What's your ideal tax-deferred vs tax-exempt (Roth) ratio at retirement?

[Gas_Doc]

I'm just curious what kind of ratio people would like to have at retirement. Obviously, 100% Roth would be better if you just dropped yourself into your life at age 65 so you'd never have to pay income taxes again. But for the sake of this exercise, let's say you are just starting out as an attending. Take into account the amount of extra taxes you'd have to pay during your high-income years if you decided on Roth contributions.

 

How would you balance tax-deferred vs Roth contributions? What ratio would you aim for?

[PhysicianOnFIRE]

If I were starting from scratch today, the ratio would likely end up 5:1 in favor of tax deferred.

Based on current law, I can invest $11,000 in a backdoor Roth each year.  For tax deferred, I put $18,000 into a 457(b),  another $18,000 into a 401(k) and my employer kicks in about $20,000 to the 401(k).  So that gives me about a 5:1 ratio.

In retirement, I'll start making Roth conversions from tax deferred to fill up the 15% and perhaps 25% tax brackets.  I would not consider making Roth 401(k) contributions at a high marginal tax bracket while working.  The money can be shifted to Roth later on after I retire.

Another ratio to consider is taxable account versus retirement accounts.  I like a 1:1 ratio here, especially when looking at early retirement.

 

[Zaphod]

PhysicianOnFIRE wrote:

If I were starting from scratch today, the ratio would likely end up 5:1 in favor of tax deferred.

Based on current law, I can invest $11,000 in a backdoor Roth each year.  For tax deferred, I put $18,000 into a 457(b),  another $18,000 into a 401(k) and my employer kicks in about $20,000 to the 401(k).  So that gives me about a 5:1 ratio.

In retirement, I’ll start making Roth conversions from tax deferred to fill up the 15% and perhaps 25% tax brackets.  I would not consider making Roth 401(k) contributions at a high marginal tax bracket while working.  The money can be shifted to Roth later on after I retire.

Another ratio to consider is taxable account versus retirement accounts.  I like a 1:1 ratio here, especially when looking at early retirement.

 

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How do you get a 1:1 taxable? I've got a two year head start on the deferred accounts, but all my projections show the taxable will overcome it quickly, unless I start a cash balance or defined benefit plan.

[jfoxcpacfp]

PhysicianOnFIRE wrote:

If I were starting from scratch today, the ratio would likely end up 5:1 in favor of tax deferred.

Based on current law, I can invest $11,000 in a backdoor Roth each year.  For tax deferred, I put $18,000 into a 457(b),  another $18,000 into a 401(k) and my employer kicks in about $20,000 to the 401(k).  So that gives me about a 5:1 ratio.

In retirement, I’ll start making Roth conversions from tax deferred to fill up the 15% and perhaps 25% tax brackets.  I would not consider making Roth 401(k) contributions at a high marginal tax bracket while working.  The money can be shifted to Roth later on after I retire.

Another ratio to consider is taxable account versus retirement accounts.  I like a 1:1 ratio here, especially when looking at early retirement.

 

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I'm going to massage PhysicianOnFIRE's technique a bit. The problem with waiting until retirement to begin converting is that, by then, the Roth has grown so high (or should have) as to make it difficult ever to convert it all, at least at the 15% and 25% brackets. During your accumulation years, consider converting chunks to Roth IRAs during bear markets, as you can afford. Consider the last bear market. If you converted when your account was down 40% or 50% and paid taxes of 40% - 45% (state and federal), the result would be to move the taxes on the conversion into the Roth. Tax loss harvesting in the taxable account could be used to pay the taxes.

At retirement, consider moving to a state that does not tax retirement income - there are plenty of good options.

My ideal tax-deferred v Roth ratio is 100% Roth, of course. I think that should be the goal even though it might be difficult to achieve. Depending upon cash flow, however, the above technique will move you closer to that target.

[PhysicianOnFIRE]

Zaphod wrote:

PhysicianOnFIRE wrote:

If I were starting from scratch today, the ratio would likely end up 5:1 in favor of tax deferred.

