JoeTaxpayer

Back in July, I wrote a post “Loving That Roth” where I discussed why the Roth account was a great deal for a select portion of savers. I went on to discuss how few people could save their way into a higher tax bracket and that the use of a Roth 401(k) should be considered very carefully as it would ignore the lower rate most of us will retire into. A fellow blogger posting under the moniker jIM_Ohio shares my view, offering his own brief post last month, “The 15% tax retirement account“. As I look at Jim’s post, I realize its brevity is its strength. I tend to offer much data to support my views and often that obfuscates the issue at hand. To the other extreme, I offer the article, “Thinking About a Roth 401k Think Again” from the Journal of Financial Planning.

The JFP article closes with “Those properties [of Roth compared to traditional 401(k)] indicate that for most moderately affluent wage earners, today’s marginal tax rates and the associated government subsidy for retirement contributions are likely to markedly exceed effective tax rates tomorrow, when that subsidy must be cashed out.”

Anyone interested in the Roth vs Traditional 401(k) or IRA discussion should read the article from JFP, and decide how to approach their own situation. As I’ve stated prior, their are few absolutes in financial matters. When I shared my thoughts in one forum and suggested that Roth was appropriate for maybe 5% of people currently working, I was told that the particular forum only contained a selection of high income people who saved above average, that most of that group would benefit from Roth. It reminded me of surveys that showed that 10% of people believed they were in the top 1% of earners. And all of their children were above average.

Joe

written by JOE \\ tags: 401(k), effective tax rates, income, IRA, journal of financial planning, marginal tax rate, Retirement, retirement account, roth 401 k, tax, tax rates

Some time ago, in an article titled Social Insecurity, I wrote about what I call Phantom Tax Rates. To understand this, one first must understand what one’s Marginal Tax Rate is. A single person, after taking his exemption, and deductions, will pay 10% of the amount up to $16,050, then 15% from $16,050 to $65,100, then 25% from $65,100 up to $131,450. Let’s stop there. The Phantom Tax Rate comes into play when there is either a phase out of deductions or phase in of other income. In the case of Social Security, when half of your Social Security benefits plus other income exceed $25,000 ($32,000 if married filing joint) your benefits start to become taxable, until 85% of your benefits are fully taxed. This create a graph that looks as follows;

While we would expect a 15% rate from $16,050 right to $65,100, instead we find that for each $1000 of income (or IRA withdrawals for the person for whom this chart applied) that the incremental tax is as high as $462.50.

In another situation, the adoption credit is phased out for AGIs between $174,730 and $214,730, and in the case I’ve been alerted to, the taxpayer loses $11,600 on the next $40,000 of income due to this phaseout. This loss, plus his marginal rate of 25% total 54.13%. My advice to him was to defer income if possible to 2009, which he will. By deferring that $40,000 worth of income he will pay $26,600 less tax this year, and just $10,000 when he receives this income in 2009.

When it comes to taxes, nothing is simple. When planning, it’s best to get a copy of TurboTax and run a few ‘what-if’ scenarios to best understand the impact of any financial changes you may incur.
Joe

written by JOE \\ tags: adoption credit, income, IRA, irs, marginal tax rate, phantom tax rate, social insecurity, Social Security, tax rates, Taxes

I recently read a post “Why I love Roth IRAs” in which the author ignores much of the math going in and coming out. Now, I love Roths myself, but only when used to take most advantage of the tax rates involved. Let me explain. From my feature article earlier this year titled “Can you save too much, pre-tax?” we see that a couple with $447,500 in their 401(k) or Traditional, Pre-Tax IRA, can take withdrawals and remain in the 0% bracket. This is due to the combination of standard deductions and exemptions. The next $401,250 will support withdrawals at the 10% rate.
If you have a defined benefit pension (a traditional pension) the numbers certainly will shift, and you need to take this income into account. Pensions are getting more scarce and those who frequently changed jobs are likely to have never vested into any one plan.
So, now I’ll ask, what percent of retirees are likely to have saved this sum, a total $848,750 from the numbers above? I cite an article from AARP titled 2004-05 Boomers which offers a forecast. One chart in this report offers that for those born in 1956-65, their mean (this means average, important distinction from median, middle) wealth is forecast to be $839K. But reading on, we find that after subtracting non-retirement wealth and present value of Social Security benefits, we are looking at a retirement account balance of just $140K. It turns out the 4th quintile (this is the second 20% from the top) is forecast to have $906K, this scales to about $151K in retirement accounts. Even the top quintile (top 20%) will average $2028K total wealth, with maybe $350K-$400K in retirement accounts. So it’s only the upper portion of that group (in addition to those with fat traditional pensions) that need to consider the Roth while working. For the rest of us, we will likely be in the 10% or if fortunate, the 15% bracket upon retiring.
I’ll close with this thought - each family has their own set of numbers. This is why if you write in to a web site or magazine and ask “Is Roth good for me?”, it’s impossible to answer without knowing many details. We know more the closer you are to retirement, but only have a series of clues the further away you are. Another blog “The Finance Buff” offers a view similar to mine. I remain surprised at how many wave the Roth flag without some level of analysis. For those who have access to a Roth 401(k) and Roth IRA, it would be a shame to load those up and find that they missed out on the tax savings that pretax savings could have provided.

Joe

written by JOE \\ tags: 401(k), Finance, income, IRA, Retirement, retirement account, roth ira, saving, Savings, Social Security, tax, tax rates, traditional pension, wealth

Most blogs you may read are starting to offer an RSS feed, a way of reading the blog through a reader. I use Feedburner and in the left sidebar offer links so you may access my blog through Google or Yahoo’s RSS feature. Few non-bloggers use this feature, and May 1st has been declared RSS Awareness Day.

So, if you are enjoying my blog, or any other blogs you read on a regular basis, consider become a “reader” through an RSS feed.

Joe

written by JOE \\ tags: Finance, IRA, money, Retirement, roth ira, RSS Awareness Day, RSS reader, tax rates, Taxes