Roth 401(k)

[laurence]

So starting next year, companies may elect to offer Roth 401(k)s. Much like Roth IRA's they are paid after tax and can be rolled into Roth IRA's. The wrinkle is employee matches would still be before tax and put in a seperate fund.

My question: While I know people love the Roth IRA because your are hedging your bets on future tax rates, couldn't this be overkill? Right now DW and are are contributing as such:

Both 401(k)+match= $32,000 (max)
Both Roth IRAs= $8,000 (max)

We are also planning on having the house paid off before retiring. My thought is even if tax rates are historically low, we are in a pretty high tax bracket at this point, and plan on keeping withdrawals low due to low expenses (like no house payment) and being in a much lower tax bracket then. It seems if I go all Roth, I may be burning up dollars on the front end that would otherwise be growing for me for an insignificant savings on the back end. Is my logic flawed? Are people actually planning on being in a higher tax bracket when they retire?

 

[moghopper]

Is my logic flawed?

No, I struggle with this as well.

Hard to predict the future, but my instinct tells me that taxes will be higher once the baby boomers continue start crying about social security, medicare, etc.

Another reason I like the Roth IRA (and as you noted the 401k can be rolled into the IRA) is because there are no minimum distribution requirements for them after age 70.5

 

[charlie]

Withdrawal from an IRA is taxed as ordinary income as we all
know. The problem for a majority of retirees is that your SS
income is exposed to taxes on up to 85% of your SS income.
This results in a high marginal tax rate. Withdrawal from a ROTH
does not expose your SS income to this marginal tax rate.

One other point .......... capital gains and dividends are taxed as
ordinary income when they are withdrawal from an IRA. You
get the advantage of the lower cap gains and div rates on a
taxable account (at least for now)

For these reasons, some experts advise funding your 401k only
up to the company match. Then max out your ROTH and put
anything left over in a taxable account. My feeling is that tax
rates will go up in the future when the dems regain power ....
and they will some day.

Everybody's situation is different so you need to do the math.
Don't just blindly max out your 401k with out looking under the
rocks.

Cheers,

Charlie

 

[OldAgePensioner]

charlie,
wish I had listened to this advice years ago.

Just today realized what a rip-off 401k's are. They are taxed in the near future, higher than my tax rate during contributiions.!!!!!!!!!!!!!! Only if you stay with low yielding choices are you better off with a 401K.

And noone knows what future rates will be.

So the gov't devised a method of taking us as fools. I qualified.

 

[LiveWell]

Laurence, I also don't consider Roth IRAs an obvious win. If you're in a high tax bracket right now then, as you pointed out, the money you're putting into the Roth IRA is quite a bit less than the money you could be putting into a 401k. In other words, if you have $1000 pre-tax dollars my gut tells me its a better idea to put all $1000 into the 401k, let it grow, and then pay taxes on the backend than give ~$400 to the govt. now and only have $600 growing in the Roth IRA.

That said, I max out my 401k and still put money into a Roth IRA, but that's because my income level disqualifies me from a Traditional IRA.

 

[cute fuzzy bunny]

Might be a good idea to do a little bit of all of the above.

You never know how tax rules will change or what your tax situation will be like.

 

[laurence]

Maxing Roth IRA and Maxing 401k, and paying off the house in much less than 30 years (sorry SG!), that's my current plan for ER. Hoping our income continues to go up so I can start socking away some after tax money. I figure that way no matter which way the tax law changes, I'm screwed covered.

 

[sgeeeee]

While I was working, I never qualified for a Roth IRA. Now, it's not clear to me how much I gain by transfering conventional IRA dollars to a Roth. Since my retirement in March 2003, I have been doing a lot of different things (travel, new hobbies, etc.) and I have not been able to predict my tax situation either short term (this year) or long term. Since I haven't been able to convince myself that conventional to Roth transfer is valuable to me, I've avoided making a decision -- avoiding the creation of a Roth. I'm convinced that there is probably some optimum amount of money that I could be transferring from my conventional IRAs to a Roth, but I am at a loss to figure out what that amount might be.

 

[sgeeeee]

Maxing Roth IRA and Maxing 401k, and paying off the house in much less than 30 years (sorry SG!), . . .

No need to appologize to me. I think everyone should make the decisions they are most comfortable with. If you are interested in the financial probabilities of your decisions, I have posted a way to analyze that. Many people will decide that the risk-reward profile of keeping a mortgage is not right for them.

 

[Mr._johngalt]

  Many people will decide that the risk-reward profile of keeping a mortgage is not right for them.    

That's what I did, but the numbers didn't convince me one way or the other.
I just got tired of analyzing and went with my gut. I do this a lot.
The "gut' has a better track record by far.

JG

 

[Martha]

I doubt we will establish a Roth 401(k) option at my work in the near future. Personally, at my bracket I think I would prefer to max the traditional 401(k) and then when I am at a lower bracket ( I hope) and retired, convert some to Roth IRA.

But then again, I am nearly retired. And the 401(k) is a relatively small part of the retirement pot. It is much harder for Laurence to make the call as to what will happen in the future. I can't see how our country can avoid higher taxes in the future. I am inclined to go with th's idea and choose bits of everything.

