[Editor's Note: This post is republished from WCI Network partner, Physician on FIRE.]No, Loonie Doc, I’m not talking about your loonie Canadian dollar. Nor am I referring to the measly seventy cents or so that the New Zealand and Australian dollars are now worth (in 2018). This article has nothing to do with exchange rates. Although, friends, it is true that my money is worth more than yours.
Today’s post is focused on the value of the American dollar in various retirement accounts. While I have seen a few very detail-oriented people adjust their net worth based on where their money is held, most of us — myself included — just add up the value of all the accounts to arrive at the total. Is that the best approach?
When a Dollar is Not a Dollar
If you’ve been earning and investing for a while you most likely have money in a variety of account types. Some of those dollars are inherently worth more than others, depending on the current and future tax treatment. Let’s take a look at each of those dollars, from the most to least valuable.
Roth Dollars
Roth dollars are the most valuable dollars you can have. If they were a day of the week, they’d be Saturday. You’ve already paid tax on them, and they will continue to grow tax-free until you use them. These dollars have a value of $1.00. The Roth dollars also benefit from being sheltered from required minimum distributions (RMDs).
While it may not be ideal to make large Roth investments when you are in a high-income tax bracket, particularly if you anticipate a lower tax bracket in retirement, Roth dollars are sure great to have. If nothing else, contribute to a backdoor Roth for yourself and your spouse, if you’ve got one.
I made one small Roth conversion as a resident, a Mega Roth conversion as an attending, and have made backdoor Roth contributions for several years.
30% of our dollars are Roth dollars.
HSA Dollars
Dollars in a Health Savings Account (HSA) are the next best thing. They’re like Sunday; it’s still the weekend, but not as enticing as Saturday. When used for healthcare costs, the dollars in an HSA act just like Roth dollars.
Even better, you received a tax deduction when you put those dollars in the account. In the year that you contribute, you could say these dollars are better than Roth dollars, but after you’ve received that deduction, the dollars remaining are at best equal to Roth, and at worst equal to tax-deferred dollars.
There a couple ways to use your HSA dollars to cover healthcare expenses. One tactic is to use the account to pay for healthcare expenses when they are incurred. A second option is to save receipts, allow your HSA account to grow tax-free for years, then take a large reimbursement for the sum of the receipts after collecting them for years or decades.
The latter approach, saving receipts, has the potential to work out in your favor. You receive the benefit of tax-free growth of dollars that are not withdrawn when the bill arrives. I’ve begun to implement this strategy, and I’m not convinced the record keeping is worth the small benefit. I’ll probably continue to save receipts until we pack up for our next adventure, and then cash in.
[Post-publication edit: I’ve cashed in and now choose to pay as we go. It’s a tiny portion of my portfolio and saving and tracking receipts is something I found to be cumbersome, but I do understand the benefit of doing it the other way.
I don’t pay directly from our HSA, though. I first put our healthcare expenses on a rewards credit card and then reimburse myself from the HSA. I think getting free travel is a bigger benefit than avoiding a bit of tax drag on this small portion of my money.]
If you end up with more HSA dollars than you can use for healthcare (not bloody likely), you can use the account like a traditional IRA at age 65. The money can be withdrawn penalty-free for any reason, but you will pay income tax if it not used to pay for healthcare expenses. Note that HSA money cannot pay for health insurance premiums, but can cover out-of-pocket costs and a lot of other expenses, like orthodontics and eyeglasses.
Flex Savings Account (FSA) dollars can be viewed like short-term HSA dollars, but typically must be used up by the end of the calendar year.
1% of our dollars are HSA dollars.
0% of our dollars are in Swedish krona
Taxable Dollars
“Taxable” sounds bad and expensive, just as “spinal” anesthesia sounds barbaric and scary. The truth is far from the implication from the off-putting word in both cases. Dollars in a taxable account are great dollars to have, and a spinal anesthetic, given below the level of the spinal cord, is often the safest and least invasive anesthetic option.
Taxable dollars are like Friday — part weekday, part weekend. You’ve already paid taxes on these dollars once, and the worst you’ll do is pay some tax on the growth of these dollars. At best, “taxable” dollars can be treated the same as Roth dollars.
How are taxable dollars taxed? If they earn interest in a savings account, the interest is taxed as ordinary income. If you sell a stock or mutual fund that has grown in value, you may owe some taxes on the gains. The same is true for dividends. Gains on equities held at least a year are treated more favorably, as are qualified dividends (as opposed to ordinary, non-qualified dividends).
The more gains you have, the lower the potential value of your taxable dollars. An equity purchased for $100 and worth $100 is currently worth more to you than an equity purchased for $10 and now worth $100. There are methods to avoid taxes on those gains, but some are not pretty (death) and some could be eliminated with a change in the tax code.
How can taxable dollars be as good as Roth dollars? A few conditions have to be met, but it is possible.
