Traditional or Roth 401k for my 27 year old?

[Kings over Queens]

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.

Such good advice, and not only because I agree with it. It just makes sense.

I made my 22 y/o daughter take the HSA option and fully fund her account. Just learned she's been paying small medical bills from it.

We're having a review via zoom tomorrow. She'll get the daddy voice.

"Pay those bills out of pocket!" I will say, with love.

 

[Kings over Queens]

Another vote here for the Roth.

 

[SevenUp]

Such good advice, and not only because I agree with it. It just makes sense.

I made my 22 y/o daughter take the HSA option and fully fund her account. Just learned she's been paying small medical bills from it.

We're having a review via zoom tomorrow. She'll get the daddy voice.

"Pay those bills out of pocket!" I will say, with love.

Before saying that, check to see if she is contributing the maximum to all other tax-advantaged accounts, and review the considerations in How to use the plan.

 

[Kings over Queens]

That's a really good article, and something I didn't consider.

She's 22, makes 65k, and living on her own...well, co-habituating with her boyfriend.

She's deferring 9% into her roth 401k and funding her own roth IRA as well, plus fully funding the HSA. There are no traditional ira or 401k deferrals.

The article you posted mentions a 25% tax bracket, she's no where near that. Besides, I'd rather the dollar she saves today grow tax free and be available in 30 or 40 years, or sooner, the point being is she has time for the seed to grow. It seem counter intuitive to defer money into the HSA and then pull it out right away to pay a small bill that she can afford to pay out of pocket.

"Don't let perfection become the enemy of good" comes to mind.

I'm open to thoughts.

 

[pb4uski]

If her gross pay is $65k and she is single, then it seems likely that she is well into the 22% tax bracket (which would be 25% if rates revert) so I would consider having some of her retirement savings be tax-deductible, like a traditional IRA. Perhaps enough to get her down to the top of the 12% tax bracket.

It looks to me like if she changed ~$6k of retirement savings from Roth to traditional that her tax bill would be $1,320 lower, plus any state income tax benefits.

You can play around with https://www.irscalculators.com/tax-calculator to get an idea of the savings.

 

[athena53]

The article you posted mentions a 25% tax bracket, she's no where near that. Besides, I'd rather the dollar she saves today grow tax free and be available in 30 or 40 years, or sooner, the point being is she has time for the seed to grow.

First of all, I agree with the Roth option. I wish I'd had it in my early working years.

She should, however, do her more aggressive investing in after-tax accounts and maybe keep money-market and fixed-income investments in the tax0deferred accounts. .

Now, at age 70, I question the conventional "stash as much as you can in tax-deferred" advice. IIRC, the match applied only to the employer 401(k) contributions but she may want to re-consider opening a traditional IRA outside of the employer plan even if she's within the income limits where it's allowed. I wish I'd thought about the consequences of investing in equities likely to generate dividends and LT gains in an IRA. They're all taxed as ordinary income, of course, when you withdraw them.

So.. I'm in the somewhat enviable position of sitting on about $1 million in a traditional IRA which I likely won't need to touch during my lifetime. I've done some small Roth conversions and will begin QCDs later this year and RMDs when required but I have to figure out which is worse- taking out more beyond what is required, with the nasty tax consequences, or leaving DS and DDIL with a large pile of money they'll need to pay taxes on over 10 years.

And of course tax laws can and will change.

 

[SevenUp]

She's deferring 9% into her roth 401k....

It seem counter intuitive to defer money into the HSA and then pull it out right away to pay a small bill that she can afford to pay out of pocket.

If she pays out of pocket, that reduces the amount she can put into her Roth 401k and still have the same amount for all other expenses.

By paying with the tax-advantaged HSA dollars, she can put more into the Roth 401k and be able to withdraw tax-free from that for any expense, not just medical.

 

[SevenUp]

...I have to figure out which is worse- taking out more beyond what is required, with the nasty tax consequences, or leaving DS and DDIL with a large pile of money they'll need to pay taxes on over 10 years.

If the impact on DS and DDIL is part of the picture, then estimating the degree of nastiness for you vs. for them should be done.

If you can pay the Roth conversion tax from cash on hand, that reduces the degree of nastiness over time. See the reasoning in "Traditional plus taxable" vs. Roth.

 

[Sue J]

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.

Traditional and Roth contributions both count toward the Savers Credit.

I agree with everyone else that Roth is the best idea.

