To Roth IRA, or bump 401K ...

[myself]

Due to some changes in the company that I work for, it looks like I'll be able to put another $5,000-$6,000/yr away into retirement.

I paid 2.3% effective Federal taxes last year (I'm in the 25% bracket), and I'm on the line of whether I should just do the Roth IRA (post-tax), or bump my 401K (pre-tax) retirement up. Any suggestion as to how to guide me in which choice to make?
If it helps any, my wife doesn't have a retirement plan in her name as of yet, so I'm leaning in the direction of a Roth IRA for her.
Paying so little Federal taxes is a by-product of having 4 kids and living on a single income.


PS: We're under the IRA income restrictions and haven't hit the 401K cap either. And we wouldn't hit the 401K cap if we put that much away either. The 401K company match is $1/$1 up to 4% ... I'm already putting away 6%.

 

[Mill]

Accepted Boglehead rules say to do the following

In order.

1 401(k) to the match
2 Roth IRA to the max
3 401(k) to the max
4 taxable investing


Youve already got step 1 handled, so go with the roth IRA for the wife. If you max that out (5k in 2010...) put more into the 401(k).

 

[myself]

Accepted Boglehead rules say to do the following

In order.

1 401(k) to the match
2 Roth IRA to the max
3 401(k) to the max
4 taxable investing


Youve already got step 1 handled, so go with the roth IRA for the wife. If you max that out (5k in 2010...) put more into the 401(k).

I would think that the $5k would be doubled for #2. After all, we should in theory max out a Roth for both of us before going back to the 401K.

But I guess the question I was asking was more to where is the "break even" point in the investing timeline. After all, a 401K is pre-tax now, but taxed later. And the Roth is taxed now, but not later. At some point in time they meet so that the 401K may be better for the closer term retirement than the Roth for the farther term retirement to minimize taxes.

 

[bow-tie]

Accepted Boglehead rules say to do the following

In order.

1 401(k) to the match
2 Roth IRA to the max
3 401(k) to the max
4 taxable investing

Isn't is also a function of the types of investments (fees/types/etc) of the 401k? My current 401k isn't that great fee wise, so I've thought about utilizing a Vanguard IRA instead of using work 401k and Roth IRA we've done in the past....

 

[ziggy29]

Isn't is also a function of the types of investments (fees/types/etc) of the 401k? My current 401k isn't that great fee wise, so I've thought about utilizing a Vanguard IRA instead of using work 401k and Roth IRA we've done in the past....

Yes, but usually a company match more than overcomes that objection. Of course, if it's a really weak match like 10 cents on the dollar it may not over time, and if there's no match it's an even easier call, but in general even a weak 401K is worth participating in -- to the extent of any employer match.

 

[SunsetSail]

I would think that the $5k would be doubled for #2. After all, we should in theory max out a Roth for both of us before going back to the 401K.

But I guess the question I was asking was more to where is the "break even" point in the investing timeline. After all, a 401K is pre-tax now, but taxed later. And the Roth is taxed now, but not later. At some point in time they meet so that the 401K may be better for the closer term retirement than the Roth for the farther term retirement to minimize taxes.

I don't think you can calculate a break even point without knowing exactly when you would be taking withdrawals from each account type and your tax bracket at that time.

There are other advantages to Roths that are difficult to add to a calculation such as no RMD and advantageous estate planning characteristics for beneficiaries if that is a goal of yours.

I can envision situations when the 401(k) would be better, but you are in a fairly low tax bracket now, so I would not anticipate being in a much lower bracket in retirement. However, you may have very low expenses and be able to live off of income that will limit you to a lower bracket.

 

[Animorph]

Generally I'll go with 401k (beyond the match) if taxes are higher now than I expect in retirement and Roth if taxes are lower now than expected in retirement. That applies for money that will otherwise be taxed if you don't put it in the 401k. If taxes are the same before and after retirement, the tradition and Roth accounts are dead even regardless of timing.

It's a little different if some of the money you are putting into the Roth has already been taxed. In that case you are effectively putting more in the Roth than in the 401k since it is not taxed on withdrawal.

Having some money in both the 401k and Roth accounts may help control taxes in retirement if you can fill up to your lower tax bracket using the 401k and other taxable sources and then use the Roth to fill in the rest of the income you need. If you are positioned in the tax tables at a point where that makes sense.

You will also be able to contribute to the 401k now and convert to Roth later if your income will drop dramatically in early retirement and you have some after-tax funds to pay the conversion taxes. That may favor the 401k again for now.