Am I Making a Mistake? (I don't have an IRA/Roth strategy)

[Deleted]

Am I making a basic "saving for retirement" mistake by not opening an IRA account, fully funding it, and then immediately converting it to a Roth every year?

We currently have two 401ks that we fully fund each year, and then a regular investment account (non tax-advantaged) that we invest more $$ in.

The only reasons we haven't opened IRAs up to this point is that by the time we seriously considered them, we were making too much to get the tax benefits of opening a Roth directly (without conversion) AND the "hassle" / administrative burden of opening yet another type of account, managing the investment & conversion each year.

At this point, we're anywhere from 4 - 8 years away from early retirement, so let's be extra conservative say I'm off by two years and we have a decade more to work and therefore invest with earned income.

WDYT: Worth it to start investing to get some money into a Roth, or not "worth it" at this point?

[awkwardpenguin]

@shoegal, 5:30 a.m. financial planning?

I think since you plan to retire early and you have substantial tax-advantaged retirement assets, it may not make a ton of sense. Do you have existing pre-tax IRA assets? Those make implementing a backdoor Roth more complicated.

Conversion Roth contributions can't be withdrawn for 5 years without penalty, and earnings can't be withdrawn until 59 1/2. So you'd be trading some flexibility for some tax savings down the road.

All that said, the backdoor Roth and mega backdoor Roth are pretty popular in ER circles, so maybe I'm missing something.

[fitnessjunkie]

Mar 18, 2017 4:52:01 GMT -5 awkwardpenguin said:

@shoegal , 5:30 a.m. financial planning?

Although I'm somewhat of a beginner and I don't have much to offer on the topic of the actual thread, I'm up early because it's the norm around here and because of my dog. So I thought I'd hop onto my new vanguard account and on here! Just wanted to point out that you have company in the early morning financial planning group  

[Deleted]

I got caught!! I woke up early and checked not sleep, it was still too dark for my run...so thought let's update my retirement models. Obviously!!!

I do not have any IRA assets today. I believe H has an IRA worth something like $6k in one from years ago.

And what is the "mega backdoor Roth"?? - it sounds like an amazing cheeseburger.

[kadams767]

Well, the benefit is something that you would probably need to model in order to determine how valuable it would be to you. It sounds like, best case scenario, in your "worst case scenario", lol, of being 10 years from retirement, you and your husband could contribute a maximum of $110,000 to these accounts. So if you didn't bother with the early-withdrawal ladder system that I've seen talked about (ie. "laddering" your withdrawal of contributions every year, so in Year 5 when you are eligible to withdraw converted funds for the first time, you take out Year One's initial $11,000, tax-free, Year 6 you take out Year 2's $11,000, and so forth), and just left the $110,000 in there until retirement, you'd have $110,000, plus any earnings, available to you for withdrawal, tax-free. This could piggy-back onto your last question of tax-free capital gains under a certain $ amount and help you stretch that tax-free threshold longer.

Also, I can't remember, but I think you might plan on doing some work in your early retirement. If that is the case, you could continue to contribute as long as you have earned income, so you could theoretically have higher tax-free income that the $110,000+ earnings.

[mesop]

I have to admit that I contribute to 401ks and regular IRAS but have never taken the dive to figure out how to convert them to roth iras. My taxes are higher now than it will be in retirement, so it would just hurt to pay the taxes now - unfortunately that's about as far as my thinking has gone. I'm probably missing something major but to learn more about backdoor roth iras are on my to-do list that I haven't gotten to yet.

[Deleted]

kadams767, thank you for the reply! I suppose tax-free income is generally always better than income you have to pay taxes on (and our income would essentially exclusively be from investments, so subject to cap gains taxes, if applicable.) HMMMM.

I could imagine choosing to do a few consulting projects here and there in retirement - only stuff I'm interested in - and I've also considered setting myself up to be ready to join a few paying boards right before I retire, but both are vague "ideas" at this point- either of those might generate earned income though, you're right!

[Deleted]

Thank you, spearmintleaf! We value the ability to reduce our taxable income with our 401ks, so we'd *probably* shift some of the money that's currently going earmarked for the "non tax advantaged" regular (Early Retirement) vanguard account. At least that's my initial instinct....a day after doing our 2016 taxes....so recency bias probably making me even more motivated to reduce today's taxable income

Shifting the money from our ER fund then means we'd retire a little later than in our current model, but then we'd have this little egg to access either in "regular" retirement or using the 5-year "trick" which I am still learning about.

So much to consider....!

[atarianna]

I don't think its a mistake, but I am also not super well versed in financial retirement.

Since you're planning early retirement, I would recommend doing non-retirement mutual funds or similar now instead of a Roth. This way you have access to this money sooner than traditional accounts.

Once you DO retire and your yearly income falls below the Roth threshold, I would then begin contributing to a Roth (for each of you) that you can draw from in the future. This way you won't have all pre-tax retirement income in the future.

[barefootcontessa]

If you convert, you will be able to access the contributions in five years without penalty, so you could use that money to supplement your income in early retirement. Also, the idea of no tax is very appealing, especially when you consider how much time the money will have to grow. So yeah, I would look into it.

