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Tax deferred accounts…

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  • Avatar deanyar 
    Participant
    Status: Physician
    Posts: 26
    Joined: 03/06/2019

    Help!  Can someone please, in simple terms, explain how a tax deferred account works?

    I am in my mid 40s, mid career, and have a tax deferred account (a money purchase pension plan that my group contributes to, for the past almost 10 years).  It has been under the management of an advisor up to this point, but now I have liquidated the assets into cash to prepare them to be transferred (probably to Fidelity) and then re-allocated.

    Just to be clear, there are no tax implications for selling funds that have capital gains in a deferred account, right (I mean, after all, they are sheltered from taxes, right)?  In other words, I did not screw myself by liquidation these funds?

    Also, when time comes to withdraw these accounts, how are they eventually taxed in the end? This is what is fuzzy for me right now. Do capital gains ever matter?  Now that I am writing, I vaguely remember that once I retire, I can perhaps roll this fund over into another account, maybe an IRA…

    As always, thanks!  We all learn so much from each other!  I appreciate it!!

    Dean

     

    #232750 Reply
    Avatar jhwkr542 
    Participant
    Status: Physician
    Posts: 1312
    Joined: 02/15/2016

    When you defer your income, you pay no federal or state income tax (fica taxes are paid though). While inside the account, there are never taxes on gains or dividends. When qualified withdrawals are taken, the entirety of withdrawal is taxed as ordinary income. So you do pay tax on what you initially contributed, hopefully at a lower income tax rate. Feel free to trade inside a tax deferred (or Roth) account at will without tax implications on trades. This is why many people put bonds in tax deferred accounts, so they don’t pay tax on dividends.

    #232763 Reply
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    Avatar deanyar 
    Participant
    Status: Physician
    Posts: 26
    Joined: 03/06/2019

    Thanks – that makes sense to me.  That is what I understood before.

    I got into an online discussion with someone about tax deferred vs Roth IRA accounts, and it regarded tax location of bonds. He was telling me that bonds are better suited for tax deferred accounts because the Roth is more valuable tax-wise – and his explanation was that the GROWTH on the tax deferred account would eventually be taxed.  Growth to me sounds like cap gains, which certainly is NOT the case!  But if it is taxed as income, the growth (in my thinking) is irrelevent.  Shouldnt the tax deferred and Roth accounts almost be similar in their implications except the tax deferred is taxed as income once withdrawn?

    Maybe this is a classic case of me overthinking the issue…

    Dean

    #232770 Reply
    Lordosis Lordosis 
    Participant
    Status: Physician
    Posts: 1807
    Joined: 02/11/2019

    There is a portion of your tax deferred account that is not yours but belongs to the government though future taxes.  The bigger the account through contributions and gains the bigger the government part as well.

    Roth is all yours so it does not matter how much it grows.

    People make a big deal about bonds in roth vs deferred but it is just a cheap trick to get you to invest a little more aggressively.  There is no free lunch having high risk funds in Roth.  You are just playing with a larger pot of future money.

    “Never let your sense of morals prevent you from doing what is right.”

    #232772 Reply
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    Avatar jhwkr542 
    Participant
    Status: Physician
    Posts: 1312
    Joined: 02/15/2016

    I got into an online discussion with someone about tax deferred vs Roth IRA accounts, and it regarded tax location of bonds. He was telling me that bonds are better suited for tax deferred accounts because the Roth is more valuable tax-wise – and his explanation was that the GROWTH on the tax deferred account would eventually be taxed.

    This is correct. No growth on Roth money. Tax deferred contributions=traditional contributions. Everything (original contributions, dividends, capital gains) is taxed on withdrawal at ordinary income tax rates. No tax implications on trading. Roth contributions for any account are funded with post-tax dollars and nothing is ever taxed again.

      Growth to me sounds like cap gains, which certainly is NOT the case!  But if it is taxed as income, the growth (in my thinking) is irrelevent.  Shouldnt the tax deferred and Roth accounts almost be similar in their implications except the tax deferred is taxed as income once withdrawn?

    Not necessarily. If you have $10k in a tax deferred account and $10k in a Roth account and they both double in size, the Roth account is worth more because that money won’t be taxed. If you have 2 investments and one of which is intended to grow faster, you’d put that into the Roth to minimize tax on withdrawal.

    #232790 Reply
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    Kon Litovsky Kon Litovsky 
    Participant
    Status: Financial Advisor
    Posts: 920
    Joined: 01/09/2016

    Help!  Can someone please, in simple terms, explain how a tax deferred account works?

    I am in my mid 40s, mid career, and have a tax deferred account (a money purchase pension plan that my group contributes to, for the past almost 10 years).  It has been under the management of an advisor up to this point, but now I have liquidated the assets into cash to prepare them to be transferred (probably to Fidelity) and then re-allocated.

    Just to be clear, there are no tax implications for selling funds that have capital gains in a deferred account, right (I mean, after all, they are sheltered from taxes, right)?  In other words, I did not screw myself by liquidation these funds?

    Also, when time comes to withdraw these accounts, how are they eventually taxed in the end? This is what is fuzzy for me right now. Do capital gains ever matter?  Now that I am writing, I vaguely remember that once I retire, I can perhaps roll this fund over into another account, maybe an IRA…

    As always, thanks!  We all learn so much from each other!  I appreciate it!!

    Dean

     

    Click to expand…

    If you have an existing plan, one can’t do a rollover unless you are terminated, or reach normal retirement age. You can’t just take assets in a plan and roll them elsewhere.  So if you have a pooled plan for example, you can’t just open a self-directed brokerage account for yourself unless the plan allows this for all participants. I’m assuming that the plan allows self-directed brokerage accounts, which is the only way I can interpret what you are doing, but that creates other issues.  If you have NHCE participants (non-partners), you can’t just keep them in a high expense pooled plan (or a high expense participant-directed plan) while the partners go to Fidelity/Vanguard and open self-directed brokerage accounts there to invest in low cost index funds.  I see all types of things happening with group practice plans, resulting in issues which can be easily avoided:

    How to Have the Best Group Practice Retirement Plan

    Money purchase plan is very much obsolete, so this type of plan should be upgraded to a 401k with profit sharing plan, and if you have a pooled plan, instead of doing to SDBAs, you should consider setting up a participant-directed plan (so that any SDBAs are within the plan, if you decide to have any available for participants).  There are a lot less issues with participant-directed plans vs. SDBA plans, and you really don’t want to deal with the complexity of having everyone set up their own account vs. having a single fund menu and having all accounts set up at the same record-keeper (and especially if the practice has any non-partner staff).  One thing to remember is that if you are a partner in a group, all retirement plan issues are a problem for all the partners in a group, so even if just one partner does something really wrong, the whole group is responsible for fixing this mistake (and paying any penalties).

     

    Kon Litovsky, Principal, Litovsky Asset Management | [email protected]
    -401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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