I don’t think anyone is assuming that. Most people are contributing what they can that will leave them with a take-home pay (after taxes and retirement savings) that they can live with. That’s why we’re saying to keep that constant.
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Would still like to hear why you think it’s appropriate to apply the marginal tax rate in both scenarios.
It should be pointed out that while there is no income limit to making trad IRA contributions, you can no longer take the immediate income tax deduction after a certain threshold
Which is around the Roth IRA income limit
I have proven this point is not correct. Why do you restate such fallacy?
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A traditional plan defers income tax until such a point when it is assumed to be much lower.
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A Roth plan takes an immediate full hit on receiving the owners highest marginal income taxes for the benefit of avoidance of all future capital gains taxes.
You could possibly imagine an unlikely scenario where the income tax savings on the traditional plan are less than the capital gains tax savings on the Roth, but I think those situations are “real world unlikely”.
RN
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Ehhhh… I definitely think it’s more frequently “people will save what they can after their lifestyle allows for it”
Sounds the same in reverse but the opposite end is the determinant. Lots of people earning $300k and barely making ends meet, what with the $1M house, the weekly maid service, private school…
I guess you don’t know many people with 6 figure RMDs.
And yes I agree that most low income workers are going to better off with traditional than roth.
Yes, I think less than 50% of the retired population has a 6 figure RMD. I don’t really know how a person could put themselves into that kind of situation.
You must have maximized your contributions for a long long time, had incredible better-than-average-market returns, and worked well past the age where you could retire,
I think the most common situation is a person does not have enough to retire upon reaching retirement age.
I think it is quite uncommon for a person to reach retirement age, have enough to retire comfortably, but that person prefers to continue working.
But hey, I didn’t say it was impossible, I said it was unlikely.
Currently the threshold between the 12% and 22% federal tax brackets is $89,450 if filing jointly. The percentages are likely to go up somewhat, given how low they are historically but I assume the 12% is unlikely to go up to 22% any time soon. Certainly, the threshold can also change but I also assume that it will be somewhat similar in today’s dollars.
If I retire at the age of 60, my average life expectancy would be around 21 years. This will vary given family history, gender etc. If it was 21 years, I would withdraw $89,450 a year (2023 dollars) each year at the lower tax rate. Taking out investment gain and inflation, 21*89,450 = $1.88 million dollars.
In this case (assuming I am currently in one of the higher tax brackets), should I ensure I have $1.88 million dollars in traditional before allocating anything to Roth?
That’s why you do a backdoor Roth.
Make the after-tax contribution to Traditional and then immediately roll it over to a Roth account.
Which is basically what I said.
I think that the traditional is a more better* deal for HIGH income workers, because there is a higher differential between current marginal rates (like 40% in our example) to the potential sub 10% rate that i had previously calculated. That differential is not as high if your marginal tax rate is currently 24%
*Yes, I know I said more better.
Mm, here’s the difference I get at.
Fiscally responsible people say, “If I save 20%, I’m able to live off of 80%” and do that.
Non-responsible people say, “Okay I spent how much felt right. Shit, I have $20 left.”
Are you asking why marginal tax rate instead of average tax rate?
That should be obvious: if you decide on a Roth account instead of Traditional that means your taxable income is $10,000 higher… it’s going to increase your taxes by the marginal tax rate * the contribution.
Or same idea at withdrawal time but in reverse.
I’m asking about the withdrawal, and specifically assuming that withdrawal happens in retirement.
I will add that it’s not always obvious what your marginal tax rate actually is.
Things like NIIT, EITC, AOTC, taxation of Social Security and more can distort your marginal tax rate into something that you don’t see on tax charts.
At its most extreme is it you are Single / Head of Household and you hit the investment income threshold and lose your EITC. $1 of additional investment income can be a $7,830 hit to your tax bill. (Most people in EITC territory don’t have that kind of investment income, but I prepared a return where a couple got dinged the year he had an inheritance from a rich aunt. $11,000 of investment income cost them over $6,000 of EITC.
But far more common is it you’re on the slope where only a portion of your Social Security income is taxed. You can easily hit marginal tax rates well in excess of 50% in that income range. And that’s ordinary middle class retirees.
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Not realistic.
Better:
Traditional: Set aside $10,000 of pre-tax money. It doubles to $20,000. Take out the money a little at a time over a period of years when you have no other income and the effective tax rate may be a lot lower than 40% and perhaps even 0%.
The worst thing you could ever do with a retirement account is flush it all through the tax gate at once so it gets taxed at a super high average and marginal rate.
The point of having a retirement account is to distribute the value slowly and evenly over time to take advantage of lower tax brackets and live off the proceeds.
If you had a Roth withdrawal the tax would be zero. But a traditional withdrawal is taxed… so you should be looking at your marginal rate since it is increasing your income.
Now your marginal tax rate in retirement may well be different from your marginal tax rate when you’re working for a gazillion reasons. It might be higher or lower. Conventional wisdom is that it will be lower, but that’s certainly not always the case.
And the dollar amounts that we’re talking about may be high enough that they span more than one tax bracket, so that is certainly a simplifying assumption. In your circumstance it might be that the traditional distribution ends up being taxed half at 24% and half at 37% and so you should be calling the tax 30.5%, or better yet manage your mix of Roth & Traditional to “soak up” the lower tax bracket and avoid the higher one.
I think it’s generally understood that we are assuming you understand that we’re talking about the impact of adding an additional ($10,000 now or $20,000 at retirement) to your taxable income.
How can your income tax rate be higher when you don’t have a job?
Because all of those traditional distributions you’re taking are taxed as ordinary income… exactly the same as if you did have a job.
If you make $150,000 at your job and sock a crap ton away in a traditional accounts and now you want to travel the world in luxury cruises that you never had time for when you were working, maybe you take retirement distributions resulting in an annual income of $250,000 a year. Maybe you have a pension that’s also going into that $250,000, and of course 85% of your Social Security benefit too.
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