First, you must have a taxable income that keeps you in the 0% long term capital gains / qualified dividend tax bracket, which is about $77,000 for a couple in 2018 — a feat easily achieved by an early retiree.
Second, the investment must not spin off ordinary dividends or short-term capital gains. Passive index funds are good choices to meet these criteria. Growth stocks tend to pay fewer dividends, and Berkshire Hathaway famously pays none. Finally, your state of residence must treat gains the same way the federal government does. Not all of them do.
52% of our dollars are taxable dollars.
Tax Deferred Dollars
The final category contains your least valuable dollars. Monday dollars. While you have every reason to put as much as you can into tax deferred accounts when you earn a physician’s salary, the dollars won’t be worth as much as those above when it comes to retirement.
These dollars have not yet been taxed, but when accessed in retirement, you can bet your bottom dollar that they will be. These dollars can be held in a variety of numbered and acronymed accounts, each of which behaves a bit differently, but they all have one thing in common: income tax will apply.*
Unfortunately, many retirees will have most or nearly all of their dollars in tax deferred accounts. This isn’t an inherently bad problem, particularly if the balances are sufficiently large, but if you’re relying solely on tax deferred dollars to fund your retirement, your dollars won’t go as far as any of the other dollars we’ve discussed. If your total tax in retirement is 15% to 25%, your tax deferred dollar is worth 75 to 85 cents.
17% of our dollars are tax-deferred dollars.
Other Dollars
I’ve ignored other dollars thus far because I’ve already accounted for 100% of our retirement dollars. Other dollars would include pensions, which is a complicated topic recently covered by the Financial Samurai.
He frequently discusses real estate, too; we do not own investment real estate, but there are ways to own real estate or real estate funds in all of the account types listed above. We currently have a handful of investments in crowdfunded real estate in our taxable account. You can also hold real estate investments in a self-directed IRA.
Annuities can also be held inside and outside of retirement accounts. Cash value life insurance is something I have stayed away from and probably doesn’t deserve my attention (or yours).
Social Security is a benefit we Americans who have worked our 40 quarters can expect to collect at some point. I’m nearly 30 years away from collecting if the rules remain constant over those three decades. I have no idea how to value this benefit with so much time remaining. I expect we will receive a benefit and will treat it like an added bonus when the day finally comes.
Are My Dollars Worth More Than Your Dollars?
bad dog
Probably. With more than 80% of my retirement dollars residing in post-tax accounts, I’m in pretty good shape. If the situation were inverted, and more than 80% of my retirement dollars were living in tax-deferred accounts, those dollars simply wouldn’t go as far in retirement. The latter is a common situation. Certainly, some of you will have an even higher percentage in Roth and taxable accounts. You win! Someone will always have a higher income, a nicer home, a more ideal asset location ration, or a better behaved dog. Actually, the vast majority of you probably have a better-behaved dog, if you have a dog.
So what?
I don’t think we need to go to any great length to devised a formula or conversion factor for the different types of dollars we have. There are just too many variables. Even if the tax laws stay forever unchanged — they won’t — our circumstances will change. I could pay between 0% and 40% on the dollars I withdraw from tax-deferred accounts depending on what happens in coming years. Income can change, deductions will graduate and leave the nest, even **gasp** filing status can change.
I do think it’s worthwhile to consider where your money is, and understand the relative value of your different dollars. Sometimes, I think we should shoot for a specific dollar amount before making drastic changes in our work/life balance. When I stop and think about our 25x (or 36x = financial freedom), I realize that the absolute number isn’t all that important, anyway. So now we’re shooting for a specific date.
What are you aiming for? Do you discount tax-deferred or other dollars when calculating your retirement assets or net worth? I’d love to hear your thoughts.
*Strategies exist to make Roth conversions while avoiding federal income tax. You must have low expenses and/or a substantial amount of other dollars to spend in order to employ this strategy, and will only be able to convert a relatively small amount annually, but it is possible.
Roth money is indeed valuable, but being in the highest tax bracket right now it doesn’t seem to be the best strategy for me. One thing about my plan to retire early (thinking age 53) is that it will give me a long opportunity (17 years till RMD kicks in) to do ROTH conversions. Gasem has written some great posts on this and extols having a large cash allocation (several years of living expense) that you can live on thus keep your taxable income low so you can do roth conversion up to I believe the 25% tax bracket.
I know people get a bit spun up about having to save every medical receipt for potentially decades because they think that is the only way to take out HSA money triple tax free. Although I do save the major receipts now (and will cash flow my current health expenses), in the end I think with how much medical care is going to cost in retirement anyway (they say a 65 yo couple will have $250k of medical costs), most people will far exceed what they have in their HSA accounts anyway which could then be pulled out without tax consequences based on ongoing Healthcare expenses from 65 on.
