Traditional v. Roth for NYC Residents?

[El Turk]

Sorry for creating a new thread, but I didn't want to hijack a different one. If this should go into the "Retirement Plan" thread, Matt, please put it there.

I'm starting a new job that has a 401(k) and offers me more than enough salary that I should (and will) be maxing out my contributions. I've been back and forth between Roth and Traditional 401(k) for the past week. A bunch of articles one Bogleheads, The Finance Buff, and elsewhere, have had me leaning towards Traditional up to 18K, and then mega backdoor Roth for the rest (till 53K). But I continue to go back and forth, since I feel like since this is a transition year for me, and I'll only be in the 28% bracket, maybe I should go Roth all the way.

One factor that just occurred to me today is that I'm currently paying NYC income tax and, although I love Manhattan more than anything, there's a pretty strong chance that I might not live in the five boroughs come retirement. Is that NYC tax that I'll avoid paying by going the Traditional route enough to influence the decision? Should it be a serious factor? I mean I don't see myself moving to FL or TX, where there are no state income taxes, but I thought knowing I'll be avoiding NYC tax might be enough to give me some comfort that traditional is the right move. Is the tax too small to matter?

To be clear, the main factors influencing my decision are the ability to roll traditional to Roth during times of lower taxes, the fact that traditional comes out of the top of my tax bracket but, if used wisely, will fill in the bottom, etc. (i.e. the usual considerations).

 

[Matt]

I've mentioned my approach to this a few times. Basically in 'high' earning years I defer (traditional) and in 'low' earning years I roll over. There's an additional, empowering thing about this in that it can make certain life choices more viable.. eg going back to college, traveling for a year, starting a business can all provide opportunities to rollover, and be more efficient as such.

The key for decision making is drilling down into 'high' and 'low'. Is 28% high (and therefore should be an automatic signal to defer) or is it low? This depends a lot on your career and earning potential. Your filing status also matters.

When I look at the tax table today I see that I can earn up to $74,900 per year at <15%. (of course tax tables can change, but its a guide) for me, this is more than enough to live on in retirement at this time.



Since there isn't much lower than this, I'd have to say that my 'low' number is the 15% bracket - I'd lock in this today (via rollover) the theory behind locking in the rate today is that it provides a hedge for me against future tax increases.

Additionally, and this gets into personal situations and will be unique... my goals are to continue working for some time, and I expect my salary to increase somewhat in the upcoming decade. So I'm building Roth levels today and will later build Traditional (as salary increases).

Back to the 28% bracket. I can't see me needing >$151K per year in retirement income (noting that Muni bonds and Cap Gains, perhaps at 0% may be options at this time also) I'd see that rate as one I'd like to defer, and skip out of it when the opportunity arises.

 

[El Turk]

Ya, I have heard you, and others mention your approaches before. And I generally agree with them--though, it does complicate things a little when you are young and are giving up some of the "maximum" you can contribute by going Traditional (though, since I have a Mega Back Door Roth available, I'm probably not giving up that much at all).

It's hard for me to figure out what "low" is, since I'm basically just starting and I'm in the 28% bracket. My wife will definitely be moving up. If I stay in my current job, I will too. But it's far from certain that I will.

I guess part of what I was trying to unpack was the fact that the NYC income tax was often ignored (or people just say, well, my state income taxes might be different). But if you aren't going to live in the five boroughs, and you do most of your earning in them, then they will definitely be different!

 

[Matt]

I'm not sure that my approach is "giving up some of the "maximum" you can contribute by going Traditional" perhaps I'm missing something?

It's hard for me to figure out what "low" is

Like I said, cast your mind forward, what bracket do you hope to be in when you retire? Mortgage is paid off, kids through college, what taxable income level do you need? The numbers/brackets will likely change by then, but they should be a guide.

NYC is no different from any other tax, your decision to pay it is greatly appreciated by the City of New York. Don't forget that many people who still work in NY do not live there. For the question, will I retire there - it makes little sense to me, your question is basically 'should I give them x% of my salary today to keep the city running nicely for my enjoyment now and in the future?' I still enjoy NYC, but don't pay the city taxes.

