I just realized IRA is not that good.

[aj485]

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.

You missed the point that Roths weren’t even available to make contributions to until 1998. Therefore, even if you were over 65 in 2002 (20 years ago), you couldn’t have had qualified Roth contributions, because the Roth account wouldn’t have been 5 years old until 2003. I guess you could call the difference of 1 year a nit, but you were the one who wanted to pick nits…

I suppose the tax code can say anything is part of MAGI

Yes, that’s my point. My response also said Income from qualified Roth withdrawals doesn’t currently count toward limits that are based on any type of MAGI. and 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?

Whether Roth distributions are taxable or not won’t keep them from being added back in as part of MAGI, just like tax-free interest on municipal bonds is added back in when calculating IRMAA and taxability of SS. Given that Congress is going to need to make some rule changes on SS and Medicare in the next few years makes ‘tax-free’ Roth income ripe for adding back into MAGI, IMO.

AJ

[ptheland]

But that ignores the fact that any gains are not taxed until they are withdrawn.

But they ARE taxed when withdrawn. At ordinary income rates.

It’s like municipal bonds. You wouldn’t invest in muni bonds in an IRA because the interest is tax free outside of your IRA, but loses its character in the IRA and becomes taxable when withdrawn. In the same way, capital gains that would have been taxed at a rate lower than ordinary income lose that tax advantage when in an IRA.

—Peter

[ptheland]

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.

I agree. But there is more nuance to this that we rarely discuss.

In the typical Roth v. Traditional debate, someone (including me) will eventually trot out our usual formula. Roth is P * (1-T0) * R = V. (Where P is the original principal available, T0 is the current tax rate, R is the overall rate of return from beginning to end, and V is the after tax value at withdrawal. For the traditional IRA, the formula is (P * R) * 1-Tn) = V. (Tn here is the tax rate at withdrawal.) We then point out that if T0 = Tn, the end result is the same. If they are not the same, the one with the lower value for T is the better choice.

But we never talk about IRA v. an ordinary savings account. We’ve already got the two formulae for the IRAs. We need one for ordinary savings. Here’s my shot. It’s a nasty summation, which I’m generally terrible at writing out, made even worse by the inability to use subscripts and traditional summation notation here. I’m sure someone can clean it up.
P0 + P1R1(1-T1) + P2R2(1-T2) + P2R3(1-T3) + … + PnRn(1-Tn)
That’s the ending after tax value. Here Px is the beginning principal for each period, which would be the sum of the initial after tax principal plus all of the previous returns. (Like I said, probably not the best summation formula, but I think it get the idea across). In words, it’s the initial after tax principal available, plus the annual after tax returns for each year.

Here, if all of the Tx values are the same as the Tx in the Roth or Traditional IRA formulae, then they are indeed equivalent. But we know going in that to the extent the Tx values are based on LTCG (and/or qualified dividend) rates, they will be less than the T values in the IRA formulae.

So I think that there can be an advantage to ordinary savings accounts for at least some people. And I don’t think that number of people is vanishingly small. I think its a significant number. Somewhere between 2% and, say 50% of people with money to invest each year.

Of course, it’s moot for a lot of people reading these boards, since they can save and invest more than can be put into an IRA (or even a 401k). So even if they choose to use either form of tax-favored retirement savings account, they will need to add some ordinary savings/investing account to their retirement plan.

To be sure, I’m missing plenty of non-tax issues that might favor IRAs over taxable savings. But I’m not delving into those at the moment.

–Peter

[foo1bar]

In words, it’s the initial after tax principal available, plus the annual after tax returns for each year.

That’s not comparing apples to apples with your traditional IRA formula.
Because the traditional IRA it is the before tax principal that you are starting with.

To have an accurate comparison for Traditional IRA vs. Taxable account, you have both sides be before-tax principal that you’re going to invest.
On the IRA side, you don’t pay taxes until the end.
On the taxable account side, you do pay taxes on that principal (at regular income tax rate) - and only after then is it that you invest it.

