After reading a lot of documents about 401(k), IRA and ROTH, I realized that if you put money on IRA you loose the 40k to 80k 0% tax bracket for LTCG. I plan to harvest as much as possible of my capital gains by selling just enough to enjoy the full 0% range each year. That seems better than paying regular income tax on my withdrawals as I don´t plan to live as a pauper on retirement.
Am I right or just wrong again?
–
Juan@Austin
There is no perfect answer.
Qualified ROTH distributions aren’t subject to income taxes.
Not contributing to an employer 401(k) will lose any company match and many employers do match ROTH 401(k) contributions.
It works while income is low enough to use the 0% tax bracket.
In retrospect, we contributed more to 401k plans that would be optimal given the knowledge we have now. We have been doing ROTH conversions which wouldn’t be an option if we hadn’t contributed to our 401ks. Still better than not having retirement savings.
Long term investment growth in a Roth IRA is hard to beat. But best to do your Roth conversion early to allow most of the gain to be untaxed.
Am I right or just wrong again?
Neither.
If you have a good crystal ball, it’s much easier to choose the right vehicle for retirement savings. Without it, it’s much harder.
There are advantages and drawbacks to IRAs, Roth IRAs, their 401k counterparts, and plain ol’ savings and investment accounts.
What you’ve noted is one drawback to an IRA account. But let’s not forget it’s positive: deferral of taxes to the future. For many people, deferring that tax means their tax will be lower in the future than it is today. If that means the income gets taxed at 15% in the future instead of 32% today, that’s a benefit comparable to the 0% rate on LTCG.
There is no one size fits all solution here.
The only real mistake is failing to save for retirement.
–Peter
Thanks for al your answers!
So comparing my regular investment account and ROTH, I have restrictions on when I can withdraw tax-free from ROTH (5 years, 59 1/2 age), and in my investment account I have 40/80k per year of LTCG tax-free, but the rest is regular income and the LTCG will push all my regular income to the higher tax-bracket (instead of getting 10k at 10% and 30k at 12% as usual).
So quoting Plato, “it’s a trade-off”
So quoting Plato, “it’s a trade-off”
Actually, it’s all smoke and mirrors. A simple crap-shoot.
Do you believe that the government would promote a savings vehicle that did not have net tax income benefit?
I had the similar experience with 529s. A complete waste.
I had the similar experience with 529s. A complete waste
Why? I found the 529 somewhat of a pain to use but I saved a fair amount not having to pay cap gains on the growth.
the LTCG will push all my regular income to the higher tax-bracket (instead of getting 10k at 10% and 30k at 12% as usual).
It’s the other way around. You look at ordinary income first and tax that at the lower rates. Then if there’s room left, you get some LTCG at 0%. But only to the extent you have room left in the 10% and 12% brackets.
On the other hand, even as you run out of the 0% tax on LTCG, the rate goes to 15%, which is still less than the 22% rate which that income would have been hit with had it not been LTCG.
–Peter
PS - Please feel free to add Qualified Dividends anywhere you see LTCG above.
Hi Juan. You write: That seems better than paying regular income tax on my withdrawals as I don´t plan to live as a pauper on retirement.
I came to the same conclusion 20 years ago, and stopped Traditional IRAs, and converted them to Roths.
I also chose an individual brokerage for my other savings, over a 403b, specifically due to the LTCG rate being 15%, while TIRA and 403b being taxed as “normal income”.
I’m retired and pay about the same income tax (22-24%) as when I was working.
Like you, I have no desire to live as a pauper. So far, so good.
Read all the posts by folks who are scrambling to "back door Roth " or to do “Roth conversions”, before it’s too late.
It’s impossible to know the PERFECT plan, so, I chose the “good” plan. This is also called “don’t let PERFECT be the enemy of good”.
Good investing!
ralph
I came to the same conclusion 20 years ago, and stopped Traditional IRAs, and converted them to Roths.
I would point out that if you plan to self-fund for long term care and other medical expenses over and above Medicare, withdrawals from Traditional 401(k)s/IRAs and other ordinary income may be mostly offset by medical expense deductions. If you have significant medical expenses and your income to pay those expenses consists of Roth withdrawals, then you have wasted the deductibility of the medical expenses by pre-paying taxes on your Roth account.
Moderation is good in many things, potentially including asset location.
AJ
<I would point out that if you plan to self-fund for long term care and other medical expenses over and above Medicare, withdrawals from Traditional 401(k)s/IRAs and other ordinary income may be mostly offset by medical expense deductions. >
Thank you for pointing this out.
I have two questions.
For tax returns filed in 2022, taxpayers can deduct qualified, unreimbursed medical expenses that are more than 7.5% of their 2021 adjusted gross income. How is that affected by offsetting Traditional IRA withdrawals? Is there special treatment?
Shifting the subject to Long-term Care Insurance (LTCI)…I just did a Tax Aide return for a 93 year old woman who got a 1099-LTC for about $4250. This was a LTCI per diem distribution for 30 days of care. It wasn’t taxable since it’s below the IRS limit. But she did not include her expenses for the LTCI services and I didn’t realize that they would offset the distribution.
