Wanting some to weigh in on the difference in the 2 investments and when to invest in each. Currently my DH contributes the max to traditional 401k. His company started offerig a Roth 401k about 2 yrs ago. He is at a point where the company will automatically contribute 10% of salary to traditional 401k no match required. We have discussed the benifits of reducing our current tax bill but wonder about future tax implications. He is at about 400k in his portfolio at 34yo. We talked about switching over to the Roth 401k when his tradition reaches 500k maybe another 2yrs. We think our Magi may completely box us out from being able to do our Roth IRAs at that point, thus losing one advantage of diverting $$from taxation now.
401k vs Roth 401k
- Thread starter Penny6
- Start date
Lawrencewendall
Full time employment: Posting here.
What's your current tax bracket and what do you envision for retirement bracket?
"We have discussed the benifits of reducing our current tax bill but wonder about future tax implications."
A ROTH would increase your current tax bill. If your in a high bracket, shield the earnings now and convert it to ROTH in retirement, staying in the bracket you decide.
I think we are in 25% bracket
Lawrencewendall
Full time employment: Posting here.
If you think you can live off 96.5k a year in the future, with current brackets, you can pay 25% now (ROTH) or 15% later. (96.5k = 75.9k top of 15% bracket plus 12.7k for couple standard deduction and 8.01k combined personal exemption)
Last edited:
You need ~$2.4 million in traditional accounts before a 4% withdrawal ratio would put you into the 25% bracket, based on those withdrawals alone.
If you have other guaranteed retirement income, such as pensions, that $2.4 million decreases by 25 times the other annual income.
Given that, it seems continuing with the traditional 401k is the better bet. How does it look to you?
It would not preclude a Backdoor Roth IRA.
Will be at - 3.8mil at ER age 48&51 with expected pension. We could delay pension and start converting traditional but its my understanding that you can not start converting until age 59.5 without penalty. We should have enough taxfree IRA and roths to draw in until that time. DH also though about working as teacher/coach for a few years after ER for fun so we can bridge the gap on time til withdrawl.
Lawrencewendall
Full time employment: Posting here.
IIRC, age only factors in if you're still working for them (can't convert until after 59.5). You're not withdrawing so there should be no penalty, just taxes.
Contrary to traditional, sound advice, I put my last few working years of contributions in a Roth 401k. It now looks likely that will end up costing a few thousand in taxes compared to having made deductible contributions and converting later. Circumstances changed, and I now expect to be in a lower bracket than forecast.
Didn't look that way at the time though, and no regrets about having a Roth "starter fund"
My experience is things can change quickly, and things can change a lot over many years. Having a range of sources to draw from gives one flexibility. I consider the higher taxes to be the price of that flexibility.
Didn't look that way at the time though, and no regrets about having a Roth "starter fund"
My experience is things can change quickly, and things can change a lot over many years. Having a range of sources to draw from gives one flexibility. I consider the higher taxes to be the price of that flexibility.
For me, I'd probably max out a traditional 401k when in the 25% tax bracket.
Check to make sure that reduces your taxes as much as you would expect (it might depend on the types and sizes of deductions you take). Also try to take a stab at what your tax bracket might be in retirement, assuming current tax laws stay the same.
Nobody knows what the future holds, but there are many ways you could reduce your tax burden down the line when you retire. The rates might be changed by the current administration. In early retirement, you might have a period of low income where a Roth conversion might work out well.
For me, I got my tax breaks already in my pocket.
How to withdraw funds from your IRA and 401k without penalty before age 59.5 might be of interest.
Ty this is helpful
evilanne
Recycles dryer sheets
Even if you will have a lower tax rate in retirement, it may still make sense to contribute to a Roth that will grow Tax Free. Suppose you contribute $100K over several years and pay 25% tax. In 20-25 years, with a reasonable RoR that amount should grow to about $300K (probably more). If you are at 15% tax bracket when withdrawn, the total amount of taxes paid will be 80% more in the long run. Any employer matching will still be tax deferred withdrawals taxed as ordinary income.
$100K *.25 = $25K Tax Roth
$300K *.15 = $45K vs Tax Deferred related Withdrawals
$100K *.25 = $25K Tax Roth
$300K *.15 = $45K vs Tax Deferred related Withdrawals
It isn't the amount of tax paid that matters. What matters is the amount you get to keep.
Taking the above example (i.e., investment growth of 3X), with a traditional account one gets to spend
$100K * 3 * (1 - 15%) = $255K
With a Roth,
$100K * (1 - 25%) * 3 = $225K.
The amount of tax paid is, strange as it may seem, irrelevant.
See Traditional versus Roth - Bogleheads for more.
How would you pay taxes on conversion? If you can pay with non-TIRA funds
(funds already taxed ), then there is tax on the conversion but no penalty.
If, however, you pay the conversion tax w/ more TIRA funds, you have then done an early distribution which is taxed and penalized if earlier than 59.5.