My HSA has a “claims vault”. You send in the receipts, they store them and keep a running tally of your total receipts. I check it just like I check my other investments online. We have a spot on my desk that the wife and I put receipts. I send in receipts every few months. It takes some time, but I think its worth it. Over the years I have built up a nice chunk of money that is earning interest tax free and is available if needed.
What HSA does that? Great idea!
benefit wallet does that. although I just switched over to fidelity for the no fee account.
Fidelity offers a vault for storage of many e-documents including Healthcare receipts.
Our HSA sits with Fidelity
https://thehsareportcard.com/new-page-1/
The ChooseFi guys may have talked about this on a Podcast last year
Good to hear that now that I have an HSA there.
Benefit coordinators. I got hooked up with them through my bank years ago. I have left that bank and the bank has left Benefit coordinators. I dont know all the details but they had to change some things around recently. Very easy to deal with and they have good customer support.
HSA bank has this, and the ability to scan receipts.
Too late now. I’ve already left!
Optum does this now, too. It wasn’t an option when I first opened an HSA. With the online vaults and phones that take great pictures, saving receipts is a lot easier than it was even a few years ago.
Cheers!
-PoF
Haven’t thought about using my phone! Actually I copy and fax them in. I need to get into the 2000’s!!
Are some saying it’s best to take the money out now? I get some interest on the money, I dont really need it to pay any debt, and I have some investment options with them I could use. I call it my emergency fund, quick access to some cash if needed.
My concern about the online vaults is if they are transferrable if and when the HSA platforms change. I’ve only had an HSA about 4-5yrs and it’s already changed over twice (once from USBank to Optum, and then Optum changed it’s whole system).
When the bank dropped my HSA, the HSA company said they were putting together some kind of holding company to replace the bank. One day I logged on and my vault was empty. I called and they said don’t worry, they are working out the website getting the new system running. So, like you, it got me thinking. I really dont know how they are regulated and if your money is somehow insured.
Recently, we had a local guy scam a bunch of people out of a lot of retirement money. He is in federal prison now. Hope he rots in hell after prison. I guess you have to be careful.
Losing all those receipts would suck. During the Optum conversion, they actually lost my money!
I called and noted that my account was empty (or missing money) and they had to escalate and find out that in the transfer the $$ was accidentally distributed but not sent to me, so they were in the process of sending a check to me to re-contribute, and I basically said I needed them to figure out a way to transfer the $$ internally, which they finally did. This was before I had extra accumulated, but no idea how it would have worked if I was limited on putting all back in!
These anecdotes are reconfirming my decision to pay as we go from the HSA.
One clarifying point that may be of some importance to readers – HSA dollars can be used to pay you and your spouses Medicare premiums once you’re enrolled in Medicare.
Great point; I think the choice between reimbursing yourself now vs. saving receipts is a false one. As long as your future likely liabilities are larger than your account, just let it ride and then pay those expenses from the HSA. Save time coming and money going.
I consider this a lot along with inheritance issues. I am trying to decide how much to put in Roth. I did some panic conversion while our income was lower once I realized that with RMDs (on our prior balance) of tax deferred accounts plus social security we will (probably) be in a much higher tax bracket at 70 than in any year I’m not working the whole year. Want to be more certain of the best way forward during that lower income time between retirement and age 70. As we get closer the risk of wacky tax or social security or Roth law changes may be lower.
The Roth accounts as inheritances only seem more valuable to the kids if they will use them for THEIR retirement; if they’re gonna want a chunk of money as soon as they get it (if we leave them any) the taxable accounts with a step up in basis are best, or if they are in a lower tax bracket than ours during conversions tax deferred stuff will be worth more. (Less an issue for Roth conversion than for which money we spend in retirement.) Guess I’ll research this more if it seems likely they’ll be getting a lot, but I want to decide for my actions in low tax years before 70. (And we’re hoping that decade plus will be long before they inherit anything.)
At the moment thinking 50-50 Roth tax deferred retirement money might be the balanced sweet spot- we’ll hopefully only lose out on 50% of any wonderful or horrible changes in tax law – and no need yet to decide which pot of money to spend from.
Just a couple observations as a recent retiree. When you plan for retirement, consider your state of residence. SC adds a 7% cost to IRA withdrawals. Medicare premiums are our biggest medical expense, spending $5,000/yr for myself and spouse, up from $0 as a military retiree. Already lost one advantage with the new tax law when they disallowed recharacterization. Finally I expect means testing for future social security payments. The politicians won’t be anxious to return the money they “borrowed” from high wealth taxpayers.
Great article. Roth accounts are indeed king! We have 17% in Roth accounts. Speculatively, this may become even more evident in the future when congress will have no choice, but to deal head on with the growing national deficit by raising taxes, especially on those in the higher tax brackets (it will be the path of least resistance). The tax base is simply not growing fast enough to absorb this cost. Folks simply will not stand for other methods such as austerity measures (just observe what a partial gov’t shutdown is causing!) or an increase in the age to receive social security. The current tax rates may likely look like bargains in hindsight. Again, this is speculation on my part.
