I’m in a pretty high tax bracket, but I still do Roth IRA/401k contributions. This is because if you are maxing out your accounts (which if your goal is “early” retirement, you almost certainly will be) you are protecting more real dollars from taxes. The contribution limits are the same regardless of whether you contribute on a traditional or Roth basis. If I can protect $6000 and never have to pay taxes on it or protect $6000 that I’ll eventually have to pay taxes on, I’d rather take the tax penalty now and protect more real dollars. I never see this discussed anywhere, but it’s my primary motivating factor in doing Roth. There is also the flexibility consideration which you mention. (There are also more advanced strategies such as backdoor Roths and mega-backdoor Roths that you didn’t really touch on, but they’re not super important.)
One thing you don’t discuss is the tax advantages of owning a home. All interest you pay (in the US) is tax deductible. Commentary on the prudence of that aside, it doesn’t seem likely to change any time soon. Besides which, interest rates are currently so low that it probably makes sense to finance other items as well, even if you have the ability to pay for them out of pocket. But I’m not up to speed on car/student/etc. loans, so that might not be true for other asset classes. My recently refinanced interest rate on my home is 2.5%. At a rate like that they are literally giving money away, if you assume 3% inflation every year (admittedly a debatable assumption). If you are risk-tolerant (most people aren’t risk tolerant enough, remember) you should generally be happy to finance debt to invest the returns in the market.
Note: As of 2017, mortgage interest is (effectively) no longer tax deductible for families, because the Standard Deduction was increased, making all deductions that aren’t given special treatment moot (cash contributions to charity have a special call-out, and there may be others like student loan interest—consult your tax professional, I am not one).
If you are single, and have a large mortgage, the amount of interest(and other deductions like property taxes) over your standard deduction does provide some tax advantage.
This was a bigger deal back pre-2000 when mortgage interest rates were ~6% instead of the ~3% they are now: prices have gone up, and more of the monthly payment is non-deductible principal, not interest.
cash contributions to charity have a special call-out
Is this true? I don’t think it is. From irs.gov: “You may deduct charitable contributions of money or property made to qualified organizations if you itemize your deductions.”
Here’s how the CARES Act changes deducting charitable contributions made in 2020:
Previously, charitable contributions could only be deducted if taxpayers itemized their deductions.
However, taxpayers who don’t itemize deductions may take a charitable deduction of up to $300 for cash contributions made in 2020 to qualifying organizations. For the purposes of this deduction, qualifying organizations are those that are religious, charitable, educational, scientific or literary in purpose. The law changed in this area due to the Coronavirus Aid, Relief, and Economic Security Act.
The CARES Act also temporarily suspends limits on charitable contributions and temporarily increases limits on contributions of food inventory. More information about these changes is available on IRS.gov.
Three hundred dollars is a pretty minimal deduction. I expect there are at least a few effective altruists on here who have significant enough charitable contributions that it still makes sense to itemize deductions even with the increase in the standard deduction.
Mentally, I categorize “donating half your income” as “exceptional circumstance” and trust people in that 1% sliver of the population to make the right choice for them.
Also, too, heavy donors probably aren’t the same people looking to retire early
I only give 10%, but that is enough to make itemizing deductions worth it for me, when combined with my mortgage interest. I am also looking to retire early (or at least become financially independent and increase donations substantially). Good financial advice is always relevant to everyone.
Re 1: This is a good point; I did the math on this at some point for myself and ended up still landing on traditional by a large margin (even though I wanted it to turn out pure Roth for simplicity). But it’ll be dependent on your expected tax rates, opportunities for low-tax conversion, and your retirement timeline (more tax-advantaged money dominates on longer timelines).
Also yeah, I skipped backdoor and mega-backdoor to keep things simple. The goal was to give people a linkable 90⁄10. The outcome I was aiming for is that people read, get the important parts of the memetic package, and then some of them will dive in more to find things like that for themselves—for instance, they’re mentioned in the flowchart I linked.
Re: tax advantages of homes, yeah . Homes are probably a better long-term expected value than I make them sound for this and other reasons. Still, transaction costs suck, and I think they stop being a good idea if you buy/sell them too often—I’ve heard you need to hold ~5 years on average to break even on transaction costs vs mortgage advantage, but haven’t done the math myself. I am biased toward the flexibility of being able to change my physical location in order to take better jobs, decrease my commutes, decide to decrease my expenses, etc. If you do buy a home, you can ameliorate these concerns by just buying a small home so that you can more easily decide to eat the proportional transaction costs if necessary.
Re: financing things at low interest rates to instead invest in the market, I agree this is correct to maximize expected value but 1. it’s not all that big of an impact for things smaller than a house or new car and 2. I think most people would do better by avoiding the over-spending tendency that credit brings, and the negative psychological effects of future spending obligations. If you’re buying a house or new car regardless and can get a low interest rate, I agree you should take out low interest debt instead of buying it with cash.
