100% of retirement accounts in Roth- is tax bracket 0%?

If one is in the 'zero' bracket, 2007, single = $5350 + $3400 = $8750 It doesn't matter where the income comes from. i.e. the STD deduction and exemption can wipe out dividends if you wish.

I think that as much as we talk about 'saving your way to the next bracket' at retirement, you can certainly do the opposite, live in the

28% bracket, and retire at zero. We've discussed the point of diversifying across tax status to maximize wealth and minimize taxes. As you suggest, even a Roth 401(k) isn't purely post tax if the company matches. A $100K earner, 5% match, will have $15500 pre tax, $5000 post. I think that over weighting in post tax (Roth) retirement accounts is a missed opportunity, the $8750 above, plus the 10% rate up to $7825. So for a single person, $16575 has a total tax of $782.

Yes, rates change, past performance, yada, yada. Either extreme on the tax continuum is lost opportunity.

JOE

This is a very individual thing. My advise is to not live your life merely with taxes in mind. Thumper

But, with a bit of research and education, one can make some better, informed choices. In the end, there's more to gain by saving the right percentage and investing with an eye toward diversification, I'd agree. Proper tax structuring can add a 5-15% boost that's not trivial. Why would you be so quick to dismiss that, when, as a group, we analyze everything else to death?

JOE

Just remember that if you plan everything using the current tax laws, the government can come along and retroactively change the rules on you

15 years from now. That's exactly what happened with the UTMA account that I set up for DD's college savings. The saving grace is that the account had very poor returns (therefore little income to be taxed at high rate) and other accounts have had very good returns. DD can leave most of that money alone until she's 24, meanwhile I'll pay for much of her college using other funds as tax efficiently as I can. She can eventually use the UTMA to pay off her student loans when she gets out of college and doesn't have much income yet.

Unless they change the rules again.

I fully expect a "flat tax", under the ruse of "fairness", to be implemented in such a way and just in time to tax my (and other baby boomers') Roth account withdrawals.

Bob

I'm surprised at you, Joe. There are many of us here who advocate not letting the tax tail wag the dog. jIM may or may not be doing this (we don't have enough information), but Thumper's response is right on.

Elizabeth Richardson

Elizabeth Richardson wrote on [Fri, 1 Jun 2007 18:06:41 -0500]:

Right on for providing very little information.

There's not letting the tax tail wag the dog and there's ignoring it completely, which is a waste of good money.

I'm surprised at you, too. Thumper says "not live your life merely with taxes in mind." I don't suggest it's the top priority, just that's it's worth a look. We agree that we don't know what the tax structure will be in 5 years, let alone 10 or 20. To that, I suggest that choosing to go to either extreme, all pre-tax 401(k) or all post tax Roth type accounts, is putting all your eggs in one tax basket. My initial rambling about the numbers was just pointing out to jIM that a certain amount of income is nearly free, and likely to continue to be free (or nearly so) moving forward. This is all after choosing the right amount to save and diversifying. Are you suggesting it just be ignored?

I don't mean to pick anyone's words apart, but I thought the expression "tax tail waging the dog" implied choosing wrong investments and ultimately getting a lower total return, while paying too much attention to the tax aspect and not enough to the big picture. I treated jIM's question as first assuming everything else is in order, and jumping right to the tax status question. Sorry if I misunderstood his intent there.

JOE

I always thought it meant deciding upon a course of action based on tax implications regardless of consequences. You might be either lucky or unlucky in your results. I think we agree that a better approach is that your first line of decision-making should be choosing the investment, regardless of tax implications, but not ignoring tax implications either. You seemed to take an adversarial position (at least it looked that way to me) to Thumper's statement "to not live your life merely with taxes in mind." Perhaps I jumped to conclusions (yet again).

Elizabeth Richardson

Because I believe that living a happy and productive life can be worth far more than that 5-15%.. For instance, I can probably save a good chunk of change burning wood, especially if I do the cutting, but all that work isn't worth the saving to me. Thumper

Thank you. I've paid so many different rates of income tax over my lifetime I have lost track. They have been as high as 46% marginal to only 15% and I haven't been able to see any difference in my happiness that correlates to tax rates. Thumper

I appreciate your reply, Elizabeth. I did jump into 'defensive' mode seeing Thumper's first comments, and I'll stay there after seeing his posts this morning. You agree not to ignore tax implications. I agree with you that one has some other decisions that take priority. I think we agree here.

I continue to read Thumpers' posts to mean that the tax discussion should simply be ignored. But since jIM's question was ONLY about tax implications, it seemed that going backward to point out that the larger impacts to retiree wealth first come from savings rate and then asset allocation, etc.

Thumper then states,"[tax rates] have been as high as 46% marginal to only 15% and I haven't been able to see any difference in my happiness that correlates to tax rates."