This was my first experience with 1099-LTC. Since DH and I have LTCI it’s worth knowing that expenses should be reported to offset large distributions or they may be taxed.
https://www.aaltci.org/long-term-care-insurance/learning-cen…
https://www.irs.gov/forms-pubs/about-form-1099-ltc
Wendy
LOL aj. That’s why I put the line about letting perfect be the enemy of good.
I’ve minimized some KNOWN taxes, vs some maybe taxes if I need LT care?
Add in the effects of “taxable income” on taxing social security, IRMAA, etc? *
At some point, at the very least, the tax savings for medical expense deductions becomes a wash?
*20 years ago Roth IRA income did NOT increase taxable income, and supposedly did NOT trigger SS taxation.
I wasn’t aware of IRMAA 20 years ago.
Does Roth income add to the income number that impacts SS taxation and/or IRMAA?
ralph
Wendy,
There are multiple items: deductibility of long term care insurance premiums, payments from LTC policy and medical deduction for Long Term Care.
Long Term Care Premiums can be deducted as a medical expense on Schedule A.
There are specific requirements for deducting Long Term Care costs as a medical deduction. Once those requirements are met then the unreimbursed expenses for long term care are deductible as a medical expense.
https://www.irs.gov/faqs/itemized-deductions-standard-deduct…
Most payments from Long Term Care policies are not taxable.
For tax returns filed in 2022, taxpayers can deduct qualified, unreimbursed medical expenses that are more than 7.5% of their 2021 adjusted gross income. How is that affected by offsetting Traditional IRA withdrawals? Is there special treatment?
No special treatment. It’s just that Traditional IRA withdrawals are ordinary income, which would be the income that is offset by the medical expense deduction in excess of the current 7.5% AGI limit. Add in other typical deductions, like state/local income taxes, sales taxes and/or property taxes up to the $10k SALT deduction, mortgage interest and/or charitable deductions, and it’s quite possible to have large T-IRA withdrawals (whether they are RMDs or not) that are mostly offset by the deductions.
Shifting the subject to Long-term Care Insurance (LTCI)…I just did a Tax Aide return for a 93 year old woman who got a 1099-LTC for about $4250. This was a LTCI per diem distribution for 30 days of care. It wasn’t taxable since it’s below the IRS limit. But she did not include her expenses for the LTCI services and I didn’t realize that they would offset the distribution.
As vkg mentioned, there are some hoops to jump through before you can use LTC costs to offset LTCI payments, but for those with a qualified LTCI policy that pays per diem amounts, as long as the per diem amount doesn’t exceed the limit of $390/day for 2022 (was $400/day in 2021) LTCI per diem income is not taxable. Even if your payment was above the per diem limit, if your qualified expenses exceed the payment, the payments are not taxable. That’s figured on Form 8853 https://www.irs.gov/pub/irs-pdf/f8853.pdf So even if your taxpayer had gotten more than $12,000 (30 x $400) from a qualified LTCI policy for her 30 days of care in 2021, as long as the LTC expenses were the same or greater than the payment, the payment would not have been taxable. So, I would say that unless your LTC policy is paying more than the per diem limit, or it’s a non-qualified LTCI policy, you probably don’t have to worry about tracking the expenses.
AJ
I’ve minimized some KNOWN taxes, vs some maybe taxes if I need LT care?
I would disagree that you’ve ‘minimized some KNOWN taxes’ if you converted all of your Traditional accounts into Roth accounts, which is what you seem to imply. Even without taking into account the medical expense deduction, since Roth conversions are taxed at your marginal rate (including the possibility of kicking you into a higher bracket), it’s likely that if you had left money in Traditional accounts, at least some of the future withdrawals would be taxed at a rate that’s lower than your marginal rate(s) when you converted unless you managed do all of your conversions in year(s) when you had little/no other income, and stayed at or below the marginal rates that you saved when you made your contributions. If you did so, good for you. Most people who are still working don’t have that opportunity, and would pay a higher rate on at least some of their conversions than they saved on their contributions.
Personally, all of my Traditional contributions were made at a rate that was 25% or higher, so I consider any conversions at or below 25% to be ‘tax minimizing’, but if I were to do conversions in a bracket higher than 25%, it probably wouldn’t be ‘tax minimizing’.
*20 years ago qualified Roth IRA income did NOT increase taxable income, and supposedly did NOT trigger SS taxation.
I wasn’t aware of IRMAA 20 years ago.
There, fixed that for you.
Well, since IRMAA didn’t start until 2003, you wouldn’t have been aware of it 20 years ago. And since Roth IRAs weren’t even a thing until 1998, qualified Roth IRA withdrawals, which require that a Roth IRA be at least 5 years old, wouldn’t have even been available until 2003.
Does Roth income add to the income number that impacts SS taxation and/or IRMAA?
