1) Aren’t your contributions to a Traditional IRA limited to $5500/yr for individuals? The more I read, the more I’ve been kicking myself! I know employer sponsored 401ks are like $17K or so, so that’s not nearly as low, but my understanding is that as an individual you can’t increase your contribution to individual IRAs beyond %5500. I am actually self-employed with my own s-corporation and contribute an additional $15k above the normal $18k (which I do). Florida)? He contributes the $70 directly into his Roth 401(k) where, over the next 30 years, it triples to become $210. Yes, the conversion can be taken without penalty after 5 years but not the earnings. So is the “backdoor tax” only for non-deductible IRAs? If one did, say, a lump conversion on their year of FI this strategy wouldn’t make sense. So, you are planning for retirement and wondering which option will be the best – IRA vs. 401k vs. Roth IRA? I would hate to hear others jumped on this not realizing the irs limitations. What is the best strategy if I already have a significant amount in a Roth IRA account? While 72(t) substantially equal periodic payments is one way to get money out of any IRA early, the rollover strategy described in this post (and in greater detail in this post) is a more optimal method, in opinion. As far as the 401k, I have an SCorp but no employees. Also, check out this article on HSAs If a college student wanted to start investing, what account would you recommend they use? Also, since I’m paying the taxes on the conversion, out of a separate, there is definitely and significant compounded cost beyond the tax bill for all taxes paid. When it comes time to withdraw money from your retirement accounts, you withdraw how much you need to live on so you can think of all of the withdrawal being taxed at an average rate. You’d want to make sure not to convert so much that you get bumped into the 25% bracket, which would cause your qualified dividends and long-term capital gains to be taxed. In addition, 70-80% of my income will be derived from my 20-year military retirement pension with the remainder coming mostly from tax advantaged accounts (Roth or Traditional). Are you truly going to retire (not work) or just leave your job and draw a pension along with working? 401(k), 403(b), etc. At lower tax brackets, that savings might not be that much. 3) You can start whenever you want but you’ll only want to do it when your tax rate is low, so you don’t get taxed a lot on the conversion 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. Required fields are marked *. But I’m not sure I agree with this article. I have maximized my Roth IRA for the last two years and bought low-cost index funds within the Roth ira account. The comment stream was also very useful. This year I should be exempt. I know you strategy focuses on early retirees (moving a 401K to a traditional IRA and then Roth IRA) but when your employer offers both what do you do?. 401(k) Withdrawal at Age 59 1/2 to 70. We do have a relatively high sales tax to make up for it, though the cost of living is substantially cheaper than some of the other non-income tax states. I am always up for a spirited debate here so if you don’t agree with something, I definitely want to hear why and chat more about it. It’s definitely a great trick if you want to maximize your savings at age 59.5, but it doesn’t really seem to help those of us who want to retire as early as possible, since you can’t touch the Roth IRA until then without paying a huge penalty. For #2, the idea is to do a conversion when the taxes are minimal. For example, New Jersey treats traditional IRAs the same way as roths: taxed on the way in, not on the way out. I am now at a new employer that also offers a 401(k). Not counting tax-free and real estate income, I earn roughly $110-140k AGI. 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?”). Thanks for all your good work! The New Year’s Day tax deal (also known as the fiscal cliff legislation) made headlines in the retirement world because it included new rules to make it easier for employees to convert existing traditional 401(k) plans to Roth 401(k) plans. 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.” At one point I would have called myself an organic chemist, but with my new job I’ve kind of been shifted to more of a synthetic/polymer materials scientist. I would still consider contributing because it lowers your MAGI. is realistic with rising healthcare costs and inflation, but to each his/her own for sure. I agree with Jim_ this is a huge issue for me as well. However, it is also smart to open a Roth IRA account early to get the 5-yr. clock ticking. I’ve since run the numbers to find a Roth conversion ladder is possible in my case without pushing me into a higher tax bracket. 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. When I retire from the military (9 years and counting) I will more than likely move to an area that has state taxes (Oregon or California). It helps because of the company perks pushes my salary above 95% percentile (US average income). Why do you not have to still pay tax on the $9k that was converted? Thanks! The rule of thumb is to contribute to Roth as long as one is in the 15% tax bracket or lower. There are differences in state tax treatment, differences in income and differences in retirement expectations that all affect what the “right” choice is. We also cannot directly contribute to a ROTH IRA due to our high income. Thanks a lot for the response. Andy, You are correct. In the Ultimate Retirement Account article, I described how an HSA can also be used as a completely tax-free retirement account. Remember to include all your fees! I’ve gone cross-eyed feeling like I’m just trial-and-erroring the numbers in my spreadsheet. Follow him on Twitter @DollarsAndData. That amount is then