Traditional vs Roth IRA

[BuffJim]

Preferences there?

Thinking of starting one. I'm less than 3 years from being 59 1/2 so I should be able to fund without needing to get my paws on it.

[Bikeguy]

https://www.irs.gov/retirement-plans/traditional-and-roth-iras

[Dirtyhip]

Roth is great if you have time and want to protect your gains from taxes.  This is a better option after they changed the laws on RMDs.  RMDs have been moved up to 72 now.

I like roth, cause I don't want to pay taxes on the gains.  Invest wisely.  You get no help on losses like you do with taxable trading.  No tax harvesting.

Most early retirees will likely have Roth, a 401K or the like, and taxable trading.  Each one has it's advantages and disadvantages. 

Can't put much in Roth at this point (7K a year), unless you do a mega backdoor Roth.

[Dottleshead ★]

38 minutes ago, Dirtyhip said:

Roth is great if you have time and want to protect your gains from taxes.  This is a better option after they changed the laws on RMDs.  RMDs have been moved up to 72 now.

I like roth, cause I don't want to pay taxes on the gains.  Invest wisely.  You get no help on losses like you do with taxable trading.  No tax harvesting.

Most early retirees will likely have Roth, a 401K or the like, and taxable trading.  Each one has it's advantages and disadvantages. 

Can't put much in Roth at this point (7K a year), unless you do a mega backdoor Roth.

DH what do you do?  Do you work in finances?  Or do you just ride bikes, schralp, and invest on the side??

[Tizeye]

Do you NEED a tax deduction now? That would be the only reason to consider a contributory. While in theory you will be at a lesser income bracket (hopefully not!!!) when you retire when you pull out of a contributory IRA it is taxable that year and your standard deduction has typically been used with other income so the full amount becomes taxable immediately, potentially pushing you into a higher bracket overall. While yes, they did extend the required minimum distribution from 70.5 to 72 but that is initially a very nominal amount (I think 3% of IRA value) and increasing with age. But RMD is not the issue...you can always take a larger amount out if needed - again immediately taxable.

Now consider the ROTH. While you don't enjoy the deduction now, any that you remove with one except is not subject to tax. Since the Government isn't receiving anything in taxes, they don't care or require you to distribute it (RMD) during your lifetime. The one exception where may be penalty/taxable is the requirement for a 5 year hold on the account prior to withdrawals so if you have an exist Roth, use it if possible. During that 5 years you can always pull out the contributions made without penalty/taxes as it is when you start withdrawing the earnings from those contributions and the earnings are taxable until the 5th year of the account (not date of multiple contributions during the 5 years).

Estate issues are a little more favorable with a Roth vs contributory, again because the government isn't going to get tax revenue from the Roth. The contributory requires some specified withdrawal plan to be fully flattened within 5 years and taxable at the beneficiary's tax bracket. A Roth similarly has to be flattened over time as the government doesn't want a perpetually growing tax free machine, but the withdrawals are tax free to the beneficiaries. 

Now let's take a hypothetical. Same contribution and (aggressive) investment if Contributory and Roth with the account growing to $1M. You decide you are going to buy that yacht for $1M cash and withdraw everything. The Contributory lump sum distribution at that level would be taxed at the highest rate, around 39% where you basically keep $610,000 to purchase that yacht. With the ROTH...you keep the full $1M. $390K in taxes kind of makes the front end tax savings on the initial contribution seem like a bad joke doesn't it. 

Another thing to consider which impacted my mom is the "other taxable income" didn't keep her in the lowest tax bracket. While it could be a pension from your employer, in her case a stock and bond portfolio with expected interest and dividend income. That was all fine and good and budgeable.  Most stock splits and takeovers were a non-event as it simply represented the number of shares adjusting reflecting the recalculated cost basis applied in future sales. The issue is when it wasn't a stock buyout receiving shares of the acquiring company, but cash buyouts. Cash buyouts are a tax liability in the year of the buyout even if you re-invest the proceeds. There is no escaping a tax event that year and the lump sum typically pushes one or two brackets higher. The RMD of an IRA taken that year would be then taxes, as additional income, at that much higher rate.

