How Much Tax Should One Avoid?

[Tyler]

Not that I won't try and exploit a few tax loopholes now and then when I find them, but... if my spreadsheet says "More options with cash in the bank" vs. "Better Tax treatment with 401K", then I sit up a few nights and figure out which is better for *ME* - assuming that whatever legislation that is currently active is temporal.

I'm in the same boat as you, Mark.

Tax-deferred retirement accounts are designed to benefit the very specific goal of saving money to retire on when you hit 60+. Sure you can access money before that if you jump through a few narrow hoops, but in general they're not designed with that purpose in mind. The primary goal is to help the average person 1) save more than zero for retirement, and 2) hopefully forget about that money so they don't touch it too soon.

A while back I decided that waiting until 60 to retire was a life assumption I was ready to challenge. I wanted to do it before 40 and met my goal with a few years to spare. Well, someone in my situation has a very different viewpoint of the benefits of tax-deferred savings versus liquid money I can spend today. I made a conscious decision as I was accumulating to not necessarily max out my tax-deferred savings, and instead focused on maintaining a set percentage of my net worth in taxable vs. tax-deferred. It's all about not putting all of your eggs into one basket with a lock on it.

Now I fully admit I'm an outlier. I just wanted to point out that tax savings is not necessarily the only thing you can optimize for and sometimes a bit of balance is helpful.

[WiseOne]

Tyler, what's the percentage you set for tax-deferred long-term investments? (Or taxable, lumping in Roth IRA and HSAs).

I few posts back, I was thinking on the order of something like no more than 50-60% for tax-deferred. I'm at 70% currently and that feels like too much.

[ochotona]

One more thing, you can always withdraw your Roth IRA contributions, since you paid taxes on them already. But you can't take out any growth without penalty. If your account value went down? So sorry!

Also, you can't take a distribution from a Roth EVEN IF YOU'RE OLDER THAN 59.5 UNLESS THE ACCOUNT IS FIVE YEARS OLD... wow, who knew?

http://www.rothira.com/blog/the-five-ye ... ithdrawals

I'm in the higher marginal Federal bracket, 28%, but I'm still putting into Roth, because of tax diversification reasons. I am diversifying against the risk that over the next 35-40 years tax rates will become confiscatory. If this happens, I'd rather pre-pay now.

I don't think they'd undo the Roth tax-free promise, but they might definitely cap the amount of the Roth... like you get $2 million in a Roth, then that's all, once it hits that, you can't put any more in ever, maybe even amounts greater than the ceiling get exposed to taxation again. Those ideas have been floated already. Then count on the Govt to neglect to index the ceiling, then $2 million deflates to $500,000 in purchasing power over 40 years, like it did 1977-2017. Or worse.

[Xan]

Even if you're planning to (or could potentially need to) withdraw the money early, it could still be a smart move to put money in tax-advantaged accounts.

Yes, there's a 10% penalty, but at some point that's worth it for tax-free growth, right? And this would be more true the more trading there is in the account.

[Tyler]

Tyler, what's the percentage you set for tax-deferred long-term investments? (Or taxable, lumping in Roth IRA and HSAs).

I few posts back, I was thinking on the order of something like no more than 50-60% for tax-deferred. I'm at 70% currently and that feels like too much.

I won't claim I planned for a target number from the start, but we ended up with 60% taxable and 40% tax-deferred. I'll also point out that I'm naturally frugal with a very high savings rate, and there were a few years in there where I maxed out the 401k while still putting even more money away in taxable so the final percentages may honestly speak more to my personal savings habits than anything else. I only cut back the 401k contributions towards the very end when I realized we already had "enough" long-term and started to think more about mid-term goals.

The main point is that there's more to managing money than reducing taxes paid, and you have to think about how you want to use it and when you need access to it. Even if it could save me a bit of taxes on paper, I'd personally have a tough time locking more than half of my money in a tax-deferred account for the same reason that I'd have a problem locking a large percentage in home equity. Sometimes maximizing efficiency minimizes options.

Even if you're planning to (or could potentially need to) withdraw the money early, it could still be a smart move to put money in tax-advantaged accounts.

Yes, there's a 10% penalty, but at some point that's worth it for tax-free growth, right? And this would be more true the more trading there is in the account.

There will always be situations where stuffing all your money in tax-deferred makes sense, and excessive trading is one of them. I don't think too many of us should fall into that camp, though.

Also, remember that tax-deferred accounts are designed to be appealing to hard-working accumulators where taxes are relatively high. But pair an income level that keeps you under the threshold for zero long-term capital gains with a very tax-efficient investing strategy like the PP, and even a taxable account can enjoy tax-free growth. You still have to pay income taxes up-front, but for me it was a fair price for the added capital flexibility.

[barrett]

Tyler, what's the percentage you set for tax-deferred long-term investments? (Or taxable, lumping in Roth IRA and HSAs).

I few posts back, I was thinking on the order of something like no more than 50-60% for tax-deferred. I'm at 70% currently and that feels like too much.