What do you mean have no choice? You’ve never heard of inflation?
The problem with this line of thinking is that Congress could just as easily choose to deal with the deficit by ending the Roth program. Demagogues could cite articles such as this one and paint it as a tax loophole for the rich. VG etc would have no choice but to comply and give them your money.
The only ways I can see to “protect” your money against this situation would be to keep it in a mattress or else keep it in a safe deposit box in a foreign bank like this guy:
https://johntreed.com/blogs/john-t-reed-s-hyperinflation-deflation-blog/65776963-swiss-francs-in-an-outside-the-u-s-safe-deposit-box
Of course, neither of these options protect you from inflation. And this is all very theoretical.
The volume of tax-deferred accounts to Roth accounts is something like 20 to 1, if I recall correctly. Consequently, finding a new way to tax tax-deferred accounts would be a far ‘juicier’ target to a hungry politician than taxing Roth accounts.
Roth dollars are the most valuable but for most docs they are the most expensive! Many of us have to earn $1.33 or more to “purchase” 1 Roth dollar. Whereas your pretax 401k dollar might only cost $1.24 in retirement. The post retirement Roth conversion is a great strategy. Unfortunately/happily a really generous military pension will limit this option for us.
Yes — I’ve advocated that anyone in a high income tax bracket make tax-deferred retirement contributions. In the 32% bracket or higher, that’s the route I would go. In the 24% and below, I’d make Roth contributions.
In retirement years, I’d be quick to fill up the 24% bracket (up to $321,450 in 2019 if married filing jointly) with Roth conversions before these current rates sunset in 2025. Even with the pension, I would guess you’ve got some room there. Factor in the $24,000 standard deduction and you can have nearly $350,000 in gross income while staying in the 24% bracket.
Best,
-PoF
I get what the author is saying, but there needs to be a clarifier. What he is talking about is how to value a current asset, basically “marking to market” for future tax purposes. And for these purposes everything here is true. But…for people who are trying to DECIDE where to put their money, they have to look at the NET tax cost, and doing so for docs makes it clear that putting money in tax deferred accounts is the right move (I’m not saying the author doesn’t know this, just needs to be explicitly clarified for some readers with less experience).
I don’t think it’s too difficult to adjust your personal balance sheet for expected future taxes of these accounts. The author seems to think it’s too uncertain, but a reasonable estimate of the most likely scenario is possible. This would vary from person to person, and requires a little bit of analysis, but it’s probably worth doing. For me, I discount by taxable account by 10% of gains-to-date, and my tax-deferred accounts by 15%; both are probably slight conservative over-estimates of liability. I also discount my home value by 6%, and discount my SS NPV by 30%. All of these are easy ways to reflect my true financial situation and the resources available to me to finance my choices. The overall net effect is about a 10% haircut on my net worth. This seems material and worth the time to consider.
You make a good point — I am talking only about the dollars as they exist in my various accounts, not the value of placing them there — I’ve already reaped those benefits.
WCI made a similar comment on the original post on my site. His comment and my response:
The White Coat Investor
January 6, 2017 at 7:44 pm
You give tax deferred accounts way too little credit. Not only do you get the upfront tax break ( especially useful if future tax law changes, like a new Roth IRA tax) but you get tax-protected compounding, arbitrage between your tax rate at contribution and withdrawal and significant asset protection. If taxable is Friday tax-deferred is at least Thursday afternoon. Monday dollars would be like earned income in your peak earnings years.
Reply:
[email protected]
January 6, 2017 at 7:59 pm
You make some great arguments for contributing to tax deferred accounts, and I contribute the max to every tax deferred account available to me, which is a 401(k), 457(b), and an HSA. The only Roth contributions I make are the personal and spousal “backdoor Roth” contributions. It’s great to make tax deferred contributions because you get a lot of value back right away – up to 50% or more depending on your marginal tax bracket. That is why the tax deferred dollars are worth less later on; you’ve already received a portion of those dollars back.
In this post, I’m talking about the value of the dollars in your various accounts today. A net worth of $2 Million largely in a 401(k) or any tax deferred account has less value than $2 Million that is mostly in Roth and taxable accounts. It could be in the neighborhood of 20% less, which is huge for people making retirement decisions based on “The Number.”
I can agree that current-year earned income that you haven’t yet paid tax on is worth even less, but I would never consider all of those dollars in my net worth calculation if I knew some of it belonged to the government. Yet that is exactly what many (including me) do when we calculate our nest egg including tax deferred accounts.
Thank you for your thoughts!
-PoF
If I’m understanding this dilemma between investing in tax-deferred accounts vs Roth-type accounts, one has to guesstimate the difference between current tax rate (X) and future tax rate (Y), which we can call Z. So with the tax-deferred compounding, the benefit is the compounding of Z, right (with the expectation of paying Y)? And with the Roth-type accounts, the benefit is in avoiding paying Y on those distributions?
