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401K: Roth or Traditional (for me)?
Old 05-06-2013, 12:01 PM   #1
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401K: Roth or Traditional (for me)?

I have been reading the forum for awhile now. I don’t post, as I typically don’t have anything to add to the great ideas presented. I do have a question and I was hoping for some help with it. I am trying to decide between traditional and Roth 401K contributions. This is the first year where I’ll be making enough to max out both my Roth IRA and my 401K. A little about my situation:

I am 30 years old. I do not have a target retirement age. I try to save as much as I can without depriving myself. I file a single return and I am in the 25% tax bracket. I do not have children or own a home. So I take the standard deduction and that’s about it. I currently contribute close to the limit (around 17K) to a traditional 401k. My company matches 6%. The company also contributes 4% to a cash balance pension plan, in which I am fully vested. I believe I should be able to take this pension money and roll it to an IRA if I leave the company before retirement age. I basically treat the cash pension as a fixed-income component of my retirement savings. I also fully fund an HSA and a Roth IRA as well.

So here’s the question: I currently have over 80% of the money I save (including company match and ‘pension’) going in to tax deferred accounts. Less than 20% of it goes in to the Roth account. I have the option of making some or all of my 401K contributions as Roth contributions as well. Should I be contributing more as Roth?

I intend to begin funding some taxable investments once I can comfortably max out the 401K. I’d at least like to be investing my tax savings from the tax deferred contributions. I will increase that as I go along. If I transition to Roth contributions I will not be able to invest as much in a taxable account.

I like the lower taxable income. It allows me to save more money comfortably. I also like the idea that I can have more control over my tax rate in retirement by using the Roth and the Traditional accounts in combination. What is the right balance of Roth vs Traditional money? What else should I be looking at when I make this decision? Any thoughts would be appreciated.
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Old 05-06-2013, 12:24 PM   #2
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This is a difficult question because we don't know what your future tax rate will be. So I'd say if you are frugal and figure that your retirement income and hence tax rate, will be less than your income while working I'd emphasise the TIRA plan. If you think your tax rate won't drop much in retirement I'd emphasise the ROTH, while making sure you get any company match.
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Old 05-06-2013, 12:37 PM   #3
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Since your are currently in the 25% tax bracket you are probably better off in the traditional 401k instead of the Roth. The Roth IRA should be better than taxable accounts as well. However, you may want some taxable accounts if you retire early. Since you are now maxing out 401k and Roth IRA, the taxable account should start growing soon enough.

If you retire early and have a few years of no income and a healthy taxable account you will be able to Roth convert your 401k/tIRA into a Roth, so you may be able to delay building your Roth accounts until then without missing out on anything. That should be more tax efficient for you. The taxable account balance versus the 401k/tIRA balance is probably one to watch, with a goal of getting whatever you can into the Roth before the taxable account runs out sometime after 59 1/2. It's nice if that brings your income down to the 15% bracket after 401k/tIRA RMD's start.

It's all tax minimization, so you need to figure out the details for yourself.
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Old 05-06-2013, 12:56 PM   #4
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This is a difficult question because we don't know what your future tax rate will be. So I'd say if you are frugal and figure that your retirement income and hence tax rate, will be less than your income while working I'd emphasise the TIRA plan. If you think your tax rate won't drop much in retirement I'd emphasise the ROTH, while making sure you get any company match.
I don't know what it will be either. Its seems impossible to predict what tax rates might be 15 or 20 years from now, or longer if I don't manage to save more. I would be comfortable living on an income consistent with the bottom of the 25% bracket (in current terms). If tax rates are similar when I retire, I expect I'd be in a similar range but maybe the lower end of the bracket.

I guess I'm just looking for some tax diversification and trying to decide what the right mix of Roth vs Traditional might be.
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Old 05-06-2013, 04:04 PM   #5
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What is your Roth inception year? What is your emergency fund amount and how many months does it cover?
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Old 05-06-2013, 05:01 PM   #6
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What is your Roth inception year? What is your emergency fund amount and how many months does it cover?
The Roth IRA is right at 5 years old. I keep about 25-30K in accessible cash at any given time. It would easily cover me for a year if my income were to disappear tomorrow. Probably longer if I made an effort to live on less. My necessary expenses are relatively small. I have a possible job relocation coming up and impending dental work. Some cash is slated for those things.
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Old 05-06-2013, 05:21 PM   #7
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I would attempt to achieve a 25% Roth/75% tax deferred relationship on total account value. You don't have to get there all at once, just move in that direction.
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Old 05-06-2013, 05:45 PM   #8
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I would attempt to achieve a 25% Roth/75% tax deferred relationship on total account value. You don't have to get there all at once, just move in that direction.
Thanks for your input. How do you come to that breakdown? Is there some analysis behind it or just a preference?
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Old 05-06-2013, 05:54 PM   #9
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You will be able to use the Roth for 1) emergency fund 2) controlling taxable income 3) controlling MAGI for Obamacare 4) estate planning later in life. Based on your intention to max out your 401K, maxing out your Roth IRA should get you close to 25/75 over a few years time. You may want to see if your employer allows back door Roth 401K to use if your income rises and shuts you out or limits your regular Roth contributions.
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Old 05-06-2013, 08:54 PM   #10
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You will be able to use the Roth for 1) emergency fund 2) controlling taxable income 3) controlling MAGI for Obamacare 4) estate planning later in life. Based on your intention to max out your 401K, maxing out your Roth IRA should get you close to 25/75 over a few years time. You may want to see if your employer allows back door Roth 401K to use if your income rises and shuts you out or limits your regular Roth contributions.
My 401K has the option for Roth contributions. That's what prompted my question. Should I be contributing to the 401K as Roth in addition to the Roth IRA?

Would there be a difference between backdoor Roth contributions and just contributing to the 401K as Roth contributions in the first place? Maybe I don't understand the backdoor Roth contributoins correctly?
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Old 05-06-2013, 08:59 PM   #11
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Back door Roth is primarily used for people that cannot contribute to a regular Roth because their income exceeds the limits. These same limits do not exist in a Roth 401K.
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Old 05-06-2013, 11:49 PM   #12
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if you think future tax rate < present tax rate = TIRA

if you think future tax rate > present tax rate = RIRA

if you think future tax rate = present tax rate = TIRA/RIRA*

*Technically, you can save "more" if you max out your both Roth 401k and Roth IRA. This assumes you "invest the rest" if going T401k/TIRA in taxable accounts. The difference represents value eroded by taxes in a taxable account by divs and other taxable events. for some, this can be very little. for others (calling all dividend investors) it can be more substantial.
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