My employee match is a measly $500/year, and the best fund I can contribute to is Ivestco Equally Weighted S&P 500, VADRX. Despite all the back and forth on which 401(k) account is right for you, the only right answer is to talk to a tax advisor. Your email address will not be published. I’m hoping to get that in the next month or so so that I can rejoin my wife in Scotland at the end of May. What the effective tax rates are on your contributions is very relevant. =). >90% of my net worth is in real estate equity (it is what I understand and I like that it pays me income (8-15%) every month on top of all its other benefits). Thanks for the clarification of what seems obvious. You just need to make sure you have enough to “bridge the gap” between FIRE and 59 1/2 when you can access more of the tIRA/401k/403b contributions. All that said, I get it and don’t necessarily disagree, but it is not quite as cut and dry as presented. I do agree taxable money should be used before withdrawing from Roths in most situations though. I don’t how this works if your 200K/yr income is from self-employment. I love the blog (especially since I’m an actual scientist). The phaseout is a payout to the financial firms. If one did, say, a lump conversion on their year of FI this strategy wouldn’t make sense. 1) Keep in mind that there is a 5-year holding period (lockout) when you convert a Traditional IRA to a Roth IRA. Would you personally keep contributing to your Traditional 401k once you are in the 15% tax bracket (and put the rest into a Roth 401k)? How would paying taxes now to contribute to a Roth (or straight to a taxable account) be more advantageous than paying taxes much later at a lower tax rate? Does an age restriction exists for widthdraws? Traditionally, a 401(k) allowed workers to contribute pre-tax dollars to an investment account, watching their money compound and grow prior to having to pay taxes. Thanks, Jim! It will be my first time using my TEFL degree so should be interesting. 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%. Though I am not expecting you to forecast the future path of income tax rates in the U.S., I do think that spending time to think about your retirement situation can help clarify the traditional vs. Roth decision. Let me repeat that. Is there any difference during early retirement between (a) living on after-tax Roth contributions and converting the entire 0% bracket from 457 to Roth each year, and (b) living on taxable 457 distributions and converting the remainder of the 0% bracket to Roth? 2) Yes, you’ll have to start taking Required Minimum Distributions (RMDs) at some point I’d be interested in some commentary on how this changes if the protagonist expects post-retirement income similar to or above the working career period income. I had the exact same question as Ron, curious if my annual “backdoor” Roth Conversion was the right move given my joint income is above the deductible IRA threshold…. What counts as taxable income for the ACA subsidy calculations has to be taken into consideration. Hi Will, email me your spreadsheet and I’ll take a look. Assuming one maxes it for fifteen years or so straight out of University and has a total contribution of over 300k before gains does it bring up the Roth vs IRA debate again? Wonderful article! For more information on Roth IRA Conversion Ladders, you can check out my guest post over at jlcollinsnh.com – http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/. From reading your article and the other comments on this page, I’m thinking that we should still contribute to a traditional IRA to allow us to pursue a backdoor ROTH IRA. I left my job almost 4 years ago when I was 33. We max out two 403bs and two Roth IRAs and get employer match. A TRAD IRA would reduce your Federal Income tax even in an income tax free state. This is a quick response based on my own history — I am sure someone will give you a more considered opinion. In my bank, I have ~$50K in a non-tax advantaged mutual fund account, ~$5K in a Roth IRA, and ~$5K in a traditional IRA. It was interesting article though and it highlighted some downsides to backdoor Roth IRA contributions that I wasn’t aware of so thanks for sharing! Contributions to your 401(k) or 403(b), 457(b), HSA, and your standard deduction and personal exemption should be subtracted from your gross income to calculate your MAGI. Great job making this super clear; however, there is one thing to look out for…. The short answer would be, if you are eligible, you would just want to contribute to a Roth now and not a Traditional IRA, as the conversion would be taxed as income above the “post-retirement income” you expect and would likely push you into an even higher tax bracket. Great post! 