Supposing Y is larger than Z (meaning the difference between the 2 rates is not that large and/or Y is pretty large) — does this make the argument for prioritizing Roth contributions/conversions (including mega-backdoor) vs deferring X as much as possible?
Am I thinking of this correctly?
No. It really is all about the rate at withdrawal vs the rate at contribution. For most docs, that argues for tax-deferred contributions during peak earnings years and Roth contributions (and conversions) during other years.
My confusion is with working part-time now (and likely more later, but when and how much more is still not clear) and 20yrs more of practice ahead, this is not “peak-earning” necessarily now, but not like earnings are going to increase significantly any time soon. Let’s say the difference between current and future tax rates may not be much (example = 5%?). And let’s say future tax rate is 10% (making this up). Does it still make more sense to contribute pre-tax as much as possible at the cost of Roth contributions?
If you’re an attending in a “real” job (not temporarily in military etc) and working full-time, then you’re in a “peak earnings” year. Even if your income goes up in the future, the question is whether it will rise much faster than inflation or not.
Yes, there are scenarios that can be concocted where it would be better to do Roth contributions now. That’s why it is only a rule of thumb.
That was the “dilemma” of my original query: What might the scenario be where it’s better to forego pre-tax savings in lieu of Roth? I assume if you’re in a situation where you have no or little income, but considering scenarios when you’re not a high earner or don’t have a very high tax burden now for whatever reason — what are the factors to consider (I was taking a stab at it with my X,Y,Z scenario above)?
Also are there ever recommendations to do “semi-mega backdoor Roth conversions”, meaning that one’s income isn’t expected to rise a lot (but still could be 20-40% of a lower income), but if marginal tax rate is still below a certain threshold compared with that in retirement, converting an extra $5-10K may be more helpful in retirement than it would be harmful now? I guess I’m still thinking of the comparing or Z to Y in my example above…
Okay. Not sure this will help you but could help someone —
Scenario: you are in the military and inthe 24% federal bracket. No matter where you are stationed you can still claim FL as your state of residence so you currently pay NO state income tax. Your pension is $100K (retire at 30 years as O-6) and taxable and starts when you retire from the military, meaning that even with $24K standard deduction your interest income easily gets you back in the 24% bracket. And you might decide not to live in FL later, but in a state with an income tax. Then the Roth will be the right move.
Or if tax bracket %ages go up on the future.
Thanks for this. Though I guess this is sort of an extreme example, where you know for sure (assuming you retire from military) that your Y will be GREATER than your X (unusual) due to the large pension.
Assuming X is still greater than Y, how big should Z (= X-Y = positive number) be — say, in comparison to Y — to have it still make more sense to put away pre-tax in lieu of Roth? I can’t tell if I’m missing a compounding factor that makes comparing Z to Y more complicated than it may seem.
https://www.whitecoatinvestor.com/should-you-make-roth-or-traditional-401k-contributions/
So your additional factor is whether or not you will actually work full time again, and whether or not (if you never do) your retirement income will be higher than it is now working part time. I’m in those shoes, and I am hedging my bets trying to have about 50% Roth 50% tax deferred. Since I’m counting all of our TSP and 401K in that number, almost all of our IRAs will be Roth by the time we’re 70. May change again- I went from not working 2/3 last year to ft this year so probably no conversions until I retire or go pt again.
Thanks Jenn,
Being primary caregiver to kids is such a gamechanger. Plus if I feel I can work more in the future, it’s unclear when/how much my current employer (whom I want to stay with) would allow that, depending on multiple other factors at that time. I may only increase by 20% in several years, or I could double my workload (and income)!
I would say that my income is more than it would be in retirement, but I’m not sure about tax bracket given my current deductions. That’s the tricky part. I know anything can happen, but I expect to get at least a small pension and I have NO money in Roth now (will finally be starting that pot this year) and so the question is if I should do a conversion in 2019.
I’m leaning toward yes since my tax rate will only go up and it might not be this low in retirement…but it seems like such a strange thing to do. I could just contribute directly to the in-house Roth account in lieu of pre-tax, but since I front-load, I need to make that change NOW. 🙁
I have a post on how I think through whether or not to make tax-deferred or Roth contributions, as well: https://www.physicianonfire.com/roth-or-traditional-401k/
Jim’s post is probably better than mine; I didn’t realize I wrote a nearly identical headline.
PoF: I just saw your article – very helpful, thank you (btw, links are still helpful when we’re looking at different topics, because so many relate, but we all don’t have the info in mind at the same time, some of us are still learning, plus contradictory recs can be confusing unless we step back and/or focus in sometimes).
I wanted to ask, your article mentions that a taxable income of $60K (in retirement) would put one in the 12% marginal tax bracket. I feel like other tables I have been looking at seemed to be saying that an income between ~$35-85K puts one in the 22-25% (used to be 25, now 22) bracket. Can you tell where the discrepancy lies?
