Hi, I need to get up to speed on tax advantaged accounts quickly. I have a Roth and IRA but I need to know better what other account types, how to figure out if/when to do IRA conversion to Roth and any info/tips on how to beef up my financial journey quickly.
Sorry if this seem urgent but I have very limited time between now and Wednesday when I start a new job and then my free time will drop considerably and I still have two kids to attend to so I just need to be efficient at gathering information.
Thank you in advance,
Scot
tax advantaged accounts
-
Western Red Cedar
- Posts: 1237
- Joined: Tue Sep 01, 2020 2:15 pm
Re: tax advantaged accounts
You can check out the MMM sticky on investment order and accessing tax advantaged accounts for a crash course:
https://forum.mrmoneymustache.com/inves ... ent-order/
https://forum.mrmoneymustache.com/inves ... -age-59-5/
The Mad Fientist has quite a few posts arguing why tax advantaged accounts are beneficial for early retirees. He focuses heavily on tax optimization, which is the route I personally chose.
https://www.madfientist.com/how-to-acce ... nds-early/
Here is a short forum thread talking about the pros and cons of tax deferred accounts:
viewtopic.php?p=137898&hilit=tax+advant ... ts#p137898
Your particular strategy will ultimately depend on your individual circumstances, but it is wise to ensure you have a portion of your investments in taxable accounts when you leave work. You probably won't need to worry about Roth conversions prior to leaving work.
https://forum.mrmoneymustache.com/inves ... ent-order/
https://forum.mrmoneymustache.com/inves ... -age-59-5/
The Mad Fientist has quite a few posts arguing why tax advantaged accounts are beneficial for early retirees. He focuses heavily on tax optimization, which is the route I personally chose.
https://www.madfientist.com/how-to-acce ... nds-early/
Here is a short forum thread talking about the pros and cons of tax deferred accounts:
viewtopic.php?p=137898&hilit=tax+advant ... ts#p137898
Your particular strategy will ultimately depend on your individual circumstances, but it is wise to ensure you have a portion of your investments in taxable accounts when you leave work. You probably won't need to worry about Roth conversions prior to leaving work.
Re: tax advantaged accounts
Swedroe gives a decent high level overview of retirement tax strategy in his book:
https://www.amazon.com/Complete-Guide-S ... author_mpb
In short, you work backwards. What does your withdrawal strategy look like? That informs where the money goes during accumulation.
If you lean fire, and especially ERE, it kind of doesn't matter. You simply max whatever accounts pay the least taxes during accumulation. Your income in retirement is so low, that pulling from the IRA or 401k doesn't trigger much in the way of taxes. The biggest concern is producing enough income (via dividends and roth conversion, typically), so you aren't forced into Medicaid.
You can do a little better by strategically positioning asset classes during accumulation, so dividends and interest are thrown off in a tax advantaged account. But that's a minor detail. The clever stuff, like back door roth contributions, is more relevant for fat FIRE types. Swedroe gets into the complexities those groups face.
https://www.amazon.com/Complete-Guide-S ... author_mpb
In short, you work backwards. What does your withdrawal strategy look like? That informs where the money goes during accumulation.
If you lean fire, and especially ERE, it kind of doesn't matter. You simply max whatever accounts pay the least taxes during accumulation. Your income in retirement is so low, that pulling from the IRA or 401k doesn't trigger much in the way of taxes. The biggest concern is producing enough income (via dividends and roth conversion, typically), so you aren't forced into Medicaid.
You can do a little better by strategically positioning asset classes during accumulation, so dividends and interest are thrown off in a tax advantaged account. But that's a minor detail. The clever stuff, like back door roth contributions, is more relevant for fat FIRE types. Swedroe gets into the complexities those groups face.
Re: tax advantaged accounts
The account types are called IRA (individual retirement account) and 401k (retirement account connected to your workplace). Some workplaces (especially educational, healthcare and government) will have 403b accounts instead of 401k.
The tax strategies for retirement accounts are traditional or Roth. Both retirement account types can be Roth or traditional.
So you can have a traditional IRA, a traditional 401k (or 403b), a Roth IRA and a Roth 401k (or 403b).
