Help me decide 401-K vs. Roth 401-K

[wanaberetiree]

As the title says, I have an option right now to participate in my company 401-K plan.

There is no company match unfortunately.

So the question is to contribute $23K (I am older then 50 yo) into 401-K or Roth 401-K? or use some kind if split?

[pb4uski]

IMO it depends on the tax rate when you contribute compared to your tax rate when you withdraw the funds in retirement.

If you are currently in a high tax bracket and expect to be in a substantially lower tax bracket in retirement, then the 401k is preferable. If you expect your tax bracket in retirement to be the same or higher, then I think the Roth is preferable.

For me (and I suspect many people) the 401k is/was preferable.

Another thing to consider balance between your taxable funds, tax-deferred funds (like a 401k) and tax-free funds (like a Roth) especially if you plan to retire before you are 59 1/2.

[veremchuka]

Wish I'd had this option, they came about too late for me. Virtually everything is in tax deferred.

[wanaberetiree]

Quote:

Originally Posted by veremchuka Wish I'd had this option, they came about too late for me. Virtually everything is in tax deferred.

So if you had income ~$200k you would still consider the Roth option?

[Rothman]

Since Roth options became available that's my choice. The thought of tax free growth is just too exciting. Also no RMDs with Roth so it can make for a great transfer to next generation or better yet grandchildren who can take withdraws over their life expectancy and the fund can continue to grow many more years. If you can afford the max on after tax basis it's a great option in my opinion.

[karluk]

Quote:

Originally Posted by Rothman Also no RMDs with Roth so it can make for a great transfer to next generation

I believe it's incorrect to think that Roth 401ks are exempt from RMD requirements, the same way that Roth IRAs are exempt. It's certainly not the way my Roth 457 plan works, and my understanding is that 401k rules also require minimum withdrawals at age 70 1/2, even if the 401k money is in a Roth. A web seach also turns up a bunch of links to articles that state that Roth 401ks are subject to RMDs. See, for example, The Roth 401k Rules | eHow

Quote:

When you reach age 70 1/2, you must start taking distributions from your Roth 401k.

[karluk]

Although you should be able to get around the RMD requirements by rolling the Roth 401k into a Roth IRA before reaching age 70 1/2. Just be sure to be aware of the need to do this because of the different RMD rules.

[Willers]

I had the option to do either and chose the traditional IRA because I'm in a very high tax bracket now and expect to be in a very low one in retirement with proper management of cap gains before 59 1/2 and Roth conversions from then until RMD's start. I'd have to do the math, but I'd guess that if I was in the 15% bracket I'd choose the Roth.

[karluk]

Quote:

Originally Posted by wanaberetiree So the question is to contribute $23K (I am older then 50 yo) into 401-K or Roth 401-K? or use some kind if split?

During my working years, the best choice for me was generally to "use some kind of split". That's because our joint income put us into the 25% tax bracket, but not too far into the 25% bracket. These circumstances allowed us to get back into the 15% bracket by aggressively contributing to a traditional 457 plan. Once we got all of our income into the 15% bracket, all additional retirment contributions would go into either a Roth IRA or Roth 457. So we tended to have a mixture of both traditional and Roth, but with the lion's share in traditional.

Depending on your income, this kind of split might also work for you. As a general rule, the higher your income now compared to after you retire, the more money you should put into a traditional 401k. Of course rules of thumbs like this tend to have lots of exceptions, so you need to do a lot of tax planning to pick the best mixture, and then hope that tax laws don't change too drastically in the future and invalidate all of your planning.

[Sesq]

Quote:

Originally Posted by wanaberetiree So if you had income ~$200k you would still consider the Roth option?

I am in that situation, and I do the Roth.

I max my 401(k) and both mine and my wife's IRA (backdoor). By doing roth contributions I am able to fill the limitations with after tax dollars vs pre-tax dollars.

Also, my current last dollar tax rate is in the mid 30's. I suspect that either through means testing of other benefits, law changes, etc that my retirement tax rate will be at least mid twenties. So I am not looking at it as a 40% versus 10% analysis, my likely delta is perhaps a negative 5%.