My personal situation is that I don’t expect to have a mortgage paid off (but hopefully won’t be much) and won’t have deductions, but still maybe spending $80K max, most coming in would be taxable. But current income is pretty low and deductions high, so…if I had an idea of future tax rate, would be easier to feel better avoiding taxes now as much as possible (vs doing mega Roth conversion or sacrificing tax-deferred space). Thanks!
Remember there are 2+ tables, single and married filing jointly. $60K of taxable income has a marginal tax rate of 22% for singles but only 12% for marrieds.
Also, don’t forget what you subtract before you get to the taxable income- all your deductions. So at a minimum- subtract out $12K for singles and $24K for married filing jointly. So in reality, it’s $48K single (still 22% marginal) and $36K married (12%).
Hope that helps.
WCI, you listed “must have a taxable income that keeps you in the 0% long term capital gains / qualified dividend tax bracket, which is about $77.00 for a couple in 2018” — did you mean $77K?
And could you please estimate what this number would be for a *single* person in 2018?
Also does this number really represent the amount of total “taxable income” one can have without needing to pay taxes, or just the amount of income taken from a *taxable account* without needing to pay capital gains (I thought one pays at regular income tax rates for untaxed retirement savings)?
Thanks!
You can blame me for that typo, not WCI. The number was $77,200 in 2018 and has been updated to $78,750 in 2019 for those married, filing jointly.
The 0% LTCG bracket for individual filers is exactly half of the MFJ numbers. $39,375 for an individual in 2019.
Thanks for catching that!
-PoF
I think you are underestimating the benefit of Social Security for those of us at or nearing retirement age. If you have been a high earner for many years and retire at 701/2 years, you currently receive about 42k per year.. This is equivalent to 1 million dollar pot of money at a conservative 4% withdrawal rate, and it is inflation adjusted (a 2.5% increase this year). I understand the rules could always change over the next 30 years, but I think it is unlikely any cut back in benefits would pertain to those already retired. If you are retired, add 1 million dollars to your net worth in calculating your future needs.
I’ve delved deeper into the topic of Social Security since first writing this post, coming up with a spreadsheet calculator to best estimate my future benefit. I’m a few years shy of the second bend point, after which further contributions will result in only a slightly bigger check. Diminishing returns, for sure. https://www.physicianonfire.com/ssa2017/
As it is, if I were to quit working today and never earn another dime, I could anticipate a benefit worth about $28,400 in today’s dollars if I hold out to age 70, and my wife would get about 40% of that depending on when she files. I’ll run the numbers in 25 years or so to see what actually makes the most sense based on the current law of the land.
Cheers!
-PoF
POF – when deciding on Roth conversions, you also need to consider State tax and Obamacare tax. As a California resident with significant investment income, those would add another (9.3+3.8) =13.1% to my Federal marginal tax rate on any Roth conversion dollars.
Good point UAPhil, definitely something to keep in mind when comparing tax rates now vs later. Also being in CA (btw, what’s Obamacare tax?), wondering if there would be a difference in how we make these decisions or if the fed vs state rates are usually proportionate as taxable income goes down.
Obamacare tax: https://www.whitecoatinvestor.com/obamacare-part-1-increased-taxes/
You’d only pay 0.9% PPACA tax on a Roth conversion. The 3.8% would be added on to dividends and capital gains.
California marginal tax rates reach 9.3% fairly quickly ($52K singles, $105K Married filing jointly – MFJ), then level out until your taxable income reaches about $250k/$500k. So the rates are not directly proportional to Federal rates. Other states have different marginal tax rate structures.
“Obamacare tax” is a nickname for the Net Investment Income (NII) 3.8% surtax that applies to singles with AGI over $200K/MFJ over $250K. It was passed to help fund Obamacare. It is not indexed for inflation, so it will impact more and more people over time.
UAPhil – so in today’s dollars, how would you compare tax rates on $120K vs $80K in California? Overall it seems maybe the rate may not be THAT much lower in CA vs another state?
There are actually two taxes- 0.9% on ordinary income and 3.8% on investment income for all income over $200K single/$250K married.
Between reading these comments about trying to keep the money you earned and watching Atlas Shrugged last night……I need to get away from electronics for a day or two!!
I have trouble seeing any actionable course in this topic for me. We are a two physician couple, each eligible to put away ~$54,000 per year into solo 401Ks. This leaves us at around age 60 with ~96% of our savings in tax deferred accounts. Ok, we’ve been making backdoor Roth contributions for a few years since following WCI, but those are small numbers. There’s not much cash for making Roth conversations, and probably only 5 years from 65 to 70 to do it even if possible. I’m afraid we will have no choice but to go into retirement with a massively skewed tax-deferred component to our portfolio. Sigh.
