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Author: LearnTheHardWay Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75820  
Subject: Are retirement accts really the best strategy? Date: 5/11/2007 11:24 AM
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Recently, I had a friend come to me seeking advice on whether they should continue contributing money to a traditional 401(k) or their company's new Roth 401(k). As I was explaining the basic tax considerations (tax bracket now versus potential tax bracket later) for making this decision, it got me thinking about my own investment strategy. I realized that there were still some things I was unsure of with regards to 401(k)s, IRAs, and "non-retirement" investing.

I have a question that is probably pretty simple to answer. Also, I'll try to explain my financial situation at a high level just so you can understand what my potential options may be.

THE PURPOSE OF ALL OF MY QUESTIONS is to determine whether or not, based on my situation, I'm getting any benefit, beyond my employer's 401(k) match, from contributing the maximum amount to my retirement accounts.

MY SITUATION

- I'm currently in the 33% tax bracket, which means that I can't contribute to a Roth IRA and that my contributions to my traditional IRA or non-deductible
- I max-out my traditional IRA contributions each year
- I max-out my traditional 401(k) contributions each year
- I have extra after-tax money that I've decided to invest in stocks that I plan on holding to for at least a year (unless there is a significant reason to sell them earlier)
- I will most likely remain in the 33% tax bracket (unless they raise the tax rates) until I retire
- I still have over 35 years until "official" retirement
- I will most likely not have a mortgage payment when I retire
- My only source of income when I retire will be from my retirement/non-retirement investment accounts


MY ASSUMPTIONS

- Stocks held for more than one year are taxed at a current rate of 15%
- Distributions from both my traditional 401(k) and IRA are taxed as income subject to the tax rate associated with the annual sum of all my distributions (ie. if I withdraw a total of $175,000/year at retirement, I will fall into the 33% tax bracket)
- If I plan on being in the same tax bracket in retirement that I am in now, there is no difference in the compounding effect of my long term investments (ie. $1000 taxed now growing at 10% would equal the same as $1000 taxed later growing at 10%)

MY QUESTION

- If I currently receive no tax credits that would be diminished by having a higher AGI due to less 401(k) contributions, and it wouldn't put me in the next higher tax bracket, wouldn't it be better to contribute just enough to my 401(k) to receive my company match, then invest the rest of my available investing income in a personal investment account that would give me more flexibility in case of emergencies and allow me a maximum tax hit of 15% versus the 33% hit of IRA and 401(k) withdrawals?
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Author: hockeypop Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57256 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 11:49 AM
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If I plan on being in the same tax bracket in retirement that I am in now, there is no difference in the compounding effect of my long term investments (ie. $1000 taxed now growing at 10% would equal the same as $1000 taxed later growing at 10%)

MY QUESTION

- If I currently receive no tax credits that would be diminished by having a higher AGI due to less 401(k) contributions, and it wouldn't put me in the next higher tax bracket, wouldn't it be better to contribute just enough to my 401(k) to receive my company match, then invest the rest of my available investing income in a personal investment account that would give me more flexibility in case of emergencies and allow me a maximum tax hit of 15% versus the 33% hit of IRA and 401(k) withdrawals?


1. I wouldn't contribute after-tax dollars to the IRA. I think your cap gains approach is more effective.

2. Don't forget that after retirement you are paying taxes at your effective total rate (which probably is about 19% after first paying at the 15% rate, then at the 28% rate, and finally paying your marginal rate of 33%). Your decisions in retirement may determine how deeply you go into your marginal rate of 33%.

3. If you put both the salary saved AND your tax savings into a tax-deferred account that extra money from the tax savings should be appreciating over time.

4. You are absolutely right to have a balance between after-tax and tax-deferred accounts from which to draw, but that may actually allow you to defer more now and plan for your outlays later (those after-tax investments may allow you to stay within that 28% rate).

Hope that helps.

Hockeypop

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57258 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 1:01 PM
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- Distributions from both my traditional 401(k) and IRA are taxed as income subject to the tax rate associated with the annual sum of all my distributions (ie. if I withdraw a total of $175,000/year at retirement, I will fall into the 33% tax bracket)

You may be in the 33% marginal tax bracket, but your effective tax rate will be much lower than 33%. This can be very important because...



- If I plan on being in the same tax bracket in retirement that I am in now, there is no difference in the compounding effect of my long term investments (ie. $1000 taxed now growing at 10% would equal the same as $1000 taxed later growing at 10%)

Not necessarily. When you get the tax benefit today, that benefit comes at your marginal rate -- if you are in the 33% tax bracket, every dollar you put in saves you 33 cents in taxes. But when you make withdrawals in the future, you have to "fill up" the lower tax brackets before you hit the 33% bracket. If you have no other sources of income, you will end up at an effective tax rate on these withdrawals of under 25%.

So look at the options this way:

Case 1 -- pre-tax contributions; taxable withdrawals (i.e. Traditional 401k)
-- Contribute $10K today
-- let it grow for 30 years at 5% more than inflation and you will have $43,219 in today's dollars
-- withdraw this money and pay $5116 in taxes (taking standard deductions)
===> $38,103 in spendable money

Case 2 -- post tax contributions; no tax on withdrawal (i.e. Roth 401k)
-- Contribute $7500 today (assumes 25% marginal tax bracket to be consistent with case 1)
-- let it grow for 30 years at 5% more than inflation
-- withdraw
===> $32,414 in spendable money

Case 3 would be a taxable brokerage account; no real need to include this since it will always be inferior to the Roth account.


As you can see, because you get today's deduction at the MARGINAL rate but often pay taxes at a lower EFFECTIVE rate on withdrawal, even if your tax bracket does not change, the Traditional account can be significantly superior to the Roth account.

Also, there is the whole "bird in hand" idea -- passing on a tax break today for something in the future might not be a great idea. You just never know what the government will decide in the future.



MY QUESTION

- If I currently receive no tax credits that would be diminished by having a higher AGI due to less 401(k) contributions, and it wouldn't put me in the next higher tax bracket, wouldn't it be better to contribute just enough to my 401(k) to receive my company match, then invest the rest of my available investing income in a personal investment account that would give me more flexibility in case of emergencies and allow me a maximum tax hit of 15% versus the 33% hit of IRA and 401(k) withdrawals?


Maybe. But your question is comparing apples to oranges.