Based on current law, I can invest $11,000 in a backdoor Roth each year.  For tax deferred, I put $18,000 into a 457(b),  another $18,000 into a 401(k) and my employer kicks in about $20,000 to the 401(k).  So that gives me about a 5:1 ratio.

In retirement, I’ll start making Roth conversions from tax deferred to fill up the 15% and perhaps 25% tax brackets.  I would not consider making Roth 401(k) contributions at a high marginal tax bracket while working.  The money can be shifted to Roth later on after I retire.

Another ratio to consider is taxable account versus retirement accounts.  I like a 1:1 ratio here, especially when looking at early retirement.

 

Click to expand…

How do you get a 1:1 taxable? I’ve got a two year head start on the deferred accounts, but all my projections show the taxable will overcome it quickly, unless I start a cash balance or defined benefit plan.

Click to expand...

True. That's an issue that savers / investors like you and I and many WCI readers have.  I'm right around an equal 1:1 ratio of taxable: retirement at the moment.  I put more in taxable each year, so that ratio will continue to grow in favor of the taxable account until I retire.

Many physicians who don't think and write about money are less likely to have large taxable accounts.  In the early years, quite a bit of money goes towards mortgage and loan debt.  I didn't start a taxable account until I had been working 3 years.  I think most docs would look at a 1:1 ratio and wonder how one can put so much in taxable.

 

 

[Zaphod]

PhysicianOnFIRE wrote:

Zaphod wrote:

PhysicianOnFIRE wrote:

If I were starting from scratch today, the ratio would likely end up 5:1 in favor of tax deferred.

Based on current law, I can invest $11,000 in a backdoor Roth each year.  For tax deferred, I put $18,000 into a 457(b),  another $18,000 into a 401(k) and my employer kicks in about $20,000 to the 401(k).  So that gives me about a 5:1 ratio.

In retirement, I’ll start making Roth conversions from tax deferred to fill up the 15% and perhaps 25% tax brackets.  I would not consider making Roth 401(k) contributions at a high marginal tax bracket while working.  The money can be shifted to Roth later on after I retire.

Another ratio to consider is taxable account versus retirement accounts.  I like a 1:1 ratio here, especially when looking at early retirement.

 

Click to expand…

How do you get a 1:1 taxable? I’ve got a two year head start on the deferred accounts, but all my projections show the taxable will overcome it quickly, unless I start a cash balance or defined benefit plan.

Click to expand…

True. That’s an issue that savers / investors like you and I and many WCI readers have.  I’m right around an equal 1:1 ratio of taxable: retirement at the moment.  I put more in taxable each year, so that ratio will continue to grow in favor of the taxable account until I retire.

Many physicians who don’t think and write about money are less likely to have large taxable accounts.  In the early years, quite a bit of money goes towards mortgage and loan debt.  I didn’t start a taxable account until I had been working 3 years.  I think most docs would look at a 1:1 ratio and wonder how one can put so much in taxable.

 

 

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Thats about exactly where I am now, but Im only paying slightly more on my debt (due to picking a timeline I liked) than is the least possible. Just started the taxable, but did a projection over the next 5 years and couldnt believe how fast it became the largest account. This is not counting on anything besides savings and dividends from them, which is minor and even if backed out doesnt change the overall trajectory. Really the limiter in tax deferred is simply the contribution limits, and probably the psychological effect of feeling like you are done after that, instead of thinking of it as the first bucket and not the largest.

[62cutlass]

I am in my first year as an attending and had a similar question.

My employer makes a significant contribution to a 401a. I am not allowed to make any additional contribution to it.

I have the ability to contribute to both Roth or traditional 403b and governmental 457b.

I am currently putting in the max 18k in each Roth accounts. Plus, I am funding a Backdoor Roth for my wife and I.

Is that the best choice?

[litovskyassetmanagement]

If you are an employee, and are in the lower tax brackets, I'd consider going all Roth.  Once you are in highest brackets, backdoor Roth plus tax deferred is fine.  If/when you retire, it might make sense to roll everything into a Traditional IRA and convert to Roth in pieces once you are in the lower brackets.