Here, if all of the Tx values are the same as the Tx in the Roth or Traditional IRA formulae, then they are indeed equivalent.

Not really.

If your tax rate for the profits in your taxable account is 0%, then your end result will be equal.
If not, then you were better off investing inside an IRA.

For example.

$1000 of income that you have to invest.

IRA: $1000 invested, grows to double, so will withdraw $2000 at the end of N years. At that time, paying 25% income tax rate. So left with $1500 to spend.

Taxable account: $1000 of income taxed at 25% = $750. $750 invested. It grows to double (same investment choice), so $1500. Now $750 * (cap_gains_tax_rate) == amount IRS wants from you. If cap_gains_tax_rate is 0%, $1500 to spend. If cap_gains_tax_rate is 10%, $1425 to spend.

Taxable account where you change investments some and cap gains tax rate is 10% (and income tax rate is still 25%):
$1000 taxed = $750.
$750 invested, grows to $900 and you take profits and reinvest elsewhere.
10% cap gains means $15 of that $150 profit goes to IRS.
$885 invested, grows another 66% to $1475. 10% cap gains takes another $59 of that.
And at the end you have $1416. (If cap gains had been 0%, then you would have gotten to $1500, same as IRA example)

Of course, it’s moot for a lot of people reading these boards, since they can save and invest more than can be put into an IRA (or even a 401k). So even if they choose to use either form of tax-favored retirement savings account, they will need to add some ordinary savings/investing account to their retirement plan.
I can put $20.5k into a 401k, $6k into an IRA, $7.3k into an HSA, $16k into a 529.
Total: $49.8k in tax advantaged accounts.
And for folks who are 50+, some of those limits are higher.

Even if you assume that the people on this board are all in the top 30% of US incomes, that only means they’d be at $100k (or more). And at $100k income it’d be a big challenge for most people to have $50k to put into investments. (or at least I know that I wouldn’t be able to - taxes, food, housing, utilities, etc. would eat up more than $50.2k if I had that as an income)

[ptheland]

That’s not comparing apples to apples with your traditional IRA formula.
Because the traditional IRA it is the before tax principal that you are starting with.

Fair enough. Change that first term to the before tax principal you start with and multiply it by 1-T0 - the tax rate you start with. Fixed.

If your tax rate for the profits in your taxable account is 0%, then your end result will be equal.
If not, then you were better off investing inside an IRA.

Now I’m getting myself confused. I know I had this conversation several years ago (on a different set of boards) and we came up with some way of benefiting from ordinary after-tax investing. And not just staying even at best. I’ll need to sleep on this a bit. It can’t be my error in that first term because that would have never slipped through the conversations there - just like it didn’t slip through here.

–Peter

[Wradical]

Now I’m getting myself confused. I know I had this conversation several years ago (on a different set of boards) and we came up with some way of benefiting from ordinary after-tax investing. And not just staying even at best. I’ll need to sleep on this a bit. It can’t be my error in that first term because that would have never slipped through the conversations there - just like it didn’t slip through here.

Oh, you’re right; it can work out that way. And I think the biggest reason is that if you’re going to invest your retirement in stocks in a regular taxable brokerage account, the dividends and long-term capital gains from those investments can be taxed at a rate as low as zero. (Federal rate only, probably.) And withdrawals are not taxable transactions.

But in a traditional IRA, they will be deferred, hopefully to a post-retirement date when you have a lower effective rate, but they will still be taxed the same as other ordinary income when distributions are made.

A Roth is still the best deal, if the option is available.

Bill

[vkg]

A Roth is still the best deal, if the option is available.

Bill

For younger workers, the answer for most is that ROTH is the best.

For older retirees, ROTH conversions may not be the best answer. A comprehensive plan for funding retirement, possible long term care and estate needs to be done. For older retirees, ROTH conversions are best for assets that aren’t planned on being needed.

[MCCrockett]

For younger workers, the answer for most is that ROTH is the best.

For older retirees, ROTH conversions may not be the best answer.