 

[El Turk]

I'm not sure that my approach is "giving up some of the "maximum" you can contribute by going Traditional" perhaps I'm missing something?

Yes, generally, if you max out contributions, and go Traditional, then you are protecting less money than if you go Roth; that can matter: http://thefinancebuff.com/roth-401k-for-people-who-contribute-max.html

NYC is no different from any other tax... Don't forget that many people who still work in NY do not live there.

That's fine, but I am currently addicted to the City, and am willing to pay a premium to live here.

 

[Matt]

Yes, generally, if you max out contributions, and go Traditional, then you are protecting less money than if you go Roth; that can matter: http://thefinancebuff.com/roth-401k-for-people-who-contribute-max.html

OK.. lets just say its not for me, and I'd rather pay the rate of tax that I do

 

[El Turk]

OK.. lets just say its not for me, and I'd rather pay the rate of tax that I do

Unfortunately, I have to pay my rent.

 

[Matt]

Unfortunately, I have to pay my rent.

Yep, which is why I'm trying to suggest that you cast your mind forward to when you do not.

 

[raenye]

For me it just seems obvious that traditional is superior because if there's a year in which you're low earning (laid off, unpaid extended leave, stay at home parent) you could then exercise your low tax bracket and convert to Roth.
Put off taxes today if you can pay them tomorrow.

 

[El Turk]

Yep, which is why I'm trying to suggest that you cast your mind forward to when you do not.

Ya, an I appreciate that. It's just that I don't have a crystal ball. I guess I can look at my parents, who are closing in on 70, but they seem to be spending a decent amount, too. In short, who knows what kind of income I'll need, then. Of course, I suppose a decent amount of it can come from Roth (and not count as taxable income). But that still doesn't answer the question. The annoying thing is that there are so many people around me who assure me that I'll be in a higher tax bracket when I retire. They insist that when your investments are large enough, you can't avoid it. Somehow, I find it hard to believe. I also find it hard to believe that if I'm fabulously wealthy, I'll really care about whether I have to pay taxes on my IRA distributions.

 

[Matt]

For me it just seems obvious that traditional is superior because if there's a year in which you're low earning (laid off, unpaid extended leave, stay at home parent) you could then exercise your low tax bracket and convert to Roth.
Put off taxes today if you can pay them tomorrow.

Plus lets remember that the taxes we pay today are taken out of our 'family ecosystem' and therefore aren't earning us money any longer. We're loaning the government money...

 

[El Turk]

For me it just seems obvious that traditional is superior because if there's a year in which you're low earning (laid off, unpaid extended leave, stay at home parent) you could then exercise your low tax bracket and convert to Roth.
Put off taxes today if you can pay them tomorrow.

Yes, I agree. But bear with me for a second. I have a wife and a kid (with more, hopefully to come). Maybe my wife will stop being a doctor for a year--and/or open her own practice. Maybe this will be the very year that I leave my job. Our tax rate will be wonderfully low. But, of course, we'll still have a ton of bills to pay and probably be stressed out about it. What makes you so certain that I would want to chose this year--a year where I really need to take advantage of my low tax rate to milk every cent out of whatever I scrap together that I can--to roll over enough tIRA to bump me into the next tax bracket (and, let's face it, if it's not enough then there really isn't much of a difference to begin with.

 

[Matt]

Ya, an I appreciate that. It's just that I don't have a crystal ball. I guess I can look at my parents, who are closing in on 70, but they seem to be spending a decent amount, too. In short, who knows what kind of income I'll need, then. Of course, I suppose a decent amount of it can come from Roth (and not count as taxable income). But that still doesn't answer the question. The annoying thing is that there are so many people around me who assure me that I'll be in a higher tax bracket when I retire. They insist that when your investments are large enough, you can't avoid it. Somehow, I find it hard to believe. I also find it hard to believe that if I'm fabulously wealthy, I'll really care about whether I have to pay taxes on my IRA distributions.