My son started his Roth in his early 20's when he was self employed. Last year he started a new job with Federal benefits. He opted for the TSP as Roth. The matching is Traditional. He contributes 6% and they match that at 7%.

 

[SevenUp]

Traditional and Roth contributions both count toward the Savers Credit.

Yes, but only traditional contributions reduce AGI and thus bring more favorable tiers of the saver's credit into play.

In this thread's case, the person is too far away from any saver's credit tier to make much difference in the marginal tax rate she would save. Thus, chalk up another vote in the Roth column.

 

[Kings over Queens]

If she pays out of pocket, that reduces the amount she can put into her Roth 401k and still have the same amount for all other expenses.

By paying with the tax-advantaged HSA dollars, she can put more into the Roth 401k and be able to withdraw tax-free from that for any expense, not just medical.

You are raising interesting points, and I'm going to look at her return and play with that calculator link you provided earlier. She got a refund this year, but that might be due to her just starting the job in July, thus, not a full year at 65k, and why I commented about her tax bracket. Now I have to check.

My hesitation with paying out of the HSA now is that she just started funding it. Seems to me like trading dollars. I suppose the counter argument is that she should or could up her contributions into her roth 401k (she fully funds the HSA and roth IRA) by the difference. It's valid.

Now you have me thinking. On a FRIDAY!

 

[RE2Boys]

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.

++++1

My 26 year old son started a new job last fall and he requested advice regarding his 401k. My recommendation is to make standard tax deductible contributions to the 401k up to the full match ( in his case, 9% to get the max 4.5% match), then contribute to his existing non-401k Roth IRA that he has had for 8 years. He has much more control and investment options in his brokerage Roth than complicating live with a 401k based Roth. Also, he can withdraw Roth contributions early if needed without regard to any employer 401k rules. being single , he's just cross into 22% tax bracket.

 

[Phroig]

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.

I’d heard about this, but have wondered how it works in practice. Does the match just go into a regular 401K instead of the Roth? If it goes into the Roth, does the provider keep track of the match amounts and earnings thereon, or is that all up to the participant? I can imagine things getting very complicated over several years. Does anyone have experience with this?

 

[mwilson]

Roth, based on current vs. future tax bracket.

Another consideration I did not see in replies above is pre- vs. post-tax diversity. If her employee makes matching contributions it will likely be pre-tax, doing Roth now will also diversify tax risk, allowing her to draw from pre-tax up to desired tax bracket and Roth after that, should she choose. Alternatively if Roth's are taxed down the road, that risk is mitigated by having pre-tax balance.

 

[Sue J]

I’d heard about this, but have wondered how it works in practice. Does the match just go into a regular 401K instead of the Roth? If it goes into the Roth, does the provider keep track of the match amounts and earnings thereon, or is that all up to the participant? I can imagine things getting very complicated over several years. Does anyone have experience with this?

My understanding is that the employer match is always Traditional pre-tax.

 

[Phroig]

My understanding is that the employer match is always Traditional pre-tax.

Yes, thanks. I did a bit of googling. Currently, the match goes into a Traditional 401K, so there's no complicated record-keeping. Secure Act 2.0 will give employers the option of doing Roth matches, but the employer contribution will be treated as income for the participant in the year of the match. The Roth match is still better, given the potential decades of tax-free growth.

 

[SevenUp]

My understanding is that the employer match is always Traditional pre-tax.

Probably, but maybe not. See Secure 2.0 - Too much too soon - Bogleheads.org for more.

 

[orbops]

Tell her that all her contributions should go into the Roth. Any company match by default goes into a traditional 401K.

I contributed to a Roth for the last 10 years of my career, and the $136K that I contributed has turned into $500K in less than 10 years. The tremendous benefit of contributing to a Roth will allow your daughter to control what tax bracket she will be in once she retires in 30-40 years by utilizing the Roth as a way to offset any ordinary income.

 

[badatmath]

Such good advice, and not only because I agree with it. It just makes sense.

I made my 22 y/o daughter take the HSA option and fully fund her account. Just learned she's been paying small medical bills from it.

We're having a review via zoom tomorrow. She'll get the daddy voice.

"Pay those bills out of pocket!" I will say, with love.

You guys are good parents helping your kids, giving advice etc. No one ever told me **** about money. Mostly they just told me to shut up.

