Traditional or Roth 401k for my 27 year old?

[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.

 

[CardsFan]

My opinion: She is in the 12% tax bracket - Roth.

 

[MarieIG]

If it were my kiddo, I'd steer her toward the Roth. Think of all those years of compounding.

I think you mentioned before she was a good kid - so if she is feeling a tax bite - maybe her poppa wants to gift her the $ for her Roth IRA.

Just my thoughts of course.

 

[JDARNELL]

Going thru the same thing with my kids. Roths.

 

[copyright1997reloaded]

Unless she is making serious coin, ROTH.

Personal Experience: I have enough in tIRA etc. that I will be lucky to stay in the 32% bracket (single) come RMD time. (Currently in the 24% bracket.) I really wish a lot more of that was in a Roth (even with what would have been the tax hit).

I will be trying to convert at least to the top of the 24% bracket (really 31% with NY state taxes) and will go to the top of the 32% bracket if I move to a state that doesn't tax IRA distributions....but still see a lot of money eventually coming out via RMD's at not so good rates.

ETA: As MarieIG mentions, one approach (that I'm using with my DC, age 20) is to effectively reimburse the tax hit of DC doing a Roth (vs. tIRA) via the annual gift exclusion.

 

[disneysteve]

Thanks everyone. That’s what I was thinking. I just wanted to make sure I wasn’t missing anything.

 

[Jenna]

If it were my kiddo, I'd steer her toward the Roth. Think of all those years of compounding.

I think you mentioned before she was a good kid - so if she is feeling a tax bite - maybe her poppa wants to gift her the $ for her Roth IRA.

Just my thoughts of course.

This is what we do for our kids...nothing better than to get that money in early!

 

[rmorris50]

Def Roth. But they key will be for her to know if and when traditional might make sense in the future. If she starts making enough money to throw her into the high marginal tax brackets. Or if she were to marry and their combined income is very high. But at this stage in life I’d be shoving as much as I could into Roth.

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.

 

[Stormy Kromer]

Roth.

 

[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.

 

[pb4uski]

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.

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.

 

[CardsFan]

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.

Good points. This sounds better than the Roth 401k.

 

[rmorris50]

Good points. This sounds better than the Roth 401k.

Agreed, unless she is someone who has the opportunity to super save half her income and wants to aggressively shove as much as possible into a Roth while she is young (still living at home?). And there a behavioral component of the automatic, out is sight out of mind to the 401(k).

But beyond any match I assume chances are the individual Roth prob makes more sense.

Chances are she will move on to another company in a few years so she would want to roll over when she moves on anyway. Another case for the individual Roth. Again unless she wants to aggressively save.

 

[pb4uski]

^^^ Yes, if she wants to save more than 15% of her gross pay then she can do anything above 15% in a taxable brokerage account invested in a domestic equity fund where both qualified dividends and LTCG would be tax-free (0% rate) at her income level... just as good as a Roth.

 

[Texas Proud]

My opinion: She is in the 12% tax bracket - Roth.

Yes... big time +1


No need to save taxes at a 12% bracket and maybe pay at a 22% or higher..

 

[rmorris50]

^^^ Yes, if she wants to save more than 15% of her gross pay then she can do anything above 15% in a taxable brokerage account invested in a domestic equity fund where both qualified dividends and LTCG would be tax-free (0% rate) at her income level... just as good as a Roth.

I sure wish I had started a brokerage account when I was young. Good advice. But who knows if I would have been more tempted to touch it. Part of the reason I have so much saved today is more behavioral. I just maxed out all employer retirement account and deferred comp and it was much much harder to touch. Is my asset allocation among pre and post tax accounts where I want it to be, no. (Too much pre tax). But at least I have plenty of money saved. Could be worse.

Important thing at this age is to first get into the habit of saving and be self aware of your personal behavior regarding money. I don’t think she can go wrong doing employer Roth, individual Roth and/or brokerage.

 

[38Chevy454]

Does your daughter get any company match on the 401k contributions? If so, ensure you have her max out the free matching money. That's worth the small hassle to roll it over later.

 

[disneysteve]

She has a Roth IRA and has maxed it the last few years. She started that when she was 16 with babysitting money.

There is a match on the 401k. 100% of the first 3% then 50% up to 5% so she’ll do the full 5% even if it means slightly reducing her IRA contribution. Stupid to pass up free money like that.

 

[pb4uski]

At $42k gross if she contributes 5% or $2,100, then she'll get $1,680 of match/free money... that's a great deal and worth the hassle of doing a rollover later if she changes employers.

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.

 

[arcyallen]

This seems unlikely at her income level, but don't forget that maxing a Roth with post-tax money is allowing you to save more money than maxing a Traditional with pre-tax money. I get giddy even thinking about a 27yo saving $22,500 a year, haha!

 

[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.

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]

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]

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]

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.