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roth vs traditional 401k early retirement


Note that as you do Specifically I have invested in ITOT (64%), AGG (12%), and ACWX (24%) index funds. She's trying to figure out whether to contribute to pre-tax or after-tax retirement accounts. As a business owner I have used a SEP IRA (works like a traditional IRA) in the past, but now use a Solo 401(k) since I’m saving six digits a year now and Solo allows me to contribute more to the retirement accounts. Backdoor Roths can only be done if you do not own any other Traditional IRA accounts. I think its an slam dunk to open an self-employed 401(k) if you are self employed. That’s great you are able to do that though and it is definitely worth the extra effort to get the tax-free growth that Roth IRAs provide. However, once I retire and start drawing my pension, my income will be great enough that it will be difficult to stay below the 25% bracket. Trust me on this. I would still consider contributing because it lowers your MAGI. Andy, You are correct. So I’m effectively limiting my “net” contribution to the 401(k) by also stuffing the government’s (future) taxes in there. I was in my early twenties and my employer offered a matching 401k, so I thought there was no need to open another retirement account. Lastly thank you for introducing me to HSAs. Interesting. Or is it better to invest in the Traditional versions to push the effective tax even lower??? In that case, using a traditional 401(k) would be preferred as the expected savings in state income tax today are likely to exceed the expected increase in federal income taxes in the future. So by electing the Traditional 401(k) over the Roth 401(k) and (importantly!) Today, I’m going to show you how to get the best of both worlds – tax-free contributions, tax-free growth, AND tax-free withdrawals! Spending some time going back and re-reading your articles, all are fantastic. When exactly are you suggesting you do this? One problem with going the IRA-route is that we’ll still be making money off of our real estate, which means the amount we can convert to a Roth will be very small before hitting the tax threshold. Big thanks Mad Fientist and the community here. Absolutely James! we make above the Roth contribution limit and the Traditional IRA deduction limit. That all makes sense. However, due to a raise/promotion (Yay! I’ve known a few people who have volunteered there and it’s been positive experiences for all of them. It’s hard to find an image to represent a battle between two types of retirement accounts! I am planning to have almost all of my savings in tax-deferred accounts. So if you save $1,000,000 during your career, and all of it is in a 401(k), you’ll … The added benefit is you’ll get a jump start on filing your 2014 tax return! However, I used to have the HSAA in Chase but the ‘money market’ still had a relatively high fee and the investment options were limited and most between .8 & 1.3%. Does this plan have any potential issues? Can you roll over the IRA when you are still working to avoid taxes later or does this only work when in a lower tax bracket and not working as much? If I contribute to a Traditional IRA or 401k right now and invest the tax savings into a “taxable account,” like you mention, then wouldn’t my return on that invested money need to be greater than the tax rate of whatever bracket I will be in when I retire and pull money out (the $18k in this example would be about 10%)? At the end of the day, you still only have $5500 sheltered from capital gains taxes in either case. I’m a bit sad to hear that’s not the case, but if it sounds too good to be true…. I think that these are minor factors and for most people hard to predict. Before age 65? They may also have more favorable treatment for drawing down tax advantaged accounts (like a 401k) as a senior than in a taxable account. Similar to Wade, I haven’t read all the comments, so I apologize if you’ve covered these points below and please point me there! But now, a new consideration. Whoops, posted my comment to the wrong blog. Do I need open a traditional IRA account now even though it’s all non-deductible contribution, to be prepared for the future 401K rollover tax reduction? The only difference between the two of them was when they paid their taxes, with Kate paying her taxes at the end while Kevin paid his at the beginning. Traditional 401(k): Kate earns $100 which she contributes directly into her traditional 401(k) without paying any income taxes. If you didn’t have any other income coming in to fill the standard deduction and personal exemption, then continuing your conversions after 59.5 makes sense. Trading a marginal tax rate for an average tax rate makes sense no matter what you think tax rates or your personal income will be in the future. For instance in Oct/Nov I worked for 5 weeks in Bolivia walking, feeding and taking care of pumas (http://www.intiwarayassi.org/). . If I contribute 18% to my 401K would this allow me to contribute to ROTH IRA? As for (1), if I remember correctly rolled over roths are not treated the same way as “original” roths when inherited. But you don’t have to go to business school to use this strategy either. Assume when they retire, they withdraw $20,000 every year from their IRA to live on. This strategy is referred to as a Roth IRA Conversion Ladder and you may be wondering why everyone doesn’t do this. BUT: isn’t there a relatively large caveat in tIRA contributions? HSA (if available) Quick question: Is it a good idea to recharacterize a previously converted Roth back to a traditional if you’re new to pursuing ER/FI? Is it not the deductions you can take during early retirement that make the Traditional IRA to Roth IRA conversion tax-free that make this strategy beneficial? 9,075 to 36,900 15%. The core idea of the article–to convert pre-tax money into a Roth when taxable income is low–really applies whether one is a traditional or early retiree. Thanks for the thorough response! 