[Dirtyhip]

8 minutes ago, Dottie said:

DH what do you do?  Do you work in finances?  Or do you just ride bikes, schralp, and invest on the side??

I am a secretary.  I just happen to be a smart one.

Investing and finance is just a side sling.

[Prophet Zacharia]

1 hour ago, BuffJim said:

Preferences there?

Thinking of starting one. I'm less than 3 years from being 59 1/2 so I should be able to fund without needing to get my paws on it.

Remember you need to have contributed to a Roth for 5 years before taking money out to be able to do so tax-free.

I see @Tizeye already covered that, though.

[Tizeye]

17 minutes ago, Dottie said:

DH what do you do?  Do you work in finances?  Or do you just ride bikes, schralp, and invest on the side??

Before you ask, while I am not DH, I am a former stockbroker. Before I was laid off at Schwab I took the preliminary courses for the CFP (Certified Financial Planner) exam. Ready to send them the $500 to sit for the very difficult exam and part of the application (to keep people off the streets from taking the exam) required a letter from your supervisor stating you were doing financial planning work. I was laid off and didn't have a supervisor.  Oh well. While I can't put CFP after my name, and I obviously haven't done periodic refreshers, they can't deny me the knowledge which will stay with me. Please only consider it in that context...not professional advice.

[Dirtyhip]

3 minutes ago, Tizeye said:

Do you NEED a tax deduction now? That would be the only reason to consider a contributory. While in theory you will be at a lesser income bracket (hopefully not!!!) when you retire when you pull out of a contributory IRA it is taxable that year and your standard deduction has typically been used with other income so the full amount becomes taxable immediately, potentially pushing you into a higher bracket overall. While yes, they did extend the required minimum distribution from 70.5 to 72 but that is initially a very nominal amount (I think 3% of IRA value) and increasing with age. But RMD is not the issue...you can always take a larger amount out if needed - again immediately taxable.

Now consider the ROTH. While you don't enjoy the deduction now, any that you remove with one except is not subject to tax. Since the Government isn't receiving anything in taxes, they don't care or require you to distribute it (RMD) during your lifetime. The one exception where may be penalty/taxable is the requirement for a 5 year hold on the account prior to withdrawals so if you have an exist Roth, use it if possible. During that 5 years you can always pull out the contributions made without penalty/taxes as it is when you start withdrawing the earnings from those contributions and the earnings are taxable until the 5th year of the account (not date of multiple contributions during the 5 years).

Estate issues are a little more favorable with a Roth vs contributory, again because the government isn't going to get tax revenue from the Roth. The contributory requires some specified withdrawal plan to be fully flattened within 5 years and taxable at the beneficiary's tax bracket. A Roth similarly has to be flattened over time as the government doesn't want a perpetually growing tax free machine, but the withdrawals are tax free to the beneficiaries. 

Now let's take a hypothetical. Same contribution and (aggressive) investment if Contributory and Roth with the account growing to $1M. You decide you are going to buy that yacht for $1M cash and withdraw everything. The Contributory lump sum distribution at that level would be taxed at the highest rate, around 39% where you basically keep $610,000 to purchase that yacht. With the ROTH...you keep the full $1M. $390K in taxes kind of makes the front end tax savings on the initial contribution seem like a bad joke doesn't it. 

Another thing to consider which impacted my mom is the "other taxable income" didn't keep her in the lowest tax bracket. While it could be a pension from your employer, in her case a stock and bond portfolio with expected interest and dividend income. That was all fine and good and budgeable.  Most stock splits and takeovers were a non-event as it simply represented the number of shares adjusting reflecting the recalculated cost basis applied in future sales. The issue is when it wasn't a stock buyout receiving shares of the acquiring company, but cash buyouts. Cash buyouts are a tax liability in the year of the buyout even if you re-invest the proceeds. There is no escaping a tax event that year and the lump sum typically pushes one or two brackets higher. The RMD of an IRA taken that year would be then taxes, as additional income, at that much higher rate.