 

[unclemick]

Roth doesn't count against you(at least now - remember Mark Twain about Congress in session) - when figuring what % of SS gets lumped into income. Filing single at 61/62 - the three card mounty now has a fourth wrinkle - which I don't know - if it's included in ORP. Also the ORP calc requires you to 'pick' a return if you don't like the historical default(10%??).

Did a mini Roth conversion last year at age 61.

This be a winter problem - for a 13 now older bored female posting from Missoula(I'm with SG - maybe an after summer calc.).

You also have to pick when you croak(aka span time) - how much estate to leave, etc.

May just give up and go with dividend streams/pay the 70 1/2 RMD piper aka - the Norwegian widow and party while young.

 

[wildcat]

Roth 401K conclusion = it all depends on..

Other + on the Roth 401K side that I haven't seen yet is you get to choose where your money goes, i.e. low cost Vanguard funds.

 

[Nords]

I'm convinced that there is probably some optimum amount of money that I could be transferring from my conventional IRAs to a Roth, but I am at a loss to figure out what that amount might be.   

I think the optimum amount is that which avoids ever having to track RMDs, especially when a 401(k) has been rolled into a conventional IRA. Sure, I know that fund companies will calculate the RMD for you, but they won't fill out the tax forms or pay your penalties if they make a mistake...

We're converting all of our conventional IRAs to Roths over the next 7-8 years.

 

[laurence]

Good points by all. Hmmm, so something mentioned above makes me think, if I retire at 45, roll my 401(k) into a traditional IRA, I could take my 72t withdrawals from it until I'm 62 (or whatever they set SS early payment age to) and then when I become eligible for SS I start hitting the Roth IRA. 15 years of max Roth contributions with almost 20 years of growth afterwards should grow that to a nice chunk!

 

[JB]

While I was working, I never qualified for a Roth IRA. Now, it's not clear to me how much I gain by transfering conventional IRA dollars to a Roth. Since my retirement in March 2003, I have been doing a lot of different things (travel, new hobbies, etc.) and I have not been able to predict my tax situation either short term (this year) or long term. Since I haven't been able to convince myself that conventional to Roth transfer is valuable to me, I've avoided making a decision -- avoiding the creation of a Roth. I'm convinced that there is probably some optimum amount of money that I could be transferring from my conventional IRAs to a Roth, but I am at a loss to figure out what that amount might be.

I'm in a similiar situation and am not planning on moving any $ to the Roth as long as I'm on the cusp of the 25% rate. If my plan works out, I'll have plenty of doe to pay the taxes. If not, I'll be in a low marginal bracket.

 

[unclemick]

Young is calc friendly - ie the younger who convert depending on how they convert/invest with the tax hit - time then is on their side and the effect of compounding with no taxes really, really starts to look good.

For 61 yr old pharts like me - it's a little more dicey - plus the blinding obvious - how hard am I going party in my 80's - really

There's a Clint Eastwood line lurking here - punk!

heh, heh.

 

[REWahoo]

For 61 yr old pharts like me - it's a little more dicey - plus the blinding obvious - how hard am I going party in my 80's - really

What about Paul Neuman driving a race car at 80 (age 80, not 80MPH)... 8)

REW

 

[unclemick]

Hmmmm

Maybe - at least in a race car - you are sitting down!

Heh, heh.

 

[cute fuzzy bunny]

Two words: tony randall.

 

[newellcr]

Laurence,

I've been off line for a bit, but found this in the archive.  There are times in the ER planning stages that the numbers get a bit too chewy to say one investment vehicle is "best" or even "good".  You mention ER at 45 and 72(t).  Your goal is similar to mine (48).  There are two problems with the 72(t) withdraw as I see it.  From the mid 40's to 59.5 is a long way to go and the amounts you can take under 72(t) are limited.  Couple one of the more aggressive withdraw rates with a severe market decline and it could be nail-biting time.  If it goes bust, you owe a 10% penalty on all of the withdraws you took over the years.  OU-eeeeeee-OOuuuch!!!. 

I haven't seen the details of the Roth 401k yet but the Roth IRA allows you to take your contributions after 4 or 5 years (can't remember) without penalty.  If the Roth 401(k) also allows this, it might be beneficial to have some funds in one.  You can fund the Roth 401k more so that there is more money available as contributions and have the earnings be tax free later on. 

I'm still 10 years away from wanting any access to the ER funds, but I don't see a "best" answer anywhere.  You pay your money and you take your chances...

Cheers,

Chris

 

[gindie]

I believe you can take your "contributions" at any time. The 5-year rule applies to distributions of "earnings"

 

[OldAgePensioner]

nm

 

[MileKing]

I think it really depends on your situation. Currently, Mrs. MileKing and I are in the 28% tax bracket. In retirement (at least 10 years off), I expect we will only be in the 25% bracket and that is only if everything we spend each year is from our 401k or deferred compensation plan so it may be lower. Also, we currently pay 5.75% in state income tax. Plan is to move to a state with no income tax, thus saving that 5.75% on anything I can defer now. 3% Fed tax savings plus 5.75% state tax savings is quite a bit. Coupled with the time value of money, it seems like a no brainer to defer as much as possible now and pay the taxes later.