The maximum 15% tax ignores the fact that you paid taxes today to get the funds...then taxes on the gains. It also misses out on the situation I described above. You will likely have other income in retirement, so some of the tax brackets below your marginal bracket will already be filled. But unless your other income already puts you into your marginal bracket, your effective tax rate on your withdrawals will be below your marginal tax rate. And that is a powerful concept.

As I showed in my cases, there are plenty of times where the Traditional 401k/IRA account is superior to the Roth account. And since the Roth account is always better than a taxable brokerage account, the Traditional account must be better than the taxable brokerage account in these situations.

My advice for determining which is best is to use "real" rates of return (return minus inflation rate) and then enter numbers into a mock tax return to see how much you would have left after taxes in each scenario. Then play around with changing tax rates based on what the Feds might do. Then you can make a more informed decision.

Acme

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57259 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 1:07 PM
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1. I wouldn't contribute after-tax dollars to the IRA. I think your cap gains approach is more effective.

I don't think this is what he was proposing. If it is, then you are certainly correct -- there is little to be gained from the after-tax IRA contributions. About all I can think of are legal protections in case of certain lawsuits and I don't think money in IRA accounts goes against you when applying for Federal aid for education.



2. Don't forget that after retirement you are paying taxes at your effective total rate (which probably is about 19% after first paying at the 15% rate, then at the 28% rate, and finally paying your marginal rate of 33%). Your decisions in retirement may determine how deeply you go into your marginal rate of 33%.

Don't forget the 0% and 25% brackets! They might get lonely if you leave them out. :^)



4. You are absolutely right to have a balance between after-tax and tax-deferred accounts from which to draw, but that may actually allow you to defer more now and plan for your outlays later (those after-tax investments may allow you to stay within that 28% rate).

I agree. However, I think there are very few people that are better off investing after-tax money in a brokerage account (non-Roth account) than they are taking the current tax deferral of a 401k. As long as the plan options are reasonable, the current tax deduction has tons of power due to bracket shifting (as you described in note 2 and I talked about at length in my reply).

Acme

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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57260 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 1:20 PM
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There are some considerations that I didn't see mentioned;

1) If you retire in 35 years, you might live an additional 35 years, so that could be up to 70 years of paying taxes on the dividends in the taxable account. There is probably a breakeven point where the non-deductible retirement account is better because you can let the dividends compound for decades before paying taxes.

2) (Gasp, choke, and the should of heck freezing over.) You could be in one of the rare situations where a carefully selected low cost annuity might make sense because of the tax advantages.

3) If you might retire in a state with higher or lower income taxes, this might affect your choices.

4) Don't over estimate your retirement tax rate. Sure when you retire early and spend lots of time traveling and other money gobbling pastimes, you will need to withdraw enough money that you might be in a high tax rate for the first few years, but by the time you get to be in your 70's you will be slowing down and not likely not spending as much so your tax rate will likely be lower then. In addition to slowing down and not needing as much, if you can draw down your retirement savings for several decades and still be in a high tax bracket, then you probably saved too much.

5) With 35 years until retirement there is lots of time for "stuff" to happen that may change your life plans( not all of it is bad). Unlike the kids at Lake Woebegone who are all above average, having so much money that you are in a high retirement tax bracket is not the most likely outcome. Until you have your core retirement savings pretty much on track(like a couple of hundred thousand in retirement account) I would not worry too much about optimizing future taxes 50 years from now.

Greg


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Author: LearnTheHardWay Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57261 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 1:23 PM
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Thanks Hockeypop. I see where some of my math was flawed when comparing taking after-tax investments and comparing them to my 401(k). My example below proves you are correct.

Traditional 401(k) scenario
- $10,000 initial investment, growing at 10% for 30 years = $174,494
- less 33% in taxes = $116,911

After-tax personal investment scenario
- $10,000 less 33% in taxes = $6,700
- $6,700 initial investment, growing at 10% for 30 years = $116,911
- also need to take 15% off the interest growth of $110,211 = $93,679
- adding the original $6,700 to $93,679 = $100,379

So, I will keep contributing the max amount to my 401(k).

With regards to my traditional IRA, am I correct in assuming that any withdrawals, regardless of how long my investments have been in the account, are treated as taxable INCOME (and therefore subject to my effective tax rate), rather than long-term capital gains?


2. Don't forget that after retirement you are paying taxes at your effective total rate (which probably is about 19% after first paying at the 15% rate, then at the 28% rate, and finally paying your marginal rate of 33%). Your decisions in retirement may determine how deeply you go into your marginal rate of 33%.

Also, I'm a little confused by your second comment. Are you saying that even though I'm in the 33% tax bracket, unless my AGI is exactly $160,850 that I'm actually paying between 33% and 35% depending on where my AGI falls between $160,850 and $349,700? I guess I don't understand the difference between effective total rate and marginal rate. Can you please explain?

4. You are absolutely right to have a balance between after-tax and tax-deferred accounts from which to draw, but that may actually allow you to defer more now and plan for your outlays later (those after-tax investments may allow you to stay within that 28% rate).

Lastly, in your fourth comment, when you refer to my after-tax investments allowing me to possibly stay within the 28% tax rate, would that be because I'd be able to withdraw part of the money I need at a 15% rate from personal investment account and the amount of the withdrawals that I would need from my 401(k) would be less meaning that my taxable amount from 401(k) would probably keep me in the 28% bracket?

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57262 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 1:40 PM
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So, I will keep contributing the max amount to my 401(k).

Good decision. :^)



With regards to my traditional IRA, am I correct in assuming that any withdrawals, regardless of how long my investments have been in the account, are treated as taxable INCOME (and therefore subject to my effective tax rate), rather than long-term capital gains?

Yes, this is correct as long as all of the contributions were made with pre-tax money. If there is post-tax money in the accounts, a small portion of each withdrawal will not be subject to taxes; the rest will be taxed as ordinary income.



Also, I'm a little confused by your second comment. Are you saying that even though I'm in the 33% tax bracket, unless my AGI is exactly $160,850 that I'm actually paying between 33% and 35% depending on where my AGI falls between $160,850 and $349,700? I guess I don't understand the difference between effective total rate and marginal rate. Can you please explain?

No, he's saying that you are always paying less in taxes than the tax-rate indicated by your tax bracket. If you are in the 33% tax bracket, you will never actually pay 33% in taxes.



