Traditional or Roth 401k for my 27 year old?

[SevenUp]

Quote:

Originally Posted by SevenUp If she could put $20,250 into a traditional 401k, that would eliminate her federal tax liability due to the saver's credit, but that would still be only a 15-16% marginal tax saving rate. Thus, chalk up another vote in the Roth column. Getting beyond trad vs. Roth, Investment Order and Prioritizing investments are a couple of articles that suggest pretty much the same things, just said somewhat differently. You could suggest those to her.

Quote:

Originally Posted by pb4uski Neither unless her employer 401k offers a match and then a Roth 401k only to the match. IMO a Roth in her name at a broker would be better. She can contribute up to $6,500 in 2023, 15% of her gross income. She'll have more control and not have to do a rollover from the employer Roth to an individual Roth if she later changes employers which is a hassle that my kids are going through. And while the retirement savers tax credit is a good idea, I think her income is too high for her to qualify.

The "investment order"/"prioritizing investments" posts also suggest the order of "401k match>IRA>more 401k" but that is separate from the trad vs. Roth choice.

She would qualify for the saver's credit if she makes large enough traditional contributions, but at most that moves the dial on her marginal tax rate by 3-4%.

[pb4uski]

How much would she want to save?

Given the 10% early withdrawal penalty would lock up that money for 30 years, I'm struggling to see it make sense to do high tax-deferred savings just to get the retirement savers tax credit... the 10% credit would be equal to the 10% penalty. At least with the Roth she could withdraw contributions if she later needs the money for a house down payment.

[SevenUp]

Quote:

Originally Posted by pb4uski I'm struggling to see it make sense to do high tax-deferred savings just to get the retirement savers tax credit

I think everyone is in agreement on this point.

[gwill1010]

Quote:

Originally Posted by pb4uski How much would she want to save? Given the 10% early withdrawal penalty would lock up that money for 30 years, I'm struggling to see it make sense to do high tax-deferred savings just to get the retirement savers tax credit... the 10% credit would be equal to the 10% penalty. At least with the Roth she could withdraw contributions if she later needs the money for a house down payment.

With respect.. Put it in your 401k with the mindset and intentions to never, ever touch it until you retire. About 40 years for me, it pays off.

[ncbill]

Quote:

Originally Posted by disneysteve Our daughter becomes eligible for her company's 401k next month. How do I advise her if she should go with the traditional or Roth options, or some combo of both. She already has a Roth IRA that she has been maxing the past few years if that matters. She is single and earns about 42K currently.

~25% to Roth is what my roughly-the-same-age kid does.

[Kings over Queens]

Quote:

Originally Posted by rmorris50 Is she also eligible for an HSA with her health insurance? She should max that out. Ideally also pay her health expenses (which are hopefully low given how young she is?) out of pocket and save the receipts for later for when she may need access to the HSA money.

Such good advice, and not only because I agree with it. It just makes sense.

I made my 22 y/o daughter take the HSA option and fully fund her account. Just learned she's been paying small medical bills from it.

We're having a review via zoom tomorrow. She'll get the daddy voice.

"Pay those bills out of pocket!" I will say, with love.

[Kings over Queens]

Another vote here for the Roth.

[SevenUp]

Quote:

Originally Posted by Kings over Queens Such good advice, and not only because I agree with it. It just makes sense. I made my 22 y/o daughter take the HSA option and fully fund her account. Just learned she's been paying small medical bills from it. We're having a review via zoom tomorrow. She'll get the daddy voice. "Pay those bills out of pocket!" I will say, with love.

Before saying that, check to see if she is contributing the maximum to all other tax-advantaged accounts, and review the considerations in How to use the plan.

[Kings over Queens]

That's a really good article, and something I didn't consider.

She's 22, makes 65k, and living on her own...well, co-habituating with her boyfriend.

She's deferring 9% into her roth 401k and funding her own roth IRA as well, plus fully funding the HSA. There are no traditional ira or 401k deferrals.

The article you posted mentions a 25% tax bracket, she's no where near that. Besides, I'd rather the dollar she saves today grow tax free and be available in 30 or 40 years, or sooner, the point being is she has time for the seed to grow. It seem counter intuitive to defer money into the HSA and then pull it out right away to pay a small bill that she can afford to pay out of pocket.

"Don't let perfection become the enemy of good" comes to mind.

I'm open to thoughts.

[pb4uski]

If her gross pay is $65k and she is single, then it seems likely that she is well into the 22% tax bracket (which would be 25% if rates revert) so I would consider having some of her retirement savings be tax-deductible, like a traditional IRA. Perhaps enough to get her down to the top of the 12% tax bracket.

It looks to me like if she changed ~$6k of retirement savings from Roth to traditional that her tax bill would be $1,320 lower, plus any state income tax benefits.

You can play around with https://www.irscalculators.com/tax-calculator to get an idea of the savings.

[athena53]

Quote:

Originally Posted by Kings over Queens The article you posted mentions a 25% tax bracket, she's no where near that. Besides, I'd rather the dollar she saves today grow tax free and be available in 30 or 40 years, or sooner, the point being is she has time for the seed to grow.

First of all, I agree with the Roth option. I wish I'd had it in my early working years.

She should, however, do her more aggressive investing in after-tax accounts and maybe keep money-market and fixed-income investments in the tax0deferred accounts. .

Now, at age 70, I question the conventional "stash as much as you can in tax-deferred" advice. IIRC, the match applied only to the employer 401(k) contributions but she may want to re-consider opening a traditional IRA outside of the employer plan even if she's within the income limits where it's allowed. I wish I'd thought about the consequences of investing in equities likely to generate dividends and LT gains in an IRA. They're all taxed as ordinary income, of course, when you withdraw them.