deducted from your income, regardless of your itemization status. Based on current returns, the balance in my Roth IRA will be greater at the end of this period than my tIRA – and reduce the tax liability for our heirs, as well as the RMDs required. However, if you didn’t withdrawal from the IRA the deductions would still lower your taxable income to 20k vs 29k, thus the IRA withdrawal increases your tax bill? I’m not MF but the most prudent thing to do in this situation is to simply just rollover your old 401k into a Traditional IRA with either Vanguard or Fidelity. In other words, by making such a compromise, is it possible to actually determine the number of years it would extend out my retirement and/or a dollar amount difference if I were to just go all in to traditional, pre-tax, retirement funds? Spending some time going back and re-reading your articles, all are fantastic. I wouldn’t withdraw from the Roth now and put it in a taxable account. Thank you for writing this and all your shared insights! Your slow-travel lifestyle sounds excellent and I’m glad to hear you recommend volunteering as you travel. 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. As a 27 year-old who has only recently begun to realize that financial independence is possible, you are an inspiration. :). I’m reading it at every available minute and burning through the podcast archive at a furious pace. No, you’d only have to pay early-withdrawal fees if you took money directly out of the Traditional IRA. I appreciate whatever feedback you’re able to give, particularly jargon-free feedback! 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. Am I missing something? Thoughts on this type of mix? If I do want to retire early, would you advise that I take out the amount I’ve already contributed to my Roth and put that in taxable accounts while I continue contributing to the Traditional IRA? However, based on another post you made here http://www.madfientist.com/how-to-access-retirement-funds-early/ I still can’t decide between a Roth or Traditional. Trust me on this. We’re getting a late start here, 42 and 44. I can’t speak to #1. 0 to 9,075 10% Love the content you have, and am currently trying to get my husband on board with reaching FI. Great job making this super clear; however, there is one thing to look out for…. Though I don’t know which of these tax tactics will be most useful to you in the future, I do know that none of these options are available with a Roth 401(k). Earlier in our lives, we were making yearly max contributions to our Roth IRAs, which I’m relieved to read in your article was a good idea, because we were usually in the 0 or 10% brackets. First, I want to thank you so much for all of your advice! I am less familiar with that, but you can search these comments if that is a concern to you. (FYI – I’m a SCORE volunteer helping others start businesses; great organization for small biz owners and entrepreneurs looking for free business advice). You will see that if you are in a lower tax bracket than the 25% bracket, your qualified dividends and long-term capital gains should be taxed at 0%. Initially, I had thought about using our Roth IRA to double as an tax-savings investment account should we owe taxes on her income next year (you can pull some or all of your principle contributions on the roth and, from what I read, replace it penalty free within 60 days w/o adding to your contribution limit). Thank you so much for this information. Keep this in mind before converting your traditional 401(k) to Roth IRA. Thanks. Money is invested pretax and can be withdrawn penalty free and tax free at any time. I’ve always joked about wanting to retire today, and I say joked because I didn’t see how it could be possible. >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). Also wondering this. Not specifically asking about Traditional or Roth IRAs. Then after tons of research (before finding the FI community) i started a Roth IRA at vanguard ans am maxing that out as well. So what’s the best approach? So by electing the Traditional 401(k) over the Roth 401(k) and (importantly!) 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. Thanks! I have two questions, that may be obvious to others but aren’t really to me as I’m still educating myself on all this. In 2013 you could convert $10K and still not pay any tax: My $0.02: Not really, but that may just be semantics. Would you still suggest a traditional over a Roth? I assume still go with the traditional IRA and then convert to a Roth once our income drops below the Roth limit when we semi-retire? Wish we could hear more about how 457’s play into this strategy. This is exactly what I have been doing since I stopped working in 2007 at age 54. If I’m understanding these previous comments that money would not be taxed at all when converting from traditional to Roth? I too will probably not retire crazy early, maybe not early at all, but I still want to be making the best decisions. Thanks, Why is this true? The 401(k) plan comes in two varieties -- the Roth 401(k) and the traditional 401(k). Here’s how the Secure Act could create a disaster, We were friendly with our neighbors for decades, until recently. Steve, You can utilize the Roth contributions while you are in the five year conversion waiting period, so having a Roth IRA is not a bad idea. Awesome post FI! It’s news to me, but my employer would allow me to double my contributions by using a 457. An entrepreneur, I have worked for myself for a few decades and still enjoy it. we make above the Roth contribution limit and the Traditional IRA deduction limit. 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! Because I’ll be living abroad for a good part of my life after FI, I’ll need to investigate which state would be best to establish residency in prior to leaving America. 