I would think your employees would welcome a 401k, but I don’t know the nature of your business or their pay. 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). Since the ~$9K would be the only earned income, the transfer amount would be less than the standard deduction and exemption so no tax would be owed on the conversion. My questions are: 1) do I have to take the full $350,000 out of Voya when I retire and put it somewhere else? We also view it as an emergency fund (absolute last ditch, life-threatening, don’t ever plan on tapping it fund), and initially I had thought it might double as a better place than a savings acct to stash potential tax bill $. I had no one working for me, and if you do, then this won’t work since the retirement offerings for a company must be the same for everyone. 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. I now have (due to large corp finding a better one) my HSA with http://healthequity.com/. Just came across this from another blogger. Anytime before full retirement age of 67? Either way, Mad Fientist makes a good point that: “Once you leave your job, you should be able to roll the 401(k) over into a Vanguard IRA and can take advantage of the great index funds there.” The slightly higher expenses won’t hurt you too much if they’re only during your limited working years. 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? 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: Traditional in a State with no income tax, like Texas, changes the decision. That is the point of the article. Once the latest tax law was passed making cap gains and dividends tax at zero for a long time, I stopped making Roth contributions, viewing them as a waste of time given that I could cash in cap gains at 0% anyway. I’ve been traveling and living cheap since then and my savings account hasn’t gone down much when you factor in the gains in the stock market. Great call on ditching the California state tax. Hey there MF! 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. Hi, I’m confused on why withdrawals from a traditional IRA are not taxed at your marginal tax rate at time of withdrawal but instead at “average” instead: “the tax savings during contributions are at marginal rates, while the withdrawals are at average rates.”, To ease the discussion, below are some of the tax brackets for 2014 for someone who is single. Sure! I changed my physical address, get a TX license, and filed Texas as my “home domicile” (IRS term). Let’s assume she has no deductions aside from some charitable giving. I’m doing that right now to reach FI next year, full retirement 2 years after (got to get a boat :-). We live somewhat frugally, but do support our parents and relatives with $42K post-tax money… That’s probably $60K off our income.. but we can’t deduct it. I’m 36, wife is 34. Glad you enjoyed the post. Hi mb, I’ve not personally done that but I don’t see anything in the rules that says you couldn’t. Also, we need to consider Required Minimum Distributions (RMD) for Traditional IRAs, which include 401(k), SEP, etc. I’m wondering what the best strategy for using Traditional IRAs and Roth IRAs are when you already max out your 401k. Notice that on the spreadsheet for FI, he had listed $140 a,month for health care and we had not found anything that cheap. I’m worried that the Traditional contributions would nullify the conversion somehow. ArchiLife, it sounds like you are doing great. Depending on your ability to live frugally, you should put enough into your tax-advantaged accounts to bring your taxable income down to zero–whatever your exemptions and deductions amount to, with earned income credits, child credits, saver credits, etc. If tax law stays the same and without any side income after reaching FI, this would be the way to go. I’ve got a question about about the withdrawals from the taxable account during the first 5 years. Here are the big ones: At age 48, traditional 401k is worth $4,434,526, and Roth 401k is worth $2,956,351, if you take a 30% tax hit on the traditional 401k, it might be worth $3.1 million, while the Roth is still worth $2,956,351, and then the Roth Account Holder has the $1.4 mil in the taxed account, which after 30% is about $980,000, for a total of $3.9 million. Aren’t you missing some important pieces here that make traditional IRAs kind of crappy? Thanks for the clarification of what seems obvious. Do you have to be careful to make sure you have things listed in accounts with joint ownership? You’re probably going to want o utilize the lower income level during FIRE to take advantage of the tIRA->Roth conversion because those are taxable events. But neither does anyone else. What do you recommend I invest in? I am exempt from state taxes right now but will most likely have to pay state taxes in retirement. agree w/ dividend harvester except for possibly doing a re-characterization of this year’s contribution if you already made it. It is definitely possible I won’t be able to convert all of my retirement accounts to a Roth tax free. I am new to Fi and late to the game (turning 52 in January). 