@Antares – think of it as less “actionable” and more “how to measure” and you will see the value of the post. You are already doing the correct (in my understanding) action. But later when you are trying to decide if you want to cut back, or retire early, or take a sabbatical, you will remember to assign the correct “after-tax guesstimate” to the money you have put away to make that decision.
Very true. Good point, and thanks.
The good news is that will still be pretty awesome given your two physician family income now. You’re likely saving at 30%+ and pulling out at sub 20%.
Antares in addition as Army Doc says to knowing to do conversions ASAP (or consider doing them) if your current timeline alters, I recommend you think it all through and be certain your retirement income will really be at a lower marginal tax rate than your current income (if tax rates are unchanged). If you ARE saving much more than 30% your passive income plus social security plus RMDs on all that tax deferred might be close to your current income- or if tax rates rise, at a higher tax rate. Might decide to do some conversions now, or save less, or spend/ donate more, or retire earlier.
Does your Solo 401K Plan offer a Solo Roth 401K option? You can max out the Employee Contribution portion each year ($18.5K, 19K for 2018,19 respectively. + an additional $6K if >=50 years old).
Thanks for the suggestion. The 2018 contribution limit is 55K. I am under the impression that I can’t do both a backdoor Roth, which I’ve been doing yearly, and also a Solo Roth 401K, but I’d like to be mistaken.
You are indeed mistaken. Totally separate limits.
Good news. And thanks!
What would be the requirements for a solo Roth 401k? I had been planning to open a solo 401K just to rollover my IRA assets so I could do a backdoor Roth, but then I found out that I could roll over into my employer 457b plan, which I figured was easier. But I do have some 1099 income, does that mean I could open a solo Roth 401k and put all that income there?
Sure it’s the 457b not the 403b?
If you have a business, you can open an individual 401(k) for it and contribute up to $19K if under 50 as an employee contribution if you haven’t used that elsewhere plus up to 20% of self employment income up to a grand total of $56K if under 50.
My employer account if 457B through Fidelity and I confirmed they will allow reverse rollovers.
My side gig does not bring in a ton of income, was just going to open the solo-K for the bd Roth. How can one open a solo Roth 401K? I assume you can’t contribute more than the total income you have from that job, correct?
When you open a solo 401k the application will have have an option as to whether you want a Roth subaccount for the plan or not, as long as supported by that particular institution. Fidelity for instance doesn’t allow Roth for their solo k. I think Schwab is the same. Vanguard does allow Roth, but their plan doesn’t allow rollovers. So you should first look at Etrade or TD Ameritrade.
But the next question is, why do you want a Roth subaccount? Your rollover is going to pretax. And employer contributions to the solo k would as well. Roth would only be for deferral contributions and you would only choose that if you were in a lower tax bracket. If you’re in the 22% bracket or higher and you’re in CA I doubt you would be making Roth contributions. So you probably don’t need a Roth option in your solo k.
The reason for Roth is that I have basically no post-tax investments right now, will just be starting Roth this year (despite already 15yrs in practice). But though I missed many good windows of low-earnings, I am expecting my income will only slowly increase until retirement (COLA alone, plus I’m part-time now), and my deductions may be at an all-time high.
I haven’t done the math yet (and this will likely be a forum question soon), but it’s possible that my rate this year will be under 25%, as I believe it has been thus far. I’m losing some deductions I had before (the cap on property/state taxes is not cool for those of us in CA) but I have more than I will have in retirement, so it’s possibly my rates are similar enough it might be worth me trying to put away more Roth money now (esp if we expect tax brackets will only go up from here).
Preview to my question: how do I interpret my 2018 tax return to compare to a future tax bracket (i.e. see if it’s really lower than 22-25%)? I have a couple side gigs that I started claiming as self-employment income with business expenses last year, have 2 kids who (hopefully!) won’t be dependents in retirement. Possible that the cap on property/sales taxes could be lifted (as of now I don’t plan to leave CA, but who knows). Does any of this factor in to comparing apples to apples?
I still don’t think I’d roll money over into a 457, even if allowed. A 457 is technically your employer’s money and subject to their creditors. A 401(k) or 403(b) or IRA is your money.
Ack – every time I think I’m on the road to a plan, there is more to learn!
To clarify, this is a governmental plan (the government entity being the 2nd largest county in CA). Still bad idea to roll my IRA funds into it?
As far as I can tell, the fund options seem pretty good, I posted them a few weeks ago and if I recall was basically advised to go with a Vanguard TDF.
The only downside I see is that the money is basically stuck there until I retire, correct?
most professionals will have an overwhelming majority of wealth in their IRA. Absolutely nothing wrong with that. With mine hopefully I will never touch the principal and my kids or grandkids will STRETCH it over their lifetime,
Partial Roth conversions are fine as well and the author Lange universally feels conversions are best for everyone
Who wants to pay 40-50% in taxes on a portion of their earned income
Socking away big numbers in ret plan is very very PRUDENT! It is forced savings
Although the Roth program has some great benefits, the opportunity cost and time value of money need to be considered. I personally would rather not pay taxes now and defer the payment into the future. Who knows what rates will be, if the Roth program will exist, of 401k’s will no longer be tax deferred etc…but I would much rather not pay taxes now and have that sunk and gone than pay them now and hope the program isn’t altered decades from now.