I wish I had read this thread ten years ago! When I "retire" next year at age 59.5, I'll be roughly at 54% tax-deferred, 40% taxable and 6% Roth. Even that 54% I think is too high but tax deferral has generally been just too tempting for me. I've never been in a very high bracket but I am self employed, and in addition to the the initial savings, I also consider that paying lower taxes now means making lower estimated payments for the ensuing 12 months or so. In recent years I also take into account that making a bigger solo 401(k) contribution helps me hit the sweet spot for ACA subsidies.

So I'll be as aggressive as possible with Roth conversions over the next decade or so but there are some things already baked into the retirement tax cake. For example, I have big whacks of EE savings bonds maturing between 2021-2023 and the interest on those is quite high. So that's three years that I won't be able to convert much to the Roth without bumping myself into a higher bracket.

WiseOne, your 70% strikes me as really high but I think you have a lot more time than I do to turn the tax ship around. The thing is, and this will be obvious to anyone who is older, it's hard to build up Roth accounts relative to tax-deferred when the latter have a 30-year head start!

Another factor to consider is where one is at with cost basis in taxable accounts. The higher the cost basis, the more flexibility one has with using those funds in retirement.

[WiseOne]

Thanks Barrett! Yes, I'm slowly but surely getting the Titanic away from that iceberg with increased taxable savings.

It sounds like you're caught in a bit of a dilemma, as I guess you have to balance the Obamacare subsidies with having a higher percentage of savings in tax-deferred accounts. 54% sounds manageable though. The problem is that there's not much of a window between Obamacare and age 70 for you, correct? so not much opportunity to really push on Roth-converting the tax-deferred savings? It might be that giving up the Obamacare subsidy after you hit Medicare age and it's only Li's subsidy in question is the way to go. Can you estimate how much you can safely withdraw after age 70 without triggering Social Security taxes, then use that to decide if those Obamacare subsidies are really worth it? Also, check into whether your town has special breaks on property taxes for senior citizens, and whether there are income limits. In NYC, an income of under $50K over age 65 gets you a 50% property tax break.

It would be nice if there were an online calculator for this - there's retirement calculators out there but none that take taxes/subsidies into account.

[Knot Theory]

Knot,

It sounds like cash, not long-term investments, is your top priority in taxable right now. I wouldn't dive into the PP just yet.

Perhaps you could continue to throw whatever income would be taxed at 25% into retirement savings, then put the rest into taxable cash to save toward those goals you mentioned.

Sad but true. The more I read my own words the more I realize that's the adult thing to do, as much as it will pain me in ten years to realize the opportunity cost.

But when is it ever any different?

A word about home-buying...why are rents going up 7-10%/year in your area? If it's because of property tax increases, then buying property won't save you from that. If it's because there's a shortage of available rentals, then buying may be a good idea unless that same squeeze is driving up home prices as well. The decision to buy, really, is about whether you plan to stick around for at least 5-7 years. The way you're talking about your job raises that question, for sure.

Indeed, it's a complex mess. Locally, the following factors are at play:

[*]Over 150 people a day move to this city.
[*]NIMBYism is incredibly strong and the city council refuses to make realistic zoning laws despite everyone crying about "stealth dorms" and the cost of housing... which are a direct result of NIMBYism. It's amazing how much they cry about these things and then immediately block any effort to build more housing or allow housing options in between single family homes and high rises to be built. There's no row houses, town houses, 6 plexes, etc. here to speak of and virtually all of the new apartments built are higher end units.

One aspect of the job situation is even if things do go badly for me there (good chance they will not I should note), I am most likely to get another job here in the same locale because it's where my experience is the most valuable to employers.

Housing, if you look at it, is a racket between different socioeconomic classes anyway. Most people's FIRE plans involve getting someone like me to give them my money via rent or else passively letting my needs give them lots of tax free capital appreciation. That's fine as far as it goes, but some day I sincerely want to be the one on the other side of this racket.

[Pointedstick]

It sounds like you live in the bay area. If so, my advice is to escape while you still can. I lived and worked there for a while, and especially for those who didn't buy property 15 years ago, it becomes an even more insane lunatic nightmare madhouse every day, by virtually important every metric: housing prices, property, income, and sales taxes, commute times, political attitudes, witchhunting behavior, employment blacklisting, sense of community, desirable place to raise kids.

The only thing it has going for it is plentiful six-figure jobs. But the wealth is an illusion. Between the crazy housing prices, the high taxes, and the fact that you phase out of every favorable tax category, you don't actually see as much of it as you would expect. If you're in tech, your skills are portable. There are tech jobs outside of the bay area. Good ones. Better ones. Move to Denver, or Austin, or Dallas, or heck even Albuquerque!

I'm currently in New Mexico, earning a little under 75% of my peak bay area earnings, but living like a king, and my company treats me like a human being, not a replaceable cog in a machine. The difference in attitude is just amazing. And I'm able to keep myself below the 15% tax bracket, so I pay no capital gains taxes. I contribute just enough to tax-deferred accounts to get under the cut-off point.