Lastly, in your fourth comment, when you refer to my after-tax investments allowing me to possibly stay within the 28% tax rate, would that be because I'd be able to withdraw part of the money I need at a 15% rate from personal investment account and the amount of the withdrawals that I would need from my 401(k) would be less meaning that my taxable amount from 401(k) would probably keep me in the 28% bracket?

I think you are starting to get it. The key is to understand how the taxes work. For 2007, the tax table for a single person will be:

If taxable income is
over-- But not over-- The tax is:
$0 $7,825 10% of the amount over $0
$7,825 $31,850 $782.50 plus 15% of the amount over 7,825
$31,850 $77,100 $4,386.25 plus 25% of the amount over 31,850
$77,100 $160,850 $15,698.75 plus 28% of the amount over 77,100
$160,850 $349,700 $39,148.75 plus 33% of the amount over 160,850
$349,700 no limit $101,469.25 plus 35% of the amount over 349,700

You also get a total of $8450 in standard/personal exemptions. So at least $8450 of your income will be tax-free (higher if you itemize which is likely given the income level we are discussing).

Since what a retired person is really after is a certain amount of "spending money" rather than a certain amount of pre-tax income, you will get to choose the source of funds in order to minimize your total tax burden from year to year. For someone that is going to take enough to put them in the 33% tax bracket, the ideal scenario might be to take enough from the tax-deferred accounts to max out the 28% tax bracket and then take any additional funds from the brokerage account. This way you pay 15% taxes on your income that would have fallen in the 33% tax bracket.

I hope this is making sense. It is a simple enough concept to explain when I can put together a few tables/diagrams; it's a little more complex when I have to use text in place of diagrams!

Keep asking questions and you will get there quickly enough.

Acme

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Author: LearnTheHardWay Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57266 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 2:36 PM
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Thanks Acme. I truly appreciate your patience. I'm glad I put this post up because my basic understanding of the tax implications of my investment options needed some adjusting.

O.K.! I think that within the past 30 seconds, the difference between marginal rate and effective rate just sunk in. For some odd reason, I guess I've never actually done the calculation I needed to do to understand what you are saying. I always thought that once your AGI reached a new tax "clip level," that your total taxes due would be that bracket percentage on all of your earnings. If I understand what you're saying (and what I calculated) the effective tax rate for someone whose AGI is $160,850 is 24.33%, and for someone whose AGI is $77,100 is 20.36%, and so on.

Going back to your original reply-post, based on my AGI, I'm not eligible for a Roth IRA and my company has yet to offer a Roth 401(k). So, for now, I'm going to max out my traditional 401(k) and instead of continuing to contribute to my non-deductible, traditional IRA, I'm going to put all of my leftover, after-tax money into my brokerage account. If I have kids one day and need to be concerned with financial aid calculations, I'll reconsider where I put all of my after-tax money.

If my company does end up offering a Roth 401(k) option, in addition to the traditional 401(k) plan, I think I want to understand the calculation in your initial reply-post better. I know that if you tax money "Z" at rate "X" and allow it to grow at rate "Y", that it is equal to letting that same money "Z" grow at rate "Y" and then taxing it at rate "X". What I think you're saying is that distributions in retirement from a traditional 401(k) would be taxed at an effective rate of 24.33% (assuming the total of my distributions are $160,850), but that if I took the same amount of pre-tax money and it was taxed while being contributed to a Roth 401(k), then it would be taxed at the marginal rate of 33%.

If that is a correct understanding of your calculation, why are contributions to a Roth 401(k) taxed at the marginal rate now instead of at the effective rate which I think is how they would be taxed if you were contributing to a Roth IRA?

If I didn't understand your calculation correctly and your calculation includes my Roth 401(k) contributions being taxed now at the same effective rate as in retirement, assuming my AGI now equals my total annual distributions when I retire, wouldn't the amount of money I end up with (regardless of time or rate-of-return) be the same for both 401(k) options?

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Author: pokerden One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57267 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 2:36 PM
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Are you planning on rolling the traditional IRA to a ROTH IRA in 2011? (or is it 2010?)


-pokerden



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Author: LearnTheHardWay Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57268 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 2:43 PM
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To be honest, I haven't gotten that far yet. I know that it's an option, but since it was a few years off before being able to take advantage of it (if it is an advantage), I haven't really considered it. If there is an advantage to doing so, maybe I should reconsider my decision to not contribute the max amount to my traditional IRA.

Based on my situation, that I described in probably too much detail, what would be the pros and cons for converting my traditional IRA to a Roth IRA?

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57269 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 2:46 PM
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Going back to your original reply-post, based on my AGI, I'm not eligible for a Roth IRA and my company has yet to offer a Roth 401(k). So, for now, I'm going to max out my traditional 401(k) and instead of continuing to contribute to my non-deductible, traditional IRA, I'm going to put all of my leftover, after-tax money into my brokerage account. If I have kids one day and need to be concerned with financial aid calculations, I'll reconsider where I put all of my after-tax money.

That sounds like a *great* plan to me.



If my company does end up offering a Roth 401(k) option, in addition to the traditional 401(k) plan, I think I want to understand the calculation in your initial reply-post better. I know that if you tax money "Z" at rate "X" and allow it to grow at rate "Y", that it is equal to letting that same money "Z" grow at rate "Y" and then taxing it at rate "X". What I think you're saying is that distributions in retirement from a traditional 401(k) would be taxed at an effective rate of 24.33% (assuming the total of my distributions are $160,850), but that if I took the same amount of pre-tax money and it was taxed while being contributed to a Roth 401(k), then it would be taxed at the marginal rate of 33%.

By George, I think he's got it! :^)

Your understanding of the basic math of compounding is dead on. The place you were lacking is in the breakdown of the taxes. The "bracket shifting" that occurs due to needing to fill the lower brackets first is a critical, but much misunderstood, concept.

If you had enough "other" income to put you in the 33% tax bracket before taking money out of the 401k, then a Roth and a Traditional 401k would end up basically the same. But since that is rare, the Traditional often comes out ahead. And this is often true even if your tax bracket is slightly higher in retirement than it was when working/contributing.



If that is a correct understanding of your calculation, why are contributions to a Roth 401(k) taxed at the marginal rate now instead of at the effective rate which I think is how they would be taxed if you were contributing to a Roth IRA?

No, the money is taxed the same for either. Roth IRAs are good because:

(1) Many people are not eligible for deductible Traditional IRA contributions, so the comparison between the 2 types of account is irrelevant; and
(2) They are better than taxable brokerage accounts since the starting funds are the same, but the Roth avoids all future taxes.



