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Roth 401k, or not?
Old 02-28-2011, 04:55 AM   #1
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Roth 401k, or not?

I am a 33 year old single male with no dependents that currently makes about $100k a year. I have full benefits, including a matching 401k up to 6%. Recently, my employer introduced a 401k that included a ROTH 401K option. As a point of reference, I have $115k in a “traditional” 401k. I contribute 12% of my salary every other week towards this fund.

What I am trying to determine is if I should take advantage of this ROTH 401K option? I do have a separate ROTH IRA, which I contribute the maximum allowed amount to each year.

The issue I have run into is tax deductions. I have mortgage interest and property taxes that I can deduct that amount to something. Unfortunately, that’s about the extent of it outside of donations to charity, etc.
I realize I get the benefit of using after tax dollars NOW to fun the ROTH 401K option with the idea that when I retire, my tax bracket will be higher and I won’t then have to pay the tax on the funds I take out since I paid the tax on them now. In exchange for this, I don’t then get to deduct them on my taxes NOW like I do with the “traditional 401K” offering.

I’m trying to decide if I should contribute the full 12% to the ROTH 401K, if I should split it and put 6% there and the balance into the “traditional 401K” offering, or if I should continue to keep 12% in the “traditional 401K” offering.

What are your thoughts?

Thanks!
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Old 02-28-2011, 05:44 AM   #2
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Hello - you may find this thread helpful :

Roth v. Traditional
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Old 02-28-2011, 12:10 PM   #3
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It depends on your tax levels now and during your 401k withdrawals, with the Roth having a slight edge if taxes are equal in and out. Quite likely it will be better to use the traditional 401k now and then convert to Roth after you retire, before SS and RMD's kick in, and fill up the lower tax brackets.

If you are currently saving some funds in a taxable account and don't mind tying them up in a Roth, then you might put that extra cash into the Roth. It will be better than a taxable account, and you can withdraw contributions (but not growth) any time.

It you were maxing out the 401k, the Roth holds more after-tax value than the regular 401k. You owe some of your 401k to the IRS, the Roth is all yours, but the same contribution limits apply to both. So you get more from your contribution with a Roth.

Whether by conversion or contribution it'll probably be good to have some balance between the regular and Roth accounts just for diversity's sake. One good retirement strategy is to fill your nearest lower tax bracket with 401k/IRA income and then take the rest of your expenses from the Roth. That'll minimize your total taxes.
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Old 02-28-2011, 10:17 PM   #4
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i'm in a similar situation and age (5 years younger) and i max out the roth 401k.

as animorph says, you get more after tax value with a roth. of course, if you invest the difference anyway, the result is the same (assuming the same return and tax rate). it may make our nest egg look smaller than it is (as we don't have to pay taxes on it under the current rules).

things i like about the roth...forces me to "save more" (investing the difference). i personally think tax rates will increase over the next 15-20 years. things that worry about the roth...the gubmint's word is about as good as a frat boy promise on friday night.
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Old 02-28-2011, 11:55 PM   #5
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Originally Posted by startingover View Post
I’m trying to decide if I should contribute the full 12% to the ROTH 401K, if I should split it and put 6% there and the balance into the “traditional 401K” offering, or if I should continue to keep 12% in the “traditional 401K” offering.
If you are set on contributing 12% and always 12%, you should do full 12% to Roth. That way you will have a smaller take-home pay, which automatically limits your spending power. If you adjust your lifestyle accordingly and don't notice any difference, you just fooled yourself into saving more. You can achieve the same by contributing 18% to traditional but that'll be too obvious.

A true comparison would hold your take-home pay constant. Something like:
* 12% to traditional, 0% to Roth; OR
* 6% to traditional, 4% to Roth; OR
* 0% to traditional, 8% to Roth
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Old 02-28-2011, 11:59 PM   #6
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Originally Posted by ronocnikral View Post
i'm in a similar situation and age (5 years younger) and i max out the roth 401k.

as animorph says, you get more after tax value with a roth. of course, if you invest the difference anyway, the result is the same (assuming the same return and tax rate). it may make our nest egg look smaller than it is (as we don't have to pay taxes on it under the current rules).

things i like about the roth...forces me to "save more" (investing the difference). i personally think tax rates will increase over the next 15-20 years. things that worry about the roth...the gubmint's word is about as good as a frat boy promise on friday night.
not so, let me demonstrate. i will use and hold constant a figure of 8% for the return and 25% as the tax rate. i am also going to use as the 401k max contribution per year the figure $15,000. (note, i have been retired for 7 years so i dont know the exact number so i just picked a number but this isnt a problem mathematicly because it is the ratio between how much after tax money is left at the end of the timeframe between the 2 methods that is important and that isnt affected by the max 401k contribution number.)