Income from qualified Roth withdrawals doesn’t currently count toward limits that are based on any type of MAGI. Income from non-qualified Roth withdrawals can count toward your AGI, and thus, toward MAGI. However, I would point out that for the first 48 years (1935 - 1983), SS wasn’t taxable, until it was, starting in 1984. Roths have only been around since 1998, and qualified Roth withdrawals have only been around since 2003, so that’s either 24 or 19 years, depending on how you want to count them. Once Congress starts seeing people with significant qualified Roth income paying little/no taxes on SS and not paying IRMAA premiums, who knows how long it will take before qualified Roth income starts being counted in some of the MAGI modifications? While they may not be directly taxing Roth income, having it count toward MAGI means it will be indirectly taxed, despite already having paid income taxes on the contributions/conversions and being promised that qualified withdrawals would not be taxed.
AJ
I realized that if you put money on IRA you loose the 40k to 80k 0% tax bracket for LTCG
In reading through this thread, I realized that nobody ever asked you how you think you ‘lose the $40k - $80k 0% tax bracket for LTCG’. So, I’m asking - how do you think you lose it? Nothing in capital gains taxation depends on whether or not you have an IRA. It only depends on your income and filing status. Here are the effective 2022 LTCG rates, accounting for the NIIT adjustment of 3.8%:
Tax Bracket/Rate Single Married Filing Jointly Head of Household
0% $0 - $41,675 $0 - $83,850 $0 - $55,800
15% $40,676 - $200,000 $83,351 - $250,000 $55,801 - $200,000
18.8% $200,001 - $459,750 $250,001 - $517,200 $200,001 - $488,500
23.8% $459,751+ $517,201+ $488,501+
As long as your total taxable income (i.e. after deductions) is below the capital gains 0% bracket for your filing status, all of your LTCG will be taxed at 0% Even if your total taxable income is above the 0% capital gains limit for your filing status, if your taxable ordinary income is below the capital gains limit for your filing status, you will have some of your LTCG income taxed at 0%. So please explain to me how you are ‘losing’ the possibility of having LTCG taxed at 0%
AJ
I’m pretty sure he is talking about the capital gains inside the IRA. Outside of an IRA, they would be eligible for a 0% tax rate. Inside the IRA they become ordinary income when withdrawn and lose their character as capital gains.
—Peter
I’m pretty sure he is talking about the capital gains inside the IRA. Outside of an IRA, they would be eligible for a 0% tax rate. Inside the IRA they become ordinary income when withdrawn and lose their character as capital gains.
But that ignores the fact that any gains are not taxed until they are withdrawn. That means that you have 0% taxes on any and all capital gains that are realized within the IRA, even if it’s larger than the $80k limit that was originally specified.
AJ
aj485,
You fixed rainphakir’s statement with, *20 years ago qualified Roth IRA income did NOT increase taxable income, and supposedly did NOT trigger SS taxation.
I wasn’t aware of IRMAA 20 years ago.
I have some nits to pick with this statement.
First, IRMAA doesn’t kick in until Medicare and you have to be at least 65 for Medicare. That means your Roth IRA distributions are probably going to be qualified if you have had the account open and funded for at least 5 tax years, which seems like by age 65.
And technically you’re talking about qualified vs. non-qualified distributions. Whether that’s the same as income is arguable, though I suppose the tax code can say anything is part of MAGI. But in any case, some non-qualified Roth distributions will be non-taxable. Original contributions and conversions are not subject to ordinary income tax. Certain conversion amounts that were previously taxable may be subject to the early withdrawal penalty, but conversions are not subject to ordinary income taxes at distribution. Only earnings are subject to ordinary income taxes when the distributions are qualified and those are withdrawn last. So arguably you could have non-qualified Roth IRA income that did not increase taxable income … and that’s still possible even at age 65.
ptheland,
You wrote, I’m pretty sure he is talking about the capital gains inside the IRA. Outside of an IRA, they would be eligible for a 0% tax rate. Inside the IRA they become ordinary income when withdrawn and lose their character as capital gains.
I take the position that gains in an IRA are never taxed. As long as the marginal tax rates are the same at the time of contribution and distribution, this is obviously true because the outcomes are the identical whether the savings is in a T-IRA or a Roth IRA.
With T-IRAs, you defer paying the taxes. So the taxes paid at distribution are principally the deferred taxes PLUS the earnings on those deferred taxes. But since the deferred taxes were never yours to begin with, you can’t really count their earnings as yours either. After taxation, a Traditional IRA basically leaves you with your savings less taxes plus any earnings after the deferred taxes and their earnings are removed from the balance.
In the end, Roth and Traditional IRAs (mostly) avoid taxation on earnings and should produce similar results if you are careful to not over-fill your Traditional IRA. But the best any taxable account can do is match that … unless you actually intend to lose money with your investments, in which case a taxable account clearly wins.
To match an IRA, the taxable account has to take advantage of the 0% LTCG tax brackets. But this limits your investment options, which can limit your ability to maintain an asset allocation later in life.
In any case, I take the additional position that if your plan has you paying 0% in taxes in retirement, you probably left some tax-saving opportunities on the table when you were working. And ultimately saving on taxes over your entire lifetime is how you maximize the amount of money you get to keep and enjoy…