Another Roth 401k vs Traditional 401k Thread

[SkinsFan0521]

Hi,

I want to explain my situation a bit and see what people think about if we should be investing in a Roth or Traditional 401k going forward.

My wife & I are both 34 and hoping to FIRE between 45 & 50 with spending around $100-120k/year (basically the max to be at the top of 0% cap gains bracket for married filing jointly). We only have a few thousand in a brokerage account and plan to contribute about $6k/year going forward. All the rest of our money is in Roth IRA, Roth 401k, & Traditional 401k. We currently max both of our Roth IRA and both of our Roth 401k and the family HSA. We're right at the cusp of the income limits for Roth IRA contributions, so if we continue to contribute to Roth 401k, we'll be disqualified from Roth IRA contributions in the next 1-2 years.

My biggest concern right now with FIRE is not having enough money to bridge the gap between whatever age we do RE and 59.5. I'm aware that I can use 72t, but I really would like to avoid that. I'm also aware that I can withdraw our contributions to our Roth IRA, but that's probably only going to be like 1-2 years of spending.

Based on all of that information, I'm thinking that we should start to max our traditional 401k instead of Roth going forward and take the tax savings (something like $9-$10k I believe?) and put that into our brokerage account. That would get us to about $15k/yr into the brokerage. As we earn more, we would obviously increase that amount. If I understand it correctly, the other benefit of that is that it would also put us below the income limits for Roth IRA and allow us to continue to max those out for several more years. Is that correct?

The other thought that I had is that if we continue to contribute to Roth 401k, we can roll those into an existing (open for 5+ years) Roth IRA at the time of FIRE and that $$ will then be considered contributions which would be able to be withdrawn at any time prior to 59.5 without penalty. Is that correct?

So, does anybody have any thoughts on what would be recommended for our specific situation? I just want to do everything I can to give us the best chance of having $$ to bridge the gap from FIRE to 59.5 when we can access all of our traditional 401k money.

Thank you!

 

[SevenUp]

To get $100K/yr from investments, you need $2.5 million if using a 4% withdrawal rate. You need a higher investment balance if using a lower withdrawal rate.

What are your projected taxable, traditional, and Roth balances at retirement?

See How to withdraw funds from your IRA and 401k without penalty before age 59.5 and Traditional versus Roth - Bogleheads for pertinent reading.

In short, traditional is likely better for you now than Roth.

 

[pjigar]

I have always maxed HSA and Traditional 401k (in that order) to save on taxes today. I then contribute to backdoor IRA and super-backdoor IRA (aka non-deductible contributions to traditional 401K). But if you want to build up after-tax balance then you should contribute to brokerage AFTER HSA and traditional 401K max out.

And don't forget, you only need enough funds to cover the first 5 years of expense when you retire. You can build a Roth ladder for the expenses from 6th year and out by converting traditional IRA/401K balance to Roth. Distributing principle from Roth is always tax and penalty free after 5 year of waiting period.

 

[SkinsFan0521]

I have always maxed HSA and Traditional 401k (in that order) to save on taxes today. I then contribute to backdoor IRA and super-backdoor IRA (aka non-deductible contributions to traditional 401K). But if you want to build up after-tax balance then you should contribute to brokerage AFTER HSA and traditional 401K max out.

And don't forget, you only need enough funds to cover the first 5 years of expense when you retire. You can build a Roth ladder for the expenses from 6th year and out by converting traditional IRA/401K balance to Roth. Distributing principle from Roth is always tax and penalty free after 5 year of waiting period.

Thanks for your reply. I do think that the backdoor Roth is something that I'll eventually need, but won't need for a while if we switch to traditional 401k contributions. Like I said, we're right at the cutoff where we would start getting contributions limited, so if we then reduced our MAGI by $37k by contributing to traditional 401k, we would most likely have several years before our raises catch up to the income limits again.

To your second point about the Roth ladder... I've read a bit about this, but it seems that in my planned position, it won't really work for me. If my expenses are going to put me at the top of the 0% cap gains bracket, then I wouldn't have any room left to convert to a Roth ladder without bumping me up into the next bracket and then all of my cap gains would then be taxed. From what I understand, it seems that the ladder is meant for people who will have expenses less than the top of that bracket and you fill in the difference between your expenses and the top of the bracket with conversions.

Please let me know if I'm wrong about this, but that's the way I understand it.

Thanks!

 

[SkinsFan0521]

To get $100K/yr from investments, you need $2.5 million if using a 4% withdrawal rate. You need a higher investment balance if using a lower withdrawal rate.

What are your projected taxable, traditional, and Roth balances at retirement?

See How to withdraw funds from your IRA and 401k without penalty before age 59.5 and Traditional versus Roth - Bogleheads for pertinent reading.

In short, traditional is likely better for you now than Roth.

