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Tax Deferred Investing: The Unexpected Tax Trap

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Don't get me started on quotes:

Mark Twain said: What is the difference between a taxidermist and a tax collector? The taxidermist takes only your skin.

Will Rogers: The only difference between death and taxes is that death doesn't get worse every time Congress meets.
 

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13 hours ago, tony said:

You make me laugh  too Steve. I never thought I would hear anyone say how grateful they are to pay taxes. 🙂

I pay so little in investment costs, that alone, pays for the taxes, new cars, remodeling, giving and traveling. Of course, the returns help but I cannot control returns, nobody can. 

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Folks with pensions are well served to consider how the pension income and social security will affect their tax brackets and their Traditional/Roth mix. To the extent that people take that great advice, this article is wonderful. To the extent that people walk away thinking Roths are clearly the way to go, this article isn't so awesome.

On 2/6/2019 at 11:56 AM, sschullo said:

the article debunks the long-held view that our incomes will be lower in retirement than while working.

The strength of this statement isn't in line with the rigor of the article.

The article relied on an entirely hypothetical scenario rather than real world data. They presented us with a hypothetical person who spends well under 90k per year (salary is 90k, they're investing money, and they're paying taxes) and we're told they'll earn 80k through their pension and social security. Well of course that person wouldn't see the benefit (and will likely be hurt) of a traditional retirement account!

You know what else this hypothetical person was hurt by? Working much longer than they needed to and/or living most of their life with a lower standard of living than they could have afforded...and apparently will afford in retirement (assuming they're healthy enough to).

On 2/6/2019 at 4:15 PM, tony said:

This is why I stopped investing in tax sheltered investments the minute Roth 403b 's /457b Roths became  available and why I have money in Roth IRA's and taxable accounts and  why I suggest going Roth all -the -way to the new folks. I know some may disagree based on math projections but who cares about the math projections.

Obviously I care about math as we all should 🙂 . Roth investments are superior when:

1) You are going to have more income in retirement than you did when working. Everybody has different goals, but I think most people who could potentially fall into this scenario would be happy to avoid it by retiring earlier and/or increasing their standard of living during their working years.

2) You are currently in an artificially low tax bracket. Maybe you're a doctor in residency, maybe you worked a couple months of the year before taking a break from working, maybe you're a poor teacher getting ready to marry a CEO, etc.

3) You are willing to bet on or hedge against much higher taxes by the time you hit retirement.

On 2/6/2019 at 4:15 PM, tony said:

If you pay the taxes along the way you don't get straddled with huge tax hits and  don't suffer the shock and trauma of having to pay huge amounts of taxes at a time when you are not working.

I understand there is a psychological effect of paying taxes at the end, but as we both know a Roth doesn't avoid taxes...it saddles you with a likely larger tax bill every year leading up to retirement.

On 2/6/2019 at 4:15 PM, tony said:

Won't our RMD's be taxed as income?

Any money you take out of a traditional retirement account will be treated as ordinary income.

On 2/6/2019 at 8:56 PM, MNGopher said:

I plan to retire at 57 or 58, with the help of taxable savings between age 57-59.5, 403 B between 59.5 and full retirement age (67), and Roth whenever extra is needed.

I'd have to google the ins and outs of a 403b, but I figured I'd point this out...

With IRAs at least, you can retire as early as you want and access the money WITHOUT paying the penalty. I can't remember the section of the tax code, but I think you basically start taking RMDs early. So the odds are you don't have to rely on your taxable account to fully fund an early retirement. I think can probably use your 403b in early retirement to fill up the lower tax brackets (and maybe even convert some of it to a Roth).

On 2/7/2019 at 6:57 PM, tony said:

If you expect to to have more income in Retirement than you had while on the job, it's a tax trap to go 403b tax deferred and should go Roth.

I'd modify that slightly...

In an ideal world we'd save exactly the right amount in a traditional account to fill up our future tax brackets that are less than or equal to our current top marginal tax bracket and then we'd put everything else in a Roth account.

20 hours ago, tony said:

You make me laugh  too Steve. I never thought I would hear anyone say how grateful they are to pay taxes. 🙂

As much as my Republican friends and the ghost of Reagan would vehemently disagree, I'm with Steve on this one.

Nobody wants to pay money and nobody wants to waste money, but In my mind at least, tax day is the true celebration of America (not the 4th). Nothing is more patriotic than getting hundreds of millions of people on the same page to pool our resources for the common good because without it we wouldn't have a nation. I don't like that this part of civic life is viewed as awful.

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17 minutes ago, EdLaFave said:

 

April 15 is sooner than July 4th. I vote with Steve!

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4 hours ago, EdLaFave said:

Folks with pensions are well served to consider how the pension income and social security will affect their tax brackets and their Traditional/Roth mix. To the extent that people take that great advice, this article is wonderful. To the extent that people walk away thinking Roths are clearly the way to go, this article isn't so awesome.

The strength of this statement isn't in line with the rigor of the article.

The article relied on an entirely hypothetical scenario rather than real world data. They presented us with a hypothetical person who spends well under 90k per year (salary is 90k, they're investing money, and they're paying taxes) and we're told they'll earn 80k through their pension and social security. Well of course that person wouldn't see the benefit (and will likely be hurt) of a traditional retirement account!

You know what else this hypothetical person was hurt by? Working much longer than they needed to and/or living most of their life with a lower standard of living than they could have afforded...and apparently will afford in retirement (assuming they're healthy enough to).

Obviously I care about math as we all should 🙂 . Roth investments are superior when:

1) You are going to have more income in retirement than you did when working. Everybody has different goals, but I think most people who could potentially fall into this scenario would be happy to avoid it by retiring earlier and/or increasing their standard of living during their working years.

2) You are currently in an artificially low tax bracket. Maybe you're a doctor in residency, maybe you worked a couple months of the year before taking a break from working, maybe you're a poor teacher getting ready to marry a CEO, etc.

3) You are willing to bet on or hedge against much higher taxes by the time you hit retirement.

I understand there is a psychological effect of paying taxes at the end, but as we both know a Roth doesn't avoid taxes...it saddles you with a likely larger tax bill every year leading up to retirement.

Any money you take out of a traditional retirement account will be treated as ordinary income.

I'd have to google the ins and outs of a 403b, but I figured I'd point this out...

With IRAs at least, you can retire as early as you want and access the money WITHOUT paying the penalty. I can't remember the section of the tax code, but I think you basically start taking RMDs early. So the odds are you don't have to rely on your taxable account to fully fund an early retirement. I think can probably use your 403b in early retirement to fill up the lower tax brackets (and maybe even convert some of it to a Roth).

I'd modify that slightly...

In an ideal world we'd save exactly the right amount in a traditional account to fill up our future tax brackets that are less than or equal to our current top marginal tax bracket and then we'd put everything else in a Roth account.

As much as my Republican friends and the ghost of Reagan would vehemently disagree, I'm with Steve on this one.

Nobody wants to pay money and nobody wants to waste money, but In my mind at least, tax day is the true celebration of America (not the 4th). Nothing is more patriotic than getting hundreds of millions of people on the same page to pool our resources for the common good because without it we wouldn't have a nation. I don't like that this part of civic life is viewed as awful.

 

True, but I have more in taxable then 403B (because of bad 403B choices most of my career), so I figure I might as well spend that first (pre 59.5).

 

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20 hours ago, Admin said:

Great discussion. It was asked if this was a new article by Joel and it is. - Dan 

Thanks Dan for answering my question. 

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