Most employers offer traditional 401ks, and more and more, but not all, employers offer a Roth 401k.
As for the tax strategies:
A traditional IRA and a traditional 401k reduce your tax burden now but you will have to pay taxes on the distributions. The contributions now reduce the taxable income in your highest tax bracket (the contributions are taken from the top of your income). In retirement the distributions will fill up your tax brackets from the bottom upwards (although remember that you may also have social security income which will also fill up your tax brackets). A Roth IRA and a Roth 401k are funded with posttax money (so you pay taxes now, and in your highest tax bracket), but distributions are tax free. If you expect that your income NOW is much higher than your income in retirement, choose (mostly) contributions to traditional accounts.
Be aware that we don't know what the tax percentages will actually be in retirement. If they were to increase a lot, you might later on pay more taxes even when your income at that point is lower than it is now.
Lots of people therefore also have the majority of their retirement income in a traditional account, but also have some in a Roth account to hedge their bets.
Advantages of IRA
* you decide with what company you have this IRA and thus you are free to choose a good brokerage with low fees and the investment options you want
* the IRA is independent of your workplace so you get to keep it and take it with you through life no matter where or whether you work
* 401ks from previous employers can be rolled over to IRAs. Traditional 401k to traditional IRA, Roth 401k to Roth IRA. If you work at say 5 employers over your career, this means that over time five different 401ks can be rolled over into one IRA - that's a nice simplification and much better than keeping track of five different 401k accounts.
Advantages of 401k
* your employer may offer a match, which is free extra money
* the contribution limits of a 401k are higher than the contribution limits of an IRA.
* your employer may start one for you automatically with no or little work that you need to do (with the IRA, YOU have to do the "work" of opening it up and setting up contributions). I think this is a major factor for the general population, but I would hope that someone striving for ERE will put in the effort to open up an IRA if that is best for their strategy.
The tax strategies for retirement accounts are traditional or Roth. Both retirement account types can be Roth or traditional.
So you can have a traditional IRA, a traditional 401k (or 403b), a Roth IRA and a Roth 401k (or 403b).
Most employers offer traditional 401ks, and more and more, but not all, employers offer a Roth 401k.
As for the tax strategies:
A traditional IRA and a traditional 401k reduce your tax burden now but you will have to pay taxes on the distributions. The contributions now reduce the taxable income in your highest tax bracket (the contributions are taken from the top of your income). In retirement the distributions will fill up your tax brackets from the bottom upwards (although remember that you may also have social security income which will also fill up your tax brackets). A Roth IRA and a Roth 401k are funded with posttax money (so you pay taxes now, and in your highest tax bracket), but distributions are tax free. If you expect that your income NOW is much higher than your income in retirement, choose (mostly) contributions to traditional accounts.
Be aware that we don't know what the tax percentages will actually be in retirement. If they were to increase a lot, you might later on pay more taxes even when your income at that point is lower than it is now.
Lots of people therefore also have the majority of their retirement income in a traditional account, but also have some in a Roth account to hedge their bets.
Advantages of IRA
* you decide with what company you have this IRA and thus you are free to choose a good brokerage with low fees and the investment options you want
* the IRA is independent of your workplace so you get to keep it and take it with you through life no matter where or whether you work
* 401ks from previous employers can be rolled over to IRAs. Traditional 401k to traditional IRA, Roth 401k to Roth IRA. If you work at say 5 employers over your career, this means that over time five different 401ks can be rolled over into one IRA - that's a nice simplification and much better than keeping track of five different 401k accounts.
Advantages of 401k
* your employer may offer a match, which is free extra money
* the contribution limits of a 401k are higher than the contribution limits of an IRA.
* your employer may start one for you automatically with no or little work that you need to do (with the IRA, YOU have to do the "work" of opening it up and setting up contributions). I think this is a major factor for the general population, but I would hope that someone striving for ERE will put in the effort to open up an IRA if that is best for their strategy.
-
scottindenver
- Posts: 57
- Joined: Wed Jul 19, 2023 10:06 am
Re: tax advantaged accounts
Thank you to everyone! I am going to go over this today and take notes. Also the books mentioned are at my library so double plus!