Hi,

Thanks for the reply and the links. I'm not 100% sure off the top of my head what my balances will be per account, but I've run the projections before and it comes down to the fact that my plan is doable if I were able to access enough of that money between FIRE and 59.5. I project my total balance to be above the $2.5M and I would use a smaller withdrawal rate since my retirement would be planned to last essentially 40-45 years.

ETA: We've always been focused on saving for retirement, but it wasn't until a few years ago that I realized that FIRE was a real possibility. Until then, the mentality was just to save as much as we could comfortably and then worry about the details later. Now that I'm trying to sort out those details (because this could potentially be in as early as 11 years from now), I've realized that by not saving any money in a brokerage account, we've put ourselves in a tough spot to retire early even though we may have "enough" by the time we're 45 or 50. So, we need to do some catching up with the brokerage account and also figuring out the best way to access some of the other money in retirement accounts before 59.5. That's the purpose of this post.

 

[pjigar]

Thanks for your reply. I do think that the backdoor Roth is something that I'll eventually need, but won't need for a while if we switch to traditional 401k contributions. Like I said, we're right at the cutoff where we would start getting contributions limited, so if we then reduced our MAGI by $37k by contributing to traditional 401k, we would most likely have several years before our raises catch up to the income limits again.

To your second point about the Roth ladder... I've read a bit about this, but it seems that in my planned position, it won't really work for me. If my expenses are going to put me at the top of the 0% cap gains bracket, then I wouldn't have any room left to convert to a Roth ladder without bumping me up into the next bracket and then all of my cap gains would then be taxed. From what I understand, it seems that the ladder is meant for people who will have expenses less than the top of that bracket and you fill in the difference between your expenses and the top of the bracket with conversions.

Please let me know if I'm wrong about this, but that's the way I understand it.

Thanks!

You are confusing expenses with income! Your living expenses in retirements doesn't HAVE to come from income. Your living expenses CAN come from savings or balance in your brokerage account. The idea is to live off of your savings for first five years so that you don't have any income on paper and instead fill up that void with Roth conversions. Does that make sense?

 

[SkinsFan0521]

You are confusing expenses with income! Your living expenses in retirements doesn't HAVE to come from income. Your living expenses CAN come from savings or balance in your brokerage account. The idea is to live off of your savings for first five years so that you don't have any income on paper and instead fill up that void with Roth conversions. Does that make sense?

Yes it makes sense in theory, but in reality, that money has to come from somewhere. Most likely from a brokerage account where the gains and dividends are going to use up a good portion of that tax bracket. That means that I won't have room in the tax bracket to convert $100k/yr of future living expenses if I'm using up 50% of that bracket by selling brokerage account assets to cover living expenses in the current year.

Does what I'm saying make sense?

I completely understand how the ladder would work for someone (married filing jointly) with $50k of living expenses. Use brokerage to fund $50k of living expenses this year and then convert $50k from IRA to Roth for future living expenses. The math just doesn't make sense to me when your expenses get up near the top of that tax bracket.

 

[SevenUp]

To your second point about the Roth ladder... I've read a bit about this, but it seems that in my planned position, it won't really work for me. If my expenses are going to put me at the top of the 0% cap gains bracket, then I wouldn't have any room left to convert to a Roth ladder without bumping me up into the next bracket and then all of my cap gains would then be taxed. From what I understand, it seems that the ladder is meant for people who will have expenses less than the top of that bracket and you fill in the difference between your expenses and the top of the bracket with conversions.

Please let me know if I'm wrong about this, but that's the way I understand it.

The question about using relatively low income years for 0% LTCG or low cost Roth conversions occurs often. The usual answer is that for long investment horizons, Roth conversions win.

There is a recent update to a spreadsheet tool hosted on the MMM forum, with the following comment (follow link to the post): Added a worksheet tab, 0% LTCG or t->R, to evaluate the choice between Tax Gain Harvesting (TGH) vs traditional to Roth conversions when one is in the 12% (or lower) federal bracket.
I don't know if it is accurate, but it might be worth a look.

 

[deserat]

The question about using relatively low income years for 0% LTCG or low cost Roth conversions occurs often. The usual answer is that for long investment horizons, Roth conversions win.

When I was using the different financial calculators to determine my retirement amounts, the difference between converting my IRAs to ROTH and not doing that and having RMDs at 70.5 made a fairly big dent in the 'computed' yearly withdrawal amount. Roth won out.

The other thing I like about the ROTH is the ability to withdraw any amount at any time I want (subject to the different rules beforehand, of course, 59.5 age, etc).

In fact, the ORP showed the ROTH conversions in HUGE chunks after the entered date for retirement with the concomitant tax hit. Financial Engines had a similar approach. I am in a bit of a lull right now and am putting a priority on the ROTH conversions until my military pension hits at 60.

{don cynical hat} Now watch as the ROTH rules change when it come time for me to tap them {/undon}