If I didn't understand your calculation correctly and your calculation includes my Roth 401(k) contributions being taxed now at the same effective rate as in retirement, assuming my AGI now equals my total annual distributions when I retire, wouldn't the amount of money I end up with (regardless of time or rate-of-return) be the same for both 401(k) options?

We have to work in "real" dollars since inflation changes things. Assuming your "real" dollars are the same today and in the future, the Traditional 401k actually comes out ahead in a lot of cases even when the tax brackets do not change.

Unfortunately, I have to hop in the car right now, so I cannot get into more detail, but I would be happy to continue answering questions if you have more. There's a lot of important stuff here -- things that can make a measurable difference over time.

Best of luck!

Acme

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57270 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 2:47 PM
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Are you planning on rolling the traditional IRA to a ROTH IRA in 2011? (or is it 2010?)

All of my personal T-IRAs have pre-tax contributions, so I have little interest in rolling them over in 2010. My wife's T-IRA, however, is post-tax, so we will definitely be rolling it over.

Acme
(Who suddenly thinks you might have been meaning to ask this of the OP...)

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57271 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 3:24 PM
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why are contributions to a Roth 401(k) taxed at the marginal rate now instead of at the effective rate which I think is how they would be taxed if you were contributing to a Roth IRA?

The contributions are taxed at the marginal rate because you already have all of that other income to get you to the 33% bracket.

Basically, your choices are to do the Roth 401k and have 180K of taxable income or do the traditional 401k and have 165k of taxable income. In either case, you'll be in the 33% marginal bracket. And that means that the 15k of 401k contributions would be taxed at 33% if you choose to go the Roth route.

But in retirement, we're starting from zero. Assuming that these accounts will be your entire source of retirement income. So we have to go through the standard deduction, the personal exemption, and all of the lower tax brackets before we get into the 33% bracket.

And this brings up the next consideration. When you start out saving for retirement, the deductible savings (traditional 401k and IRA) make more sense. You save money now, and in retirement (if you do nothing else between now and then) you'll pay little or no tax.

But as you accumulate these tax deferred savings over the years, your calculations need to change. When you've already accumulated a few hundred thousand dollars in a 401k plan (and/or traditional IRA) and are deciding whether to use a traditional or Roth vehicle THIS year, you're not starting from zero in retirement. You already have all of these tax-deferred savings, so you need to consider what they will contribute to your taxable income. Additional tax deferred savings are on top of what you have already accumulated and will be taxed at some marginal rate in retirement. At some point, you'll probably cross over and want to do the Roth account.

And one more thing to consider. I always like to see people have SOMEthing in tax deferred accounts. Because there are often little windows of opportunity that life throws at you. You may have some year where you have very little income. There could be a variety of reasons - temporary disability, caring for family, a sabbatical, starting a new business. Any of these can drop your income significantly for a time. And that low income year can give you a chance to convert some of your traditional IRA/401k money into a Roth account with little or no taxes.

--Peter

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Author: InvestMechanic Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57272 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 3:46 PM
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What exactly is happening in 2010 with regard to Roth conversions?

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Author: ziggy29 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57273 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 3:52 PM
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>> What exactly is happening in 2010 with regard to Roth conversions? <<

1) Traditional IRA to Roth conversions will be allowed with no upper income limit.

2) The taxes due on the conversion can be delayed and spread out: half due in 2011 and half due in 2012.

Keep in mind that what Congress giveth, Congress can taketh away, and in theory the enabling legislation could be repealed before it takes effect. This president would surely veto such a bill to repeal it -- and there's no way Congress would have the 2/3 majority to override it -- but if the next president is willing to sign a repeal in 2009 and Congress wants to scrap it, they still can.

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Author: Hawkwin Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57274 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 4:01 PM
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My advice for determining which is best is to use "real" rates of return (return minus inflation rate) and then enter numbers into a mock tax return to see how much you would have left after taxes in each scenario. Then play around with changing tax rates based on what the Feds might do. Then you can make a more informed decision.

You can follow Acme's editorial on the "proper" way to figure all of this out or you can just do it the easy way and decide at retirement to leave the country and take all you money with you to some country with favorable tax laws. That is my plan B.

:P


Hawkwin
Who believes your mileage may vary on the quality of the above advice.

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57275 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 5:13 PM
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Hawkwin: "You can follow Acme's editorial on the "proper" way to figure all of this out or you can just do it the easy way and decide at retirement to leave the country and take all you money with you to some country with favorable tax laws. That is my plan B."

I think that you are being facetious, but USA citizens owe US income tax on their world-wide income regardless of where they reside.

And while I have not kept up-to-date, IIRC, renouncing US citizenship to escape the taxes referenced in the preceding sentence is made more difficult by a required exit payment (and ignoring completely all other issues related to renouncing US citizenshp except the US income taxes).

IOW, that dog don't hunt wo well anymore.

Regards, JAFO



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Author: InvestMechanic Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57276 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 5:30 PM
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1) Traditional IRA to Roth conversions will be allowed with no upper income limit.

2) The taxes due on the conversion can be delayed and spread out: half due in 2011 and half due in 2012.


Thanks. I'm not converting.

I think the Infernal Revenue Service would be smart, from a revenue-generating point of view to mandate that all traditional IRA's be converted to Roth IRA's and that all taxes be paid immediately. Then eliminate all tax-deductible IRA's. I don't agree with that notion at all but I think many more people who were expected to convert to Roth when it was enacted did not do so and are still reaping the benefits of taking the tax deduction. This reduces revenue beyond what I think they originally anticipated. It's a balancing act but I'm taking a current deduction because a bird in the hand is.....

When the reality of the social security system comes home to roost in a few years, politicians will have no stomach to take it away from retiree's. Geezers will be safe. Politicians will have no choice but to raise taxes anyway they can on current and younger workers. I'd rather take the money now and when I'm an old fart be safe knowing that politicians won't have the guts to mess with the geezers. The future is uncertain and stuff changes and promises are broken, especially when the government is involved. I have not liked Roth IRA's since they were enacted and would be very surprised to see the government leave them unchanged when they finally have to look straight in the eyes of that SS monster in a few years.

It is interesting to observe which party tried to do something about SS and which party blocked the efforts and decided to kick the can down the road. Most politicians don't have the guts to do what is necessary. But instead they wait until there will be no choice. Boy, some s*it will hit the fan then. People will not believe the inevitable consequences and there will be nothing they can do about it.