37,500 company stock vested in 5 years 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. Taxable account (currently contributing $4k/month). Essentially, with a traditional 401(k), you have the flexibility to decide when you’ll pay taxes on the money. …”from the taxable accounts.” In other words, you use the money you have in after-tax accounts such as a taxable brokerage account since that money can be withdrawn at any time. Hence the tax rates you are avoiding would be equally an “average” tax identical to the withdrawal case. Hi, It’s a shame that 401ks are dripping with fees. 9,075 to 36,900 15%. I think its an slam dunk to open an self-employed 401(k) if you are self employed. Cheers! When you put the money in the nondeductible IRA it has been taxed, so you just turn around and convert it to a Roth the next day or two. Hey Dan, I’m really glad to hear you are enjoying all of the posts! If tax law stays the same and without any side income after reaching FI, this would be the way to go. You really can’t go wrong with Vanguard. $6,300 – standard deduction and personal exemption Tenseng, my $.02. Here are some other pro/cons of a traditional IRA vs Roth IRA. Our Roth IRA is all Vanguard stock/bond index mix, so I’m not too worried about it’s volatility. In Feb. 2013, I contributed 10,500 to my Roth IRA for 2012 and 2013. My income has been very low, so every year I have converted $25k or more from traditional IRA to Roth IRA, increasing my income to the point where I owe >= $0 in federal income tax. Between MMM, jcollins, and you, I have a lot to learn…. C) invest anything above our 401ks in a normal brokerage account This post was originally published on February 12, 2013 but was updated on March 21, 2017. If you actually have a large enough brokerage account, or do some large trades (eg a radical rebalancing of your investments) where the realized gains and dividends are greater than that, then you may want to not do the conversion that year as the conversion may push you into a situation where you are paying 15% on all those capital gains. 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 left my job almost 4 years ago when I was 33. We max out two 403bs and two Roth IRAs and get employer match. Hi, love the article! So, here goes: Yeah, realizing that I could easily tap my tax-advantaged accounts early without penalty really changed how I approached saving for FI. Am I missing something? I am currently living abroad and we are thinking of traveling for a year or so prior to returning to America and not making any income. Let’s say all or most of the money is in from one of the pairs savings, say a 401k. 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. The US progressive tax system has standard deductions and brackets. Yes, they too can potentially become completely tax free! Goal: Find the best theoretical conversion amount for each year, for up to 40 years, that will completely drain the 403b, and minimize the taxes paid (and the lost time-value of paying taxes earlier rather than later). Thank you very much for the All Hands Volunteer recommendation. 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. Also, a question about this post in general. Big thanks Mad Fientist and the community here. The point when one reaches 59 and six months is the time an investor can make withdrawals without penalties from previous works’ 401(k) assets. What the effective tax rates are on your contributions is very relevant. I would think your employees would welcome a 401k, but I don’t know the nature of your business or their pay. And its better than the 5K limit. We’ll take some income from savings, some from the Roth and some from the Traditional to minimize taxes. I am already retired, FI and taking RMDs from my rollover IRA. 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? Here’s what a taxable account looks like: Not only is your money taxed before it enters the taxable account, your investment growth is also taxed along the way. 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. I hadn’t heard of that organization before so I appreciate you letting me know about it! This works out okay if you stay a NJ resident in retirement, but if you leave, you’d have to pay income tax again in your new state during the rollover period if you go over the 0% portion. This is because when contributing to a traditional 401(k), part of the invested money will eventually be taxed. Nick, are the fees because you have a low balance, or just general administrative fees regardless? Both invest all leftover money into taxable accounts. If you went with a Roth instead, you’d have to pay more tax and would therefore be investing less overall. Note: To avoid paying a 10% early-withdrawal penalty, you have to wait five years after the conversion (or until you turn 59.5, if that’s sooner) to withdraw the converted funds from the Roth. Good point Matt. However, if you are not making a lot of money and your income is in the lower bracket then you should go with Roth IRA? So it might look something like this: withdraw from taxable accounts, withdraw Roth contributions (at the same doing IRA->Roth conversions), then after the 5 year wait period, withdraw those conversions, and hopefully that lasts until 59 1/2 when you can start tapping the pre-tax accounts: 401k, tIRA (what’s left), 403b, etc. limit. But I am always interested in other resources. there are separate limits for each; total IRA and total 401K. I like that idea, as long as you have a backup plan if your investments tank! I believe that because of our tax bracket we won’t have any capital gains taxes on the sale of the house. Thanks, Nice, a real scientist! So with a 0% tax rate right now, I think that the Roth is our best choice, at least until kids start leaving home. Hey Mr. Fientist. 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