Good advice here.  Take heed.

You want to keep exposure low in retirement. This is where taxable trading and Roth can be so powerful.  You can essentially look really really poor at tax time.  You already paid taxes on mostly all of that cash.  Play poor and take advantage of any medical insurance subsidies, etc. 

[Prophet Zacharia]

4 minutes ago, Tizeye said:

Before you ask, while I am not DH, I am a former stockbroker. Before I was laid off at Schwab I took the preliminary courses for the CFP (Certified Financial Planner) exam. Ready to send them the $500 to sit for the very difficult exam and part of the application (to keep people off the streets from taking the exam) required a letter from your supervisor stating you were doing financial planning work. I was laid off and didn't have a supervisor.  Oh well. While I can't put CFP after my name, and I obviously haven't done periodic refreshers, they can't deny me the knowledge which will stay with me. Please only consider it in that context...not professional advice.

States tax 401k withdrawals too, yes? So a Roth would be prudent if you end up moving to a state with higher income taxes after retirement? Even if your federal tax bracket doesn’t change, you’d get the savings on the state side?

[Dottleshead ★]

Basically, I've heard and seem to be reading that Roth is the way to go, no?

[Tizeye]

2 minutes ago, Dottie said:

Basically, I've heard and seem to be reading that Roth is the way to go, no?

Yep. Particularly late in life. Consider BuffJims situation...3 years to 59 1/2, so in 5 years 61 1/2 and fully able to utilize without penalty or tax. Almost perfect timing if you consider formal retirement at 65. One thing I hinted at but didn't mention, the IRS doesn't care how many IRA's (Roth or Contributory) you have. You could have one at Schwab, another at Fidelity, another at Vanguard, etc as it is the age of the first one for the 5 year rule. (Think about it, if they used the date of each qualifying independently, simply do an account transfer (a non-taxable ira to ira event) into the oldest. While  do have a Contributory but never contributed into it. Rather it was used as a vessel to transfer employer based 401K assets with tax free rollover as I left employment and had assets in the employer plan which then gave me direct investment control rather than the basket of mutual funds/annuities with high management fees that made up the employer's plan.

[Dirtyhip]

9 minutes ago, Dottie said:

Basically, I've heard and seem to be reading that Roth is the way to go, no?

Not necessarily.  

Roth is very powerful if you have time on your hands.  You want time to reap the benefit of the stock gains that you will not be required to pay taxes on.

Another vessel is to defer taxes to a time to when you expect them to be much lower aka:  401K, traditional IRA or 403b  The idea is that your earning years should be at a higher income.  Hence a higher tax bracket.

Personally, I think smart people utilize all of the options.  (Roth, 401K, and Taxable trading)  

Utilize 401K for the match, Roth for the tax relief, and taxable trading because the IRS is stingy on the caps for the normal retirement accounts.

[BuffJim]

2 hours ago, Bikeguy said:

https://www.irs.gov/retirement-plans/traditional-and-roth-iras

Looks like I wouldn’t qualify for the traditional version. Roth is still a possibility. I do generously fund my 401k, and add a percent each year. 

[Dottleshead ★]

2 hours ago, Dirtyhip said:

I am a secretary.  I just happen to be a smart one.

Investing and finance is just a side sling.

 

1 hour ago, Dirtyhip said:

Good advice here.  Take heed.

You want to keep exposure low in retirement. This is where taxable trading and Roth can be so powerful.  You can essentially look really really poor at tax time.  You already paid taxes on mostly all of that cash.  Play poor and take advantage of any medical insurance subsidies, etc. 