You youngin's beware! The Gubmit gits his prey one way or another and there won't be any mercy (except for the untouchables accustomed to their entitlements) - everyone will pay - that means YOU!

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Author: InvestMechanic Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57279 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 5:39 PM
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And while I have not kept up-to-date, IIRC, renouncing US citizenship to escape the taxes referenced in the preceding sentence is made more difficult by a required exit payment (and ignoring completely all other issues related to renouncing US citizenshp except the US income taxes).

What if someone takes a trip overseas, stays longer than anticipated, transers his/her money to a local bank or brokerage house, changes his/her mind and decides to take up citizenship in a country of choice? You mean to tell me they have to pay a tax To Uncle Sam to do that? How would US even know?


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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57280 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 6:07 PM
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What if someone takes a trip overseas, stays longer than anticipated, transers his/her money to a local bank or brokerage house, changes his/her mind and decides to take up citizenship in a country of choice? You mean to tell me they have to pay a tax To Uncle Sam to do that? How would US even know?

Because when you become an expatriate, you are required to fill out an IRS form: http://www.irs.gov/businesses/small/international/article/0,,id=161325,00.html

There is a $10k penalty for not filling it out.

AJ

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57281 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 6:16 PM
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InvestMechanic:

<<<1) Traditional IRA to Roth conversions will be allowed with no upper income limit.

2) The taxes due on the conversion can be delayed and spread out: half due in 2011 and half due in 2012.>>>

"Thanks. I'm not converting.

I think the Infernal Revenue Service would be smart, from a revenue-generating point of view to mandate that all traditional IRA's be converted to Roth IRA's and that all taxes be paid immediately."


You bias is noted, but these are not IRS decisions, they are Congressional decisions but feel free to keep bicthin about the IRS.

"I don't agree with that notion at all but I think many more people who were expected to convert to Roth when it was enacted did not do so and are still reaping the benefits of taking the tax deduction."

There wer a lot of people who took advantage of the prior 1998 convert now, pay taxes over four years option. And I have no idea about what you mean when you write "still reaping the benefits of taking the tax deduction". The deduction is only available in the year the contributions are made. How are people still reaping benefits (that would not otherwise be available)?

"This reduces revenue beyond what I think they originally anticipated. It's a balancing act but I'm taking a current deduction because a bird in the hand is....."

I largely agree with this statement.

A national sales tax - like FairTax would also play havoc with those who planned on spending Roth IRA money without owing (or owing little in) federal income taxes.

Regards, JAFO



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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57282 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 6:20 PM
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InvestMechanic:

<<<And while I have not kept up-to-date, IIRC, renouncing US citizenship to escape the taxes referenced in the preceding sentence is made more difficult by a required exit payment (and ignoring completely all other issues related to renouncing US citizenshp except the US income taxes).>>>

"What if someone takes a trip overseas, stays longer than anticipated, transers his/her money to a local bank or brokerage house, changes his/her mind and decides to take up citizenship in a country of choice? You mean to tell me they have to pay a tax To Uncle Sam to do that? How would US even know?"

Yes as to your firs question. See http://www.irs.gov/businesses/small/international/article/0,,id=97245,00.html

AJ answered the second question.

Regards, JAFO



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Author: InvestMechanic Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57283 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 6:29 PM
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And I have no idea about what you mean when you write "still reaping the benefits of taking the tax deduction".

I must not have made myself clear. I was talking about the people who decided not to convert to a Roth IRA. They still take deductions every year. I think the gubmint thought more people would take advantage of the Roth IRA since the money is not taxable when you begin to receive it at retirement. Many instead said I'll take the deduction now and into the future and bet that come retirment the tax situation won't be so bad. They also didn't trust the gubmint's promise of tax-free withdrawals, instead believing, among other things, that it might change its mind. Gasp!

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Author: InvestMechanic Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57284 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 6:35 PM
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JAFO:

So if I save money that has already been taxed and take it with me to another country and invest it and spend it on living, I still owe taxes to the US? I belong to the gubmint?

How's a body to avoid paying US taxes anymore? Where are the loopholes? I'm sure there are ways to get-er-done aren't there?


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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57285 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 7:10 PM
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A national sales tax - like FairTax would also play havoc with those who planned on spending Roth IRA money without owing (or owing little in) federal income taxes.

I take it from this (and other comments you have made) that you are not at all a fan of the Roth 401k. I would assume, however, that you think Roth IRA accounts are fine for people that are not eligible for deductible Trad. IRA contributions since there are no downsides to a Roth IRA compared to a taxable brokerage account.

Are those statements accurate? If not, I would love to hear see your extended views of the different retirement options.

Acme

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57286 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 7:12 PM
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So if I save money that has already been taxed and take it with me to another country and invest it and spend it on living, I still owe taxes to the US? I belong to the gubmint?

That's not what was proposed. Hawkwin was saying to take your retirement accounts (that would not have been taxed) with you to another country and spend the money there without paying US taxes. That does not fly...

Acme

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57287 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 7:26 PM
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AcmeFool:

<<<<A national sales tax - like FairTax would also play havoc with those who planned on spending Roth IRA money without owing (or owing little in) federal income taxes.>>>>

"I take it from this (and other comments you have made) that you are not at all a fan of the Roth 401k."

Not a big fan. There is a reason that the cliche is a bird in hand is worth two in the bush.

"I would assume, however, that you think Roth IRA accounts are fine for people that are not eligible for deductible Trad. IRA contributions since there are no downsides to a Roth IRA compared to a taxable brokerage account."

Generally yes. If those are the only two choices, then it is one of the few no brainer questions in this area. It not entirely clear that a Roth IRA beats a buy and hold, regular account (as long as taxes on qualified dividends and LTCG remain low.

Ultimately, it is a pick your own poison scenario. My crystal ball is no better than anyone else's, and the actual outcomes will depend on changes made in the intervenign years (and which changes none of us can predict with anything near 100% accuracy).

I also supect (and posted elsewhere on TMF [and which you may have even seen]) that when Congress gets desperate enough for revenue, withdrawals from Roth IRAs and Roth 401ks will be tax like distributions from an after-tax traditional IRA ---- exempt to the extent of basis, with basis allocated over all withdrawals.

Currently contributing to 401-k and taking the current tax benefits, contributing to Roth IRA when eligible and funds are available, and holding tax deductible traditional IRAs from the old days, but never making an after-tax traditional IRA contribution because I do not want to fiddle with allocating basis.