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. Is it better to move the old 401(k) into the new one, or as you mentioned above, to convert it into a Traditional IRA? https://www.powerofzero.com/books I recently read the power of zero -The over arching story is pay taxes now and invest in roth accounts to take advantage of the historically low taxes we have until 2026 – and it is extremely likely taxes will be higher in the future because of the rising unsustainable national debt. (forgive me if you’ve covered this in prior posts – I searched but I couldn’t find any mention of them), Looking forward to reading more great posts; you’re in my RSS reader! At 22 you shouldn’t have anything in bonds. :). The company has a 401k plan, but I’m not enrolled as it doesn’t match my contribution. It’s a shame that 401ks are dripping with fees. Hi, love the article! Then went I retire, I convert the whole amount to IRA. I was always under the assumption since having no income tax is such a great benefit, I should contribute to a roth account. I have some immediate plans to save on taxes by moving to a no-state income tax area, or even go out of country to get the federal income exclusion. I was curious how you file your taxes, i.e. As a 27 year-old who has only recently begun to realize that financial independence is possible, you are an inspiration. Also use the withdrawals of Roth IRA contributions for living expenses. I receive tax credits for college expense payments and health insurance and just today a stimulus check based on my income. $30K investment income (long-term capital gains and dividends). I currently have a Roth IRA and I am self-employed, so no option for 401(k). Also, don’t have a whole lot left over to save along the way after maxing out my TSP contributions. Sally placed more total dollars into the tax-deferred account to begin with. That’s great, are you living in Scotland now? I agree with Jim_ this is a huge issue for me as well. I would LOVE to see what the cut-off cost-of-living dollar amount is where the Roth starts to beat the traditional 401k… For example: You said you currently max out every tax-advantaged account so you’re already socking away as much money as you can in tax-advantaged accounts (going with Roths wouldn’t increase the amount you contribute to those accounts because you’re already maxing out the contribution limits). Haha, nice! FI, let alone early retirement wasn’t even under consideration for me but after reading through your blog it really feels like a possibility for me. :). In addition, high savers may find that some of the optionality in a traditional 401(k) is closed off to them. Why is this true? I would hate to hear others jumped on this not realizing the irs limitations. I am glad that my assumptions were not incorrect as I do expect to have a lower tax bracket if I reach FI. When j first gor my job, They sold us on the Roth 401K option, so ive been putting just enough to get the employer match. I know Roth contributions could be taken before but can your conversion (assuming you wait 5 years and it contains earnings) be taken before 59.5? 1) There is a difference between money that was contributed directly in a tax year from wages, money that was converted to the Roth from an IRA, and the earnings (realized and unrealized capital gains and distributions). $18,000 – 401(k) That allows me to get close to the max on my 401k, but that does not allow any money to go into a Traditional IRA. It’s simple because the goal when making retirement contributions is to avoid paying taxes when your tax rate is at its highest. First, I want to thank you so much for all of your advice! One thing alway makes me curious! It’s hard to find an image to represent a battle between two types of retirement accounts! When I first started investing I did not really know the difference between a Roth IRA or a Traditional IRA. Are you talking about money in the 401ks, or money you want to save for retirement beyond the 401ks? Thanks for the clarification. It’s been an AMAZING help for this FI newbie! It is my understanding that there is a 10% withdrawal penalty regardless of the amount for any funds taken from a 401 or traditional IRA before the age of 59 and a half. Just reading this post now, hopefully you get notified – I was under the assumption that 457 plans were created for government or nonprofit employees only because they don’t get 401ks…how can it be fair for a person to double dip 401k/457? Thanks a lot for answering my questions. On year 5, you are then able to take out 10K tax free(59.5 does not factor into this scenario, I can be any age under 59.5)? For 2018 those numbers are like $12K for a single person or $24K for a couple, but may be higher if you have kids or the other handful of deductions that remain. Here are some other pro/cons of a traditional IRA vs Roth IRA. The solid lines are the investors’ normal taxable accounts, the dashed lines are the investors’ Roth IRA accounts, and the dotted line is Investor B’s Traditional IRA account. I am a 22 year old deciding on which index funds specifically to invest in my Roth IRA I have opened with Vanguard. (surplus meaning above my SIMPLE IRA match)Since it is going to be taxed anyway on any conversion? What do you think is best? My Wife and I have just started on our path to FI, currently saving 60+% of our income. So for planning treat them the same. Would it make more sense in my situation to use an taxable account since I will be needing the money in ten years? Maybe because I’m an engineer :-). If I contribute 18% to my 401K would this allow me to contribute to ROTH IRA? Though we cannot predict future tax rates, what we can do is estimate how much income we will need in retirement and where we plan on taking that retirement. ArchiLife, it