[Poppy]

Mar 18, 2017 11:52:41 GMT -5 @juno said:

My thinking for us is that maxing out 401ks is not sufficient. So i need to save outside that. And if my choices are put 5k in an account where i have to pay taxes every year and then again when i sell or put 5k in an account where i will never have to pay taxes again at any rate, the second one is a clear winner, no matter what my tax bracket in retirement. The choice would be harder if it was Roth v. traditional, but that's not an option since i'm maxed on trad. options. If you are working a few more years, that should get you close to or over the seasoning hump, i think?

But as i said in a post before i'm squirrely about the step transaction rules even though it seems unlikely they would apply, so i don't do immediate conversions. Maybe read a couple of articles if you want to add that to your risk-benefit assessment.

Yes!

I have to say I'm really surprised that you haven't already got this all analyzed and integrated in your model!

Another benefit, if you want to minimize your taxes in retirement, is that you'll be able to balance your Roth and brokerage withdrawals to control your AGI. There are some weird effects due to phase outs and credits where your tax rate can go non linear. A lot of people on Bogleheads go really overboard optimizing their AGI to maneuver around those.

[niq]

You at least defer taxes on the gains.

I think you make enough money that your taxable investment income hits a bunch of those higher tax rates? So anything other than growth stocks, a backdoor roth would at least save you a decent chunk of taxes. On the other hand, 23.8% (the absolute maximum capital gains tax rate) of a 4% return on a single year's Roth max is $104. So if you are ten years from retirement you're talking about ~$5-6000 in tax savings over ten years.

That doesn't sound like a ton to me, you can probably get nearly equivalent benefit by being careful about which investments are in taxable vs tax deferred accounts, and save yoursellf the hassle of filling out the backdoor roth paperwork every year or worry about accruing a few cents of interest because you didn't do the traditional->roth conversion fast enough. But we're getting close to "this is not the financial planning advice you're looking for" territory.

[mrsdoe]

kadams767 just out of curiosity is the early-withdrawal ladder system you mentioned part of any strategy why someone do that other than just wanting the $$ back in their pocket?

[kadams767]

Mar 18, 2017 20:27:37 GMT -5 mrsdoe said:

kadams767 just out of curiosity is the early-withdrawal ladder system you mentioned part of any strategy why someone do that other than just wanting the $$ back in their pocket?

For people who retire early, they "ladder" or stagger their withdrawals for a couple reasons as I understand it.  First, under normal circumstances, you cant withdraw IRA funds until age 59.5.  However, you can withdraw your contributions to a Roth IRA at any time (just not the earnings).  If you've been doing the back-door Roth, those converted funds (again, up to the initially converted amount, no gains earned post-conversion) are able to be withdrawn penalty free after 5 years.  So if you've been contributing and/or converting for awhile and retire before 59.5, people withdraw them as a source of funds to live on before they reach traditional retirement age and can use their 401(k) or other traditional retirement savings freely.  Second, to piggyback on the first reason, you not only can strategically time your use of the funds for early retirement, that money is tax-free.  Having a very low taxable income is a big part of a lot of these people's strategy and their ability to reach financial independence or early retirement.  

I should add, this is not my own personal strategy, just what I've read about online.  

[Susie]

Mar 18, 2017 6:27:39 GMT -5 @shoegal said:

I do not have any IRA assets today. I believe H has an IRA worth something like $6k in one from years ago.

In that case, I think I would try to do a full traditional IRA contribution every year and converting to Roth.

I don't do it, because most of my retirement savings are in a SIMPLE IRA.    I'm trying to convince my firm to switch to offering a 401k instead of SIMPLE IRA, because the SIMPLE IRA totally screws us over - both on really low annual contribution limits and by blowing my backdoor Roth out of the water.  I'm making headway.

[gt7301b]

Honestly, I don't see why you wouldn't do it if your other option is just an ordinary investment account.

[Deleted]

Mar 20, 2017 16:07:40 GMT -5 gt7301b said:

Honestly, I don't see why you wouldn't do it if your other option is just an ordinary investment account.

Inertia and the added administration of yet another type of account are why I haven't yet!

[gt7301b]

Mar 21, 2017 7:57:47 GMT -5 @shoegal said:

Mar 20, 2017 16:07:40 GMT -5 gt7301b said:

Honestly, I don't see why you wouldn't do it if your other option is just an ordinary investment account.

Inertia and the added administration of yet another type of account are why I haven't yet!

I get the inertia rational, but the administrative burden really isn't that much. I have a rollover IRA, Roth, and taxable account within my Vanguard portfolio and it takes no more time to look at the three accounts than it would if I only had two.  Executing the rollover shouldn't take more than five minutes a year.

[tacom]

@shoegal, I agree that the administrative burden is super low.

but also, this isn't something you MUST decide on now, right?

not sure if regulations have changed, but in 2012 I was able to contribute up to the amount of my earned income. if you're considering partial retirement, this may be a savings vehicle available to you for decades.