Retirement Investing - Pre vs. Post Tax Advice

[parafly]

My wife and I are seeking advice regarding retirement investing. We firmly believe that future tax rates will be going up so our general mindset is to take the tax hits now instead of retirement time. However, our worry is that we are too strongly invested through post-tax investment vehicles and not leveraging ourselves enough with pre-tax accounts. We are both in our late 20's, and here's a breakdown of our active retirement investing:

My retirement accounts
Roth 401K - 5% (employer matches up to 5%)
Roth IRA - $5000 / year

Wife's retirement accounts
Roth 401K - 3% (employer contributes 4.5% annually to 401K regardless of employee participation)
Roth IRA - $5000 / year
Employee stock plan - $4030 / year

As you can see, everything is post-tax. I would like to add that both of us have Rollover IRA's (pre-tax) from old 401K plans, but we are not currently contributing to these accounts. Also, we are near the top of our tax bracket so lowering our taxable income through pre-tax accounts would not get us into a lower tax bracket.

Are we too strongly invested in post-tax accounts? Should we switch our Roth 401K contributions to regular 401K contributions? Maybe a mix of both?

Thanks in advance!

[bjl584]

Do you have any taxable accounts outside of your retirement accounts? I wouldn't worry so much about being leveraged heavily in post tax accounts as I would about having liquidity today (i.e. money that you have immediate access to as oppossed to 30 years from now.)

I am a believer that future tax rates will be higher too, so I contribute the max to my Roth IRA. I also have a traditional 401K and a taxable brokerage account that I regularly invest in.

Bumping up my 401K and reducing my taxable account contributions won't lower my tax rate either, so I have a blend of pay tax now, pay tax later.

I am trying to build up my Roth to a point where I have a regular tax free dividend cash stream, but I also keep a lot of investments in taxable accounts to maintain liquidity.

[parafly]

Do you have any taxable accounts outside of your retirement accounts? I wouldn't worry so much about being leveraged heavily in post tax accounts as I would about having liquidity today (i.e. money that you have immediate access to as oppossed to 30 years from now.)

I am a believer that future tax rates will be higher too, so I contribute the max to my Roth IRA. I also have a traditional 401K and a taxable brokerage account that I regularly invest in.

Bumping up my 401K and reducing my taxable account contributions won't lower my tax rate either, so I have a blend of pay tax now, pay tax later.

I am trying to build up my Roth to a point where I have a regular tax free dividend cash stream, but I also keep a lot of investments in taxable accounts to maintain liquidity.

As far as immediate liquidity, we have a "high" interest savings account which we use as our Emergency Fund, and we have two brokerage accounts with small balances which we use as stock play money. Also, we both have HSA accounts to which our employers contribute $500 annually, but that is "liquid" only in terms of health expenses.

Our main concern is being too strongly invested in post-tax retirement accounts without much pre-tax retirement account leveraging. The question is whether or not it's a warranted concern.

[bjl584]

As far as immediate liquidity, we have a "high" interest savings account which we use as our Emergency Fund, and we have two brokerage accounts with small balances which we use as stock play money. Also, we both have HSA accounts to which our employers contribute $500 annually, but that is "liquid" only in terms of health expenses.

Our main concern is being too strongly invested in post-tax retirement accounts without much pre-tax retirement account leveraging. The question is whether or not it's a warranted concern.

It's a good move as long as your prediction of higher taxes in the future comes true. If taxes are lower in the future (which I don't see happening), then you will have paid your taxes today at a less than favorable rate. Either way, you will have a very nice source of tax free income when you and your spouse retire.

Even if taxes do go down in the future, I don't think that the change would be signiicant. Maybe a few percentage points? I personally wouldn't worry too much about it since you already said that upping pretax investments won't change your tax bracket.

[Slug]

I tend to think you're right as well that tax rates will be going up, but I'm not sure in what manner. What if we end up moving to something VAT-like and reducing income taxes. In that case you're doing yourself a disservice to be so post-tax focused. For me, I'm diversifying across taxable and non-taxable. There's about 30 years until I retire and my ability to predict 30 minutes ahead is not so good, let alone 30 years. So I diversify.

[feh]

Given your age, I'd stick w/ the Roth.

[parafly]

I made a couple of corrections to the numbers of my wife's retirement accounts, but that shouldn't affect the primary question.

[dczech09]

You believe your income will be higher in the future, so you want to contribute to post-tax accounts. Based on your rationale, you're doing the right thing by being heavily invested in Roth accounts. Leveraging with pre-tax accounts will not really provide benefit to you other than give you additional retirement funding. If you're maxing your Roth investments, go for the pre-tax stuff since that is your next option.

We do not know what tax laws will be 30 years from now. For all we know conservatism could take over, debt-spending drops, and taxes drop like a rock. Conversely, we could continue going down the path we're on and continue getting gradual tax increases by a government that thinks our money is their money. So, we can only use today's tax laws as a proxy for tomorrow's.