To that, I respond, That's my point exactly! Blinding thinking that pre-tax accounts are sacred, or that a Roth is best for 100%, will lead to lower returns. If Thumper had the opportunity to go pretax 401(k) in the 46% years, and convert to Roth in 15% years, that looks like a 31% delta to me. When I sit with a client discussing year end strategies, for some, the Roth/401(k)/tax discussion takes about 5 minutes. Far less time than the discussion of asset allocation, or the other things you and I know take priority. That 5 minutes isn't 'living with taxes as priority'. (didn't we agree long ago 'tax diversification is good'? I'm saying no different now) JOE

I'm not sure I can fully agree that blind thinking will always lead to lower returns. There are many (most?) households in the US where no savings would take place if it were not for the automaticity of pay-related pre-tax contributions to a 401k. You may be correct that these contributions have lower returns than might be, but I'll say the returns are higher because the savings exist at all.

As to jLM's initial question: Part of the beauty of these accounts is the absence of RMDs, not just the absence of taxes on withdrawal. Others have noted that the rules regarding inheritance are different, too. While I hold the optimistic view that Uncle Sam will not mess with the current status of a Roth, others believe there are ways to affect its tax status obliquely if not directly. Pay attention to Joe and his recommendations for diversification if you have more than just this vehicle available to you.

Elizabeth Richardson

Here's the line of thinking.

The assumption with a Roth, is that it makes sense if tax rates in retirement are higher (than when contributions were made).

If you "know" this to be true, then all assets are in a Roth account, isn't the tax rate now zero in retirement (because of tax advantaged withdraw status).

Ok. Let's hold all other variables constant. i.e. no change to tax structure, no congress finding a way to bone us on the favored status of Roth accounts, etc.

Today, you have a (single person) zero rate to $8750. 25X that is $218750. Even if you are in a 15% bracket today, saving pretax will allow you to put $10,000 in a 401(k) for every $8500 you are out of pocket. At the other end, you get it back tax free.

But, jIM, even the initial premise is too shakey, and I'd dig my heals in to suggest that 100% of one's wealth in Roth accounts or 100% in pre-tax 401(k) accounts are the two points on the curve with the highest overall tax bite. The curve in between may not be smooth, it may not even be knowable, but as I offer above, there is a number that can go in pre tax and come out tax free.

Side note - the 48 year old whose money I manage, pushed her to deposit to her 401(k), became disabled, have been using Roth conversion since it was available. She now has $90K converted. Money that went into the

401(k) pretax, and is getting converted, each year, at her zero rate, now continuing to grow tax free. I'd say the planning we've done each year to avoid taking this money out at 10% was well worth the effort, and since she was in the 28% bracket while working, the tax savings added up.

JOE

This is my premise I started thinking about...

Consider- married filing jointly, currently in 25% tax bracket (combined Gross Income close to 110k). Have around 125k in 401ks and another 35k in Roth, plus two smaller rollover IRAs.

My thought was if I used the Roth 401k now, there is a situation where the "traditional" 401k/Rollover money is "tax free" (RMD's taken as

72T and/or at 0% tax rate because of exemptions).

Then use Roths for rest of money to be tax free during retirement.

If working life was age 25- age 45, with early retirement at 45... there might be some logic to suggesting that paying high taxes for 20 years and none for next 40-50 is better than some taxes at ages 25-95.

I mostly agree with your approach. I'd just suggest that the goal of 'zero bracket' in retirement ignores any use of whatever the first bracket is, currently 10% for that first $7825. I'm not saying to change your path, just be aware that any opportunity to put money away in one bracket, and take it out in a lower bracket, is money in your pocket. JOE

An overlooked factor is "means testing of medicare premiums" which suggests reducing taxable retirement accounts too. Though this factor is minimal in the inaugral 2007 year, there are escaltors in the tax formulas which suggest very high medicare premiums for the median retiree by the 2020s. I'm talking about over $1000 a month medicare premium for those with poor tax planning.

can you explain this with slightly more detail, please?

Currently retirees making less than $80,000 a year pay $0 for medicare part A and $93.50 per month for medicare part B. Each part has the nominal insurance full price of $374 a month, 7/8ths which is paid for by medicare. The Medicare Drug Act of 2003 makes high-AGI taxpayers pay all of the part B premium. This phases in over eight years. 8% of retirees have to pay more the $93.50 in 2007.

Now comes the interesting parts. First, medicare premiums are inflating rapidly. In 2002 they were $53 a month, or an increase averaging 13% a year. Should this continue, the monthly subsized medicare premium will be $400 by 2020. $1600 a month if not subdized.

Second, the $80K number was intentionally not COLA indexed. So while only 8% are above this in 2007, its estimate over half will be so in the 2020s, just from basic inflation.

Now the "means-testing" genie has let out of the bottle, nothing stops means-testing of part A and the social security pension. A bill to extend means testing to part D failed last year, probably due to the new democratic majority.

Currently the law says a social security check can never go down. So the medicare increases would mainly end COLA increased in current retiree's checks and decrease starting checks of new retirees.

Now the rub may be to make your income appear below $80K by careful tax planning. I havent seen this kind of tax planning widely discussed yet. But health insurance costs for retirees in the next decade or two look like they are going to be gigantic even for those covered by medicare.