So.. I'm in the somewhat enviable position of sitting on about $1 million in a traditional IRA which I likely won't need to touch during my lifetime. I've done some small Roth conversions and will begin QCDs later this year and RMDs when required but I have to figure out which is worse- taking out more beyond what is required, with the nasty tax consequences, or leaving DS and DDIL with a large pile of money they'll need to pay taxes on over 10 years.

And of course tax laws can and will change.

[SevenUp]

Quote:

Originally Posted by Kings over Queens She's deferring 9% into her roth 401k.... It seem counter intuitive to defer money into the HSA and then pull it out right away to pay a small bill that she can afford to pay out of pocket.

If she pays out of pocket, that reduces the amount she can put into her Roth 401k and still have the same amount for all other expenses.

By paying with the tax-advantaged HSA dollars, she can put more into the Roth 401k and be able to withdraw tax-free from that for any expense, not just medical.

[SevenUp]

Quote:

Originally Posted by athena53 ...I have to figure out which is worse- taking out more beyond what is required, with the nasty tax consequences, or leaving DS and DDIL with a large pile of money they'll need to pay taxes on over 10 years.

If the impact on DS and DDIL is part of the picture, then estimating the degree of nastiness for you vs. for them should be done.

If you can pay the Roth conversion tax from cash on hand, that reduces the degree of nastiness over time. See the reasoning in "Traditional plus taxable" vs. Roth.

[Sue J]

Quote:

Originally Posted by SevenUp If she could put $20,250 into a traditional 401k, that would eliminate her federal tax liability due to the saver's credit, but that would still be only a 15-16% marginal tax saving rate. Thus, chalk up another vote in the Roth column.

Traditional and Roth contributions both count toward the Savers Credit.

I agree with everyone else that Roth is the best idea.

My son started his Roth in his early 20's when he was self employed. Last year he started a new job with Federal benefits. He opted for the TSP as Roth. The matching is Traditional. He contributes 6% and they match that at 7%.

[SevenUp]

Quote:

Originally Posted by Sue J Traditional and Roth contributions both count toward the Savers Credit.

Yes, but only traditional contributions reduce AGI and thus bring more favorable tiers of the saver's credit into play.

In this thread's case, the person is too far away from any saver's credit tier to make much difference in the marginal tax rate she would save. Thus, chalk up another vote in the Roth column.

[Kings over Queens]

Quote:

Originally Posted by SevenUp If she pays out of pocket, that reduces the amount she can put into her Roth 401k and still have the same amount for all other expenses. By paying with the tax-advantaged HSA dollars, she can put more into the Roth 401k and be able to withdraw tax-free from that for any expense, not just medical.

You are raising interesting points, and I'm going to look at her return and play with that calculator link you provided earlier. She got a refund this year, but that might be due to her just starting the job in July, thus, not a full year at 65k, and why I commented about her tax bracket. Now I have to check.

My hesitation with paying out of the HSA now is that she just started funding it. Seems to me like trading dollars. I suppose the counter argument is that she should or could up her contributions into her roth 401k (she fully funds the HSA and roth IRA) by the difference. It's valid.

Now you have me thinking. On a FRIDAY!

[RE2Boys]

Quote:

Originally Posted by pb4uski Neither unless her employer 401k offers a match and then a Roth 401k only to the match. IMO a Roth in her name at a broker would be better. She can contribute up to $6,500 in 2023, 15% of her gross income. She'll have more control and not have to do a rollover from the employer Roth to an individual Roth if she later changes employers which is a hassle that my kids are going through. And while the retirement savers tax credit is a good idea, I think her income is too high for her to qualify.

++++1

My 26 year old son started a new job last fall and he requested advice regarding his 401k. My recommendation is to make standard tax deductible contributions to the 401k up to the full match ( in his case, 9% to get the max 4.5% match), then contribute to his existing non-401k Roth IRA that he has had for 8 years. He has much more control and investment options in his brokerage Roth than complicating live with a 401k based Roth. Also, he can withdraw Roth contributions early if needed without regard to any employer 401k rules. being single , he's just cross into 22% tax bracket.

[Phroig]

Quote:

Originally Posted by pb4uski The thing to remember is that when she later withdraws those funds that some of the withdrawal will be taxable because the match has never been taxed so it will add some complication to her Roth basis bookeeping.

I’d heard about this, but have wondered how it works in practice. Does the match just go into a regular 401K instead of the Roth? If it goes into the Roth, does the provider keep track of the match amounts and earnings thereon, or is that all up to the participant? I can imagine things getting very complicated over several years. Does anyone have experience with this?

[mwilson]

Roth, based on current vs. future tax bracket.

Another consideration I did not see in replies above is pre- vs. post-tax diversity. If her employee makes matching contributions it will likely be pre-tax, doing Roth now will also diversify tax risk, allowing her to draw from pre-tax up to desired tax bracket and Roth after that, should she choose. Alternatively if Roth's are taxed down the road, that risk is mitigated by having pre-tax balance.

[Sue J]

Quote:

Originally Posted by Phroig I’d heard about this, but have wondered how it works in practice. Does the match just go into a regular 401K instead of the Roth? If it goes into the Roth, does the provider keep track of the match amounts and earnings thereon, or is that all up to the participant? I can imagine things getting very complicated over several years. Does anyone have experience with this?

My understanding is that the employer match is always Traditional pre-tax.