Heging my bets, JAFO





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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57288 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 7:28 PM
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InvestMechanic:

<<<And I have no idea about what you mean when you write "still reaping the benefits of taking the tax deduction".>>>

"I must not have made myself clear. I was talking about the people who decided not to convert to a Roth IRA. They still take deductions every year."

If they are still taking deductions every year, then they are still making annual contributions, which is an entirely separate issue than converting or not converting existing IRA.

Regards, JAFO


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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57289 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 7:35 PM
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InvestMechanic: "So if I save money that has already been taxed and take it with me to another country and invest it"

If your investments make money and you are a US citizen, yes you might owe federal income tax to the USA. Much would depend upon the tax rate of the jurisdiction in which you were investing and the terms of any tax treaty in place between that jurisdction and the USA

"and spend it on living, I still owe taxes to the US? I belong to the gubmint?"

No income taxes on the money you are spending.

"How's a body to avoid paying US taxes anymore?"

Not be born in the USA, never become a citizen or resident of the USA, and never work in the USA.

"Where are the loopholes? I'm sure there are ways to get-er-done aren't there?"

Have no income, or at least no income above the amount of the sum of your personal exemption(s) and standard deduction. Also, no income tax on food you grow for your own consumption; also no income tax on the imputed rental value of owner-occupied housing.

Regards, JAFO





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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57290 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 7:46 PM
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It not entirely clear that a Roth IRA beats a buy and hold, regular account (as long as taxes on qualified dividends and LTCG remain low.

This does not make any sense to me. A Roth IRA cannot lose to a taxable brokerage account. Both are funded with money that has been taxed; as long as we trust the Congress not to change the tax law around Roth IRAs, there will never be any further taxes, but the brokerage account will definitely be taxed on the gains.

Let's assume we fund both accounts with $10K and some years later, they have grown to $30K. Let's further assume there were no distributions during the interim. With the Roth, we will have $30K free and clear; with the taxable brokerage account, we will have $30K minus the 15% taxes on the $20K gain -- so we have $27K. The Roth wins every time.

Am I missing something? If so, please correct my error.

Acme

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57291 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 8:52 PM
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AcmeFool:

<<<<It not entirely clear that a Roth IRA beats a buy and hold, regular account (as long as taxes on qualified dividends and LTCG remain low).>>>

"This does not make any sense to me."

My apologies; I do that sometimes.

"A Roth IRA cannot lose to a taxable brokerage account. Both are funded with money that has been taxed; as long as we trust the Congress not to change the tax law around Roth IRAs, there will never be any further taxes, but the brokerage account will definitely be taxed on the gains.

Let's assume we fund both accounts with $10K and some years later, they have grown to $30K. Let's further assume there were no distributions during the interim. With the Roth, we will have $30K free and clear; with the taxable brokerage account, we will have $30K minus the 15% taxes on the $20K gain -- so we have $27K. The Roth wins every time.

Am I missing something? If so, please correct my error."


You assumed away my primary concern. Under the current rules, you are correct. Given that I do not expect the current rules for Roth IRAs withdrawal to remain unchanged, I wrote my "not entirely clear" line. Of course, the income tax rules could change, too, especially WRT to qualified dividends.

The other issue is liquidity. You can access all your regular investment accounts but access to Roth is limited to contributions unless (i) you want to pay a penalty or (ii) you are old enough to avoid the penalty.

In part, I also like to hedge my bets by having mutliple pots of funds with different tax consequences, because regardless of what Congress ultimately does, one of the pots will likely be getting more favorable treatment.

Regards, JAFO







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Author: hockeypop Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57292 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/11/2007 9:03 PM
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>> What exactly is happening in 2010 with regard to Roth conversions? <<

1) Traditional IRA to Roth conversions will be allowed with no upper income limit.

2) The taxes due on the conversion can be delayed and spread out: half due in 2011 and half due in 2012.

Keep in mind that what Congress giveth, Congress can taketh away, and in theory the enabling legislation could be repealed before it takes effect. This president would surely veto such a bill to repeal it -- and there's no way Congress would have the 2/3 majority to override it -- but if the next president is willing to sign a repeal in 2009 and Congress wants to scrap it, they still can.

#29


Acme and Pete has been doing a great job of elaborating.

However, regarding Roth conversion in 2011, if you are at the 33% marginal tax level I doubt that the Roth conversion provisions will help you (you'll have to pay 33% on what you convert and it may put you in AMT land, if you aren't there now). That's IF the Congress keeps that provision, which I doubt.

I'd worry about understanding the other.

Hockeypop

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57293 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 8:35 AM
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However, regarding Roth conversion in 2011, if you are at the 33% marginal tax level I doubt that the Roth conversion provisions will help you (you'll have to pay 33% on what you convert and it may put you in AMT land, if you aren't there now). That's IF the Congress keeps that provision, which I doubt.

As usual, hockeypop puts out an excellent post. I would like to make 3 comments, however:

(1) Just to keep the confusion down, I want to correct the year -- the conversion strategy is for 2010.

(2) Only the gains will be taxable and count towards AGI since the only people that should employ this strategy are people with no deductible IRA contributions. Given the limited timeframe, we are talking about less than $10K for most people.

(3) I will be shocked if this provisions is taken away, for 2 reasons:
(3a) The projected budget shortfalls in 2011 and 2012 are quite significant. Before and after those years, things are not nearly as bad. This is a strategy for getting money in the specific years where it is needed most; and

(3b) Lots of people that have made deductible IRA contributions (or rolled over 401k plans, etc.) will not realize the trap they are falling into and will convert. This will further increase the tax revenues received. I suspect the Congress and the president understand this trap and want to see how it plays out.

Everyone has to take their chances and see how it works out. When I tell people about this, I give them full disclosure on the risks because, as you said, Congress/president can take it away. But I am investing in a non-deductible IRA for my wife for 2006-2010 with the intent of converting the money at the start of 2010. If it works out, great; if not, I feel like the risk was worth the potential reward for us.

Acme

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57294 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 8:46 AM
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You assumed away my primary concern. Under the current rules, you are correct. Given that I do not expect the current rules for Roth IRAs withdrawal to remain unchanged, I wrote my "not entirely clear" line. Of course, the income tax rules could change, too, especially WRT to qualified dividends.

