Need help with balancing 401(k) and Roth IRA

[DKT]

OK, I think I follow you on that. What did you do with the Roth? Just take $3000 and grow it 10% each year? $3,000 + 300 = $3,300 at the end of year one, etc?

Then, at the end of the scenario, apply the new tax bracket to the traditional total only? And the Roth still came out ahead?


Yes, that's exactly what I did. Tradional total value $383,162, Roth $324,545. When withdrawing the money, I plussed up the Traditional so that the after tax amounts were the same. This is what kills the Traditional (at least in this model).

I'll try and modify the model as you suggested and see what we get.

 

[DKT]

I've been thinking about the change suggested, and I can't envision a scenario where someone would have $3,000 pre tax. All the savings I have is post payroll taxes, so the model change you suggest would model double taxes on the $3,000, the tax paid in payroll taxes, and then the tax on the $3,000.

 

[msparks]

Another thing is you can draw on the money you put into the roth penalty free (just can't touch the growth part.

You can also use your roth for a first time home purchase and to pay for college, without penelty. I'm starting a roth for my daughter this year(if she would ever get to work) with the money I pay her to help me with Amsoil.

This will totally be tax free!!!

 

[3000GT VR-4]

quote:

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Originally posted by DKT:
I've been thinking about the change suggested, and I can't envision a scenario where someone would have $3,000 pre tax. All the savings I have is post payroll taxes, so the model change you suggest would model double taxes on the $3,000, the tax paid in payroll taxes, and then the tax on the $3,000.

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When you say payroll taxes, do you mean FICA and Medicare, or income? Yes, the FICA and Medicare will be taken out for the traditional, but it will on the Roth too, won't it? Income tax on the traditional will come back to you when you file your tax return because the contribution to the IRA is deducted from your income for tax purposes. Or, you can change your W-4 so less income tax is withheld in the first place.

So, if I put $3,000 into a traditional I save the tax on that amount and have $3,000 in there to grow. If I use the same $3,000 for a Roth, I have to pay income tax on that $3,000 first, so I have only $2160 in my Roth to grow (assuming 28% tax bracket), correct?

What am I missing here?

 

[3000GT VR-4]

I made up an Excel Spreadsheet and ran a few scenarios. Assuming:

1. I only have $3000 to put in including taxes (All $3000 goes into the Traditional, for the Roth, the taxes get paid before contribution out of the $3000).

2. I start contributing when I'm 18.

3. I start withdrawing when I'm 70.

4. I take out the minimum amount required by the IRS each year.

5. I varied the interest rate on the IRA balance from 1 to 12% (the rate was held constant for the duration of each scenario).

The Roth was the winner when the post-retirement tax rate was higher than the pre-retirement tax rate.

If the tax rates were the same, I would have the same amount of money to spend each year, but my IRA balance was appx. 40% higher with the Traditional, so I had more $$ to leave to my heirs.

If my post-retirement tax rate was lower than the pre-retirement rate, the Traditional would win again, with more spendable income and a higher balance.

 

[DKT]

When I say after tax, I meant all taxes including income. In your example aren't you really saying that I have $3,000 to put into a Traditional, but I only have $2,160 for the Roth - not apples to apples.

For the Traditional you still need to actually produce $3,000 to get the deduction (get the taxes back) but it has already been taxed. Since you have to produce the $3,000 for the Traditional to get the deduction, you could instead use it for the Roth.

I may not have this right, but it sure seems clear to me (tunnel vision?

)

 

[3000GT VR-4]

quote:

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Originally posted by DKT:
When I say after tax, I meant all taxes including income. In your example aren't you really saying that I have $3,000 to put into a Traditional, but I only have $2,160 for the Roth - not apples to apples.

For the Traditional you still need to actually produce $3,000 to get the deduction (get the taxes back) but it has already been taxed. Since you have to produce the $3,000 for the Traditional to get the deduction, you could instead use it for the Roth.

I may not have this right, but it sure seems clear to me (tunnel vision?

