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Roth 401k when not eligible for Roth IRA?
Old 06-08-2014, 08:10 AM   #1
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Roth 401k when not eligible for Roth IRA?

My company has a Roth 401k option. Previously, I've contributed to a Roth IRA but am no longer eligible. I will be solidly in the 28% bracket for the foreseeable future, and may possibly go higher in a few years.

I've always used my 401k as a way to lower my tax burden, but am wondering if I should start splitting my money so that some goes into the pre-tax 401k and some into the Roth 401k.

Does that make sense? Or is the conventional wisdom that Roth 401k only makes sense if you are positive your taxes will go up? Since we're all shooting for ER, should my income years even matter for computing tax burden - my SWR would be less than I bring home in income now, so my taxes in ER would be lower already.

Is the primary factor just banking on conversion into the Roth after ER?
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Old 06-08-2014, 08:16 AM   #2
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The historical advice is often that you should guess at your working tax rate and expected retirement tax rate, and use the Roth IRA/401K if you expect taxes to be higher in the future, and the traditional flavor if you expect them to be lower.

That said, there are other schools of thought. One is that a Roth is better in most cases because more money is invested *after taxes*. That is, $10K in a Roth requires $15K in a traditional IRA for the same amount of after-tax retirement savings in a combined 33% state and federal tax bracket.

Also, the ACA as currently designed is a potential game changer in that it has made managing MAGI a critical part of retirement planning for some. On one hand you can reduce MAGI *now* by contributing to a traditional IRA or 401K -- but that will come out in the future as taxable income that hits MAGI in retirement. On the other hand, with a Roth you don't reduce MAGI now (which is OK if you have Megacorp health insurance), but you can take out tax-free withdrawals that do *not* hit MAGI in retirement (when you may be buying your own health insurance).
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Old 06-08-2014, 08:29 AM   #3
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That all said, I preferred a combination of traditional and Roth retirement vehicles, primarily because it gives me increased flexibility to "engineer" certain levels of taxable income in retirement. That is, it can help keep MAGI down in some cases for ACA purposes, and it can allow one to take as much out of traditional IRAs and 401Ks as possible while remaining in a low tax bracket, and switching to Roth withdrawals when they are about to (for example) move from the 15% to 25% tax bracket.
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"Hey, for every ten dollars, that's another hour that I have to be in the work place. That's an hour of my life. And my life is a very finite thing. I have only 'x' number of hours left before I'm dead. So how do I want to use these hours of my life? Do I want to use them just spending it on more crap and more stuff, or do I want to start getting a handle on it and using my life more intelligently?" -- Joe Dominguez (1938 - 1997)

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Old 06-08-2014, 03:15 PM   #4
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What will your taxes be when you hit 70.5, with RMD's and SS benefits all online? If it looks like 28% or more, I'd go ahead and contribute to the Roth if you'd like.

I have a nice period of no income just after retirement, before 70.5. I'm doing Roth conversions, using taxable accounts to live on and pay the taxes. Some of that money is coming out at 15%, though much of it is at the 25% marginal rate. That's less than the 28% to 35%+ I would have paid before retiring. If you have something similar, it may be better for you to use the traditional 401k now and Roth convert later.

Also look at doing a backdoor Roth contribution. This works best if you don't have any traditional IRA accounts. Contribute to a traditional IRA. That contribution will be nondeductible since you have a 401k. A few days later (or later) you do a normal Roth conversion. Since the tIRA contribution was nondeductible, the tax basis is equal to your original contribution and you only pay taxes on the few days of growth, if any. So it's effectively a normal Roth IRA contribution.
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