Opening a Roth IRA

[Ethan]

I am looking into opening a Roth IRA, and am interested in Vanguard. I'll likely invest it in a Target Date Retirement Fund to start with, and then perhaps move it into VTSMX or VTI later on. I am a novice investor, and would like to eventually become more savvy, however, I would also like to get started now. Is there an advantage to Vanguard or another service such as Betterment or Wealthfront for someone in my situation with my level of experience?

 

[Matt]

The difference isn't really of note at this level. Vanguard will charge you a touch more than WF as they will manage the first 10-15K for free. Free means that they waive their overlay fee, but you still pay for the underlying ETFs. But once the account grows, Vanguards fee starts to even out, and eventually becomes the cheapest. Regardless.. when all's said and done, we're not talking about anything of note.

The real value add of a Robo like Wealthfront/Betterment is in a taxable account, in an advantaged it is diminished. You could go with whatever you prefer, but perhaps if you do intend to get more savvy later, a target date keeps everything with Vanguard and easier to transition/manage down the road.

A bigger question might be why the Roth? - because that is a potential 4 figure decision. Roths are great, but best when your present salary (and therefore tax bracket) is low. If you are in the mid-high brackets, you might want to think about the traditional instead.

 

[Tom Capone]

Matt - agreed on the Roth vs. Traditional. A couple of other points:

• If your tax rate now is the same as when you retire, there is no economic difference between a Roth and Traditional. Higher taxes in retirement, Roth is better.
• Assuming no change in tax rate, the same dollar amount contribution in a Roth today will cost you more today but provide a larger after tax amount in retirement than a traditional retirement.
  
• Roth has some non economic benefits, like ability to withdraw some funds prior to retirement.
• Due to the tiered nature of our tax system, it is probably best to have both a Roth and a Traditional IRA. That will allow you to withdraw from the traditional in retirement to use up the lower tax brackets, then withdraw from the Roth so you don't have to pay the higher tax rates.

 

[Free-quent Flyer]

All good points. I would just caution against the belief that becoming a "savvy" investor is a worthwhile goal. There are a lot of things you can do with your life that are more interesting and meaningful than becoming increasingly confident in your ability to make smart bets, whether it's on the stock market, real estate, whatever. Low cost target retirement date funds are a great way to save for retirement, and if your goal is simply to save money for retirement, whether early, late, or right on time, you shouldn't worry too much about all the "savvy" people beating you at life.

If you do eventually end up with a lot of assets in taxable accounts you may want to briefly consider allowing one of the robos to handle stuff like tax loss harvesting, but you also may not! You're allowed to hold target retirement dates funds in both IRA's and taxable accounts, there's no law saying you have to do crazy things with your taxable investments. That's a choice.

 

[Ethan]

Thanks for all the great input. When I said "savvy", I was imagining perhaps picking up 'Bogleheads Guide to Investing' to start with. With most things, I pick up a bit here and there along the way, and try to make it work for me, without getting too caught up in the details. For this IRA, I want to get something is mostly stocks, so I think that a target date retirement fund is good. (I'm 31). My income is fairly low right now, I haven't yet found my way into higher income tax brackets, so the Roth seems a good choice.

 

[SC Trojan]

My two cents. I currently have Fidelity and Vanguard and I used to have TD Ameritrade. I finally closed my TD Ameritrade account because they were such a hassle come tax time they sent things out on the final day possible. Personally I prefer Fidelity over Vanguard, though they both are pretty good. In my few interactions with Fidelity customer service they have been AWESOME, and really the fees are pretty much the same.

As for what to invest in. Just do an S&P 500 ETF. The classic one is SPY, but there are a few others that have slightly lower fees (QQQ I think). You may be able to outperform the market, but it's mostly just a luck thing. Many studies have shown that ~75% of all mutual funds UNDERPERFORM the S&P 500. Why? Because they have to pay all those fund managers! You may not think 0.5% to 1.0% is a big deal, but in the long run it adds up to huge savings for an ETF.