You're in good shape if you can save the amounts you are talking about. The people around you who say you will be in a higher bracket perhaps know you better than I do, but for me, if I can earn 6 figures for some years and save as much as possible, it won't mean that I spend 6 figures in retirement. When income drops off, taxes drop down.

 

[El Turk]

Yes, I agree. But bear with me for a second. I have a wife and a kid (with more, hopefully to come). Maybe my wife will stop being a doctor for a year--and/or open her own practice. Maybe this will be the very year that I leave my job. Our tax rate will be wonderfully low. But, of course, we'll still have a ton of bills to pay and probably be stressed out about it. What makes you so certain that I would want to chose this year--a year where I really need to take advantage of my low tax rate to milk every cent out of whatever I scrap together that I can--to roll over enough tIRA to bump me into the next tax bracket (and, let's face it, if it's not enough then there really isn't much of a difference to begin with.

Also wanted to add (though I haven't gotten a response to the initial point) that the taxes you need to pay for converting a Traditional to Roth need to come from somewhere. If they come from the account itself, that's obviously bad. If they come from your subnormal income, that makes things more difficult. So in many ways, the conversion option isn't the saving grace people make it out to be.

Also, Matt, in terms of keeping money in the "family ecosystem," if you are maxing out with a traditional IRA, that means you are leaving money that you could keep in a TSA out of a TSA, so that money is not sheltered, and not kept in the "family ecosystem."

 

[Matt]

Also wanted to add (though I haven't gotten a response to the initial point) that the taxes you need to pay for converting a Traditional to Roth need to come from somewhere. If they come from the account itself, that's obviously bad. If they come from your subnormal income, that makes things more difficult. So in many ways, the conversion option isn't the saving grace people make it out to be.

Also, Matt, in terms of keeping money in the "family ecosystem," if you are maxing out with a traditional IRA, that means you are leaving money that you could keep in a TSA out of a TSA, so that money is not sheltered, and not kept in the "family ecosystem."

You seem to be missing that I roll everything into Roths.

Going Income>Roth is not as smart as Income>Traditional>Roth.

 

[El Turk]

You seem to be missing that I roll everything into Roths.

Going Income>Roth is not as smart as Income>Traditional>Roth.

I'm not missing that you do it, I'm just pointing out that it's a factor of WHEN you do it and that not everyone CAN do it.

If a person's income is in 25%, and the next year in the 28%, and then in 33%, and so on, then they can't roll until their income dips back to 25%. If you are willing to take a massive hit on AGI, and are self employed, and clearly you are, then the roll works for you. But if you (1) don't think that will happen for a long time and/or (2) don't think you will be able to afford rolling over much in the off chance that it does then you are paying a high price for an option that you probably won't be able to exercise. Sure, you might be able to roll it in 25 or 30 years from now, when your kids leave home, but by then I've already allowed a lot of money to leave my "family ecosystem."

I'm not saying what you are doing is wrong for you, obviously its working fabulously. I am saying that it's not as universally accessible an approach as you advocate. I think the approach works well for you because you have direct control over your income. So, maybe you should say, "if you think you will be self employed for a number of years, Traditional is better because..." But not everyone falls into that category.

If you can figure out a way for most people at high paying jobs to build in roll over years, please send me a PM, I know a bunch of people who would like to hire you (don't worry, you can send the income to your business, so you won't increase your AGI). Again, the common response "oh, well, you never know when you'll be between jobs" isn't an answer because many if not most of us wouldn't be able to afford rolling over very much, then.

 

[Matt]

I'm not missing that you do it, I'm just pointing out that it's a factor of WHEN you do it and that not everyone CAN do it.

If a person's income is in 25%, and the next year in the 28%, and then in 33%, and so on, then they can't roll until their income dips back to 25%. If you are willing to take a massive hit on AGI, and are self employed, and clearly you are, then the roll works for you. But if you (1) don't think that will happen for a long time and/or (2) don't think you will be able to afford rolling over much in the off chance that it does then you are paying a high price for an option that you probably won't be able to exercise. Sure, you might be able to roll it in 25 or 30 years from now, when your kids leave home, but by then I've already allowed a lot of money to leave my "family ecosystem."

