Question about ROTH and 401K contributions.

[watdaflo]

Background:
29 yrs with both 401k and ROTH IRA. I have been investing 10% of my salary in 401k and $5000 into ROTH for the past 4 years.

My understanding is to invest at least the agency match in 401k, then max my ROTH, then any remaining money should be added to 401k as long as my current salary is less than that I will receive in retirement. I am at a point where I believe my current annual income will be more than what I will receive in retirement.

If all this is in fact true, I am about to stop my ROTH contributions and concentrate solely on 401k. My ROTH is currently with Vanguard Target Retirement 2050. My question is, if I no longer make any contributions, should I keep my ROTH dollars in the Target Retirement 2050 or move it to something less risky? I was thinking something like Vaguard VASIX.

Thanks in Advance

 

[Packman]

It's not so much a question of current income versus future income, but it is the tax rate that is the issue. Conventional wisdom says that if the tax rate is higher in retirement than it is now, invest in a Roth. And most people believe it will be higher in the future.

I have a little different opinion, however. First, if you are planning ER - before 59.5, you may want to invest some funds in a taxable account as withdrawals are not penalized if done before 59.5. Though you may withdraw Roth principle without penalty. I also do not automatically buy into the fact that tax rates will be higher in retirement. With no pension and not taking SS until perhaps age 70, I will spend the first 15 years in retirement in (or near) the 15% tax bracket. The last 15 years of my career were in the 28%-33% tax brackets.

And what will happen if our congress can ever get together and change the tax code? What if we go to some kind of flat tax? What happens to all of the Roth accounts then? For those people that are 10-20+ years from retirement, it's hard to believe that our tax code would be much the same as today.

 

[timeasterday]

You might want to post a detailed breakdown of your investments over at the Bogleheads site. Regardless of your salary the general advice is to invest in the 401k up to the match, invest in an IRA or taxable depending on your feelings of future taxes, and then anything more should be put in the 401k until you hit the limit. I wouldn't necessarily stop the Roth, especially if you can get a lower expense ratio there, which is true for many people. My 401k averages a 1% expense ratio but in my Roth it is 0.07%.

 

[watdaflo]

My mistake on mentioning salary instead of tax bracket. Currently, my wife and I are in the 28% bracket. Although my company does offer a pension plan, I have done a rough estimate for my annual retirement income (assuming only 75% of my estimated SS in addition to my pension and estimated 401k value in retirement). My estimated retirement annual income only falls in the 25% bracket.

Maybe I am overthinking it and should just stick to my current contribution.

 

[Animorph]

In the 28% tax bracket it is very likely that you should be maxing out your 401k first. Your tax rate in retirement will probably be less, especially if you have no income for a few years prior to SS/pensions starting up. Then contribute any additional taxed savings or taxable account investments to the Roth. Always better in a Roth than in a taxable account. Taxable accounts get anything left over.

You will be able to use the taxable account money to convert the 401k/IRA money into a Roth during low income early retirement years, staying below the 15% or 25% bracket. Later on, you can use the 401k/IRA to fill in the 15% or 25% bracket and use the Roth to supply any additional income you need. Having all three types of accounts, taxable, 401k/IRA, and Roth, is useful.

 

[watdaflo]

In the 28% tax bracket it is very likely that you should be maxing out your 401k first. Your tax rate in retirement will probably be less, especially if you have no income for a few years prior to SS/pensions starting up. Then contribute any additional taxed savings or taxable account investments to the Roth. Always better in a Roth than in a taxable account. Taxable accounts get anything left over.

You will be able to use the taxable account money to convert the 401k/IRA money into a Roth during low income early retirement years, staying below the 15% or 25% bracket. Later on, you can use the 401k/IRA to fill in the 15% or 25% bracket and use the Roth to supply any additional income you need. Having all three types of accounts, taxable, 401k/IRA, and Roth, is useful.

If this is the case, would it be best to leave my Vanguard Target 2050 alone or move it into a less risky fund? Or maybe something else altogether?

 

[Animorph]

If this is the case, would it be best to leave my Vanguard Target 2050 alone or move it into a less risky fund? Or maybe something else altogether?

Making contributions should have no bearing on your asset allocation. The key is when are you going to use that money? The farther into the future that is, the more aggressively you can invest. The Roth and all other accounts should create one portfolio with a target asset allocation that you have selected.

I target 100% equities, so I'm happy with Target 2050 or higher. Some forum members have very little equities. Check out the allocations of the Target Retirement series to see some examples of "normal". There's actually a wide range of allocations between different companies retirement funds for the same date range, so there's no clear answer.

In my case, the portfolio allocations are duplicated in taxable and IRA/Roth accounts, with some tilt to have the heavy dividend payers in the IRA/Roth accounts and cash in taxable accounts. The duplication is because in 10 to 12 years my taxable accounts will be near zero as I Roth convert. The tilt is to avoid taxes on dividends, and have the cash where I can spend it. Keep in mind that it is not too hard to move things around if you need to, so you have a fairly wide latitude in where you place investments.

 

[EvrClrx311]

I've been in a similar situation the last 7 years... trying to decide which to go with. What I decided is that this is not black and white. Best to have multiple available options in the future. So I've been putting money into both.

Currently I have:
401K = 79.5%
401K-Roth = 14.5%
Roth-IRA = 6%

Though at the moment, I'm putting about 95% into 401K and just 5% into 401K-Roth. I've stopped contributing to Roth-IRA because my income is right on the edge of qualifying for it.

I do agree that most people are better off maxing the 401K... unless you are under the 25% tax bracket. Best to take the guaranteed 25-28% tax write-off now, particularly if you itemize, than whatever unknown advantage you'll have received from the ROTH down the road.

In today's dollars, you'd have to have a pretty large retirement account for the ROTH to have paid back more on the tail end. What is most likely to happen in my case, is that the ROTH portion becomes a nice inheritance for my kids... growing untouched into my 90s. That's 60 years of compounding. There for me if I live a lot longer than I expect and become a centenarian.

 

[LitGal]

You might want to post a detailed breakdown of your investments over at the Bogleheads site. Regardless of your salary the general advice is to invest in the 401k up to the match, invest in an IRA

+1 Eventhough I started the process late, as a part-time teacher who took time off over the years for family reasons, this basic approach worked very well. It helped to keep expense ratios very low. Also, in the last 12 years, I put into the 401K the maximum "catch-up" allowed by the IRS. (Last year I think it was $22,500.) Watching that contribution come out of my check each month was always encouraging, a reminder that one day I would have an exit, and could RE.

Good Luck!