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Trad 401k or Roth 401k for High Earners
Old 12-23-2006, 11:32 PM   #1
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Trad 401k or Roth 401k for High Earners

HatePayingTaxes started a thread on Trad 401k vs. Roth 401k for a younger worker. Most of the articles I've seen about Roth 401ks tout the advantages for younger workers.

I have only found a few articles talking about the advantages of a Roth 401k for a high earner. Next year I am going to be receiving a very large bonus and even if I contribute the maximum allowed to my Trad 401k, I'll still have too high a modified AGI (i.e. >$160K) to contribute to my Contributory Roth IRA. So I am considering whether to switch to a Roth 401k next year.

Pros: I have the means to make the full contribution and shoulder the extra taxes easily. Doing this would increase the percentage of retirement assets held in non-taxable accounts -- I have most of my retirement moneys in tax-deferred accounts right now and I am concerned about being able to control required distributions down the line. I'm not in danger of being hit by any other tax phaseouts because I don't use the deductions affected by those (such as itemizing deductions).

Cons: I would have yet another retirement account to manage. Sure, they are all One Big Happy Portfolio but in reality each one adds a little to the overhead of managing them all. And it may be advantageous for me to switch back to a Trad 401k after this one special bonus year, leaving another 'small' retirement account in place in the process.

So.... anything else I should be considering in this decision? I love analysis, but hate the paralysis that I sometimes yet . . .
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Re: Trad 401k or Roth 401k for High Earners
Old 12-24-2006, 01:15 AM   #2
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Re: Trad 401k or Roth 401k for High Earners

The website for my 401(k) provider has a Roth versus Traditional calculator. I ran it using the following info and it shows the outcome as basically a wash:

Wages: High earner

Contribution: Maximum

Current marginal federal tax rate: 28%
Future marginal federal tax rate: 25%

Current marginal state tax rate: 10%
Future marginal state tax rate: 0% and 5%

Pre-retirement return: 12%
Post-retirement return: 6%

Retirement age: 55 and 60 and 65
Years in retirement: 40 and 35 and 30

The result surprised me but it gave me the push I needed to try the Roth this year. It still feels like I'm missing something.

I will lose a little more of my itemized deductions but that won't affect how much we save which includes fully funding our traditional IRA's.
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Re: Trad 401k or Roth 401k for High Earners
Old 12-24-2006, 09:02 AM   #3
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Re: Trad 401k or Roth 401k for High Earners

http://early-retirement.org/forums/i...?topic=11064.0
discusses a little bit taxes before and after retirement. It appears that for a high wage earner who lives well below their means that the tax savings now is a win.

The articles that I have read of a high wage earner benefiting from a Roth 401(k) sort of assume a high consumption lifestyle during retirement.

If you will live on 35% of your pre-retirement income, you will have significantly lower taxes in retirement.

Furthermore, as high wage earner and ueber-investor, you will have significant after-tax investments that you can use in retirement. Withdrawal from those investments will be taxed less as well because some of it will be return of principle and right now both capital gains tax rates and qualififed dividend tax rates are lower than your marginal income tax rate.

Finally, you can always convert some funds to a RothIRA in the future when your tax rate is lower.

I have seen no calculator that takes all the above into account. If you know of one, please point me to it.
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Re: Trad 401k or Roth 401k for High Earners
Old 12-30-2006, 08:42 PM   #4
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Re: Trad 401k or Roth 401k for High Earners

www.dinkytown.com has some calculators for this
My main thought is I rather pay taxes now and then have money tax free after I retire since it would be harder to make up any difference.
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Re: Trad 401k or Roth 401k for High Earners
Old 01-01-2007, 12:53 PM   #5
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Re: Trad 401k or Roth 401k for High Earners

The problem with the most of the calculators is that they use today's tax rates and today's tax brackets to do these calculations comparing pre- versus post- tax retirement account contributions. I've been paying taxes for 30 years now and tax rates & brackets have varied significantly over the years.

What I really need is a FireCalc-type of calculator which will run scenarios using different tax rates and tax brackets from the past 30 - 50 years

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Re: Trad 401k or Roth 401k for High Earners
Old 01-01-2007, 02:55 PM   #6
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Re: Trad 401k or Roth 401k for High Earners

Quote:
Originally Posted by LOL!
Furthermore, as high wage earner and ueber-investor, you will have significant after-tax investments that you can use in retirement. Withdrawal from those investments will be taxed less as well because some of it will be return of principle and right now both capital gains tax rates and qualififed dividend tax rates are lower than your marginal income tax rate.

Finally, you can always convert some funds to a RothIRA in the future when your tax rate is lower.
This is the strategy I am planning on using. I should also add that I don't have the option yet of a Roth 401k. I am saving money in an after tax account in addtion to the 401k and Roth. My first four years of retirement will be funded by I bonds, so my tax rate will probably be zero. I think this will be a good opportunity to roll over some of my 401k money each of the four years into a Roth account up to the 15% bracket. I'll use the after tax money to pay for the additional taxes.

That will allow me to take the tax deduction of the 401k while I'm in my high income years and convert to a Roth while my income is low.

Be sure and pay attention to the AMT. If you lose the contribution to your 401k, your AGI may trigger the AMT.

BTW, I appreciate your statement of creating yet another retirement account. I'm trying to keep everything as simple as possible and yet it still seems overwhelming to keep track of all the accounts and the different rules that apply to each one.

-helen
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Re: Trad 401k or Roth 401k for High Earners
Old 01-01-2007, 03:38 PM   #7
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Re: Trad 401k or Roth 401k for High Earners

My company does not offer a Roth401k yet, but I wish they did. My concern is that after years of saving, our balances have grown (which is certainly good), but at some point we will need to start drawing on them and incurring the taxes. I plan to do that before SS when our income will be lowest so the bite may not be that bad. But the distributions may get substantial, and future tax rates only have one direction to go.

I would like to have the option of a pool of funds that I could draw upon without any tax consequences. To me, this is another form of diversification. Once you ER, you could evaluate your situation each year, both cash flow and taxwise, and decide which accounts to draw from. The Roth also does not have an RMD, so you would not need to touch it ever if you choose, leaving it to your heirs.
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Re: Trad 401k or Roth 401k for High Earners
Old 01-01-2007, 08:24 PM   #8
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Re: Trad 401k or Roth 401k for High Earners

Quote:
Originally Posted by Linney
What I really need is a FireCalc-type of calculator which will run scenarios using different tax rates and tax brackets from the past 30 - 50 years
I want the FIRECalc that will run scenarios using the data from the next 50 years...
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