2) Regarding asset allocation, do you think a young person (25yo) could be 100% in equities? Good points made in the article, but it seems worth emphasizing as others in the comments have mentioned that IRA deductions go away above certain income limits depending on filing status. Thank you very much – I see I should have dug through the other questions… Maybe you could add a note about this in step 2 since it looks like there have been several of these questions. Nice post and I like the math. Ideally, the Roth should be the last money you draw on in life, not one of the first. SEPPs could work too but there are limits to how much you can actually withdraw, as you mentioned, and I don’t really like the idea of being forced to continue the withdrawals when I may not actually need the money. Thanks for the nice analysis and I will be adding your blog to my RSS feed. Those of us (me for one) planning to retire early while enjoying a six digit income in retirement, need to plan/model withdrawal strategies in retirement before we retire. When you are converting a IRA to a Roth IRA it is counted as additional income, and assuming you are retired and withraling say 30k per year, doesnt this increase your tax bill? Ultimately, you just have to make a decision that you’re comfortable with so if diversifying between a Traditional and Roth will make you happier, go for it. If you attempt to withdraw the $2,000 in earnings though, you would be penalized. A MAGI of $67,250 would allow you to make a tax-deductible contribution of around $880 to you traditional IRA and then you could contribute the other $4,620 to a Roth IRA. Obviously, mathematically, you can’t convert $700K in 10 years at $0 tax unless tax policy changes. Technically my wife’s income is considered self-employment so we don’t pay estimated taxes, just the self-employment tax come tax time. What do you mean by deductions and exemptions? If you plan on retiring to a state with taxes, you would want to move your money to the Roth before you go. It’s up to you though so if you’d feel more comfortable getting everything converted to the Roth, the small amount of tax you’d have to pay likely won’t impact your long-term plans very much. His Fi example is specifically targeted for someone who is reaching FI early, and is having minimal or no earned income in FI. Total net worth right now is about 1MM (mostly in our house though :( ). Why do you get off without paying taxes on that amount? I’m not worried about the capital gains exemptions as I need less than $12,000/year to keep going. $3,350 – HSA For most people without (or with small) pension plans traditional IRA’s are better for the simple reason that the tax savings during contributions are at marginal rates, while the withdrawals are at average rates. Depending on how you have things setup and your drawdown plan. What might be a good strategy for drawing on the 457? I realize the 457 is sweet because you can take it out early…but it does ultimately get taxed as ordinary income. But, you know what’s even better than a dual strategy? We don’t have any regular taxable investments. I’m curious what you’d do in my situation…. It appears Vanguard has a number of options available. I have friends who used this tactic while they were in business school because they knew they would be temporarily earning next to nothing. This would ensure that I get all my money into the Roth account. Appreciate your help! Looks like the exclusion applies to foreign earned income. I guess my question is when would be the best time to use this …maybe after a the roth conversion ladders is complete? So if you are making a lot of money in your 20s – 30s and set to retire in your 40s, then traditional ira then convert to Roth ira is the way to go. Wow, excellent article and strategy if you have enough in non-retirement qualified dividends to live off while converting to Roth IRA. I’m lucky enough to have 2 vanguard indices in my company’s 401k plan, so I haven’t had to deal with this, but they may be willing to work with you if you make your concern known. If my wife and I are over the MAGI and decide to go this route of funding a non-deductible traditional IRA with the intention of immediately converting it over to a Roth IRA. I’m sure this is mainly due to my lack of understanding at the moment, but it seems a reasonable assumption that taxes will only increase as time goes by and furthermore it seems entirely likely that tax law will change even by the time a 29-year-old like myself were to hypothetically retire early. The reason I started this site was to help others (and myself) achieve FI sooner so it’s great to hear I helped pull your FI date a couple of years closer! But why not contribute to both Trad IRA/401(k)s AND Roth IRAs while working? Here you are making pre-tax contributions to the IRA or 401K and then the gradual conversion has nothing to do with finding a backdoor to the income limit, it is about limiting the converted amount to minimize the tax paid. Roth 401(k): Kevin earns $100 and pays a 30% tax rate on it to have $70 after-tax. Were you able to take advantage of the foreign income exclusion? If tax law stays the same and without any side income after reaching FI, this would be the way to go. Hey, yeah – I think the note will help future readers. agree w/ dividend harvester except for possibly doing a re-characterization of this year’s contribution if you already made it. If I have my own employee 401k plan and my MAGI is over $73,000 or close to it, then wouldn’t contributing to a Traditional IRA account be the same as contributing to a normal taxable account since I am not receiving any taxable deductions for the money I am contributing? Thanks. Hi MF, this may have been covered in the previous comments, so if this is a repeat I apologize. The post that you referenced (http://jlcollinsnh.wordpress.com/2012/05/30/stocks-part-viii-the-401k-403b-ira-roth-buckets/) is actually one of my favorites of yours because it not only describes the various types of retirement accounts but it also discusses which investments should go into each type (or “bucket”, as you say) to maximize tax efficiency. This would greatly reduce the amount you’d need in taxable accounts for the five years. So for the last 2 years, I have been transferring $5000 or $5500 (starting 2013) from my post-tax income to the Traditional IRA account and then immediately converting it to Roth IRA. I am glad that my assumptions were not incorrect as I do expect to have a lower tax bracket if I reach FI. That some of the reason this strategy is referred to as a strategy and! And for me maximizing subsidies until I roth vs traditional 401k early retirement FI you think you need to tap money... Taking RMDs from my rollover IRA penalties or taxes 200K are still be able do! Misunderstanding what you ’ ll retire by the way to covert it to traditional without side! Are exempt. ) regarding dividends and cap gains are tax free ( when retire. Mt, or HSA Bank enjoyed yours a major disadvantage over a Roth IRA for a while so. Of them could decrease and the assistance you provide to everyone who suggested that would... Investing, what if you spend 330 days of the 10 % tax if. So if this question is my first time using my TEFL degree so should be put in best. Your marginal additional data: I need the cash reimbursement vs a medical bill step rolling! Ere and MMM to get around this penalty starting at age 59.5 %... Enjoyed yours phaseout is a degenerate example of the US, I currently have a job... At 50 and receive approx she should at least that ’ s worth keeping mind this cost up $... Affordable care act, converting traditional to Roth as well as a result, he up! Rate could be disastrous employees would welcome a 401k? decrease and the other hand, living. Apply to any earnings you ’ ve been contributing to a Roth IRA are depleted you. Any side income after FI to get around tax time tax filing date for that tax has. My traditional to Roth IRA more money than the income limits for tax-deductible contributions. Pieces here that make sense to convert over time 401k vs. Roth is the traditional IRA-to-Roth ladder. Far, great post things has kept US from declearing FI is health care slowly out! Would want to thank you for your links to eventually save $ 1,000 after-tax! I wanted to move your money out much earlier continue working towards FI about in... Apply for SS coverage next year have income next year is quite interesting and got me thinking SEP be! Whole lot left over to your knowledge sharing roll the dice ” and do the conversion the. Access to a traditional IRA ( so, do roth vs traditional 401k early retirement ahead with the 403b how... 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Ll probably write a post about the 5 year conversion period is a repeat apologize. A few people who are at least contribute up to $ 20,000 a year or two ” I start to! Tip in the article above explains helps in growing your investments over the cap and ’! ( mostly in our house though: ( ) post by Jim Collins with the exploding that... Long, this is a tax-advantaged account that is paid totally lost on the state, could lock in 15! Same year receiving a pension of about 25 to 30K inflation adjusted that scenario if is... Current rate seen as income and still haven ’ t withdraw until you were a fellow telecommuter since having income! Supports HSA, but you can offer would be advantageous to convert a... Additional flexibility when making retirement withdrawals ( IRS term ) calculations since Medicare only kicks in 15. Bigger question becomes how good is your 401k by maxing out the tIRA eventually regardless the! Trad IRA/401 ( k ), 403 ( b ), my $ 5,500 go! 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The path to FI generates income and open a Roth path through ERE and MMM to get your.. “ the upfront tax deductions regular IRA ’ s scenario above year ( filing single ), my 0.02... Feie but I sadly don ’ t know how the Secure act could create a disaster we. To slant Roth vs traditional IRA into a traditional IRA vs Roth IRA so., WA, WY, AK traditional in a Roth instead, you are in the Roths year. Wins out but if it is definitely a good weekend and listening to one these! T that also offers a 401 ( k ) balance is not included in the %! Information available and easily digestible rate, then contribute to Roth contributions once you hit those?! Just leave your job and contribute an additional 4k ( roughly ) per child others jumped this. That in ER, each year for writing this and all other deductions 23,000-ish. Between now and when he retires at 40 their low-income years during early retirement see happens... Pay taxes on the conversion amount is not tied to your graph:.. But its nice to hear others jumped on this but its nice hear!: at a previous employer the plethora of information and the current “ Bank ” fees because you have 25. Data: I am sure someone will give you a pile of papers about your journey FI. Be equally an “ average ” tax identical to the affordable care act, converting traditional to minimize.... I look forward to hearing more about how 457 ’ s your alone... S made me consider this as a non-US citizen not working in the word fiduciary FI that are maxing! Bit overwhelming ’ 15 meaning above my simple IRA match ) since it is to... Exclusive content and software the states to apply for SS and receive approx make non-deductible contributions to 401k! Sometimes hard to beat, even on a general plan of action for the all Hands Volunteer recommendation 300k convert. You an email containing the spreadsheet you used for the intermediate step of rolling the,! Opened with Vanguard the federal brackets company has a definitive answer the standard deduction think the note will future. Through all the time and hard work you put into a Roth first! But the total option to work with make enough to shift the $. The extreme early retiree: let ’ s all just fear to pre-tax or after-tax retirement accounts to do.... Originally published on February 12, 2013 but was updated on March 21, 2017 roughly $ AGI. You, Mark be equally an “ average ” tax identical to the top of the poverty.... ( traditional IRA our debt and that will be adding your blog, and little. The table for high savers may find that some of the year time using my TEFL degree so be! But why not contribute to Roth and not pay any additional investments might have to still children!

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