If you do want to make "bets" on stocks, personally, I've been accumulating a bunch of high-yield stocks. I had an professor that I respected in my MBA program that said the only strategy that consistently beats the market is value funds. He recommended the "Dogs of the Dow" strategy (just google Dogs of the Dow). Personally, I've been investing in a bunch of beaten-up oil stocks for that reason. I'll be the first to admit this strategy has a lot of risk because you're basically placing a bet on the price of crude oil. If it stays low, we could see major price collapses in the oil industry (I'm talking 50% from today's levels). My thought is oil will go up though, and if I'm right I'll be basking in sweet petro-dollar returns!

 

[DealHackin]

What all have said is pretty good. Some core questions to ask. Do you have any matches or options at work to explore with a 401k? Do you have enough in emergency funding (6 month suggestion)? Do you have the will to not bat an eye at a market correction and stay the course?

 

[lochquel]

I am looking into opening a Roth IRA, and am interested in Vanguard. I'll likely invest it in a Target Date Retirement Fund to start with, and then perhaps move it into VTSMX or VTI later on. I am a novice investor, and would like to eventually become more savvy, however, I would also like to get started now. Is there an advantage to Vanguard or another service such as Betterment or Wealthfront for someone in my situation with my level of experience?

I'd recommend starting now. Not sure of your risk tolerance/timeframe, but if you have the time/money to start slowly and keep learning/adding, I think things will make more sense in the future for you. Vanguard has many low/no fee options and is a good brand name to start off with. If your tastes/preferences change in the future, moving your whole account to new company is fairly straightforward. I started out with Etrade back in the day for my Roth (because I didn't know any better) and have now moved to WellsFargo and Vanguard. WellsFargo may be dismissed, but I don't need too much hand-holding now and I use them for what I want. Also because I got in on WF PMA account.

So start out with someone/something you're comfortable with and go from there.

 

[Jus]

I'm no expert but I'll throw my two cents in here. I currently have a Roth through TD because right now my salary is low and I can take advantage of it. Come next year that won't be the case so I will then open my traditional and go from there. In terms of investment, I'm a fan of the Vanguard lifestrategy funds over target date retirement. They have 3-4 different ones depending on your risk tolerance. Since I'm in my 30s I don't mind a little higher risk so I chose the maximal growth one which essentially puts 80% stocks 20% bonds. Depending on what your retirement date is you could opt for any of there funds. The issue I see with some of these target date funds is that a target of 2045 may not be best for you as you could maximize and do better with getting let's say a 2025 fund or something which would tend to be more aggressive to grow your funds and then change to 2045 or whatever date you prefer. That requires a little more from your end. With the lifestrategy funds its almost like a set it and forget it for now at least.

I did have a question regarding future tax rate. Our combined salary between my wife and I is about $180k right now but I'm expecting our combined salary in about 3-4 years to be > $600k. So lets say we hold steady at that income, will our retirement tax rate in about 30-35 years from IRA standpoint be the 39.6% still. If so then should I ramp up my Roth contributions now before my salary jumps?

 

[GettingReady]

Jus, do you know about backdoor Roths?

 

[Jus]

Jus, do you know about backdoor Roths?

Is that similar to traditional to roth conversion?

 

[Matt]

Is that similar to traditional to roth conversion?

Yes. It is a non deductible Traditional that is rolled into a Roth. It allows you to go over the salary limits for a Roth. The salary limit for a Trad isn't a cap per se.. rather it is the cap where you can no longer deduct.. however, you can still contribute.

 

[Jus]

Yes. It is a non deductible Traditional that is rolled into a Roth. It allows you to go over the salary limits for a Roth. The salary limit for a Trad isn't a cap per se.. rather it is the cap where you can no longer deduct.. however, you can still contribute.

