Posts Tagged ‘ira


IRA to IRA to IRA Rollover in one year?

Why surfing the interwebz, we’ve run into some potentially misleading information.  Well, it most definitely can be interpreted as being misleading, but the intent of the individuals is unknown.  Of course, the point of this blüg is to make sure people don’t use this misleading information.  So, regardless of what someone’s intention is, we hope people walk away with more knowledge than they did before they invested a few minutes in what we have written.

Over at Retire by 40’s blüg, “Ray” gave some advice in the comments that certainly deserves an asterisk.  And, we put that asterisk in the comment section.  But, here is what “Ray” said which could be misleading.

What people don’t understand is you can roll it over to say Vanguard and if you don’t like them, then roll it over to Etrade and if you don’t like them, roll it over to Schwab etc.

Usually from start to finish it’s no more than 7-10 business days if you do it right…

The implication here is that you can just rollover whenever you please.  Which is true, but not without consequences.

Continue reading ‘IRA to IRA to IRA Rollover in one year?’


Taxes going up! Taxes staying the same! Taxes going down!

Welcome! from our blüg’s tax research dawghouse based in a sunny spot here in the Milky Way.  Last week, we posted that taxes are more than likely to decrease in retirement.  And, a Grumpy, wisely gave us some push back.  Each and every one of us can toss about conjecture when it comes to future tax rates.  Personally, we like to look at our tea leaves every day to get a reading on future tax rates.

Regardless of who’s kool-aid you’re drinking, prudent retirement planning will require some sort of tax rate assumption.  So, what assumption do we use?  Well, let’s take a look at what you would have paid from 1913 all the way up to 2011 to have some sort of historical foundation to base our guess on.

First off, we should give credit, where credit is due.  The Tax Foundation did some of the heavy lifting for us.  And you can download the same data which we built our tool around here.  We also did some high level research into the Tax Foundation’s data and found it to be accurate to a degree suitable for understanding trends in Federal income taxation.  Furthermore, if you are into minutiae like we are, you should see why the Tax Foundation’s numbers will differ slightly from the IRS’.

Second, we should clear up a common misconception about how American’s are taxed.  The U.S. has a progressive tax system, meaning the more you make, the more you pay.  And more often than not, at a higher tax rate.  If an individual(s) is in the 25% tax bracket, that does not mean you multiply their income by 25%.  All American’s pay the same amount of tax on their first $10,000 (or insert whatever number you like) regardless of what their marginal tax bracket is, so on and so forth.  If this is unknown to you, please see this Wikipedia article, which even includes a sample calculation under the obvious heading.  Now that we all know our marginal tax rate is the amount of tax we pay on our next dollar, not our entire ordinary income, we can proceed.

But why is knowing our marginal tax rate helpful?  For those working stiffs like ourselves, it helps one to determine if the effort of making more income is worth the after tax payout.  It can also help in making decisions such as how much money you should convert to a Roth IRA.  These two reasons are by no means exhaustive.  Let’s pop some incomes into our handy tool and see what poops out the other end.  For this article, we are using $50k, $100k and $200k in 2011 dollars (so, your 2011 $50k spending power was the same in 1913) and a Married Filing Jointly status.

We learn a couple of things from this chart.  First, as stated previously, the more money you make, the higher your marginal tax rate.  And historically, we learn two things: 1) The tax structure changed dramatically in 1941.  We are not history buffs, but there was a war around that time.  We just merely wish to point out this change associated with major events, not to discuss every reason why this change came about (and knowing why is applicable, but a different conversation).  We would not suggest using any tax rate before 1941 for tax planning purposes.  And 2) the late 80’s early 90’s had a “rate bubble,” where higher incomes actually had a marginal tax rate less than some lower incomes.

It is also interesting to note, that for a family making $50k, the marginal tax rate has not changed for the last 25 years!  And the highest it’s ever been is 29% in 1945 and 28% in 1981.  A couple’s effective (or total dollar paid) peaked in 1945 when they had to pay $12,077 (2011 dollars) in taxes for an effective tax rate of 24%.  Oddly enough, the marginal tax rate dropped in 1954 to 22% and held there for 10 years, but less tax was paid in 1981 (marginal tax rate of 28%).

While there is an effective rate localized maximum in 1981, it is interesting that it is less than the 35 year period of 1942 to 1976.  And in fact, a couple has paid approximately 20% to 30% less in taxes the last 35 years than they would have the 35 years prior!

What about those couples making $100k and $200k?  Well, here is a chart with their marginal and effective tax rates.

The conclusion we draw from this chart is, the lower your income, the less variability for effective tax rates.  Also, as you are less likely to have significant tax increases, you also are less likely to have significant tax decreases (we all knew that already, this is just the history to prove it).

If we were to look at even higher incomes, the variability would be even higher!  So, this is another reason to keep your expenses low, you are less likely to experience large variations in your income tax.

