Hi, new to the boards here, but Fool member since '07. I am 32 years old and over the past 7-8 years I have socked away a solid chunk into my 401k and Roth IRA each year. In fact, I was fortunate enough to put in the max allowable amount in 401K for 5 or 6 of those years (along with a generous match). I also maxed out my Roth. I have since switched jobs with an increased salary and my ultimate goal is to retire by 45 or 50. Basically, how do I balance my contributions to my new 401K versus personal brokerage accounts? I think since I did so well in contributing when I was young, that my 401K balance will be in a good position by the time I'm actually able to withdraw. My goal now is to bridge the gap between my retirement age goal and the age at which I can withdraw. Any suggestions/rules of thumb on how to make this work? How much is too much now in my retirement accounts if I wish to achieve this goal?
The answer depends upon your income goals, current value in sheltered/not-sheltered accounts, expected sheltered/not-sheltered return, expected tax rate, and inflation.Given the expected returns calculate the level of assets necessary for your desired income in each asset class (tax sheltered/not-sheltered) by year, then adjust principle in each class until the numbers work and you have your answer. Best done in a spreadsheet.Don't forget the after 70 RMD.Jack
I think it's great that you are thinking about this now. To find out how to balance contributions you will need to make a projection into the future at various ages. How much $ will you need when you retire @ 45? or @ 50? Remember to account for inflation and changes in personal circumstances (new house, spouse, children, boat...)Also, what is the projected balance of your new 401k, Roth IRA and any other accounts where you are setting aside money for retirement? You will need to research and keep up with the rules of withdrawing money for each of the accounts. Key ages are 55, 59-1/2 and 70. As for rule of thumb, if your new 401k offers a match, contribute as much as you need to get the full match. If you haven't rolled over your old 401k, consider carefully whether rolling over to the new 401k is better than rolling over to a Traditional IRA. Lastly, living below your means will make it easier to retire earlier.- zol
The nice thing about IRA & 401K is the tax deferral. The bad thing is that you'll pay ordinary income tax rates on withdrawals. Plus the bit about not being able to easily take withdrawals until you are 59 1/2.The nice thing about taxable accounts is that you pay capital gains tax rate on withdrawals. Also you can withdraw at any time. You also effectively get the same tax deferral as you do in an IRA/401k -- if you buy&hold.I think the best savings order is:1) 401k, only as much as you need to get the entire employer match.2) Roth IRA.3) VTI or VOO or SPY in taxable account(s)When we were checking our accounts with a couple of FAs before we retired, they indicated that they saw a lot of people who had much more in retirement accounts than in taxable accounts, and this caused some difficulties in takng optimum withdrawals.
The nice thing about IRA & 401K is the tax deferral. The bad thing is that you'll pay ordinary income tax rates on withdrawals. Plus the bit about not being able to easily take withdrawals until you are 59 1/2.The only difference between the return of a Roth IRA and standard IRA return is due to any differences in the income tax rate when income taxes are paid. Assuming the contributions, returns, and duration are the same regardless of the type of IRA. Here's the math:Y = years heldC = contributionT = tax rate so (1-T) = after tax retained valueR = Return rate so (1+R) = after return retained valueStandard IRA (pre-tax contribution): Value = (C * (1+R)^Y ) * (1-T)Roth IRA (post-tax contribution): Value = (C * (1-T) ) * (1+R)^YSince multiplication is associative the equations are the same.Jack
The only difference between the return of a Roth IRA and standard IRA return is due to any differences in the income tax rate when income taxes are paid. Yup.The other difference is that regular IRA has an RMD after you are 70 1/2 and a Roth doesn't.In the 2-3 years before I retired (early), when I was planning for the retirement I put every penny I could into my 401K. Knowing that my current rate was 25% and my retirement rate would be 15%.The primary reason (in retirement) for converting regular IRA to Roth is: to reduce the RMD that's coming up pretty soon. That may or may not be advantageous to you, depends on your personal situation.And you can pay the tax with outside dollars and effective move more money into the Roth than you took out of the IRA. I think -- it's easy to get lost in that math.And if you think there's a realistic chance than you may be going from filing joint to filing single, probably best to pay tax now at the joint rate than later at the single rate.