If you have access to your own retirement plan (solo 401k, practice 401k), I'd also make strategic Roth conversions at or near retirement, with one advantage over the first strategy: you can make Roth conversions right inside your own plan without having to roll anything into an IRA.

Roth conversions would significantly lower your RMD taxes in retirement, especially if you will accumulate a decent amount of money in tax-deferred plans.  In any case, I'd consider doing a model of your situation with various strategies and assumptions (including amounts, timing, brackets, etc).  It is difficult to gauge the impact of  Roth conversions without making a lot of assumptions, but you can compare various scenarios and try to follow the best one as much as possible.

 

[Gas_Doc]

Kon Litovsky wrote:

If you are an employee, and are in the lower tax brackets, I’d consider going all Roth.  Once you are in highest brackets, backdoor Roth plus tax deferred is fine.  If/when you retire, it might make sense to roll everything into a Traditional IRA and convert to Roth in pieces once you are in the lower brackets.

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What do you consider the "highest brackets"? I.e., at which Federal bracket would you suggest going for tax-deferred vs Roth contributions?

[PhysicianOnFIRE]

62cutlass wrote:

I am in my first year as an attending and had a similar question.

My employer makes a significant contribution to a 401a. I am not allowed to make any additional contribution to it.

I have the ability to contribute to both Roth or traditional 403b and governmental 457b.

I am currently putting in the max 18k in each Roth accounts. Plus, I am funding a Backdoor Roth for my wife and I.

Is that the best choice?

Click to expand...

You're probably better off going with traditional / tax deferred for the 403(b) and 457(b) rather than Roth due to tax arbitrage.  There's a good chance that you can be in a lower tax bracket in retirement, so defer the tax until then.   If you're in the 33% or higher bracket, I would go with tax deferred.  If you're in the 25% bracket, then all Roth would be a definite consideration.

There was a spirited discussion about this on SDN.  Posts by bc65 align well with my line of thinking on the subject.

[litovskyassetmanagement]

Gas_Doc wrote:

Kon Litovsky wrote:

If you are an employee, and are in the lower tax brackets, I’d consider going all Roth.  Once you are in highest brackets, backdoor Roth plus tax deferred is fine.  If/when you retire, it might make sense to roll everything into a Traditional IRA and convert to Roth in pieces once you are in the lower brackets.

Click to expand…

What do you consider the “highest brackets”? I.e., at which Federal bracket would you suggest going for tax-deferred vs Roth contributions?

Click to expand...

Post above makes sense to me.  I'd say 25% and below is Roth, and anything above is tax-deferred.  It also depends on your state brackets as well.  Presumably you won't be doing Roth for longer than several years, so it is not really that big of a deal.  You can still do the traditional tax deferred with backdoor Roth and would be fine.  I'd like to give that Roth bucket a boost early on though.

[asmallchild]

Current Annual Ratio

Taxable : Roth : Tax-Deferred = 20 : 1 : 1

I realize I should probably be placing my 401K in tax-deferred but I figure since we are in a no income-tax state and plan on retiring in NYC or California, the specter of state taxes might even everything out. I figure some diversification isn't the worst thing in the world since my wife's 401k savings are all tax-deferred

[The White Coat Investor]

I try to make the best decisions as I go along (such as doing tax-free as a resident and in the military and doing tax-deferred during peak earnings years) and when I get there, it'll be what it is.

[jfoxcpacfp]

62cutlass wrote:

I have the ability to contribute to both Roth or traditional 403b and governmental 457b. I am currently putting in the max 18k in each Roth accounts. Plus, I am funding a Backdoor Roth for my wife and I. Is that the best choice?

Click to expand...

If you can afford the tax bite (and it appears you can), you're doing fine. Another thought, though - if you are able to invest even more than your current allowable contributions, contribute to a taxable account and substitute a deductible contribution at work for the Roth to equal the contribution to taxable account.

[62cutlass]

Thanks for the advice!

Looks like I need to start contributing to the traditional 403 and 457 instead of the Roth.

Is there any advantage to having certain types of funds in 401, 403, and 457 vs my taxable account? Or should I just stick with my planned asset allocation across the board?