like a second residency for a day job I don't really want is quite another!

My thoughts exactly, although the exam doesn't look that hard. I looked at some prep books, and I think I have a 50/50 chance of passing it today without any of the courses. But the test costs $595, I believe, and then I would have a job that pays less and is just as frustrating as medicine.

Why are you doing a fellowship? Will it put you in a whole new field, or just more training in what you already do? For academic advancement, or higher salary?
 

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I did not expect such a lively discourse before clicking on this topic, WOW!

My opinion is in line with most of the commenters. For most physicians, the combination of pre-tax traditional 401(k) (and 457(b) / 403(b) if you have access), a backdoor Roth, and a tax-efficient taxable account with index funds is the way to go.

If the plan that includes early retirement, the decision is easy. You defer the high tax now by contributing to a pre-tax 401(k), rollover to a traditional IRA, then start doing annual Roth conversions in the 15% or 25% tax bracket. If you complete the conversions by the time you turn 70.5, no RMDs. With deductions and exemptions (helps to have kids at home), you can have income approaching or possibly exceeding $100,000 without paying any federal taxes.

If you decide to let the 401(k) grow and might be interested in charitable giving in your seventies, you can donate your RMD directly to charity and pay no tax.
 
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bc65

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If the plan that includes early retirement, the decision is easy. You defer the high tax now by contributing to a pre-tax 401(k), rollover to a traditional IRA, then start doing annual Roth conversions in the 15% or 25% tax bracket. If you complete the conversions by the time you turn 70.5, no RMDs. With deductions and exemptions (helps to have kids at home), you can have income approaching or possibly exceeding $100,000 without paying any federal taxes.

My plan, exactly, although I will only succeed in making a small dent in my IRA by doing partial Roth conversions.

You also want to consider the tax bracket of your heirs if they will be inheriting your IRA. If they will be in a lower bracket that you are, you don't want to convert your IRA to a Roth. If they will be in a higher bracket, you should convert now.
 

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Cant think about this without the taxes. You should think about the taxes invested in a deferred account as free leverage at your marginal tax rate. It is hard for any other taxed up front method to beat this. Just think of it this way, youre starting with more principal. Its simple, do as WCI says there, max out tax deferred first, then play. I currently also use a taxable, plan to look more deeply into this backdoor business as well, however, tax deferred plans are a super gift, take them.
 
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