)

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In my example I presume I have $3,000 to invest each year, period. I can put it in a Traditional and pay no income tax on it (I either pay it up front and get it back with my refund check or change my W-4 so less $$ is withheld to begin with). With the Roth, I have less to invest because I MUST pay the income tax. I reduced the amount contributed to the Roth account by the percentage of income tax that was assumed for each scenario (i.e. for the 28% pre-retirement scenario, I only contributed the $2,160, for the 15% pre-retirement scenario, I contributed $2,550, etc.). The government got the rest. I had $3,000 each year to start with, so it's apples-to-apples. To put $3,000 in the Roth I need to get the tax $$ from somewhere else - work more hours, a second job, etc, which does not make it a fair comparison. I then taxed the Traditional during the retirement years, when the Roth is not taxed. So, taxes are paid both ways, when they are actually due to the IRS.

 

[msparks]

quote:

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Originally posted by 3000GT VR-4:
To put $3,000 in the Roth I need to get the tax $$ from somewhere else - work more hours, a second job, etc, which does not make it a fair comparison. So, taxes are paid both ways, when they are actually due to the IRS.

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Dude,

You can either retire "rich" or "poor". With a tradidional if you expect to be poor, then that is the way to go.

If you expect to be "rich" then the Roth is the way to do.

That is the only difference.

Have 1/2 million tax free or have 1/2 million that you have to pay tax on, at your current bracket that is the only difference.

Personally I'm for stopping ALL income tax and only taxing "consumption" (a national sales tax) That would hurt me big time, but overall since I'm a low consumer, I would benifit.

 

[3000GT VR-4]

quote:

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Originally posted by msparks:

quote:

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Originally posted by 3000GT VR-4:
To put $3,000 in the Roth I need to get the tax $$ from somewhere else - work more hours, a second job, etc, which does not make it a fair comparison. So, taxes are paid both ways, when they are actually due to the IRS.

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Dude,

You can either retire "rich" or "poor". With a tradidional if you expect to be poor, then that is the way to go.

If you expect to be "rich" then the Roth is the way to do.

That is the only difference.

Have 1/2 million tax free or have 1/2 million that you have to pay tax on, at your current bracket that is the only difference.

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No, that is not the only difference. With the Traditional I would have 40% MORE money in the account. If the Roth was 500,000 the Traditional would have approximately 700,000. If I die, my heirs get the 700K, not 500K.

 

[Pablo]

My issue is similar, but different.

1) I need all the tax deductions (income reductions) I can get. Lean toward 401K.

2) I have already a huge chunk in a self-directed IRA (from 3 401K rollovers). To convert this now to a Roth would be a killer tax wise. Leaning towards keeping it where it is (see the "investment thread"

)

3) Income taxes are relatively low right now...or so they say. If I get ****e canned or whatever and don't have income for a chunk of a year, think about converting then....

I like the ROTH, but the timing doesn't seem right for me??? Input, please.

 

[3000GT VR-4]

quote:

---

Originally posted by Pablo:
My issue is similar, but different.

1) I need all the tax deductions (income reductions) I can get. Lean toward 401K.

2) I have already a huge chunk in a self-directed IRA (from 3 401K rollovers). To convert this now to a Roth would be a killer tax wise. Leaning towards keeping it where it is (see the "investment thread"

)

3) Income taxes are relatively low right now...or so they say. If I get ****e canned or whatever and don't have income for a chunk of a year, think about converting then....

I like the ROTH, but the timing doesn't seem right for me??? Input, please.

---

Pablo, from the scenarios I ran in an Excel spreadsheet I came to the following conclusions (as stated in a post above):

The Roth was the winner when the post-retirement tax rate was higher than the pre-retirement tax rate.

If the tax rates were the same, I would have the same amount of money to spend each year, but my IRA balance was appx. 40% higher with the Traditional, so I had more $$ to leave to my heirs.

If my post-retirement tax rate was lower than the pre-retirement rate, the Traditional would win again, with more spendable income and a higher balance.

This tends to agree with many financial planners who say to max out your 401K first, Traditional IRA next (if you qualify), Roth next (if you qualify), and non-deductible IRA last.

So I would say that if you think you will be in a higher bracket when you retire, you might want to look at converting your IRAs to a Roth at some time in the future when you have cash available to pay the taxes on the $$ you move. Otherwise, leave it where it is.

 

[Pablo]

3000GT VR-4 - Thanks - that has been my thinking.....I guess the paranoid guy inside me is like: "When you retire tax rates will be 90%!!!"...