Also, in my current state (PA) 401(k) and roth contributions are both after state taxes (withdrawals are roth-like and state tax free). I am here for a job though, and don't expect to retire here (or anywhere in particular).

I have prior pre-tax 401(k) contributions, and my match is by law pre-tax, so if I FIRE I will have some balances to "play" with making strategic conversions, etc in the event I have some low income years.

In my opinion, there is a chance that there could be a VAT, but if it happens I think it will be for increased benefits (healthcare), not reduced income taxes (in effect). To that end, I think roth's are more likely to be closed or limited (with grandfathering) than be pillaged.

I think expected rate differences are very important, but the ability to contribute more valuable after tax dollars is my key driver.

[Rothman]

Karluk was right to correct me, you do have to move Roth401k to Roth IRA, a no tax event to avoid the RMDs. This will be easy to remember when you look at all that tax free compounded growth!

[wanaberetiree]

Quote:

Originally Posted by Sesq I am in that situation, and I do the Roth. I max my 401(k) and both mine and my wife's IRA (backdoor). By doing roth contributions I am able to fill the limitations with after tax dollars vs pre-tax dollars.

Can you share your "backdoor" observations/experiences? Particularly I'm interested in how much do you covert. details and tax implication?

Thx

[Animorph]

Quote:

Originally Posted by wanaberetiree Can you share your "backdoor" observations/experiences? Particularly I'm interested in how much do you covert. details and tax implication? Thx

I've done a couple of backdoor Roth contributions now. It's just the normal IRA contribution amount, it's not a conversion. To make it work you can't have any other IRA assets in your name. That avoids tax costs. You make a normal tIRA contribution, nondeductible because the backdoor is for people who are above the normal Roth IRA contribution income limit and/or have a qualified retirement plan at work. After some amount of time you convert that tIRA account into a Roth account. All the normal Roth conversion rules apply. Because your contribution was nondeductible, no taxes are due on that amount. You will owe taxes on any gains while in the tIRA. I'm usually just in cash for that short time, so my gains were a few pennies that round to $0 in Turbo Tax. So the tax implications are pretty much like those for a normal Roth IRA contribution. There is just an intermediate tIRA step to get around the normal Roth contribution restrictions.

[wanaberetiree]

Quote:

Originally Posted by Animorph To make it work you can't have any other IRA assets in your name.

what does it mean? I do have a 401k and IRA account. So I can not have it?

[Animorph]

Quote:

Originally Posted by wanaberetiree what does it mean? I do have a 401k and IRA account. So I can not have it?

The 401k is not a problem.

The IRA rules make you pool all your tIRA accounts when Roth converting. So if you try to Roth convert the $5k non-deductible tIRA contribution and you have a $95k tIRA with all deductible contributions you're going to have to pay income taxes on 95% of the $5k. That's instead of paying taxes on 0% of the $5k if you didn't have the $95k tIRA. That kind of closes the backdoor. You're pretty much just doing a normal Roth conversion.

If you can rollover your tIRA into your 401k (allowed by some 401k plans) you can eliminate this problem.

[wanaberetiree]

Quote:

Originally Posted by Animorph The 401k is not a problem. The IRA rules make you pool all your tIRA accounts when Roth converting. So if you try to Roth convert the $5k non-deductible tIRA contribution and you have a $95k tIRA with all deductible contributions you're going to have to pay income taxes on 95% of the $5k. That's instead of paying taxes on 0% of the $5k if you didn't have the $95k tIRA. That kind of closes the backdoor. You're pretty much just doing a normal Roth conversion. If you can rollover your tIRA into your 401k (allowed by some 401k plans) you can eliminate this problem.

So if I have for example $100K in my IRA account and I want to add $10K after tax to my taxable IRA and then convert to Roth -> not a good scenario, tax liability

BUT

if I have for example $100K in my 410-K account and I want to add $10K after tax to my taxable IRA and then convert to Roth -> GOOD no taxes!

Did I get it right?