to make this demonstration i will assume 2 different people with the same returns (8%) and same tax bracket (25%). both people have $20,000 before taxes to invest in year 1. for simplicity, both people only have wage income in year 1 (they both retire at the end of year 1). the difference is that person A chooses to put money in a 401K and person B chooses to put money in a roth 401k.

person A, at the end of year 1: $15,000 in 401k and after paying taxes on the $5,000 left has $3,750 to invest outside the 401k.
fast forward 10 years and A's 401k has grown to $32,383.87 which after paying taxes becomes $24,287.91. and outside the 401k the $3,750 has grown to $6,715.68 after taxes. A's total is $31,003.59

person B, at the end of year 1: after paying taxes on the $20,000 puts $15,000 in a roth 401k.
fast forward 10 years and B's roth 401k has grown to $32,383.87 all of which is after tax, so B's total is $32,383.87

so investing in the roth 401k results in a larger amount with the same returns and tax brackets.
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Old 03-01-2011, 08:40 AM   #7
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jdw_fire, you may be correct. i did this analysis a couple years ago when my company first offered the roth 401k. another co-w*rker and I came up that it was the same, but I don't have the analysis we did. i'll post it here if i can find it.

thanks for sharing.
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Old 03-01-2011, 09:54 AM   #8
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In a similar situation, a few things made me choose the traditional 401k

1. I don't believe Social Security or Medicare taxes are paid on 401k distributions. Hopefully that won't change.

2. I expect to retire with a household income less than half of my current income. 50% of that is earmarked for health insurance payments and expenses. With a retirement income at 25% of my working income, I won't be paying many taxes. Taxing me excessively will mean taxing the poor.

3. In a low income period (say semi-retirement at a part time job, where I'm working for health insurance only), I can roll some of the money from an IRA to a Roth IRA at a low tax rate.

Of course, if I'm wrong and retire with an income substantially higher than I expect, I'll have the money to pay the taxes.
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Old 03-01-2011, 11:38 AM   #9
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1. I don't believe Social Security or Medicare taxes are paid on 401k distributions. Hopefully that won't change.
i've found it incredibly difficult to wiggle out of SS tax.
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Old 03-01-2011, 12:43 PM   #10
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I certainly have not tried taking money out of any retirement accounts at this point.

Traditional IRA distributions are taxed as regular income. Is medicare tax and soc sec tax owed also? - Yahoo! Answers

This thread suggests medicare and social security taxes are paid prior to the contribution to a 401k or IRA?

In either case, the 401k is a clear win for me over the roth 401k, primarily due to low expected taxable income in retirement. With the house paid off, I expect non-medical expenses for my wife and I to be around 25k a year.
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Old 03-01-2011, 01:27 PM   #11
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I'm 32 and I switched to roth 401k for about a year now. Based on pimpmyretirement comment, I might switch over to traditional 401k. I expect to live off of 30% of our current income at retirement so I can do a conversion then. I do agree that tax rates will be higher but not so much for lower income folks.

Mentally, it is a good feeling knowing that whatever is in your roth is ALL yours.
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Old 03-01-2011, 09:18 PM   #12
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You are paying SS and Medicare on gross income, including whatever you put in your 401k. No help there.
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Old 03-02-2011, 12:22 AM   #13
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As young as you are, and as well paid, I expect you will spend some (many?) years in a higher tax bracket than you are now. Whether you will retire in a higher bracket will depend on tax law changes and portfolio performance. If you were older, I would suggest Traditional 401k and plan to convert after you ER, but as young as you are, I would suggest paying the tax now and getting the money safely into a Roth. This is more qualitative suggestion than quantitative, since I think any calculation of quantities depends too much on unknowable assumptions.
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Old 03-02-2011, 12:15 PM   #14
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As young as you are, and as well paid, I expect you will spend some (many?) years in a higher tax bracket than you are now. Whether you will retire in a higher bracket will depend on tax law changes and portfolio performance. If you were older, I would suggest Traditional 401k and plan to convert after you ER, but as young as you are, I would suggest paying the tax now and getting the money safely into a Roth. This is more qualitative suggestion than quantitative, since I think any calculation of quantities depends too much on unknowable assumptions.
I see it the same. Get long tax increases, as they will come.

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Old 03-02-2011, 02:41 PM   #15
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Roth 401k pros:
- RMD limits are not applicable and ability to withdraw principle without penalty (as of today)
- Tax diversification (can decide how much to withdraw from roth vs taxable space each year)
- When maxing out contributions (perhaps not your case), you get to save more money in tax-advantaged account in Roth vs traditional (because you spend more money to contribute same amount as was alluded to in earlier posts).