I agree with your assessment, particularly, once RMD withdrawals have started. The 42% haircut (Federal and State income taxes) that I would take on a ROTH conversion is a little too steep a price to pay.

[joelcorley]

ptheland,

You wrote, Now I’m getting myself confused. I know I had this conversation several years ago (on a different set of boards) and we came up with some way of benefiting from ordinary after-tax investing. And not just staying even at best. I’ll need to sleep on this a bit. It can’t be my error in that first term because that would have never slipped through the conversations there - just like it didn’t slip through here.

I’m generally in agreement with foo1bar’s analysis.

There are two situations where the taxable account could result in superior performance compared to a T-IRA. That’s when you over-contribute to the T-IRA or when you lose money in your investments. If you over-contribute to your T-IRA you may be forced to take distributions late in life where your tax rate exceeds your contribution tax rate.

If you over-contribute, you end up with a tax rate at distribution that is high which results in additional taxes being owed on your earnings. However this discrepancy has to be substantial because the on-going taxes that can accrue in a taxable account have a compounding effect that itself can be substantial. Regardless, this a similar problem to having tax rates that are imbalanced when comparing Traditional and Roth IRAs, except that a small imbalance probably favors the Traditional IRA over the long-term.

Losing money in a long-term investment is probably just a bad plan. But if you do lose money, at least you can write it off some of it off your income in a taxable account. Still, I don’t know anyone that intentionally plans to lose money over the long-term, so I think I can safely discount this scenario.

One other scenario also occurred to be just before I hit submit. If you chose to do a large, lump-sum conversion or distribution of a Traditional IRA, then a Traditional investment account may have been superior. I would argue that this is probably just a failure to plan adequately; but I could see someone doing it to fund a home purchase or because they were talked into doing a large Roth conversion because they took someone’s bad advice on the internet without doing a thorough analysis of their own. (I’m on some Facebook groups where I’ve seen a few people post about taking poor advice from Roth fanboys and wondering after the fact where the huge tax bill came from.)

• Joel

[joelcorley]

Wradical,

You replied to ptheland, Oh, you’re right; it can work out that way. And I think the biggest reason is that if you’re going to invest your retirement in stocks in a regular taxable brokerage account, the dividends and long-term capital gains from those investments can be taxed at a rate as low as zero. (Federal rate only, probably.) And withdrawals are not taxable transactions.

LTCGs and dividends can still have tax consequences that impact your effective marginal rate even if they are technically taxed at 0%. Dividends and the like count toward MAGI calculations, so this income can impact ACA subsidies, the taxation of Social Security and the assessment of IRMAA. You need to include how each dollar received as income will affect these other items in order to determine the real marginal rate of a dollar received. So while LTCGs and dividends may be taxed at 0% for some retirees, they sometimes indirectly incur additional taxes making them less than ideal.

And in any case while you were not a retiree you lost potential gains through tax friction as you were accumulating … so the taxable account might still not “win” even if you are able to incur no taxes at distribution time assuming a tax-advantaged account was an available alternative.

• Joel

[joelcorley]

foo1bar,

You wrote, I can put $20.5k into a 401k, $6k into an IRA, $7.3k into an HSA, $16k into a 529.
Total: $49.8k in tax advantaged accounts.

You completely overlooked Mega backdoor Roth contributions, which are available to some people. I was doing all of that and the catch-up contributions before I retired last year. My tax-advantaged contributions exceeded $70K in 2021 despite retiring in July. (I had to adjust my W-4 to avoid federal tax withholding to make that happen.)

• Joel

[inparadise]

The 42% haircut (Federal and State income taxes) that I would take on a ROTH conversion is a little too steep a price to pay.

But of course, you don’t have to convert the entire amount all in one year, and can space it out in smaller increments at a lower tax rate over several years.

IP

[vkg]

But of course, you don’t have to convert the entire amount all in one year, and can space it out in smaller increments at a lower tax rate over several years.

IP

or ever convert the entire amount. We have done some ROTH conversions without the intent of converting all of the 401K/IRA balances.