So one thing I never quite understood is how does one calculate one's tax rate on retirement assuming that you have no income from anything but your reitrement account. Is it based on how much your IRA is goign to pay you annually

 

[Matt]

So one thing I never quite understood is how does one calculate one's tax rate on retirement assuming that you have no income from anything but your reitrement account. Is it based on how much your IRA is goign to pay you annually

Conceptually, you need to differentiate between two types of income:

Ordinary Income
Cap Gains (long term and short term)

Then there is.. Tax Free.

In retirement, you have many things that spin off income, and they tend to fit into those brackets, some investments create income in both, such as certain dividend paying stocks.

• Traditional IRA distributions would be considered OI.
• Selling a stock in a taxable would be a cap gain (or a loss..)
• Roth IRA would be Tax Free
• Munis would be tax free
• etc etc

Properly constructed, you could easily 'pay yourself' $200K or more in retirement tax free.

 

[Jus]

Conceptually, you need to differentiate between two types of income:

Ordinary Income
Cap Gains (long term and short term)

Then there is.. Tax Free.

In retirement, you have many things that spin off income, and they tend to fit into those brackets, some investments create income in both, such as certain dividend paying stocks.

• Traditional IRA distributions would be considered OI.
• Selling a stock in a taxable would be a cap gain (or a loss..)
• Roth IRA would be Tax Free
• Munis would be tax free
• etc etc

Properly constructed, you could easily 'pay yourself' $200K or more in retirement tax free.

Thanks for that, makes a lot more sense when put it like this

 

[raenye]

• Traditional IRA distributions would be considered OI.
• Selling a stock in a taxable would be a cap gain (or a loss..)

So if instead of a Roth contribution you'd make a traditional contribution AND put aside the saved tax in a taxable account, when the time comes to take distributions from the IRA you'd only pay cap gain tax rate (which may possibly be zero) on the taxable?

Example:
Say OI tax is 33%. Instead of putting $10k in Roth, put $10k in trad and $5k in taxable. Wait 40 years and you have $200k in trad and $100k in taxable. If all distributions were taxed as OI, you'd be left with the same $200k as Roth would do.
But they're not, so you keep 67% of the 200k and 85% of the 100k --218k altogether. If you stay within the 15% bracket and pay 0% cap gains, all the better.

Doesn't this mean Roth is always a terrible choice?

 

[lochquel]

I'd look at it this way. When do you want to pay taxes?

Now? Then choose Roth
In the future? Then non-Roth

Granted you maybe in a lower tax bracket when you pull out your retirement money, but your appreciated money will then be taxed as well in non-Roth. Sure by paying taxes now, you lose a bit of your purchasing power. I for one think taxes can and will only go up in the future, plus I'd rather pull my Roth money out tax-free in Retirement.

 

[Matt]

Sure by paying taxes now, you lose a bit of your purchasing power.

Remember it isn't all or nothing. It is possible to rollover at any time, so I simply defer on high years, and roll back in on low years. There are many ways to lower your AGI.

 

[Matt]

Doesn't this mean Roth is always a terrible choice?

A roth isn't a terrible choice, but I do agree that a Traditional (401K) would be better for 33% earners.

But why would you go taxable over roth when you can have a roth for the same price?

 

[raenye]

I'd look at it this way. When do you want to pay taxes?

Preferably never (but legally).

A roth isn't a terrible choice, but I do agree that a Traditional (401K) would be better for 33% earners.

But why would you go taxable over roth when you can have a roth for the same price?

See sample computation above. For every tax bracket expected at retirement you'll be doing better by investing the money on your own (using the same allocation as the IRA) since cap gains rate is lower.
You're losing ~10% by choosing Roth.

 

[Matt]

Preferably never (but legally).


See sample computation above. For every tax bracket expected at retirement you'll be doing better by investing the money on your own (using the same allocation as the IRA) since cap gains rate is lower.
You're losing ~10% by choosing Roth.

My point is that you can't traditional at 33% so you would 401k traditional and back door Roth a portion that would otherwise be in taxable.