Traditional 401k pros:
- If you later move to another country, it's not clear whether your Roth withdrawals will be taxed by it
- It could be possible for future tax laws to effectively tax Roth money

Main distinguishing factor however remains whether you pay more taxes now or later. In determining this, you have to check your *marginal* tax rates, including state and local taxes, if any; and if you are paying AMT, don't forget to multiply 26/28% by factor of 1.25 to get the real marginal rate.

Also note that while historically we live in low tax rate environment, based on some data I found a while ago, this applies more so to higher tax brackets and not to lower ones. So chances are good that if you plan to live on relatively small taxable income in retirement, your taxes will NOT be much higher than what lower-bracket folks are paying today.
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Old 03-02-2011, 05:51 PM   #16
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Roth 401k pros:
- RMD limits are not applicable and ability to withdraw principle without penalty (as of today)
- Tax diversification (can decide how much to withdraw from roth vs taxable space each year)
- When maxing out contributions (perhaps not your case), you get to save more money in tax-advantaged account in Roth vs traditional (because you spend more money to contribute same amount as was alluded to in earlier posts).

Traditional 401k pros:
- If you later move to another country, it's not clear whether your Roth withdrawals will be taxed by it
- It could be possible for future tax laws to effectively tax Roth money
or, if the fair tax passes, traditional 401ks would no longer be taxed
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Old 05-08-2011, 04:27 PM   #17
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I'm in a similar position as startingover.

I'm 32, currently make about $90K pre-tax.
I currently max out my 401k ($16500 - there is no match).

My company got acquired and we're moving from one 401k plan to another new one. I have the option of moving the 401k funds to the new 401k account (I have roughly $31k in the 401k account), or I could move it to a roth IRA.
What would you recommend I do?

Short summary my retirement accounts:
401k account #1: $60k with Fidelity (401k from my past employer)
401k account #2: $31k (401k with my current employer - this one is being moved. I have the option of moving it to a 401k or a roth)
Roth IRA: 50K

Should I move 401k account #2 to the Roth (and pay taxes now), or move it to Fidelity (where 401k account #1 already resides)? I don't intend to take the money out - my goal is LONG term growth (and of course, paying as little tax as I can as long as I follow the laws)

After the acquisition, I still plan on maxing out my 401k (no matching) every year.


My Questions:
1. If I move my 401K to a Roth now, will I owe the IRS in penalties? (Of course if that's true, then it makes NO sense to move my 401k to a Roth)

2. Can I expect to be in a low expected taxable income in retirement? Is the 401K taxes based on your taxable income at retirement? Or is it taxed based on your taxable income during an average of N years prior to retirement (to offset people that 'cheat' by intentionally working part time 1 year prior to retiring)

3. What do you think would be a better option for me?
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Old 05-08-2011, 05:37 PM   #18
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It really depends on the detail of your situation today and in the future along with the tax laws and your tax bracket over the next 30 years and after retirement.


Do you think you are at the top of your earnings game? Will it mainly be cost of living increases and bonuses from here on... or do you plan to move up the corporate ladder?

There are a lot of variables.

You can do some projections to try to determine what the situation may be using your best guess. But that is all it will be.

If you are completely unsure, splitting between the trad and roth might be a reasonable approach. You can always review your situation each year and make adjustments if things change.
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Old 05-08-2011, 07:34 PM   #19
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thefinancebuff (who responded earlier in the thread) has a nice calculator on his website.

I think basically a Roth 401(k) is only for two types of workers:
(a) someone who doesn't pay income taxes anyways, or
(b) someone in the top bracket who will continue to work until they die.

Almost everybody else should use a regular 401(k) and not a Roth 401(k).

Here's a link to start further reading and find the calculator: http://thefinancebuff.com/roth-401k-...ibute-max.html
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Old 05-08-2011, 09:55 PM   #20
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thefinancebuff (who responded earlier in the thread) has a nice calculator on his website.

I think basically a Roth 401(k) is only for two types of workers:
(a) someone who doesn't pay income taxes anyways, or
(b) someone in the top bracket who will continue to work until they die.

Almost everybody else should use a regular 401(k) and not a Roth 401(k).

Here's a link to start further reading and find the calculator: Roth 401(k) for People Who Contribute the Max - The Finance Buff

@LOL: Thanks but I believe you misunderstood my question slightly. I'm not looking to contribute to a Roth 401k, just a regular Roth - this is a transfer from a 401k to a regular roth. My question is, which one is better, 401k or a roth?
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