Roth 401k and non-Roth 401k

[CSdot]

For the 1st 14 years of my employment at my former employer I contributed to a traditional 401k, then for the last 6 years of my employment at my former employer my employer added a Roth 401k option and I was one of the few who elected to contribute to a Roth 401k. My entire 401k portfolio from my former employer (both Roth and non-Roth) is currently 25% Roth 401k and 75% non-Roth 401k.

I left my former employer in early 2017 to go out on my own, and now I contribute to a SepIRA, which allows much more per year to be tax sheltered than my old 401k allowed. I never rolled the 401k from my former employer into an IRA. The investment options in the old plan meet my needs, so I am letting that $1M+ grow in place for now.

Here is my question: When I retire, should I begin by taking distributions from the taxable money or the tax free Roth money?

Asked another way, is it better to pay ordinary income tax on the 401k distributions and let the Roth moneys continue to grow tax free?

I imagine someone has played this out and knows the answer. Which one makes better sense mathematically?

Thanks.

[Dash man]

Well, by using your traditional IRA, you’ll be reducing the taxable Required Minimum Distributions later when you turn 72, or whatever they may change it to. That is a forced withdrawal that can throw you into higher tax brackets at the same time you’re taking social security.
However, if you’re managing your income for ACA subsidies, you may want to only have taxable income up to the ACA cliff, then use your Roth.
Without more information, it’s hard to help any more.

[CSdot]

I am 51 now so I still have 8.5 years before I can tap either source. My hope is to understand the pros and cons of each so I can think through the process. These are retirement accounts from a former employer. Presently $250K in Roth 401k, and $800K in traditional 401k.

Since I left that employer I have been fully funding a SepIRA, so will have other tax deferred amounts to go with the Tradition 401k to worry about when RMD occurs in 21 years at 72.

[Dash man]

You may want to consider contributing as much to your Roth as you can, since you have a substantial amount in your traditional 401k.
We are both currently 64 and we find ourselves with a significant sum that we are trying to convert into Roth accounts. We don’t have concerns of ACA subsidies like many in this forum do. But I wish I had started contributing exclusively to a Roth when I had the opportunity.
There are many on this forum that may chime in tomorrow that are in food comas tonight.

[Out-to-Lunch]

To first order, it really comes down to your marginal tax rate. Try to estimate your marginal tax rate now, after you retire but before RMDs, and after RMDs. A rough rule of thumb is to try to equalize your taxable income (or stay in the same marginal tax bracket) during those times.

[CSdot]

Quote:

Originally Posted by Out-to-Lunch To first order, it really comes down to your marginal tax rate. Try to estimate your marginal tax rate now, after you retire but before RMDs, and after RMDs. A rough rule of thumb is to try to equalize your taxable income (or stay in the same marginal tax bracket) during those times.

My marginal tax rate in 2020 is at the highest it will be. Hence, the reason I am no longer with my former employer (left in early 2017 so I could increase my income). I do not know what it will be as I close in on 59.5, or in retirement.

[Out-to-Lunch]

Quote:

Originally Posted by CSdot My marginal tax rate in 2020 is at the highest it will be. Hence, the reason I am no longer with my former employer (left in early 2017 so I could increase my income). I do not know what it will be as I close in on 59.5, or in retirement.

Offhand, then, I would say it makes little sense to be contributing to a Roth at this time. You would do better to contribute to a tax-deferred account.

Roths are primarily a tax-rate arbitrage play. Contribute to tax-deferred when your marginal rate is high, and contribute to a Roth when it is low. Withdraw (or convert) from tax-deferred when your marginal rate is low, and withdraw from a Roth when your marginal rate is high.

[Sunset]

As a self employed, you should be able to have both a self-401K IRA and a self-401K Roth.
Perhaps the SepIRA has the option to add on the Roth portion ?

I agree, while you are in high tax rates, contribute to the IRA, but should you have a bad yr, contribute to the ROTH side.

Note: I believe you can contribute to both your self employed IRA/ROTH to the self employed max. Then contribute a further ~$7K to the personal IRA/ROTH everyone can have (with earnings).

[gauss]

If you have not tried out the I-Orp tool yet, you may want to. It is an optimizer that is designed to maximize your lifetime amount available to spend.

When I played around with it in the past, it gave an optimal (with respect to their assumptions) year by year retirement account drawdown schedule.

-gauss

[ckelly78z]

Since my employer offered a Roth 401K option a few years ago, I have been 50/50 with 15% of my deductions going into each fund (30% total). I still have about $300K more in my standard non Roth account. I have been curious about this strategy also since I am 55, and closing in on the finish line.

[Niuatoputapu]

CSDot (OP) - if you model your income and expenditures for your remaining life including assumptions about future income tax rates (Federal and State), Medicare premiums, and possible ACA subsidies, for the Roth versus non-Roth contribution scenarios of today, you can get a feel about it. Generally, unless your marginal income tax rates are significantly different in retirement, both scenarios have similar outcomes, though the non-Roth does better if your assumed future tax rates are lower. BUT, if you are married, and you calculate the impact on a surviving spouse who does not re-marry, the Roth contributions are usually the winner. So the answer is valid to the extent you can "what if" future tax rates, Medicare premium rates, and longevity of you and your spouse.

[pb4uski]

Quote:

Originally Posted by ckelly78z Since my employer offered a Roth 401K option a few years ago, I have been 50/50 with 15% of my deductions going into each fund (30% total). I still have about $300K more in my standard non Roth account. I have been curious about this strategy also since I am 55, and closing in on the finish line.

See posts #5 and #7.
It is just tax arbitrage... save more now to hopefully pay less later.

[CSdot]

Quote:

Originally Posted by Sunset As a self employed, you should be able to have both a self-401K IRA and a self-401K Roth. Perhaps the SepIRA has the option to add on the Roth portion ? I agree, while you are in high tax rates, contribute to the IRA, but should you have a bad yr, contribute to the ROTH side. Note: I believe you can contribute to both your self employed IRA/ROTH to the self employed max. Then contribute a further ~$7K to the personal IRA/ROTH everyone can have (with earnings).

I just finished researching this with my CPA and banker, and the finding was I would be ineligible for deductible IRA and Roth due to income & SepIRA.

If I converted the SepIRA to a Solo 401k I could take advantage of the $6,500 “over 50” catch up allowance, but after doing all the research I decided all of the added head ache (set up fees, administrative and management fees with my bank, and the inability to hire additional employees), putting $57,000 into the SepIRA verses $63,500 ($57,000 + $6,500 catch up) is the better fit for my K.I.S.S. way of doing things.

According to my research, the Solo 401(k) allows the additional $6,500 catch up contribution because the Solo 401(k) is a combination of the traditional $19,500 employee contribution, PLUS the employer match not to exceed $37,500 (because the cap for both is $57,000 in 2020). That employee contribution part in the KEY.

The SepIRA is funded 100% by the Employer, so there in NO Employee contribution component, meaning the employee is not afforded the same right to contribute the additional $6,500 catch up amount.

The downsides on the Solo 401(k) are: (A) the business can only have ONE employee (though there is an exception for a spouse), while the SepIRA employer can have 25 employees. Meaning I will need to convert again if I decide to hire a full time employee; (B) there is a fast approaching deadline; and (C) there are ongoing costs and administrative fees.

The positives of the Solo 401(k) are (A) the ability to contribute the additional $6,500 catch up; and (B) the option can elect Roth Solo 401(k) treatment, which could be good if I decide to semi-retire and have low tax years.

Ultimately it seems to come down to whether the additional $6,500 is worth the ongoing costs, administrative fees, and the need to convert if I ever decide to hire a full time employee.