[scfr]

Don't forget that with pre-tax investments, the money you save on your taxes (assuming you put it away and don't spend it) will have almost 40 years to compound before you use it. Can you personally contribute to your HSA on top of what your employer contributes? That would be one option to consider.

[humandraydel]

As you can see, everything is post-tax.

Actually, everything is NOT post-tax. An employer match can NOT go into a Roth account. So, your 5% contribution goes into a Roth 401k, but your employer match goes into a traditional 401k. It sounds like you are approximately 50-50 on pre/post-tax investments.

[jpg7n16]

Given your age, I'd stick w/ the Roth.

I see this reason given often for Roth accounts, but could you explain?

What does age have to do with which account is more appropriate?

[kork13]

I see this reason given often for Roth accounts, but could you explain?

What does age have to do with which account is more appropriate?

I hear (and yes, repeat) the same philosophy all the time. I finally actually checked into it...

Two reasons I normally see:
- In most cases, younger people find themselves in lower tax brackets, because they haven't been able to establish themselves in their career and steadily build up to a higher level of income. Lower tax brackets make Roths more "worth it".

This is pretty legit--most 20-somethings start out making $30k-$40k/year pre-tax, which generally puts them in the 15% bracket. Over a lifetime of career progression, most people can probably expect to at least double, possibly even triple their starting salary. This most assuredly bumps them up into higher tax brackets later in life.

- When younger, using the Roth gives you 30-40+ years of tax-free compounding interest.

This is the one that I wanted to check into... Assuming a person's tax rates stay constant over their entire lifetime Roth vs. Regular is a total wash.

$5000 Roth contribution=$6666.67 Regular IRA contribution (in 25% bracket). Upfront tax savings w/Regular IRA: $1666.67. 30 years w/8% average gains becomes: $67k for Regular IRA, $50k for Roth IRA. Roth has no taxes due. Regular IRA has $17k tax due, post-tax value of the same $50k.

So basically, by being taxed upfront, it removes the growth potential of that extra $1666, and results in a lowered possibility for compounded gains. I'll admit, when I just worked all this out and saw the result, I was pretty surprised to see that it becomes a wash.

So assuming all factors stay constant (tax rates and an individual's tax bracket), Roth or Regular doesn't matter. But if (when) tax rates increase, and on the mostly-valid assumption that a person's income (and thus tax bracket) will increase over time, the Roth becomes a better option.

This also ignores the other advantages beholden with a Roth: No RMD's, and more favorable terms for bequeathing to heirs; freedom to withdraw contributions at any time; and providing tax-free income during retirement, potentially allowing assets in pre-tax withdrawn with a lower taxable income (and thus lower tax bracket).

[jpg7n16]

I hear (and yes, repeat) the same philosophy all the time. I finally actually checked into it...

Two reasons I normally see:
- In most cases, younger people find themselves in lower tax brackets, because they haven't been able to establish themselves in their career and steadily build up to a higher level of income. Lower tax brackets make Roths more "worth it".

True, but then it's the tax rate that makes it a good reason, not their age.

- When younger, using the Roth gives you 30-40+ years of interest-free compounding interest.

I'll admit, when I just worked all this out and saw the result, I was pretty surprised to see that it becomes a wash.

So assuming all factors stay constant (tax rates and an individual's tax bracket), Roth or Regular doesn't matter.

This has always been my viewpoint - that regular IRAs compound too

But if (when) tax rates increase, and on the mostly-valid assumption that a person's income (and thus tax bracket) will increase over time, the Roth becomes a better option.

Unless the income is higher when withdrawals are made, then the typical increase in income over the course of one's life should have no effect on the tax treatment of the account. And most people don't earn huge incomes in retirement.

This also ignores the other advantages beholden with a Roth: No RMD's, and more favorable terms for bequeathing to heirs; freedom to withdraw contributions at any time; and providing tax-free income during retirement, potentially allowing assets in pre-tax withdrawn with a lower taxable income (and thus lower tax bracket).

Also, there's no time limit on contributions to a Roth. You can keep contributing at 95+ years old if you have the income to do it.

Those are all very true, and good advantages to a Roth, but none of them are based on age

[bennkar]

I agree with the idea to have some of both pre and post tax savings. Not only do you never know what will happen long term with taxes in the US, even if things stay the way they are now having some of both types will give you flexibility when you retire. You can take out of the regular 401k in a manner to minimize your tax hit, then use the Roth funds to give you extra money as needed. The only reason I would go Roth only is if you feel comfortable maxing out your retirement accounts totally as Roth. If you have trouble maxing out, then save some using pre-tax money, this will increase your available funds for retirement.

Unfortunately for me I have no Roth option at work, though I have heard that may change in 2012. I do max out the Roth IRA though. Once I have the capability to do a Roth at work, I would probably go $10,000 post tax & $11,500 Pre-tax (thats combining the current $16,500 limit + Roth IRA of $5,000).

[littleroc02us]

Personally, I want my money taxed now while I'm making the most money and when I retire I don't want to have to pay taxes. That is why I so heavy on Roth IRA's. I don't think it would be much fun to have to dish out tax payments on my deductions.