Fair enough. But if they do change the rules, all bets are off. There is no way to even predict what they will change. As you mentioned, they could change all tax-law rules. In fact, if they make the kinds of changes to Roth accounts that we are talking about, I would be really surprised if they did not also significantly increase the LTCG rate and the dividend tax rate.

Personally, I would love to see us go to a national sales tax (I hate the name FairTax). I don't think it is perfect, but it does 3 things I like:

(1) It reduced complexity. The number of man-hours lost to tax filing is insane;
(2) It encourages savings; and
(3) It will increase tax revenues because people like drug dealers will now be forced to pay taxes when they buy things. (Yes, the underground black markets will grow, but there is little chance they will increase anywhere near as much as the new revenue base.)

Sorry if that's a bit off topic; I just think it is important enough to put out there when the conversation drifts close.

Acme

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57295 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 10:07 AM
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Acme: "(1) It reduced complexity. The number of man-hours lost to tax filing is insane;"

True...I assume that you will have your national sales tax on everything, including medical services, food, medicine?

The NJ tax code on 'what is taxable and what is not taxable' is over 300 pages. Same for most states.

Now, how do we handle business? Is something a business buys for internal consumption taxed? If they buy, let us say, a door for $100 that they add value to (let us say put on special hardware and finish) then sell it for $300, do they pay sales tax when they buy it, and your contractor pay sales tax on it when he buys it, and then you pay sales tax when you have him install it? ie, is everyone taxed, or is there a way to have the business get a tax rebate since it did not 'consume' the item?

And how many tens of thousands of pages will that run? And how much money will be tied up waiting for rebates? And how many people (millions ) will the gov't employ to process that paperwork?

HOw will you insure that folks don't create a business for themselves to get the 'tax exemption' as a middle man? ie, buy with intent to resell but never do?

How do you handle things like rentals? You rent an apartment. Do we tax your rent, at say 23%, the national sales tax rate? So you pay $1000 for rent, plus another $230 in tax. On your utility bills is another 23% tax.

Of course, state gov't who have 'income taxes' would change them to be higher state income taxes. That might have to be another 5 or 8% tacked on on top of the 23%, so you might have 35% tax levels. Many states now take a percentage of your fed tax bill, or your federal 'taxable income'...like VA was 6.25% of taxable income. SInce you wouldn't have to report that, they would just add another 5-8% sales tax (in addition to what they already have)....





"(2) It encourages savings; "

Maybe...but folks will still buy 'all they can afford' and 'all they can finance'.

This seems to be a no-brainer - it isn't going to happen. People can save now if they want. They just choose not to.

and
"(3) It will increase tax revenues because people like drug dealers will now be forced to pay taxes when they buy things."

No, people like drug dealers will still deal in the underground economy, set up phony businesses to allow for deductions...you'll get some additional consumption tax, but a lot of it won't be there.


"(Yes, the underground black markets will grow, but there is little chance they will increase anywhere near as much as the new revenue base.)"

Really? You'll likely be amazed at the 'cash economy' that happens...when the service man comes by your house, he can offer it two ways...you pay the 23% national tax plus 13% state tax, for a total of 36%, or he'll do it for 15% more than invoice, in cash...he pockets half the 'tax' amount, you only pay 15% more.....both of you come out ahead......... or he might just do it for invoice price IN CASH....

You'd have 20-30% of all business (like in Europe) done under the table.

There would be NO WAY to track it since no one would have any idea of who generated how much income. Business would not have to report income/loss. Contractors would not have to report income.

t.



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Author: ResNullius Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57296 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 11:00 AM
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True...I assume that you will have your national sales tax on everything, including medical services, food, medicine?

It's long overdue for sales taxes to be extended to services, what with our country becoming so service oreinted. I'm not for increased taxes, but I could support an extension of sales taxes to the service industry...lawyers, accountants, plumbers....



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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57297 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 11:15 AM
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"It's long overdue for sales taxes to be extended to services, what with our country becoming so service oreinted. I'm not for increased taxes, but I could support an extension of sales taxes to the service industry...lawyers, accountants, plumbers...."

You didn't asnwer the rest of the questions/comments.

If a plumber buys a water heater at a dealer supply place, does he pay sales tax when he buys it?

WHen he sells it to you, do you then pay sales tax again?

When the dealer 'bought' the water heater from the manufacturer, did he pay sales tax on the purchase?

If not, please explain how there is 'no paperwork' involved!

t.





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Author: stratton2 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57299 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 11:37 AM
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If not, please explain how there is 'no paperwork' involved!

What if it turns into "We assume you added value" and you have to fill out paperwork to prove you didn't add value? This is allegedly how VAT in the EU works. If it becomes so expensive to prove you didn't add value a national sales tax will add so much hidden cost into the system it will cripple our economy.

Paul

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57303 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 12:46 PM
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Paul:"
What if it turns into "We assume you added value" and you have to fill out paperwork to prove you didn't add value? This is allegedly how VAT in the EU works. If it becomes so expensive to prove you didn't add value a national sales tax will add so much hidden cost into the system it will cripple our economy."

You bet!

The National sales tax folks simply forget that there will be another setof equally complicated paperwork for business...

And that they will open two gigantic loopholes....people working off the books to save the National Sales Tax of 23% plus the state sales tax of 13-15% on top of that...... and people playing games with 'business purchases for resale'...

The gov't beaurocracy will be just as large.

The paperwork burden to business will be just as large.

Average tax payer, IF he/she has no rental income, no REIT investments, no MLP investments, no mutual funds, will have simple tax return. None..but if you have rental property, mutual funds, REITS, and MLPs, it gets complicated.....

Of course, 401Ks and IRAs go out the window....likely company matches too....

Now how do we track who is eligible for Social security? Reach 65, and apply for it? How about disability from SS? We have no way of knowing if you ever worked.......or need to work...if you don't need to work, you don't need disability.....

Ah, those 'minor' details....

Let's see.....if you buy some mutual funds, do you pay sales tax?

If you buy a condo to rent it out, do you pay sales tax?

Of course, the folks tell you if you buy a NEW house, you pay sales tax..but if you buy a used house, you don't...........

How about buying rental property?

t.



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Author: IndecisiveFool Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57305 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 3:06 PM
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If a plumber buys a water heater at a dealer supply place, does he pay sales tax when he buys it?

No.

WHen he sells it to you, do you then pay sales tax again?

Yes.

When the dealer 'bought' the water heater from the manufacturer, did he pay sales tax on the purchase?

No.