I'm not saying what you are doing is wrong for you, obviously its working fabulously. I am saying that it's not as universally accessible an approach as you advocate. I think the approach works well for you because you have direct control over your income. So, maybe you should say, "if you think you will be self employed for a number of years, Traditional is better because..." But not everyone falls into that category.

If you can figure out a way for most people at high paying jobs to build in roll over years, please send me a PM, I know a bunch of people who would like to hire you (don't worry, you can send the income to your business, so you won't increase your AGI). Again, the common response "oh, well, you never know when you'll be between jobs" isn't an answer because many if not most of us wouldn't be able to afford rolling over very much, then.

Certainly, when you are in control of things such as being self employed it is easier, but that's not the only way to play things, again it depends on where you are, and what is going on. If you aren't in the city, then you can tweak taxes by prepaying state. You can influence tax rate via TLH against ordinary income, which is $3K against $5.5K so worth looking at.. though in truth it is always worth doing that regardless of Roth/Trad so its something of a wash (unless you aren't doing it).

Also, in terms of this family ecosystem point - if you use a roth you are effectively prepaying your taxes - is that really keeping more in the ecosystem? A good plan will have a taxable and tax advantaged approach, the taxable you TLH your losers, and TGH your winners (again in down years.. but if you never think your family will have a down year via sabbatical, starting a business, having a baby, being fired, then yes, its a little uncertain).

Also, what you invest in matters, if you go income>roth and the investment is 'risky' its again better to go income>trad>roth as you'll have some time to reverse the election and get your prepaid tax back.

Keeping it all simple though, I think you are better funding Roths when you pay low tax rates, because that means you are paying a low tax rate... and funding traditionals when you are paying a high tax rate, because that means that your tax savings are at a higher rate.

Above all else, if you are socking away the max to 401ks and IRAs its all good.

 

[El Turk]

You can influence tax rate via TLH against ordinary income, which is $3K against $5.5K so worth looking at.. though in truth it is always worth doing that regardless of Roth/Trad so its something of a wash (unless you aren't doing it).

Pun intended?

Also, in terms of this family ecosystem point - if you use a roth you are effectively prepaying your taxes - is that really keeping more in the ecosystem?

If by prepaying taxes you open up a tax free $5K investment for 40 years, then yes.

A good plan will have a taxable and tax advantaged approach, the taxable you TLH your losers, and TGH your winners (again in down years.. but if you never think your family will have a down year via sabbatical, starting a business, having a baby, being fired, then yes, its a little uncertain).

It's not that I don't think it might happen. It's just that I have to consider ALL of the variables (and I think everyone should). The variables include--though aren't limited to--my salary (if my wife is fired), my wife's (if I'm fired), signing bonuses, if either of us switch jobs, how much money we can afford to part with (if we both aren't working), how long it will be until these events occur, how long it will be between when they occur, etc.

I think having a little bit of traditional space makes sense (and you should open that space up when you are earning the most, as we all agree). It's just that statements like this strike me as somewhat simplistic:

For me it just seems obvious that traditional is superior because if there's a year in which you're low earning (laid off, unpaid extended leave, stay at home parent) you could then exercise your low tax bracket and convert to Roth.
Put off taxes today if you can pay them tomorrow.

So does the recurring family ecosystem point, and noting that you want to pay less taxes. Like I said, we all want to pay less taxes. But investing in a Traditional isn't the best way for us all to do that.

Also, what you invest in matters, if you go income>roth and the investment is 'risky' its again better to go income>trad>roth as you'll have some time to reverse the election and get your prepaid tax back.

Good point.

Keeping it all simple though, I think you are better funding Roths when you pay low tax rates, because that means you are paying a low tax rate... and funding traditionals when you are paying a high tax rate, because that means that your tax savings are at a higher rate.

Agreed.

Above all else, if you are socking away the max to 401ks and IRAs its all good.

Let's hope so.