funding a roth before maxing 403(b)?

**Seeker** · 12-22-2010, 11:07 PM

Using a Qualified Plan Account to Fund a Roth IRA Conversion

I believe this is what you are looking for:

Ideal Candidates

The benefit of a Roth IRA conversion is that the taxpayer pays tax today at a known tax rate instead of at a future, possibly higher, tax rate. That, of course, is the unknown. Generally, the conversion should benefit those who:

Have sufficient outside assets to afford to pay the taxes resulting from a conversion with money from nonretirement funds;

Expect to be able to wait many years before they need to begin making withdrawals from the Roth IRA account;

Have made nondeductible contributions to a traditional IRA (in this case, the taxpayer�s basis in the traditional IRA may make the tax cost of conversion very manageable);

Are looking to reduce the size of their taxable estate because the prepayment of income tax may bring their estate below the applicable limits (whatever they may be) for 2011 and future years;

Have a Roth conversion that results in some or all future Social Security benefits being exempt from income tax;

Expect their federal income tax rate to be higher at retirement due to higher income or change in income tax rates;

Have current IRA or qualified plan accounts that are at a lower value due to stock market losses (the lower value would result in lower taxes upon conversion, and the recovery of the account would be tax-free); or

Have large business losses, net operating losses, or large itemized deductions (in this case, the taxpayer should convert just enough to not create income or to create income taxable at lower marginal rates).

**kork13** · 12-23-2010, 02:02 AM

Originally posted by takeback View Post

It was my understanding that by retirement age we all are at a lower tax rate. If this is so, what would be the incentive to fund a roth before maxing out tax free contributions to my employer based plan?

It is common for most people to have a lower income during retirement. However, lower income doesn't necessarily mean lower tax rate. As Seeker's post points out, it's a distinct possibility (a certainty IMO) that tax rates will be higher in the future. And with a Roth, once you pay the taxes, your tax is locked in--it's no longer subject to those future tax hikes.

The most significant reason to prioritize the Roth, however, is thanks to compounding. Put $5000 in each account this year and in 40 years, that $5000 has probably grown to $70k or more. From the 403b account, you'll owe taxes on every cent--initial principle, capital gains, and dividends. Total 403b tax bill (even assuming constant tax rates): $15k-ish. With a Roth, you paid your taxes on the $5000 upfront, and all of your gains (all $65k of it) are TAX FREE! Total Roth tax bill: $1250.

If you have more than, say, 10 years until retirement, it's most likely in your favor to prioritize the Roth. Even inside of 10 years, the tax-free status of the Roth's gains are VERY potent. Besides, if you're looking at the choice of whether you should max your 403b, max the Roth first, then you're hedging your tax bets. $5k into the Roth, and the rest ($11k+) into the 403b.

**humandraydel** · 12-23-2010, 04:51 AM

Originally posted by kork13 View Post

It is common for most people to have a lower income during retirement.

I think this depends on what part of your career you are in. Retirement income will probably be greater than the first 5-10 years of your career, but less than the last 10-15. Also, the thing a Roth provides is the ability to reduce taxes in retirement. You can take 403b distributions up to the 15% tax rate, and then supplement with tax-free Roth income. Without a Roth, you would have to take all money from the 403b which would push you into the 25% tax bracket.

**jIM_Ohio** · 12-23-2010, 06:20 AM

The more you spend in retirement, the better the Roth looks.

If your income in retirement is close to what you earn now, then look at how low your tax bracket is... if you are in 15% bracket now (meaning pay 15% taxes now), the Roth is a good deal. Pay tax at 15% and take out at either 15% or 25% brackets tax free. If you are in 25% bracket now, it is tougher to make that same assumption... I would advise to save 25% on taxes now and pay either 15% or 25% taxes later.

75% of all americans pay taxes in the 15% bracket or lower, so if you pay 25% taxes (or higher) you are in the minority from the start. If you are in 28% bracket, the income which put you there probably phased out eligibility for a Roth.

