75% salary to Roth 401k - is this a good idea?

[Zona]

We are planning our exit from the workforce...I have already taken a “sabbatical” (I don’t call myself retired yet because DH is still w*rking). DH had planned to retire in 2020, but then...pandemic. Since our main reason to FIRE is to be able to travel for long periods of time, and all the lockdowns make travel less feasible, it made sense for him to wait to pull the plug. Our dilemma as early retirees is that we have plenty — too much — in pre-tax accounts. Only 1/4 of our investments are in after tax brokerage accounts, and maybe another 10% are in Roth IRAs. I’m 45 and DH is 49 so we have almost 10 years before easy access to our IRAs. Thanks to the pandemic drastically reducing our spending, we have the equivalent of 1+ years of expenses currently sitting in cash. Sometime in 2021 DH will retire, but we’re wondering if it makes sense to max out his 2021 401k contribution to a Roth 401k, withholding 75% of each check. Plus he is 50 this year, so I think he can do the “catch up” amount too? We were already planning to do Roth IRA conversions once we no longer have w2 income. Is it a good idea to do the 75% contributions to a Roth 401k for the months in 2021 before he retires? I am thinking of it as money we won’t have to convert later, at possible higher tax rates, but would love to hear others’ thoughts. I’m sure there are many points I have not yet considered! Thanks!

 

[Ready]

I would definitely max out the contribution but I would think while you are still working you would be better contributing to a 401K rather than a Roth. Your tax bracket should go down once you retire so you can do Roth conversions after you stop generating income.

 

[Sunset]

I did 90% at one job, it was short, so I wanted to max the 401K as I wouldn't be able to contribute at the new job.

Remember you can also contribute to separate roth ira for each of you to the max (~6K each) this year.

Better to put the money in a Roth than a taxable account.

 

[pb4uski]

I think you have a way more important thing to do.... I'm hoping that you've already done it but it isn't evident from your OP.

Where is the money that you will live on between retiring at 50 and having penalty free access when he turns 59 1/2 going to come from? You didn't disclose what your WR is, but at 4% the 25% in taxable accounts will be gone in 6-7 years... then you can tap into Roth contributions and 5 year old Roth conversions so perhaps it will all work out... but have you thought it through?

I guess the Roth is a fine way to go... if and when you need it you can withdraw contributions penalty-free if you need it for spending... the same as if you didn't contribute and it was in your taxable account... but in the meantime it is growing tax-free.

 

[bada bing]

Sometime in 2021 DH will retire, but we’re wondering if it makes sense to max out his 2021 401k contribution to a Roth 401k, withholding 75% of each check.

The mathematically correct choice between traditional and Roth likely depends on how much of the year you will work and what taxable income for 2021 will be. If it's only a small portion of the year worked and low taxable income, likely Roth contributions are optimum. If you will work most/all of 2021, then traditional probably is best. It is all about the tax rate arbitrage between the year you put it in and the year you take it out.

A potential additional factor, as mentioned above, is if withdrawing Roth contributions early is part of your withdrawal strategy.

 

[Zona]

Thanks everyone for your replies, you guys always point out things that I had not considered.

Pb4uski, thanks -- I should have posted our planned WR. As our investments and savings currently stand, a 3% WR in retirement will more than cover our current/projected expenses (including taxes and healthcare). For the ten years until DH turns 59.5, we have more than enough in our taxable accounts and online savings (the total dollars divided by our annual expense budget comes out to a little less than 12 years). So we should not need to withdraw contributions or previous conversions from our Roths to bridge the gap, although we could if we needed to. (Roth contribs + conversions add up to about another years' spending).

Bada Bing, that is the tough part of the equation. DH is ready to pull the plug as soon as we are both vaccinated and the world is "normal" enough for us to travel and enjoy it (dining, museums, festivals). So he may be working only part of 2021, or he may be working most of it...if he works the full year his salary puts us in the low-ish end of the 22% tax bracket. So for a partial year we may end up in the 12% bracket.

I guess the thought of putting away $26,000 into a Roth 401k while still working is what is so tempting. Otherwise we will have to wait until tax year 2022 and beyond to really begin converting our pre-tax accounts to Roth. It would be nice to get a jump on it this year.

 

[cathy63]

It sounds like you have about 48 yrs expenses in total savings then? Given that, I think it makes sense to go direct to the Roth 401k this year, even if some of it is taxed at 22%.

If you have 3/4ths of your savings in tax-deferred accounts, then you'll be dealing with large RMDs as you're collecting SS, plus whatever tax law changes come down the pike before you get to that point. I bet you'll be in the 22% or higher bracket then too.

What are your plans for health insurance for the next 20 years? If you're going to rely on ACA, will you be trying to keep your income low enough to get a subsidy? If so, that will keep you from doing large Roth conversions.

 

[Zona]

It sounds like you have about 48 yrs expenses in total savings then?

Thanks Cathy, I should have opened Quicken before writing the OP. I estimated the percentages of our savings in the OP and should have gone for more precision in the percentages I gave. Here is the breakdown:
Online Savings: 6.8% a little more than 2 years expenses
Taxable: 30% 10 years expenses
Roth: 11% 4 years expenses
Pre-tax IRAs: 52.2% 17 years

So we only have about 33 years expenses in our accounts, not 48 years (I wish!). It is the large RMDs later in life when SS kicks in that we are trying to avoid. Once we are at 59.5 we will primarily draw our living expenses from pre-tax, but will hopefully have a large Roth bucket to allow us to manage taxes efficiently. (I'm still a newbie as far as tax strategies go, trying to learn as much as I can on this board!).

What are your plans for health insurance for the next 20 years? If you're going to rely on ACA, will you be trying to keep your income low enough to get a subsidy? If so, that will keep you from doing large Roth conversions.

We aren't on the ACA currently, we have a pre-ACA grandfathered BCBS plan that we pay out of pocket for and all our doctors accept. So we won't need to manage income for subsidies for now, but that is something to think about and yet another reason to target getting as much into the Roths as early as possible. I think we will go ahead and set his Roth 401k contributions to 75% of salary until he maxes out. I am *hopeful* that he will only work a partial year and that we will end up in the 12% tax bracket.

 

[Big_Hitter]

I would definitely max out the contribution but I would think while you are still working you would be better contributing to a 401K rather than a Roth. Your tax bracket should go down once you retire so you can do Roth conversions after you stop generating income.

I need to look into this roth conversion thing now that my wages are zero.

 

[Big_Hitter]

I guess the Roth is a fine way to go... if and when you need it you can withdraw contributions penalty-free if you need it for spending... the same as if you didn't contribute and it was in your taxable account... but in the meantime it is growing tax-free.

I have an old thrift that was post-tax deferral but zero roth. I'll talk to my FA/CPA about it during tax time.

those after-tax savings plans were great, many employers stopped sponsoring them due to the testing issues. When I was at my first mega, I used to defer into the thrift (still matched) after I hit the 402g limit in the 401k plan.

 

[pb4uski]

I need to look into this roth conversion thing now that my wages are zero.

Yup. That's the idea... get those low tax cost Roth conversions while the getting is good... typically after ER and before pensions and SS start.