Two notes:
I’m in a pretty high tax bracket, but I still do Roth IRA/401k contributions. This is because if you are maxing out your accounts (which if your goal is “early” retirement, you almost certainly will be) you are protecting more real dollars from taxes. The contribution limits are the same regardless of whether you contribute on a traditional or Roth basis. If I can protect $6000 and never have to pay taxes on it or protect $6000 that I’ll eventually have to pay taxes on, I’d rather take the tax penalty now and protect more real dollars. I never see this discussed anywhere, but it’s my primary motivating factor in doing Roth. There is also the flexibility consideration which you mention. (There are also more advanced strategies such as backdoor Roths and mega-backdoor Roths that you didn’t really touch on, but they’re not super important.)
One thing you don’t discuss is the tax advantages of owning a home. All interest you pay (in the US) is tax deductible. Commentary on the prudence of that aside, it doesn’t seem likely to change any time soon. Besides which, interest rates are currently so low that it probably makes sense to finance other items as well, even if you have the ability to pay for them out of pocket. But I’m not up to speed on car/student/etc. loans, so that might not be true for other asset classes. My recently refinanced interest rate on my home is 2.5%. At a rate like that they are literally giving money away, if you assume 3% inflation every year (admittedly a debatable assumption). If you are risk-tolerant (most people aren’t risk tolerant enough, remember) you should generally be happy to finance debt to invest the returns in the market.
Note: As of 2017, mortgage interest is (effectively) no longer tax deductible for families, because the Standard Deduction was increased, making all deductions that aren’t given special treatment moot (cash contributions to charity have a special call-out, and there may be others like student loan interest—consult your tax professional, I am not one).
If you are single, and have a large mortgage, the amount of interest(and other deductions like property taxes) over your standard deduction does provide some tax advantage.
This was a bigger deal back pre-2000 when mortgage interest rates were ~6% instead of the ~3% they are now: prices have gone up, and more of the monthly payment is non-deductible principal, not interest.
Is this true? I don’t think it is. From irs.gov: “You may deduct charitable contributions of money or property made to qualified organizations if you itemize your deductions.”
From https://www.irs.gov/newsroom/how-the-cares-act-changes-deducting-charitable-contributions
Here’s how the CARES Act changes deducting charitable contributions made in 2020:
Previously, charitable contributions could only be deducted if taxpayers itemized their deductions.
However, taxpayers who don’t itemize deductions may take a charitable deduction of up to $300 for cash contributions made in 2020 to qualifying organizations. For the purposes of this deduction, qualifying organizations are those that are religious, charitable, educational, scientific or literary in purpose. The law changed in this area due to the Coronavirus Aid, Relief, and Economic Security Act.
The CARES Act also temporarily suspends limits on charitable contributions and temporarily increases limits on contributions of food inventory. More information about these changes is available on IRS.gov.
Three hundred dollars is a pretty minimal deduction. I expect there are at least a few effective altruists on here who have significant enough charitable contributions that it still makes sense to itemize deductions even with the increase in the standard deduction.
Mentally, I categorize “donating half your income” as “exceptional circumstance” and trust people in that 1% sliver of the population to make the right choice for them. Also, too, heavy donors probably aren’t the same people looking to retire early
I only give 10%, but that is enough to make itemizing deductions worth it for me, when combined with my mortgage interest. I am also looking to retire early (or at least become financially independent and increase donations substantially). Good financial advice is always relevant to everyone.
Re 1: This is a good point; I did the math on this at some point for myself and ended up still landing on traditional by a large margin (even though I wanted it to turn out pure Roth for simplicity). But it’ll be dependent on your expected tax rates, opportunities for low-tax conversion, and your retirement timeline (more tax-advantaged money dominates on longer timelines).
Also yeah, I skipped backdoor and mega-backdoor to keep things simple. The goal was to give people a linkable 90⁄10. The outcome I was aiming for is that people read, get the important parts of the memetic package, and then some of them will dive in more to find things like that for themselves—for instance, they’re mentioned in the flowchart I linked.
Re: tax advantages of homes, yeah . Homes are probably a better long-term expected value than I make them sound for this and other reasons. Still, transaction costs suck, and I think they stop being a good idea if you buy/sell them too often—I’ve heard you need to hold ~5 years on average to break even on transaction costs vs mortgage advantage, but haven’t done the math myself. I am biased toward the flexibility of being able to change my physical location in order to take better jobs, decrease my commutes, decide to decrease my expenses, etc. If you do buy a home, you can ameliorate these concerns by just buying a small home so that you can more easily decide to eat the proportional transaction costs if necessary.
Re: financing things at low interest rates to instead invest in the market, I agree this is correct to maximize expected value but 1. it’s not all that big of an impact for things smaller than a house or new car and 2. I think most people would do better by avoiding the over-spending tendency that credit brings, and the negative psychological effects of future spending obligations. If you’re buying a house or new car regardless and can get a low interest rate, I agree you should take out low interest debt instead of buying it with cash.