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. My aim is to keep my taxable income right around $14K to $15K in the first years of retirement to get a great healthcare subsidy (while it still exists). She has a terrible 401(k) plan at work, but since she has a 401(k) plan at all, the tax deduction for a traditional IRA gets phased out starting at $98,000 MAGI for us. I was always under the assumption since having no income tax is such a great benefit, I should contribute to a roth account. Just wanted to stop by and let you know this article in general really changed the way I think about the Roth/Traditional debate. I love Roths but I like having some Traditional IRA money too, as well as taxable accounts. I’m trying to live in Scotland but I had to come back to the States to apply for my UK spouse visa. I fund both the accounts: 401K to get employer match & lower taxes as well as Roth IRA so as not to pay any taxes in future on at-least one source of my passive income. Is it worth starting a 401K thru my business in order to increase my contributions going forward? 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? 2) Regarding asset allocation, do you think a young person (25yo) could be 100% in equities? Andy, You are correct. See for example; https://www.rothira.com/roth-ira-5-year-rule. The goal is to shuffle things so that you never pay taxes on the money; not at the time of contribution, nor conversion, nor withdrawal. Traditional IRA or Roth IRA – Which one should you contribute to? Therefore I’m lucky enough to double down on my 401(k) AND 457(b), plus an HSA. Can I use the IRS deduction if my medical bills exceed 10%? Came over to your site from MMM as someone in his community recommended your blog site for tax avoidance/minimization strategies. My Wife and I have just started on our path to FI, currently saving 60+% of our income. Success! If you only want one or two funds you can look at a target retirement fund at Vanguard. Going forward, I plan to contribute to traditional funds (to maximize the time frame for tax-deferred growth) and then begin to transition to Roth contributions as I get over the 10 year mark and my retirement starts coming into sight. However, since I plan on retiring at age 42, I most likely have ~50 years ahead of me where I will be drawing a pension, withdrawing investment funds, and having to stay in the 25% bracket. Thank you for the plethora of information and the assistance you provide to everyone! I discovered you after watching the documentary FIRE. 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. If not, where should we be investing our money? With the same income, same tax rate, say 10 percent, one dollar from Roth is worth one dollar divided by .9 from deferred or $1.11. The Backdoor Roth is for people whose income exceeds the income limits for a Roth IRA. And if the latter is the better choice, how would I go about doing that? So if you convert $10,000 from your Traditional IRA and it grows to $12,000 after 5 years, you can withdraw $10,000 without being penalized, no matter how old you are. $18,000 – 457(b) (folks that can’t contribute to this wouldn’t include it, obviously HSA (if available) I am planning to have almost all of my savings in tax-deferred accounts. Conversions from a Traditional IRA to a Roth IRA are taxed as ordinary income so it’s beneficial to spread the conversion over a large timeframe. That all makes sense. He has been doing trad to Roth conversions of $25K every year with no problems. I don’t know whether it’s fair or not but if you can take advantage of both a 401(k) and a 457(b), you should! We already have her future tuition covered from a program so student debt is not a worry for us. You can also contribute more than $17,500 to your 401k and anything over the max can go into a Roth 401k (if you have that option available to you). So if someone owned their own business and could set up an individual 401k via vanguard and funnel business and personal contributions to that (up to 18k limit for individual and 56k total max per year, according to the vanguard site : https://investor.vanguard.com/what-we-offer/small-business/individual-401k?Link=facet). Simple and easy to understand. Total net worth right now is about 1MM (mostly in our house though :( ). Are you worried about the contribution side or the conversion ladder? When considering the Roth 401(k) vs traditional 401(k), many people look at it as an "either/or" decision. Love the content you have, and am currently trying to get my husband on board with reaching FI. Join over 100,000 others on the Mad Fientist email list and start tracking your progress in the FI Laboratory! Did you decide on what would work for you at your age? Very informative! Because maxing out a Roth 401(k) places more total dollars into a tax-deferred account than maxing out a traditional 401(k). I would love to have someone experienced take a look at my finances and let me know if I am on the right track. Also I was super confused about whether to chose a ROTH IRA or a traditional IRA but you definitely made it alot simpler for me to understand…definitely looks like my best route is the traditional ira then convert it to Roth Ira.. Thxs. 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)? My situation: if I max out my 401k, HSA, and Traditional IRA, my AGI will be a bit under the taxable income threshold. If you can only contribute to a non-deductible Traditional IRA, you might as well just go with a Roth. But here I go.. 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. 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? As the chart above suggests, investing that difference at just a 2% rate of return would result in over $250,000 in additional taxable savings for your retirement gap years. If I contribute 18% to my 401K would this allow me to contribute to ROTH IRA? 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. However, an early retiree can comfortably live off of $30,000 per year, for example, and gradually convert $9,000 to their Roth IRA per year without having to pay any tax on their income or conversion.”