Is a bad idea if you’re a successful retirement investor. Fund your Roth if you can.
intercst
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It depends a LOT on your specific circumstances. If you’re a successful enough retirement investor so that you can retire when you are 55 or younger, you will have at least 20 years to adjust the location of the assets through Roth conversions and/or withdrawals from retirement accounts. Even if you’re going to wait until the age when you are eligible for Medicare (65) or your FRA (67), you will have 8 - 10 years to adjust asset location.
Maybe. Again, it depends a LOT on your specific circumstances. If you’re, say, currently in the 35% bracket, and plan to be in the, say, 28% bracket (after TCJA provisions sunset) when you retire, you will likely end up with more if you do conversions after you retire.
From the article:
When you defer, all you are doing is expanding the liability. When you put $100,000 in a 401(k), you’ve deferred taxes on that $100,000, but if it grows to $500,000 over many years, wonderful, you’ve also got a tax liability on that $500,000 awaiting you. And if the tax rates are higher when you get to retirement, what you gained will be considerably less.
That’s only looking at one side of the tax equation, and completely ignores things like:
- the fact that tax brackets, deductions and exemptions are indexed to inflation - so that after 30 years at 3% inflation, the tax liability on that $500k would be equivalent to the tax liability of only $206k at the time you put the money into the account - not to mention that you can take out the $500k in much smaller increments over many years;
- tax breaks like QCDs (beginning at 71 1/2) that allow you to take money from your retirement accounts without declaring any income;
- for those who are self-funding long-term care needs, the ability to deduct qualified medical costs, plus your standard deduction and exemptions can effectively eliminate most, if not all, of the deferred taxes.
Having a short-term mentality is not prudent when it comes to investing, nor is it when it comes to taxes. It is not the person who pays the least amount of taxes this year who wins. It is the person who thinks long-term and limits their long-term tax liability — and has a more enjoyable retirement because they did so.
A very valid point. But if you’re going to try to look long term at your taxes, you need to look at the whole tax picture, which this article does not.
AJ
9 Likes
Strictly speaking “take money” might not be an accurate description of this particular tax break. Because whatever you take using QCD is immediately given away as a charitable contribution.
Of course, if you’re contributing otherwise, a simple substitution makes it a very worthwhile technique to use.
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Except that if your IRA is at least matching the return of the S&P 500, it’s going to be growing at 6% to 7% above inflation. Compounded, “skim-free” investment returns are funny that way.
I did say “successful retirement investor” – though all you need to do to be successful is to get an S&P 500 return. You don’t need a DELL or a Pfizer.
intercst
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Yes, the $100k growing to $500k over 30 years would be at a 5.5% growth rate, which is probably more realistic for most investors. That’s why the tax liability would be calculated on an equivalent $206k (after adjusting for inflation) vs. the $100k that was originally deferred. Saying that you will be taxed on “$500k” without any adjustment for inflation is sowing FUD.
AJ
2 Likes
That’s not what I’m saying. The compounded return of the S&P 500, even after the inflation adjustment, is likely to put you in a higher tax bracket (i.e., $206K is likely to be in a higher tax bracket than $100k, even after the inflation adjustment.
That’s not “fear, uncertainty and doubt” (FUD), just arithmetic.
intercst
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And you are ignoring:
In fact, if you are doing proper retirement planning, you should be probably be planning for your retirement accounts to last well into your 90s. Even at 95, your RMD will only be 11.23% of your account balances, assuming that Congress doesn’t increase the RMDs because life expectancy has decreased.
You are also ignoring:
The article makes no mention of the ability to change asset location by doing Roth conversions, or withdrawing smaller amounts over your entire retirement. It only talks about how you’ve increased your tax liability by turning $100k into $500k. By only mentioning the liability and ignoring multiple ways to manage that liability, the article is spreading FUD about the value of tax-deferred accounts.
I do think that for most people, it’s best to have a mix of account types (taxable, tax-deferred and tax-free) in retirement. But you seem to be using the article to advocate for not having any tax-deferred accounts, and funding only Roth accounts. That’s likely to end up being sub-optimal for most people.
AJ
4 Likes
No. I think it’s fine to have a mix of IRA, Roth IRA, and taxable accounts. When I retired early in 1994, I had more money in my taxable account than my IRA even though I maxed out my IRA contributions during my working career. (Roth IRAs didn’t start until after I retired.)
I’m just pointing out that if you’re successful, you’re going to wish you had a lot more of your assets in the Roth IRA (or Berkshire Hathaway in you’re taxable account.)
intercst
1 Like
That’s not what you said:
That was the entirety of your post, which says nothing about having a mix - just that you should fund Roth accounts in preference to funding deferred accounts, if you can.
AJ
2 Likes
Fine, maybe I should have titled the post “Deferring Too Much in Taxes Until Retirement?” Though, if you’re not successful, “too much taxes” won’t be a problem.
intercst
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