There are no sales taxes on business to business sales. It is not a value-added tax like in Europe. This subject has been mentioned a number of times on REHP board. You should consider reading about it someday.

http://www.fairtax.org






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Author: jg4 Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57306 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 3:39 PM
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JAFO,

also no income tax on the imputed rental value of owner-occupied housing.


I don't understand this. When would the imputed rental value of owner-occupied housing be taxed ? I live in the US in an owner occupied house and don't pay tax on the imputed rental value. I don't know for sure what imputed rental value means. Does it mean the rent I would pay for an equivalent house that I own ?

Thanks,
JG

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57308 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 3:49 PM
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The NJ tax code on 'what is taxable and what is not taxable' is over 300 pages. Same for most states.
...
And how many tens of thousands of pages will that run? And how much money will be tied up waiting for rebates? And how many people (millions ) will the gov't employ to process that paperwork?


All of this is covered very clearly in the available literature. Read up and you'll know that this system is significantly simpler than any state-based sales tax.



How do you handle things like rentals? You rent an apartment. Do we tax your rent, at say 23%, the national sales tax rate? So you pay $1000 for rent, plus another $230 in tax. On your utility bills is another 23% tax.

The 23% is included in the price of goods -- if you are charged $1000, the tax is included. You do not have a fee and then add 23% on top.



Of course, state gov't who have 'income taxes' would change them to be higher state income taxes. That might have to be another 5 or 8% tacked on on top of the 23%, so you might have 35% tax levels. Many states now take a percentage of your fed tax bill, or your federal 'taxable income'...like VA was 6.25% of taxable income. SInce you wouldn't have to report that, they would just add another 5-8% sales tax (in addition to what they already have)....

And your point is?

Eliminated state income taxes and replacing them with sales taxes does not mean that you are now paying more to the state.



Maybe...but folks will still buy 'all they can afford' and 'all they can finance'.

This seems to be a no-brainer - it isn't going to happen. People can save now if they want. They just choose not to.


You completely ignore psychology.

Currently, you will pay the same in taxes whether you spend all of your money or save all of your money. With a national sales tax, this would not be the case. The psychology of saving is strong in this system.

There is significant proof (from the experiences of other countries) that using a national sales tax promotes savings that income taxes do not.



No, people like drug dealers will still deal in the underground economy, set up phony businesses to allow for deductions...you'll get some additional consumption tax, but a lot of it won't be there.

Again, there is significant proof that sales tax systems lose less to underground and illegal portions of the economy than do income taxes.

Acme

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57309 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 3:55 PM
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You should consider reading about it someday.

It really is blatantly clear from his criticisms that he has not read the extensive literature on the proposed system of taxation. And it's a shame because he makes intelligent sounding arguments that convince a lot of people that a sales tax is a bad idea...but his arguments are meaningless since they do not apply.

Acme

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Author: whyohwhyoh Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57310 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 4:01 PM
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Doesn't a higher sales tax hurt most those that are retired and lower income, like $40k/year. They pay little to no taxes due to standard deductions, and low initial tax bracket. Dividends I beleive are taxed at 5% for them as well.

Then they will all of a sudden be hit with much higher priced goods.

--
whyohwhyoh

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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57312 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 4:35 PM
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Doesn't a higher sales tax hurt most those that are retired and lower income, like $40k/year. They pay little to no taxes due to standard deductions, and low initial tax bracket. Dividends I beleive are taxed at 5% for them as well.

Under the proposed system, everyone would receive a check that covers the tax on a subsistence level of goods and services (that level would vary by area of the country). Most people that do not pay any taxes today would not pay any taxes under the proposed sales tax.

Acme

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57313 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 4:41 PM
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Doesn't a higher sales tax hurt most those that are retired and lower income, like $40k/year.

Bingo. A sales tax is regressive. The more you make, the smaller your taxes are as a percentage of your income. It is not based on your ability to pay the tax, it is based on your need to consume goods (and possibly services).

Personally, I find the current tax system is pretty fair. Unlike the FairTax, which I believe is quite unfair.

--Peter

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Author: bighairymike Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57318 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/12/2007 5:35 PM
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I also supect (and posted elsewhere on TMF [and which you may have even seen]) that when Congress gets desperate enough for revenue, withdrawals from Roth IRAs and Roth 401ks will be tax like distributions from an after-tax traditional IRA ---- exempt to the extent of basis, with basis allocated over all withdrawals. - JAFO

---------------------

There is nothing I would not put past congressweasels in their constant search for money to pander for re-election, BUT I find some solace in that I am not required to track the basis of my Roth. So if they do go after the large pot of money setting in Roth accounts, it is more likely the weasels will declare a date after which any growth will be taxable when withdrawn. Thus I am endeavoring to shift IRA money towards the Roth each year up to the limit of the 15% bracket.

I think it is best to have a mix of IRA, Roth, and after tax accounts so one can optimize your withdrawal strategy based on the whatever changes the weasels periodically come up with.


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Author: AcmeFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57336 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/13/2007 11:04 AM
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Bingo. A sales tax is regressive.

This is NOT inherrently true. State sales tax programs are regressive, but that does not have to be the case. The (horribly named) FairTax is not regressive in nature because of the rebate checks that everyone receives regardless of income or spending level.

Calling sales taxes regressive is the kind of quick one-liner that does a disservice to everyone.

Acme

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Author: ziggy29 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57337 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/13/2007 12:55 PM
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>> This is NOT inherrently true. State sales tax programs are regressive, but that does not have to be the case. The (horribly named) FairTax is not regressive in nature because of the rebate checks that everyone receives regardless of income or spending level. <<

Not only that, but most sales taxes exempt food. Some also exempt items like clothing and medicine. Since the lower-income households tend to spend most of their money on these "essentials" -- which are often not taxed -- it's not a foregone conclusion that they are spending a greater percentage of their income on sales tax.

Just the same, any such concern can be alleviated with some form of a rebate to offset the first $X typically spent on sales taxes. It's sort of like creating a 0% bracket in the federal income tax through the standard deduction and personal exemptions.

#29

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Author: Hawkwin Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 57407 of 75820
Subject: Re: Are retirement accts really the best strateg Date: 5/14/2007 8:48 AM
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I think that you are being facetious, but USA citizens owe US income tax on their world-wide income regardless of where they reside.

I was. Note the smiley with tongue stuck out: :P

My "plan B" is more to give up my citizenship and just not return to the states.

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