**GREENBACK** · 12-23-2010, 10:38 AM

These types of posts always make me wonder if the tax free growth of 403b's, 457's, and 401k's don't offset the tax liability down the road. Which then becomes better? A tax free plan now ( roth) or a plan that grows tax free but is earning more because more is going into it. I'm not sure how to even run those numbers.

**jIM_Ohio** · 12-23-2010, 12:10 PM

Originally posted by GREENBACK View Post

These types of posts always make me wonder if the tax free growth of 403b's, 457's, and 401k's don't offset the tax liability down the road. Which then becomes better? A tax free plan now ( roth) or a plan that grows tax free but is earning more because more is going into it. I'm not sure how to even run those numbers.

IF (and big IF) you invest the tax difference it comes out the same. That is a huge IF...

for example if you put $5000 into a Roth or $6250 into a 403b, the answer should be just about the same. The only difference will be the first $X of the 403b comes out tax free (lower income tax brackets). For large amounts this is barely noticed.

If you invest $5000 into Roth or $5000 into 403b, then the Roth wins ( because taxes were really paid on the Roth already, so its $6250 Roth (before tax) vs $5000 403b (before tax).

**Hector** · 12-23-2010, 12:30 PM

Originally posted by jIM_Ohio View Post

The more you spend in retirement, the better the Roth looks.

If your income in retirement is close to what you earn now, then look at how low your tax bracket is... if you are in 15% bracket now (meaning pay 15% taxes now), the Roth is a good deal. Pay tax at 15% and take out at either 15% or 25% brackets tax free. If you are in 25% bracket now, it is tougher to make that same assumption... I would advise to save 25% on taxes now and pay either 15% or 25% taxes later.

75% of all americans pay taxes in the 15% bracket or lower, so if you pay 25% taxes (or higher) you are in the minority from the start. If you are in 28% bracket, the income which put you there probably phased out eligibility for a Roth.

I completely agree with your post. I would invest in Roth if I am in 15% bracket and would invest in regular retirement account if I am in 25% or higher bracket.

**GREENBACK** · 12-23-2010, 02:43 PM

Originally posted by jIM_Ohio View Post

IF (and big IF) you invest the tax difference it comes out the same. That is a huge IF...

for example if you put $5000 into a Roth or $6250 into a 403b, the answer should be just about the same. The only difference will be the first $X of the 403b comes out tax free (lower income tax brackets). For large amounts this is barely noticed.

If you invest $5000 into Roth or $5000 into 403b, then the Roth wins ( because taxes were really paid on the Roth already, so its $6250 Roth (before tax) vs $5000 403b (before tax).

That makes some sense of it, thanks.

**takeback** · 12-23-2010, 04:14 PM

I will probably bee in the 28-31% rate for 2011, and I think my AGI will be just under the 169k I see listed as the ceiling for eligibility, so wouldn't it be better to limit the tax hit by preferentially funding the 403?

**jpg7n16** · 12-23-2010, 05:05 PM

Another thing to consider: Required Minimum Withdrawals.

You are required to withdraw a certain amount from a 403b whether you need it or not. And it's a required percentage - so the higher your balance, the higher the required withdrawal.

Roth's don't have RMDs.

My main planning tactic is to suggest that you split evenly between the two (or close to evenly). This gets you the best of both worlds. 1/2 your retirement money would be tax free, 1/2 your contributions are tax deductible, and 1/2 your retirement money is not subject to RMDs- thus cutting the amount of required withdraws in 1/2. This just gives you more flexibility, and more control over just how much you'll pay in taxes during retirement.

If tax rates turn out to be lower in a particular year, withdraw your living expenses from your 403b, and if taxes shoot up take your RMD and then the rest from the Roth.

Another thing in favor of the 403b, is that you still get to claim standard and personal deductions in retirement. Those essentially offset a portion of the 'income' from the 403b, and lower the effective taxes overall. So there is a definite plus side to the 403b. Just saying.

In sumamry: both have complementary advantages, so use both in your plan

funding a roth before maxing 403(b)?