The other difference is that regular IRA has an RMD after you are 70 1/2 and a Roth doesn't.Thanks,Didn't know that, I only have standard IRAs.And you can pay the tax with outside dollars and effective move more money into the Roth than you took out of the IRA. I think -- it's easy to get lost in that math.The taxes are the same, you pay the taxes now and get fewer tax free dollars later, or pay the taxes later on the principle and return. It's a wash.Jack
I think the best savings order is:1) 401k, only as much as you need to get the entire employer match.2) Roth IRA.3) VTI or VOO or SPY in taxable account(s)I'd add to option 2, standard IRAs as well.
And if you think there's a realistic chance than you may be going from filing joint to filing single, probably best to pay tax now at the joint rate than later at the single rate.Unless you have some secret or both go at the same time, someone in a couple will end up at the single rate.
I'd add to option 2, standard IRAs as well. If your company offers a retirement plan at work, your IRA contributions probably aren't tax-deductible (depends on your income). Putting post-tax money into a standard IRA creates an accounting nightmare when you withdraw -- and you get punished by the way they (IRS) account for it.
I've been wondering this myself, and this also got me thinking about the tax implications of our current balance of tax-deferred accounts vs taxable, once we do start living off our investments. A little pre-planning can't hurt. A lot of this is not applicable to your situation, but maybe it will give you some ideas on things to consider.Other than an emergency fund, we have no significant investments outside of retirement vehicles. My wife and I are both 52, substantially older than you. I'm already retired, but my wife intends to work to age 60-65, in order to keep healthcare benefits. By waiting until after 60, allows us to take qualified distributions, once we are fully retired. We currently live off of her income and pretty much max out contributions to her 401(k) and both of our Roth IRAs. Doing our investments in IRAs/Roths has certainly simplified our taxes, as we don't need to worry about capital gains/losses.This morning, I created a very simple spreadsheet for myself, to hopefully provide a clearer picture of what our retirement might look like including income and taxes we will pay. I chose age 62 as our retirement goal (first we could take social security) and provided estimates for each of our retirement account balances, based on current balances, continued contributions and expected returns. Very round numbers and very prone to error, as we don't know what returns will be over the next 10 years.So, first column is estimated balance at age 62 for each account.Second column is expected income (distribution) from each retirement account - currently set to 3% of each balance, but these could be adjusted for tax reasons. This column also includes Social security benefits assuming we take them at age 62. Next column is taxable portion of each. If I understand correctly, our income will be high enough that 85% of our social security income will be taxable. I'm estimating a 15% effective tax rate on our taxable income, based on past experience. I suppose we could draw more from our Roth IRAs first and keep the distributions from our traditional IRAs and 401(k) plan initially lower, in order to reduce our taxes the first few years, but eventually, we would need to start drawing more from the other plans, as our Roths get depleted and definitely when the RMD kicks in at 70-1/2.Now, back to your situation:The rules for Roth IRAs do allow for withdrawal of contributions at any time, but withdrawals of any earnings must be made after age 59-1/2 and at least 5 years after the first contribution (if I understand correctly) to avoid penalty - so that would give you some money you could draw on at your early retirement age, but probably not a whole lot. Maybe 20 years of contributions maxing out at $5000/year = maybe $100,000 you could withdraw without penalty. Not much to live on from 50-60. So, sounds like you will need some significant savings/investments outside of retirement investments. Maybe 8-10x annual expenses in order to allow for some bad years? Maxing out the Roth would still be worthwhile and getting the match on the 401(k) plan, definitely. Perhaps invest the rest in your standard brokerage accounts, but you'll probably want to limit your trading to avoid realizing capital gains, and will of course owe taxes on any dividends, as well.Try to make some conservative estimates of what your retirement accounts might be worth (and what kind of income they might throw off) at the point you can start taking distributions without penalty, and see if the numbers look reasonable. Make some allowance for inflation. If the numbers don't look like something you can live with, you may not be able to retire at 45 or 50.
It's a wash. As you noted upthread, it's not a wash if your tax bracket changes in retirement, which it does for almost everyone.Typically, in your earning years you are in a higher marginal bracket, making it better to hide money from the tax man at that point. In your retirement years you are quite likely to be in a lower marginal bracket, making it better to pay taxes then.Personally, I have gone from the highest possible bracket during my peak employment to either the lowest, or zero in a few years by arrangement of my income. I am getting close to the point where I will have RMD's, but even so the tax bite will be far lower than it would have been 20 years ago.
It's a wash.As you noted upthread, it's not a wash if your tax bracket changes in retirement, which it does for almost everyone.This distinction, that the only return difference between Roth and standard IRAs are the tax brackets when the contribution was made compared to the tax bracket when the withdrawal was made was the point of the entire sub-discussion. Thank you for clarifying.
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