So, what to use for your retirement tax rate assumption?  The real risk is a significant change during retirement, not during the accumulation phase.  Most people will be able to react, tack on a few years of saving to account for changes during the accumulation phase.  We suggest entering your income into our tool below to see what you would have paid historically.  And make sure there is enough wiggle room in your plan to cover the highest tax rate since 1941, plus a few percentage points (more if you are a “high” earner).  And if you often sport a tin foil hat, perhaps a few more.  There is some point where enough is enough and you’ll have to accept some risk, unless you want to work into the grave.  We’ll go over how to build in wiggle room in another post (psst…it doesn’t always mean accumulating more).

What we don’t account for

Tax deductions.  We input no tax deductions.  So an interesting exercise would be to compare your annual effective tax rate in these years and see how much you are reducing your taxes through deductions.  If you have dependents or large deductions (e.g. mortgage interest), we would caution you from extrapolating straight into retirement, as those will (HOPEFULLY!!) go away.  State income tax is something we didn’t look at either.  Doing 40 something states didn’t seem like too much fun.  And, there are other ways the gubmint can tax individuals.  Social Security is a prime example and one which is not included in our tool.  Long term capital gains and dividends are not covered and in our opinion, deserve their own post.  Also, some years, for REALLY high income earners, there is a max effective rate that we did not put into our tool (sorry uber rich!).

Our tool can be downloaded here.  Just remember, it was created by us and is therefore our property.  If you use the tool for any calculations or to generate any charts which will be published, we would appreciate a little linky love.  And as always, we are human dawgs, so we can make mistakes.  Please let us know of any errors or improvements that can be made.


401(k) dividend confussion

The Beating Broke blüg recently fielded a reader question asking about why they weren’t seeing dividends on their 401k statements.  The age-old high schooler debate tactic of going on a verbose diatribe without actually explicitly answering the question was employed.  BB, however, did provide some excellent information, albeit a bit jumbled.

Beating Broke did cover that a 401(k) is a tax-advantaged investment vehicle where, regardless if the money is contributed as traditional (pre-tax) or Roth (after-tax), the growth and dividends aren’t taxed until withdrawal (traditional) or never (never say never) again (Roth).  There is actually a third “category” available at an employer’s discretion, if one contributes over the annual limit the contribution is made after-tax and will be taxed again at distribution (stinky).  Since it doesn’t matter when growth and dividends occur or are made (because you get taxed at contribution or distribution or both and not anytime in between), some companies simply capture dividends in a broad “earnings” category.

For example, Mlle Rhodesian Ridgeback currently has a 401(k) plan with a simple and cheesy “statement” simply listing “contribution” in one column and “gain/loss” in another (and a few other columns which are not pertinent for this discussion). Her funds are not open to the publick and don’t carry a ticker symbol.  La Mlle used to work for a company who’s 401(k) plan was administered by Vanguard.  La Mlle liked this much better and she could actually see when and the amount of dividend distributions for each fund, but that wasn’t the main reason she liked her Vanguard plan (a whole ‘nother story).

So, to some degree, it doesn’t matter if you see the dividend distribution or not.  La Mlle knows she is getting dividends in her current 401(k) because she is invested in a S&P 500 index.  Sure it’s nice to see when dividends are paid, but if they are just added to the funds growth, it doesn’t really matter.  It’s not clear to us if “trading” between investment options is always allowed within a 401(k) plan, but if one desired to have dividend distributions sent into other investment options within the plan, they can either move funds around within the plan or change their contribution allocation.

Where the plot thickens is if you invest in an IRA.  Typically, and it is highly suggested, that people go to a reputable mutual fund company (not insurance) for their IRA needs.  Their mutual funds (with ticker symbol and all) can be invested in taxable accounts or tax-advantaged accounts.  Because taxable accounts care (well, really the IRS cares) when the dividend distribution is made and other things like when stocks are sold (turnover), the fund company tracks this for all of their customers.  And that is why you will see dividends on the IRA accounts, but may not see them in a 401(k) (although they are there).

Other things we like that Beating Broke mentioned

BB suggested to contribute to a 401(k) to maximize the company match, then an IRA, then back to top off the 401(k) if one is able.  We generally agree this is the advice most savvy investors should follow.  It’s difficult, however, to understand everyone’s situation.  BB recommended a Roth IRA, and that may not be for everyone.  And in fact, any type of IRA may not be appropriate at all depending on income and/or the goals an individual has.  There are other considerations for foregoing the IRA as well.  M. Bichon Frise has a friend who refuses to invest in an IRA because of the ERISA protections offered to a 401(k).  While not a very valid reason in most people’s mind as no one plans to be sued and we don’t know anyone who knows anyone who has been sued.  But this is what helps this individual take his dawggie naps at night.

What we didn’t like

Generally speaking, we are very conservative with our investments.  We understand that the stock market has faltered, but we also believe it will provide returns in the future.  At least that is what our tea leaves told us this morning.  BB mentioned in a comment that he recommended such things starting a business, real estate investment and lending club to increase yield over stock market returns.  We would not recommend these to any family member (even of a different dawg breed), friends or cats who simply desires to invest for long-term savings.  Our view is these are risks that don’t need to be taken for potential and a little additional yield.  Not to mention time, if that is important to you.  But, that is the philosophy in our dawghouse and it’s like arguing over Beggin’ Strips being better than Milkbones (of course, anything with bacon is much better).