If your income in retirement is the same or more, the marginal tax rate does not matter. And that's only if tax rates aren't increased(they definitely will be)

 

Exhibit A. You could not have made my point more perfectly.


An example to demonstrate:

A pilot has $400k of income at delta. For simplicity sake, let’s say the pilot doesn’t contribute a penny of their own money and only focus on the spill cash.

Said pilot receives $70k of income beyond the 401a17 income limit of $330k, thus generating $11,200 of spill cash for a total income of $411,200 that year. Assuming this pilot is married and filing jointly, they would owe 32% on the $11,200 of spill just for federal income taxes, plus any applicable state income tax, and 1.85% ALPA dues.

So let’s assume they live in a tax-free state. In such case they would have paid 33.85% tax on every dollar of spill they earned that year.

Now, in retirement let’s say the pilot has amassed enough retirement dollars to support a $400k per year withdrawal (not likely unless the pilot has other passive or active income sources, in which case all bets are off as he/she is no longer working within the assumption that their livelihood is dependent on the career we all signed up for- which is the vast majority of our pilots).

In retirement, that pilot would pay 10% of the first $22,000, 12% of the next $67,450, 22% of the next $101,300, 24% of the next $173,450, and finally 32% of the last $35,800. Add all that together, and the pilot will have paid $85,664 of federal income taxes on $400k of retirement plan withdrawals, or an EFFECTIVE tax rate of 21.4%. This pilot is still “in the 32% tax bracket”, but the treatment of dollars on the way OUT is vastly different than the treatment of the dollars on the way IN.

21.4% is the tax rate that compares apples to apples against the marginal rate applicable to spill cash, or in this example 33.85%. It’s this arbitrage that makes a tax-deferred account powerful. Less income in retirement makes the arbitrage even better.

Now, as an aside, I think assuming an average pilot will have the ability to withdraw an equivalent income as they were making in active service from their retirement account is kind of a stretch. A more realistic example based on a legacy pension level of retirement income (60%, or $240k in this example) yields an effective rate of $18.5%. And many states also have a progressive tax rate, which also would compound the arbitrage to the pilots favor.

Disclaimer for people with other income streams, of which there are about a million considerations as to if it makes sense. My example demonstrates an average pilot who wants to fly airplanes, and not manage outside ventures.

YMMV, DYODD

 

Q: “What if tax rates go up 20 years from now? You have to Roth everything you can, now!”

A1: What if tax rates go down in 20 years?
A2: What if the tax brackets index up every year which further favor tax deferment today?
A3: What if the government means-tests the value of Roth accounts for later tax treatment, Medicare premiums, or social security benefits?
A4: What if you live in a high tax state and move to a low or tax free state during retirement?

 

You can't do the math differently in retirement. The last dollar in from MBCBP that saved 33.85% is also the last dollar out being taxed at 32% in retirement. The only savings in your example is 1.85% of ALPA dues.
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Without MBCBP, the 11,200 after taxes and dues is reduced to $7,400. Invested in a tax efficient equity like VOO it will outperform the MBCBP considerably. When withdrawn you pay no tax on the 7,400 invested and only 20% LTCG on the gains. Someone who cares about the math can calculate the years and returns required to compare the two. I've done this several times in years past, but am not at my PC to share the spreadsheets.

 

Do you not have any 401k withdrawals/RMDs?

 

Exactly! Thank you for clearly articulating this. Saved me alot of typing. Even with a Financial Advisor First Break is still confused about the tax deferral math.

 

Which actually isn’t a small number. Post on here that you’re paying 1.85% to a financial advisor and see what kind of responses you get :-).

I haven’t seen anyone’s math represent a few one-time-only raids of spill cash to finish the deck, buy a cool new Delta watch, fund a hard top to better hide in their Miata, etc…

 

Not really your tax bracket but more actually "tax burden." No one knows what the future tax rates will be but with the National Debt I don't really see it getting lower or even staying the same. In addition to my 401K I am always adding money to a post tax brokerage account totally separate from my 401K and another additional Roth account.

I personally think 401K wealth in the future will be too irresistible for politicians to keep their hands off of. It will probably start out like a 1% annual fee on accounts over 5 million or something that the average voter does not see affecting them and then will conditionally adjust downward. Where and how far it goes is anyone's guess. Is this a valid reason not to invest in tax deferred accounts? No - we have to operate within the "system" as it is now - I am just pointing out a concern that I have.

Anyone else wonder about this?

Scoop

 

Both the 401k and MBCBP will be rolled into an IRA at retirement, so at that point my assumption is that all funds are co-mingled and withdrawals are both 401k and MBCBP.

Lots of wild assumptions going on here, including Trip
who has convinced himself he will make 20% per year in perpetuity, hedge zero percent of his 401k in lower risk assets, and end up with full income replacement in retirement after investing his taxable spill cash in taxable accounts, spend none of it on a Miata, and finally assume that 401k/Roth IRA rules remain constant but also assume tax rates will go up as a matter of course. If all that’s true, then he just might be right.

 

Under $10 million in assets 20% returns annualized are not difficult. Between Real Estate and Small Cap stocks there are tons of opportunities. And it doesn't require some high level of intelligence. Just basic ability to read financial statements, 4th Grade level math, and emotional stability.