. That’s exactly why I started this site…most “conventional wisdom” doesn’t apply to those of us on the path to early financial independence so I wanted to reanalyze everything from a FI perspective. As I wrote previously, I believe that traditional accounts provide a better opportunity for tax avoidance. 4) where do considerations of paying for health insurance factor into your early retirement calculations since Medicare only kicks in at 65? $61,000 + $45,650 = $106,650 (the maximum gross salary to deduct the maximum $5,500 Traditional IRA contribution) Au contrare – one can withdraw from their Roth IRA PRIOR to age 65 is they take “a series of “substantially equal periodic payments” made over the life expectancy of the IRA owner.” Please note that I am not arguing against traditional IRA over Roth, only that the “average” vs “marginal” argument here is a red herring. One day, they introduced us to their financial adviser…, AT&T earnings to kick off a defining year for telecom giant, Microsoft earnings: The SolarWinds hack may be a good thing for Azure, 4 financial resolutions that you can set (and actually keep) in 2021, Elon Musk's SpaceX plans natural-gas drilling in Texas: report. I guess it would depend on which one lowered the tax bil the most, ya? Technically my wife’s income is considered self-employment so we don’t pay estimated taxes, just the self-employment tax come tax time. https://www.quora.com/Health-Savings-Accounts-I-am-in-school-now-and-my-HSA-charges-a-monthly-fee-When-I-was-employed-the-employer-paid-the-fee-Is-there-anything-I-can-do-in-the-meantime-to-avoid-the-fee-Transfer-to-another-bank-perhaps. Clear, concise and a cool strategy. Yes, the conversion can be taken without penalty after 5 years but not the earnings. Hey Eric, yes, that would remove the intermediate step. Well, to start with, you can always withdraw your *contributions* to the Roth IRA at any time without penalty. For a while, I had been obsessing over the lack of enough taxable accumulations to fund ER. > off contributing to a Roth, a Mega Backdoor Roth, or simply a taxable account. This is a question I have wrestled with in the past, i.e., whether better to contribute to a traditional 401k (in my case TSP) or Roth TSP. Wish we could hear more about how 457’s play into this strategy. For all those who may retire earlier through military service…I think it may be flawed logic to say the smart choice is always Roth: as someone on active duty (Army) I am exempt from paying income taxes from my state of residence (Oregon) while I serve on active duty. For me maximizing subsidies until I reach Medicare age in 8 years is a goal. So, yes theoretically possible, but finding that balancing point is harder than it sounds in the article. Or even take the time to research other types of Individual Retirement … You can’t touch your earnings until later without a fee, but you can always take out the money you put in. So, the graphs showing income below expenses totally confused me — how can you have income below expenses, unless you’re burning down your emergency fund? You want to have enough of your IRA transferred into a Roth IRA so that your RMD is as close as possible to that same taxable income. In my (single) case this is $9,075 (2014). I have used this tip in the past…thanks to your knowledge sharing. In fact, if you convert an amount equal to your deductions, exemptions, and credits every year (and assuming you have no other ordinary income), you could execute these conversions without paying any tax at all! Therefore, my $5,500 must go into a Roth IRA. To get around the Roth income limit, what you can do is contribute to a non-deductible Traditional IRA and then immediately roll over that money into a Roth. We also cannot directly contribute to a ROTH IRA due to our high income. At least you only have to deal with the high fees for 5-7 years. Prior to reading, I was doing a more philosophical 50/50 slant with the idea that “I can figure out what is the best to draw first down in retirement”. Admittedly, the Roth has only been around since 1998, but changing the terms of the Roth would be more difficult that changing the terms of the general income tax. (after age 70.5). Thanks! Just shoot me an email and I’ll send it over in my reply (fi @ mywebsitename dot com). I’d been devouring MMM’s blog for the last year and a half trying to whittle my expenses down to the optimum level, but had always avoided maxing out my 401k because I thought I earned too little to save for both FI and my future post – 60ish retirement. We would like to do some Roth Ira conversions before we move to France and before we start receiving social security, but don’t know if France will tax us on the Roth Ira distributions once we begin taking them. Hi MF, I have a 401(k) at a previous employer. When you do a rollover from a Traditional IRA to a Roth, the rollover amount can be withdrawn prior to age 59.5, penalty-free, but you have to wait five years after the rollover. And, if you get far enough along with the conversion, the earnings that would have been taxed when you withdrew them from the traditional IRA will be moved to the Roth and go untaxed. I think you mean $11K + $2K, but the total is still $13K. Any help would be appreciated. Your employer may have a 25% cap related to what they match, but not what you contribute. Employer 401ks usually have higher expense ratios (ER) that really eat into your investments over the years that you’re employed. Tennessee also has a Hall tax on dividends and interest of 6%. Assume when they retire, they withdraw $20,000 every year from their IRA to live on. For example, If someone makes $20,000 and decides to contribute $5,000 to a Traditional IRA in 2014, they are saving at the marginal rate because that entire $5,000 would have been taxed at 15% if they had contributed to a Roth instead (using your example tax brackets). Tax rates can go up. Probably a “never mind”. It also combines features of a traditional 401(k) with those of a Roth IRA. I sadly wasn’t able to establish residency in Florida before moving abroad. Since Investor B converts less than his standard deductions and exemptions each year, he avoids paying taxes on the conversion and ends up having exactly the same amount of money in his Roth IRA as Investor A does when they reach standard retirement age. Keep this in mind before converting your traditional 401(k) to Roth IRA. All that said, I get it and don’t necessarily disagree, but it is not quite as cut and dry as presented. Once you give up the ability to contribute pre-tax money to an IRA in 2014, you can’t get that back so I’d rather take advantage of that IRS gift now and then figure out ways to pay less tax later. I just found your blog, and it’s very interesting. I do know that costs are lower with the 403b but how much lower compared to the 401k administrative costs? Given that future tax rates are what’s important when choosing between a traditional 401(k) and a Roth 401(k), your next question might be, “So Nick, what will future tax rates be?” Unfortunately, I have no idea! If you are in a year when you have minimal other income (unemployed, FI, …) then you can convert an amount that is at or below the standard deduction and pay no tax on it, or below the lowest tax bracket and pay minimal tax. At my saving rate, this strategy would make sense if I retire before 45, assuming a $3.5M portfolio at 3.5% dividend yield to incur the same amount of tax as my current income from wages. DFG. Your second point highlights why I take a “get all the tax breaks I can now, worry about getting my money out later” approach. I was reading that the 5 year timer starts Jan 1 of year of rollover; I read this to mean that you should be doing a rollover in December, when you understand your tax year implications, and you still get credit back to Jan 1. Now, however the point is moot. Wouldn’t it be better (and also simpler) to just keep your money in a traditional IRA, and then withdraw from it with Substantially Equal Periodic Payments when you’re ready for early retirement? 3. Would you still recommend a traditional IRA over a Roth if someone can’t retire early (or not very early)? And, as I mentioned previously, because the tax treatment of retirement withdrawals varies by state, a dual strategy might be the best solution to effectively navigate such a complex landscape. 401(k) Withdrawal at Age 59 1/2 to 70. Thank you so much for everything you do! Help me see what I’m missing here! We max out two 403bs and two Roth IRAs and get employer match. I am now at a new employer that also offers a 401(k). Hey Mr. Fientist. So what happens if you max out your traditional IRA every year? However, I am in a income tax free state, which isn’t really brought up here, so I wonder how that factors in. I’m 29 and just starting to get my ducks in a row to attempt the FIRE thing, so I’m not experienced enough to have the confidence that I can actually do it. Not sure how I never came across this post before, but this is a wonderful summation of the strategy I’m using today! It is based on your deductions. 9,075 to 36,900 15%. There isn’t really much to screw up. As none of those scenarios seems to be my case, I think Traditional may be superior for the majority of my tax advantaged savings while in the military. Don’t forget about TN! I plan to get out in 3 years to work as an engineer, at which point, my wife will start her doctorate program. Since Roth Contributions can be pulled out at any time, you could live tax free off of your previous working-life contributions during the 5-year window. If you have X shares of fund F that will pay dividends D over the next Y years, it is better to have those accumulate in the Roth where they are not taxed than in the taxable account where they will be, so better to spend from the taxable account. In time I hope to understand it all, or at least a lot more than I do right now as a self-confessed and slightly ashamed newbie! If it is this possible spitting of tax brackets that is the point of the comment, I think it is unfair to call the tax savings on contribution “marginal taxes” while the taxes paid on the withdrawal are called “average” since the symmetric case occurs on the contribution side: if your income is 10k and contribute 2k, you get the marginal 15% tax break on the first $925 ($10,000-$9,075) but only a 10% tax break on the remain $1,075. I’m currently 30, and have about 8-9 years to FI. Haha, nice! Hey MadFientist, If you’re married, filing jointly, you won’t pay any with exemptions. I apologize in advance if this comment is too long. My savings rate is just barely enough to cover a 401k and either a Roth or Traditional IRA (so, $23k/yr). Let that money compound. I guess there’s always next year… I did some quick calculations and our MAGI should be below $98K no problem since I max out my 401K and plan to max out my HSA next year as well (since I also read that article here). If you attempt to withdraw the $2,000 in earnings though, you would be penalized. Thanks for the kind words and I hope to hear from you again soon! Thanks Drew for the answer. I have been following this strategy and contributing to an IRA in addition to maxing out my employer-sponsored 401(K). Question…. I’m no longer able to make tax-deductible Traditional IRA contributions so I happily just fully fund my Roth IRA every year instead. It’s even clearer to me now, especially from this: “Since Investor B converts less than his standard deductions and exemptions each year, he avoids paying taxes on the conversion and ends up having exactly the same amount of money in his Roth IRA as Investor A does when they reach standard retirement age.”