sounds like you are doing great. Thanks for all this information! It always had to be by the tax filing date for that tax year. Simple and easy to understand. And by traditional being superior I mean Roth :). If I have 10k of other income (to simplify, assume I have zero deductions and exemptions), and I withdraw 5k from my traditional IRA, I believe my marginal tax rate would be 15% on that withdrawal as my taxes on my full income of 15k would be calculated as: 10% * 9,075 + 15% * (15,000 – 9,075) = 1,796, The entire 5k I withdraw is taxed at the 15% rate (plus $925 of my other income). Do you still recommend a traditional IRA over a Roth if an individual does plan on retiring early? Why you would take money from a Roth where all future earnings won’t be taxed and move it to an account where it will be taxed again, along with its earnings, probably at higher rates as taxes are at an all time low and there are many looming deficit and entitlement obligations, is beyond me, personally. Am planning to be stateside for maybe half of next year so minimizing this year’s income will help. But as Norm says there can be duds. Your analysis has proven me wrong. I used to be in the boat of maxing out taxable accounts to fund early retirement. Now, I still think your traditional-to-Roth conversion strategy is great and probably worth the cost of being able to shelter a little less money from capital gains taxes. Your employer can’t cap your contributions to a 401k, that is set by the government. For me I see the most important benefit of a Roth IRA is having the ability to control the money during retirement – meaning there are no required minimum distributions so you can allow the money to continue compounding. Bottom line up front: I need some input in building an (Excel) calculator to maximize Roth Conversion. On the high side similar coverage as employed can cost upwards of $1000 a month with out ACA subsides that are scheduled to phase out. How about on the tax bomb with forgiveness? As I was marveling over this article and the article on Roth conversion ladders (and also feeling bummed that I don’t make enough to fully take advantage of all your tricks), it occurred to me that we could each year take a total of 11,000 from our Roth contributions, and put that into traditional IRAs. Also, you’re only able to rollover $10,000 tax-free each year (as of 2015 laws) as long as you don’t have any other ordinary income, so if you plan to need more than $10,000 per year to pay for expenses you will need to account for those funds in a non-taxable account, transfer more than $10,000 and pay taxes (albeit at a presumably much lower rate), or be willing to take early withdrawal fees on your Roth. Vanguard should be able to help you with this and initiate the transfer. My taxable accounts should hold me over for more than five years so I’m not too concerned about accessing that money prior to five years but I’ll likely be doing my conversions at the end of the year anyway, since I’ll be waiting to see what my tax situation is before deciding how much to convert. 1) You are absolutely correct. In my (single) case this is $9,075 (2014). But I’m not sure I agree with this article. Is the conversion to be taxed at your current rate seen as income to influence your taxable rate? So don’t sacrifice the savings of getting out of the 10% bracket. Have you figured out your timing as you head into FI this year? However, I am in a income tax free state, which isn’t really brought up here, so I wonder how that factors in. Hey James, glad to hear you’ve been getting a lot out of the articles! but you have to pay early withdrawal fees for transferring the money? This clears alot up for me regarding capital gains tax, thank you very much. Traditional IRAs impose a 10% penalty for withdrawals of contributions and earnings made before age 59.5. If the only income you have is $10k conversion from Trad to Roth, you will have $0 tax liability since you are entitled to a $12k standard deduction if you are single. I would love to have someone experienced take a look at my finances and let me know if I am on the right track. I assumed that the tax deductions were such a key part of this strategy that I didn’t need to mention that contributing to a non-deductible Traditional IRA wouldn’t work but since so many people chimed in about it, I added a new section to the post (see the section titled, “What if You Earn Too Little or Too Much?”). If you figure a way around this I would be all ears. If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. Does this concept only apply to young investors? I agree. I am in your same predicament. I’ve maxed out my 401k but neglected my wife’s 403b account in favor of building an after tax portfolio. However, due to a raise/promotion (Yay! Both Kate and Kevin end up with $210 in retirement spending because they had the same contributions, the same investment growth, and paid the same tax rates over time. We’ll take some income from savings, some from the Roth and some from the Traditional to minimize taxes. I guess im a little confused how the withdrawals from the taxable account in the first 5 years relate to the 4% safe withdrawl rate of your entire portfolio. 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