[barrett]

It sounds like you're caught in a bit of a dilemma, as I guess you have to balance the Obamacare subsidies with having a higher percentage of savings in tax-deferred accounts. 54% sounds manageable though. The problem is that there's not much of a window between Obamacare and age 70 for you, correct? So not much opportunity to really push on Roth-converting the tax-deferred savings? It might be that giving up the Obamacare subsidy after you hit Medicare age and it's only your wife's subsidy in question is the way to go. Can you estimate how much you can safely withdraw after age 70 without triggering Social Security taxes, then use that to decide if those Obamacare subsidies are really worth it?

You know, I have been so focussed on the tax side if the equation that I was forgetting to think about ACA subsidies going forward. Damn, that complicates things even further, not to mention that it's near impossible to imagine what future health care costs will be for anyone planning to pull the work plug before age 65. The wife is 50.5 and planning to keep working for at least several more years. And then there's the high probability that I'll work some and have some income in retirement.

My basic understanding is that the correct strategy when drawing from different retirement assets is to try to keep taxes at a fairly consistent level. In reality though it seems that one can only have a rough idea what the plan is and that the best way to execute it is too look at all the numbers each year in early December or so, and then decide whether or not to do a Roth conversion, harvest a tax loss or whatever.

[Libertarian666]

Tyler, what's the percentage you set for tax-deferred long-term investments? (Or taxable, lumping in Roth IRA and HSAs).

I few posts back, I was thinking on the order of something like no more than 50-60% for tax-deferred. I'm at 70% currently and that feels like too much.

I wish I had read this thread ten years ago! When I "retire" next year at age 59.5, I'll be roughly at 54% tax-deferred, 40% taxable and 6% Roth. Even that 54% I think is too high but tax deferral has generally been just too tempting for me. I've never been in a very high bracket but I am self employed, and in addition to the the initial savings, I also consider that paying lower taxes now means making lower estimated payments for the ensuing 12 months or so. In recent years I also take into account that making a bigger solo 401(k) contribution helps me hit the sweet spot for ACA subsidies.

So I'll be as aggressive as possible with Roth conversions over the next decade or so but there are some things already baked into the retirement tax cake. For example, I have big whacks of EE savings bonds maturing between 2021-2023 and the interest on those is quite high. So that's three years that I won't be able to convert much to the Roth without bumping myself into a higher bracket.

WiseOne, your 70% strikes me as really high but I think you have a lot more time than I do to turn the tax ship around. The thing is, and this will be obvious to anyone who is older, it's hard to build up Roth accounts relative to tax-deferred when the latter have a 30-year head start!

Another factor to consider is where one is at with cost basis in taxable accounts. The higher the cost basis, the more flexibility one has with using those funds in retirement.

Assuming you are married, this is exactly the type of analysis that my retirement analyzer program does.
I'll be happy to send you a link to download a copy if you are interested in it.
The same offer holds for all other forum participants, of course.

[Kbg]

Interested!

[barrett]

I am interested as well, tech. I'd be curious if you know about the Optimal Retirement Planner (i-ORP) and how that compares to what you have created. Here is the link to that one:

https://www.i-orp.com/gamma/extended.html

It's value/accuracy have been debated over on Bogleheads and a bit on MMM. It suggests that we should be very aggressive with Roth conversions between ages 59.5 and 70.5 for me (wife is 8.5 years younger).

I THINK your retirement analyzer also considers the impact of annuities and life insurance, correct? One of the things that we have been debating is whether or not to nix our life insurance over the next two years.

[Libertarian666]

I am interested as well, tech. I'd be curious if you know about the Optimal Retirement Planner (i-ORP) and how that compares to what you have created. Here is the link to that one:

https://www.i-orp.com/gamma/extended.html

It's value/accuracy have been debated over on Bogleheads and a bit on MMM. It suggests that we should be very aggressive with Roth conversions between ages 59.5 and 70.5 for me (wife is 8.5 years younger).

I THINK your retirement analyzer also considers the impact of annuities and life insurance, correct? One of the things that we have been debating is whether or not to nix our life insurance over the next two years.

Yes, I have seen iORP and it is not very similar to my program. iORP is mainly concerned with returns and variances with different asset mixes and does statistical modeling. My program assumes that you have a specific return projection for your assets, so it doesn't bother with the variances. But it does include the effects of taxes and lifespan estimates, and it has a unique (as far as I know) emphasis on the use of life insurance to mitigate against the effect of losing one Social Security benefit on the death of one spouse. With such a large difference in ages, I suspect that the life insurance will be even more important to you than to many people.

I'll PM you with the login info.

[barrett]

Thanks for the link, tech. I really look forward to delving into this but, alas, I won't have time for that until later in the week.

This looks like the kind of thing that's right in Medium Tex's wheelhouse. Maybe we can smoke him out of his PP Forum hiding place.

I'll hold off on nixing my life insurance until I've read through your manuscript. Many thanks.

[Libertarian666]

Thanks for the link, tech. I really look forward to delving into this but, alas, I won't have time for that until later in the week.

This looks like the kind of thing that's right in Medium Tex's wheelhouse. Maybe we can smoke him out of his PP Forum hiding place.

I'll hold off on nixing my life insurance until I've read through your manuscript. Many thanks.

You're quite welcome!