[pb4uski]

Yes. When you do the conversion you have to look at all your IRAs combined - if you have no other IRAs you have nothing to combine.

In your first scenario when you convert $10k you would have $9k of income ($10k conversion * ($100k tIRA/$110 total IRAs). In the second scenario you would have no income ($10k conversion * $0 tIRA/$10 total IRAs).

[Sesq]

Quote:

Originally Posted by wanaberetiree Can you share your "backdoor" observations/experiences? Particularly I'm interested in how much do you covert. details and tax implication? Thx

Sure. In the mid 2000's I funded some non-deductible IRA's for my wife and I. I shut it down pretty quick since I had a lot of "setting up house" expenses, so I focused on saving with the 401(k) for a while. I did it anticipation of the 100K income limit going away in 2010 (I am a tax guy). I also had a rollover IRA from my former employer.

In 2010 my wife and I had IRA's with a FMV of 80K, 6K of basis from the nondeductible contributions. I converted all 80K in 2010, and paid the taxes for it on my 2010 return (instead of electing to pay in 2011 and 2012). At the time I was worried about the bush rates expiring in 11/12, and about my income trajectory. I actually bumped my 2010 withholding a bit, then relied on withholding safe harbors so that I funded the tax due half in 2010 and half in 2011 (my annual bonus comes pre-4/15). Cash taxes on the 74K (80-6) was taxed at 34% via AMT. All Fed tax, no PA state tax due to their rules. So ballpark 25K, that I paid with cash on hand, not withdrawing any money and paying a penalty. In effect I viewed this as another form of contributing to my retirement. After the conversion I had the 80K of roth assets, plus prior roth assets of 55K. The market did well that year and by the end of the year my Roth IRA's were worth 153K. 2010 was also the year my employer offered Roth 401(k) contributions, so I put 16.5K in there too.

2011 I didn't backdoor since I was still gathering the cash to pay my conversion taxes, but I did contribute another 16.5 to my Roth 401(k).

2012 I didn't contribute during the year, but in early 2013 I funded 21K (5000 x2 + 5500 x2) to non-deductible IRA's. A week or so later I instructed Fidelity to convert the balances to my Roth accounts. I will have to record this in my 2013 tax return, but it will basically be a conversion of 21K, with basis of 21K. No taxes.

The key to the backdoor if you haven't read up on it is that you cannot have pre-tax IRA's if you want a tax free conversion. If I hadn't cleared my balances in 2010, I would have to allocate basis across the total IRA balance. A common work around is to roll the pre-tax money back to a 401(k) if your employer's plan will take it, or a solo 401(k).

After these conversions and Roth 401(k) contributions my wife and I are sitting on about $300K in our roth IRAs and my Roth 401(k). I have about 250K as pre-tax 401(k) contributions or matches, and in my net worth calc I estimate future taxes on that balance at 30% and assume I have about $75K in future taxes related to that balance. As I said previously, if I FIRE, I'll expect to be able to selectively convert portions of that at a lower rate.

EDIT - I see others have covered my points more succinctly. Its worth highlighting that when you look at IRA's to pool, remember the I is for Individual. If a husband has 40K in a pre-tax IRA and the wife has none, even if they file joint returns they can put 5,500 into her IRA, convert it, no tax, no need to spread the basis across the 40K in his IRA.

[woodguy00]

Quote:

Originally Posted by Willers I had the option to do either and chose the traditional IRA because I'm in a very high tax bracket now and expect to be in a very low one in retirement with proper management of cap gains before 59 1/2 and Roth conversions from then until RMD's start. I'd have to do the math, but I'd guess that if I was in the 15% bracket I'd choose the Roth.

+1

[wanaberetiree]

So here is my case.
I have ~$200K in VG pre-tax IRA account
My combine income this year will be ~$200K.

Plan:

- Open solo-401-K (where? at VG? Fido? Schwab?)
- move all my pre-tax IRA to solo-401-K
- contribute $6K to an after-tax new IRA account
- convert from the after-tax new IRA account to a Roth IRA
and tax liability will be 0.

Is it correct?

Thanks!!!