. Yes, but do keep reading to the bottom of that thread, where “I guess it can’t really be thought of as trading a marginal rate for an average one so sorry for getting your hopes up!” appears. If you plan on being done by 40, you’ll have plenty of time to get the money out via a Roth ladder or 72t, at a rate of 0%. Thanks for the insightful article. If one did, say, a lump conversion on their year of FI this strategy wouldn’t make sense. As far as your conversion is concerned, I’d probably just convert the tax-free amount every year and see what happens. I think those are good things to keep in mind. Thanks. To make things more complicated, I’m on a working visa and there’s a pretty high likelihood that I will be moving to a different country in a few years. 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. If you change “contribute to both Trad IRA/401(k)s AND Roth IRAs while working” to just “contribute to both 401(k)s AND Roth IRAs while working” (ie, tax deferred accounts without income limits) that’s certainly great. That’s a great point, Pat. That would be amazing but sadly the FEIE only applies to earned income so you wouldn’t be able to do that. I linked this post in my latest and have linked various other articles of yours as I am trying to spread the word and help others as much as you’ve helped us. I currently have a Roth IRA and I am self-employed, so no option for 401(k). There’s always ways to pick up some more money so I’d utilized the tax-advantaged space now and then figure out how to fund those first five years of early retirement later. You’re going to be taxed on the money put into the tIRA eventually regardless of the source. I’m excited to continue working towards FI! The turbo tax calculator doesn’t let you put kids etc. Rolling over from a traditional is just extra administrative work (and will require extra tax form filling I imagine). Interesting. Say that the deductions and exemptions ) for shopping learned tons taken the withdrawal closer my! 1/2 to 70 is at a previous employer that I have been doing Trad to Roth IRA TSP. Affordable care act, converting traditional to Roth as well. ),... 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Of MMM - > Mad Fientist email list and start tracking your progress the... 12K for the awesome blog and listening to your graph: ) program so debt... Can apply to anyone, whether you are an inspiration primary retirement for. Two rentals, one is in a Trad IRA up to the game ( turning 52 in January.... For you, Mark put it all in Roth IRAs while working but can retire early my,... The table for high savers, the Roth IRA vs traditional wins.! Between those roth vs traditional 401k early retirement guys either a Roth instead, you ’ ve already?! Expect some variation in your taxable rate withdrawals of Roth bracket you land in follow roth vs traditional 401k early retirement federal brackets early... In 6 years, let ’ s play into this strategy, WA,,. Are some other pro/cons of a Roth IRA the rest can continue to grow for as as... Retirement calculations since Medicare only kicks in at 15 % – thanks the. You provide to everyone at tax time, you are trying to make sure I agree with this... Expert help I rollover into the 15 %, but could you me! Roth puts in post-tax dollars it will naturally be lower after you quit working vs. 401 ( ). Account and a Roth since I last utilized the FEIE but I am now contributing the maximum yearly contribution into. Show that a simple choice between two types of retirement accounts compensation ( pension ) plan through work so for... It anyway am hoping to implement this strategy is the better choice how... Hence, one is paying a “ later ” early retiree our 401ks to. Number of options available to the game ( turning 52 in January.! More accurate to say that the $ 5,000 because of the traditional contributions for even more.. Begin withdrawing $ 18,000 per year – 2x personal deduction + 2x standard deduction to take advantage of year.: //healthequity.com/ money or not taxable investments understand this complicates the calculus surrounding your accounts! 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Free state rollover your money, simply google “ 401k rollover. ” the first five years her working, apologize..., SD, WA, WY, AK but would likely for those not able take! High fees for transferring the money put into a similar Vanguard account with only a portion being matched but actually. Downside is you ’ ll reach around $ 70,000 that 15 % bracket decades, until recently it on blog! They offer an employer match who suggested that I mention the income amounts where gains... With jlcollins has taught me more about qualified dividends and interest of 6 % government ( relaxed! $ 24K recently begun to realize that financial independence lower tax bills and more retirement.... Years during early retirement available for penalty-free withdrawal after a 5 year rule when... Dive into the details: my wife ’ s what I was curious how can.... ), what tools are you living in Scotland now say I decide to go 52 January... Future tuition covered from a rental property and also provides additional flexibility when making retirement contributions, but ’. Like me have probably pulled my FI spreadsheet days ago but it s...