Personal finance is always personal!
It’s a good point Peter. But if we’re going to “put our money” on possibilities of the future, I would sooner think that overall tax brackets will go up or they start changing rules on *contributing* to Roth, vs eliminating the Roth options altogether (how long have Roth programs been around?). It’s definitely stuff to consider…
Seems silly to make plans based on what could happen in the future. I think it’s smarter to just change your plans as changes occur. 90% of the changes you fear won’t happen.
In general, I’m a fan of Roth contributions in the 24% marginal bracket and below, and like tax-deferred investing if in the 32% bracket or above. There can obviously be extenuating circumstances, including current and future state of residence (and taxation of said state(s), current relative balances in tax-deferred and Roth, anticipated career length, anticipated income changes, etc…
I hope no one read this post as a reason not to make traditional tax-deferred contributions. In your portfolio, Roth dollars are more valuable for a reason. They cost more to obtain.
Cheers!
-PoF
It’s funny how in a discussion in the comments section of a blog post it’s like the participants have never read anything else you’ve ever written. It gets old sometimes having to link to a dozen old posts so people understand that you get it but can’t write 8000 words for every blog post to cover every possible angle.
Linking back to your old posts would be BORING. And waaaayyyy too helpful. We want to talk like we always knew this stuff! Makes us feel superior.
🙂
–The dumbest person in the world is someone who doesn’t know the thing I just learned yesterday– right?!
With the 24% rule of thumb, is that due to assuming that one would be in the 24ish% tax bracket in retirement (and less than 32%)? I’m realizing now that I should really be looking at this.
Here’s a hypothetical, if I expected to be in 22-25% tax bracket in retirement, and found myself (with deductions, etc) currently in the 15-20% tax bracket, would it make sense to do a mega Roth conversion and use whatever funds I might have otherwise used to put into a taxable account, and instead put that toward taxes on the conversion (20+yrs from retirement)?
Seems like a situation that if the numbers are relatively close, may not be worth it (esp given the uncertainty of the future tax laws), but seems more than likely taxes will increase rather than decrease.
I’m not sure that’s a particularly robust rule of thumb, but the general principle is correct that in lower brackets you should prefer Roth and in upper brackets you should usually prefer traditional unless you expect to be in the top bracket in retirement too.
Yes, being temporarily in low brackets is a great reason to do Roth conversions.
I looked hard last year of going to the roth conversion. It would take changing my office retirement plan, and adding additional costs. For the reasons Peter brought up, I passed. I decided to look into alternative investments. Like taking the money I would have paid in taxes now (converting to Roth) and investing that money in a brokerage account. Or buying something that I can enjoy, pay little tax to keep, and have full control over later in life. Something like collector cars, pine trees, etc. In 2008, I decided to slow down on investments and work on getting all debt paid off. It took some time, but I am 100% debt free and own some decent assets. That makes me feel better than the Roth account ever could. As stated, its a personal choice.
One benefit of partaking in this exercise is to determine how your savings profile meshes with the taxation policies of your current state of residence. A poor fit might drive a decision to (at least) consider relocating. Simplistically, those with most of their dollars held in tax deferred accounts might decide to leave a high income tax state for one with no income tax. Conversely, those with few tax deferred dollars might wish to live where property and sales taxes are low. Of course there are MANY factors that have to be considered in making a determination to relocate., but taxes are a part of it.
I also cannot help but wonder what changes the Federal government could implement to “tax” the Roth dollars I expect to have in retirement. I guess the obvious change would be implementation of some sort of VAT (still probably minor, but, a revamp of the system to implement a VAT and de-emphasize the income tax would certainly stand things on their head. I’m sure there are some who would welcome a regressive methodology, if they had the power to implement it). The thought allows me to be more sanguine about my tax-deferred money – “a bird in the hand”. As others have said, having a mix of these assets guards somewhat against the various outcomes.
Is there any way to establish a ROTH if you have an annuity or significant amount in traditional IRAs? When I was a young (and clearly very foolish) new grad I was sold annuities by my financial advisor to “diversify funds”. I’m sure his wallet appreciated my naivete. Fast forward to learning more about finances and the benefit of your website, and I want to start investing in ROTH IRA’s. But I’ve been told I cannot do that because of the balance on my current traditional IRA balances (one annuity and one regular IRA) which apparently precludes me from making backdoor funding an IRA? Is there any way around this?
Yes. You can either convert the entire IRA to Roth or you can roll it into your employer’s 401(k) or if you have self-employment income, an individual 401(k).