shootenducs
Level 2 Member
What is the rule of thumb for putting money in a Roth (after tax but tax free withdrawal) vs Traditional/401K (tax deferred until withdrawal).
Roth vs Traditional IRA
- Thread starter shootenducs
- Start date
There really isn't a rule of thumb for this, if I could make one is suggest the closer you are to the top of the Trad IRA salary cap the better it is, you can always roll it over in the future if you retire early, have an income reduction, lose your job etc.
Personally I load up Trad/SEP and if I have a 'bad' year I roll it over partially, up to my next tax bracket.
Personally I load up Trad/SEP and if I have a 'bad' year I roll it over partially, up to my next tax bracket.
Hutch
Level 2 Member
1. Maxing out 401k at least up to employer match is priority 1 because its "free" money and lowers your agi
2. Fund Roth if you're agi isn't too high (especially if you feel you'll be paying more in tax in later year) (other advantage a 401 and trad ira you must draw down a % at 70, roth you don't have to touch so it can be passed to heirs easier and you don't have to take the money if you don't need it
3. if you can't fund the roth because of a agi, you can always roll iras into roth but the total hits your agi so be careful as you hit the higher brackets since you starting losing credits and pay higher rates
2. Fund Roth if you're agi isn't too high (especially if you feel you'll be paying more in tax in later year) (other advantage a 401 and trad ira you must draw down a % at 70, roth you don't have to touch so it can be passed to heirs easier and you don't have to take the money if you don't need it
3. if you can't fund the roth because of a agi, you can always roll iras into roth but the total hits your agi so be careful as you hit the higher brackets since you starting losing credits and pay higher rates
DebentureBoy
Level 2 Member
Consider option 3 also -- NO IRA. (Not really, I'm not saying no IRA / 401 at all... just pointing out that many of us should have money outside of a tax shelter. )
Roths and trads both get taxed -- one now, one later. If you are in the same bracket now and later and you consider them from a marginal tax basis (last dollars earned), they are mathematically equal -- no difference whatsoever. This is not a well known piece of information and many dispute it until they go through the math.
Back to the "no IRA" part of this: When you retire, You can withdraw unsheltered long term capital gains at either a 0% or 10% or 15% bracket. This is a big deal as compared to an IRA distribution that would be withdrawn at a standard income brackets (0%, then 10%, then 15%, then 25% or higher bracket). Since some of what you are withdrawing is return of principal, you can actually take out quite a bit of money without paying much tax at all.
Dividends are similarly advantaged.
The whole IRA (both types) and 401k programs are good, but I think the main advantage of them is that people use them. They don't really add all that much to the overall return folks get if they compare them to long term capital gains associated with a low turnover taxable account.
So... I do a mix. I have some trad IRA/401, and have some Roth and I have some unsheltered. I plan on withdrawing the unshelted stuff first, then the combo of Roth and trad in order to minimize my taxable income in retirement.
Superimpose on this a few other things -- if you have high income producing investments (some REITS, junk bonds, etc), consider putting them in a sheltered account -- otherwise they are taxed as ordinary income.
For long term stocks and certain other things (real estate, small businesses) consider no tax sheltered account and use the already-in-place beneficial tax treatment described above.
For CDs and the like, right now anyway, it doesn't matter. You don't make enough money on them to make a hill of beans difference in your taxes.
Roths and trads both get taxed -- one now, one later. If you are in the same bracket now and later and you consider them from a marginal tax basis (last dollars earned), they are mathematically equal -- no difference whatsoever. This is not a well known piece of information and many dispute it until they go through the math.
Back to the "no IRA" part of this: When you retire, You can withdraw unsheltered long term capital gains at either a 0% or 10% or 15% bracket. This is a big deal as compared to an IRA distribution that would be withdrawn at a standard income brackets (0%, then 10%, then 15%, then 25% or higher bracket). Since some of what you are withdrawing is return of principal, you can actually take out quite a bit of money without paying much tax at all.
Dividends are similarly advantaged.
The whole IRA (both types) and 401k programs are good, but I think the main advantage of them is that people use them. They don't really add all that much to the overall return folks get if they compare them to long term capital gains associated with a low turnover taxable account.
So... I do a mix. I have some trad IRA/401, and have some Roth and I have some unsheltered. I plan on withdrawing the unshelted stuff first, then the combo of Roth and trad in order to minimize my taxable income in retirement.
Superimpose on this a few other things -- if you have high income producing investments (some REITS, junk bonds, etc), consider putting them in a sheltered account -- otherwise they are taxed as ordinary income.
For long term stocks and certain other things (real estate, small businesses) consider no tax sheltered account and use the already-in-place beneficial tax treatment described above.
For CDs and the like, right now anyway, it doesn't matter. You don't make enough money on them to make a hill of beans difference in your taxes.
You raise a good point here, especially about the cap gain rates.
My personal strategy is different from many as I don't have a salary, so I dial up or dial down my income, when it pops up I defer via Trad (SEP) and then when I want to rollover/ or if I just have a dry spell then I rollover - that way I capture the spread in tax brackets in a 1-5 year span, often year to year, rather than 'be taxed later' meaning way off in retirement.
jmw
Level 2 Member
If you are one of the few with a sizable traditional pension and higher than the 15% bracket today, a trad 401K/IRA is a bad idea beyond the match except in oddball situations. All of the low tax brackets in retirement are taken up by the pension payments. So that leaves Roth and No IRA. Max out the Roth if you can and put the rest in the taxable account, especially since you can take advantage of favorable cap gains and dividend tax rates.