The penalty is only on the withdrawal part used to pay taxes, not on the conversion amount itself.
so true! I had a friend w/ a rental who kept telling me he didn't want to raise the rent because that would decrease the amount of loss and cause him to pay more taxes. I don't think I ever convinced him that it was a good thing to increase income because he would pay a fraction of that in taxes but he would get to keep the rest. Need to think holistically and not just look at one of he small pieces of the puzzle.
Very good to know
evilanne
Recycles dryer sheets
This is misleading, because in the case of Roth, all earnings ($200K) are Tax Free. All qualified Roth withdrawals are tax free because you already paid the the extra $25K through your taxes when invested. 75% X $100K X 3 isn't representative of what actually happens. By paying extra $25K up front when invested, you will get the entire $300K when withdrawn with no additional taxes. $300K-$255K = $45K is more taxes than the $25K for the Roth.
Last edited:
Ok, if you want the Roth to start with $100K we can look at that. To get $100K into a Roth when one is in the 25% bracket takes a starting amount of $100K / (1 - 25%) = $133,333.33.
Assuming the same investment growth of 3X, with a traditional account one gets to spend
$133,333.33 * 3 * (1 - 15%) = $340K
With a Roth,
$133,333.33 * (1 - 25%) * 3 = $300K.
The amount of tax paid remains irrelevant - provided one compares apples vs. apples by starting with identical amounts.
As noted in Traditional versus Roth - Bogleheads,
evilanne
Recycles dryer sheets
I see where you are coming from but you are assuming that you will put more in. If you are maxing out your 401k (18,000/year to get the to get to $100K ), you cannot add the money to account for the Taxes paid. So you would only have $300K; I think your original calculation would be closer to the reality. From you link:
Based on the amounts some people in this forum have, I think it is more likely that many will be in the same tax bracket. With a higher rate of return, it may actually put you into a higher tax bracket at some point, especially when RMDs kick in. If the intent is to eventually convert, it still makes more sense to me to put money in Roth while working rather than waiting until after you retire when your income will be lower. I'm probably not going to convince you and you do make a valid argument, so I guess we will have to agree to disagree.
Based on the amounts some people in this forum have, I think it is more likely that many will be in the same tax bracket. With a higher rate of return, it may actually put you into a higher tax bracket at some point, especially when RMDs kick in. If the intent is to eventually convert, it still makes more sense to me to put money in Roth while working rather than waiting until after you retire when your income will be lower. I'm probably not going to convince you and you do make a valid argument, so I guess we will have to agree to disagree.
That's a valid consideration. E.g., starting with $24K one could
* pay $6K tax now and put $18K into a Roth, or
* put $18K into traditional, pay $1.5K tax and put $4.5K into a taxable account.
See Maxing out your retirement accounts for more.
In short, given enough time, the tax drag on the "side account" for one making the traditional contribution means Roth can be better even if the withdrawal marginal rate is a few percentage points below the contribution marginal rate. This could apply, for example, to the 28% vs. 25% marginal rates. For a 25% contribution rate vs. a 15% withdrawal rate, however, traditional will be better.
I hope you come to see why this is likely an incorrect strategy. If you can save to traditional at a higher tax rate now, and pay at a lower tax rate (when you withdraw or convert to Roth from traditional) later, you will come out ahead.
If you expect your income to be higher after retirement, in that case using Roth makes sense now.
ETA: clarify timing.
Last edited:
Very true that there is certainly uncertainty about your future tax bracket......
both because of future tax rates and your own personal situation. Even if you end up in a lower bracket, your ability to convert in that lower bracket may be
limited and you might be able to convert only a small fraction of your retirement account at those rates. So in a real situation, there is certainly room for different opinions about what to do.
However in the theoretical situation that you were discussing about about 25% rate now and 15% rate later, there should only be 1 correct answer based on hard numbers. The conclusion should be based on the funds left after taxes.
- Joined
- Oct 13, 2010
- Messages
- 10,735
Although I never used it during accumulation phase, i-orp might give you an idea of the value of tax deferral now vs later. When you have plenty of time, find the full i-orp input page, understand all of the inputs and get those right. Then alter just the one thing (add to traditional 401k or Roth) and see the results. When you see how horrific the RMDs are, you might find it easier to choose a path. Of course you must make an assumption about future tax rates, but the model let's you play with that, or presume the rates will remain the same.
The i-orp "long form" is what you use to have the most flexibility.
The i-orp "long form" is what you use to have the most flexibility.
Last edited:
In general .. I like to go with the ROTH option .. if everything is equal .. I'm 34 as well ... 59 -1/2 is 25 years from now. Who knows what the tax laws and brackets will be 25 years from now. I like my retirment money to be a predictable source of income... You have a lot more flexibility during your working years then you do when you retire. It's easier to work more.. it's easier to get a better paying job etc... I don't want to have a set income one year after tax and because of a new tax reform law have that changed in one fell swoop .
With that said.. Everything is rarely equal... but even the bracket slightly favors the 401k.. I'd rather go with the Roth
With that said.. Everything is rarely equal... but even the bracket slightly favors the 401k.. I'd rather go with the Roth
