And, ya know, consider Long Term Care insurance if that sounds unappealing to you.
Thanks. That helps.
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There’s
- Relative tax bracket (now vs retirement)
- Tax movement expectations (go up, go down, stay the same)
- Ability to pay taxes
- Tax law change expectations (change treatment of existing IRA / Roth balances)
For me, I have to assume 4 is 0. They may change the rules but they rarely let those changes apply to historical contributions/balances. So I would expect any of this money to be grandfathered in.
Even though multiplication is commutative, 1 and 3 make age a very important factor for me. I expect to be in the highest tax bracket for a big chunk of my life, including retirement. So for my earlier years, even though I was in a high tax bracket, it wasn’t the highest.
And my willingness to pay taxes is higher while earning money than in retirement. Now I can “afford it”. I can keep working longer if I need to. Money coming in is enough to support my expenses, lifestyle, and those additional taxes / savings. In retirement, even at first, my ability to afford the taxes may not be as high. And my ability to make more money deteriorates drastically over time in retirement.
Factor in 2, where I assume taxes in general will need to go up to cover an increasing amount of social programs and to eventually pay down / control the national debt.
Another factor that I left out of the list above, but others mentioned, is due to contribution limits, you can contribute more if you utilize the Roth option.
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Here’s an extreme example highlighting a few of my points. A few years ago I converted a large traditional balance into ROTH. I am already maxing out all IRA and 401K contributions, so I could not contribute another dollar to retirement accounts if I wanted to. But this instantly unlocked value for me.
$XXX,XXX in traditional account. Convert to ROTH. Pay $XXX,XXX * [tax rate] in taxes, but that comes from money that could not have otherwise gone into a retirement account, therefore could not have grown in the same tax advantaged way. Now I still have exactly $XXX,XXX in retirement money, but now that full balance and future investment income will not be taxed in retirement.
Maybe I’m missing something, but that seems like a no-brainer to me.
This is a factor that I’ve been ignoring but shouldn’t.
You’re absolutely right. Even though multiplication of the tax rate is commutative, that tax rate can (will) change between now and then.
As a jr woodchuck actuarial assistant I’m able to lock in that 22% marginal rate now instead of having to pay 37% in retirement because I’m such a great investor.
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That’s a great point I forgot. Realized one day, “Wait, $5500 (in a Roth IRA) is more money than $5500 in a Traditional” and it tipped my decision to go 100% Roth early in my career.
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You’re thinking about this right. Especially if you retire well before RMDs kick-in, you have plenty of years to spread out Traditional withdrawals so that the effective tax you are paying is 0%, or at least something significantly lower than your marginal rate today. I don’t think many others in this thread are fully grasping this.
Can you explain? Is this assuming a lower income in retirement than present? I don’t understand how to pay 0% tax on Traditional unless you’re withdrawing a very low amount, and I plan on roughly 100% income replacement.
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Yes, it all comes down to income being fairly low and having other sources of capital to pay expenses.
Looking at the 2024 tax tables, the MFJ standard deduction is $29k. So you could withdraw $29k from traditional IRA/401k accounts tax-free, assuming no other income (which, other than some small interest amounts, if you are truly retired you shouldn’t have anything).
$29k would be pretty low to live on, so you’d probably need to withdraw more. The 10% tax bracket goes up to $23k, so if you withdrew $52k from Traditional accounts, you’d pay a 4.5% effective tax rate. If you max out the 12% bucket, I think you’d pay about ~9% on $123k.
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Like a Roth IRA? 
It helps! I’m certainly not advocating against Roth IRAs. I just prioritize them lower than Traditional accounts.
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Gotcha. That matches with my plan to do 100% Roth for a few more years, then transition and eventually hit 100% Traditional for another 20 years or so. I figure I’ll end up about 50/50 Traditional/Roth. As of today’s taxes I’ll just draw up to $94,300 (the 12-22% cutoff) from the Traditional then draw Roth after that.
Agreed… but…
You seem to get hit with the state taxes, as you pay them to push the money into a Roth, whereas I am seeing that you end up NEVER paying state tax on money put into a traditional 401k if you live in one of the lucky 38 states.
Also, the bigger tax shelter of current tax deferrals of 40% marginal tax seems better than the deferred tax savings of a Roth that might be at a weighted average tax savings of 0%, 10%, 12%, 22%, even if the amount deferred under a Roth is slightly larger.
Won’t your pretax income go down $30k in this scenario, since you stop putting into your 401k/Roth when you retire?
pre-tax need will go down by $30K owing to no longer saving in the 401k/roth. also not paying SS tax.
Which states don’t tax trad 401K distributions? Most states start with your federal taxable income and make adjustments, but I’ve not seen adjustments for retirement distributions.
I don’t know every state’s tax code like the back of my hand, mind you.
AARP article here. It seems to suggest there are 12 states that do not tax 401k distributions. (and Alabama which does tax 401k/TRA distributions but not pensions)
But I would not trust Illinois. The state is so effed up, broke, and corrupt that any tax could be raised at any moment.
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Well the 9 states that don’t tax income at all… yeah, sure, but then you’re not saving the income tax when you earn it either.
But the 4 that have an income tax but not on retirement income are interesting. Illinois, Iowa, Mississippi, Pennsylvania… I’m certain that I’ve prepared returns for several of those states but maybe not for retirees from those states.
Assuming you lived there during the tax earning years, of course.
Okay with these 2 in conjunction I think I get what @knoath was saying. Yes, my pre-tax “income need” would go down. Phrasing it as “my income going down” wasn’t clicking since my income will be what I decide it is.
I’m not factoring in a reduced need for that post-retirement. Also, my house will have been long paid off since then. Should I fall short of my goals either by failing to save or deciding to retire a few years earlier, I’ll live on what I got to then. (Planning for retirement anywhere from around 54-60.)
If I was 50 I’d be more dialed in on my end-goal. Right now, I figure I won’t be mad at myself for aiming high. And should I die, I won’t worry about it.