 

56 minutes ago, Tizeye said:

Yep. Particularly late in life. Consider BuffJims situation...3 years to 59 1/2, so in 5 years 61 1/2 and fully able to utilize without penalty or tax. Almost perfect timing if you consider formal retirement at 65. One thing I hinted at but didn't mention, the IRS doesn't care how many IRA's (Roth or Contributory) you have. You could have one at Schwab, another at Fidelity, another at Vanguard, etc as it is the age of the first one for the 5 year rule. (Think about it, if they used the date of each qualifying independently, simply do an account transfer (a non-taxable ira to ira event) into the oldest. While  do have a Contributory but never contributed into it. Rather it was used as a vessel to transfer employer based 401K assets with tax free rollover as I left employment and had assets in the employer plan which then gave me direct investment control rather than the basket of mutual funds/annuities with high management fees that made up the employer's plan.

Suzie Orman backs you up. 

[MickinMD ★]

3 hours ago, Dirtyhip said:

Roth is great if you have time and want to protect your gains from taxes.  This is a better option after they changed the laws on RMDs.  RMDs have been moved up to 72 now.

I like roth, cause I don't want to pay taxes on the gains.  Invest wisely.  You get no help on losses like you do with taxable trading.  No tax harvesting.

Most early retirees will likely have Roth, a 401K or the like, and taxable trading.  Each one has it's advantages and disadvantages. 

Can't put much in Roth at this point (7K a year), unless you do a mega backdoor Roth.

Note that your taxes on Social Security depend on 50% of your social security income plus your other income including non-taxable interest. But your other income does NOT include withdrawals for Roth IRA's.  The total that decides taxes is $25K for singles and $32K for couples.

So, if you are single and have $18,000 in Social Security income and $16,000 in a pension, your calculation would be 1/2 x $18000 + $16,000 = $25,000 and you would pay no taxes on Social Security.

If you also have a Roth IRA and withdraw $5,000, your total would still be $25,000 and you'd pay no Soc.Sec. taxes.

If you have a traditional IRA and withdraw $5,000, your total would be $30,000 and up to 50% of your Social Security would be taxed, but more likely just $2,500 would be taxed - there are weird rules where where in certain cases you're taxed on more.

See: https://www.thebalance.com/social-security-taxes-and-401-k-ira-withdrawals-3971519

 

 

[BuffJim]

Lots of good input. Thanks!

[Kirby]

If you can leave the money in the account for a number of years and don't need to withdraw it quickly, a Roth is probably your best bet.   But if you intended to take the money out in a few years ,you may be better off with the deduction.

The Roth has an income limit and you can't contribute if your income is above that level, but in that case you can contribute to a non-deductible IRA and then convert it to a Roth (a backdoor Roth) right away. .  (Note, if you've made deductible IRA contributions in the past, converting an IRA gets more complicated from a tax basis since you have to convert on a pro rata basis,)

 

[BuffJim]

9 minutes ago, Kirby said:

If you can leave the money in the account for a number of years and don't need to withdraw it quickly, a Roth is probably your best bet.   But if you intended to take the money out in a few years ,you may be better off with the deduction.

The Roth has an income limit and you can't contribute if your income is above that level, but in that case you can contribute to a non-deductible IRA and then convert it to a Roth (a backdoor Roth) right away. .  (Note, if you've made deductible IRA contributions in the past, converting an IRA gets more complicated from a tax basis since you have to convert on a pro rata basis,)

 

I will tell my boss to go easy on my raise this year, so I can stay under the limit. 

[Dirtyhip]

Stay in that sweet 12% tax bracket and you have no capital gains costs. 

https://www.thebalance.com/how-to-minimize-taxes-in-retirement-4155294

BTW, we sound like a bunch of old fucks.

[Dottleshead ★]

1 hour ago, Dirtyhip said:

BTW, we sound like a bunch of old fucks.

No. We are ok. @Wilbur is not here.