 

[BubbaChris]

I'm going to speak up because I often find myself voting against the ROTH if a younger person is making $50K or more. Unless the question includes details about debt, emergency savings, after-tax brokerage account(s), and being on a path towards home ownership. In other words, a holistic view of the person's overall financial well being.

Once someone is in the 22% marginal bracket it takes an extra $282 of earnings for every $1,000 that goes into a ROTH when compared to a Traditional 401K. Applying those funds to any of what I mentioned above can be the wiser long term move (and remove the temptation to withdraw any of your contributions early).

We were able to retire early because 33% of our investments were in after-tax accounts. We should qualify for ACA premium credits up to age 65 and be in the zero tax bracket until we begin to take SS at FRA or 70. Plus once we hit 65, we can draw from the T-IRAs at a low marginal rate to work down RMDs.

If by chance we reach the point we owe measurable IRMAA and are stuck in a higher tax bracket, it means we've won the game and are probably challenged in finding fun ways to BTD.

Best regards,
Chris

 

[JDARNELL]

I'm going to speak up because I often find myself voting against the ROTH if a younger person is making $50K or more. Unless the question includes details about debt, emergency savings, after-tax brokerage account(s), and being on a path towards home ownership. In other words, a holistic view of the person's overall financial well being.



Once someone is in the 22% marginal bracket it takes an extra $282 of earnings for every $1,000 that goes into a ROTH when compared to a Traditional 401K. Applying those funds to any of what I mentioned above can be the wiser long term move (and remove the temptation to withdraw any of your contributions early).



We were able to retire early because 33% of our investments were in after-tax accounts. We should qualify for ACA premium credits up to age 65 and be in the zero tax bracket until we begin to take SS at FRA or 70. Plus once we hit 65, we can draw from the T-IRAs at a low marginal rate to work down RMDs.



If by chance we reach the point we owe measurable IRMAA and are stuck in a higher tax bracket, it means we've won the game and are probably challenged in finding fun ways to BTD.



Best regards,

Chris

What is your support for on “can be the better long term move”?

Also I think there are provisions that allow you access to tax deferred dollars allowing someone to still retire early.

Just trying to fill in the mental gaps I am experiencing in your post

 

[pb4uski]

I'm going to speak up because I often find myself voting against the ROTH if a younger person is making $50K or more. Unless the question includes details about debt, emergency savings, after-tax brokerage account(s), and being on a path towards home ownership. In other words, a holistic view of the person's overall financial well being.



Once someone is in the 22% marginal bracket it takes an extra $282 of earnings for every $1,000 that goes into a ROTH when compared to a Traditional 401K. Applying those funds to any of what I mentioned above can be the wiser long term move (and remove the temptation to withdraw any of your contributions early).



We were able to retire early because 33% of our investments were in after-tax accounts. We should qualify for ACA premium credits up to age 65 and be in the zero tax bracket until we begin to take SS at FRA or 70. Plus once we hit 65, we can draw from the T-IRAs at a low marginal rate to work down RMDs.



If by chance we reach the point we owe measurable IRMAA and are stuck in a higher tax bracket, it means we've won the game and are probably challenged in finding fun ways to BTD.



Best regards,

Chris

I agree. For the OPs daughter who is single and makes $42k the Roth makes sense because she is in a low tax bracket. But for Kings over Queens' single daughter earning $65k a year in post #29 and is in the 22% tax bracket then some deductible IRA contributions to lower her income to the top of the 12% tax bracket make more sense to me.

All this assumes that the person will be in the 12/15% tax bracket when retired. If they are more financially successful and are in the 22/25% tax bracket then the deductible IRA does no harm and is the same as the Roth, if they are in higher tax brackets in retirement then it didn't work out as planned but it's ok... it is just a penalty for ending up more financially successful than planned.

 

[Vacation4us]

DD gets a company match so I signed her up for their 401k ( less complicated then having Roth plus pre-tax $) she also fully funds her Roth at Fidelity. As a part time server after 2 years she has 5 k in her 401k, and about 26 k in her Roth. Not bad for a 23 yo full time student that lives at home. Plus her 40 k CD and 15 k checking accounts. Not to mention the 20k she put down on her first car with 0.9% finance on the rest. Proud mama here. She got her first job at 15yo.

She had an accounting internship this last semester and is super excited they already asked her back for next year.

These are habits that I hope will last a lifetime.

Moms rule was 50% of take home pay to savings and she could blow the rest if she wanted too.

 

[BubbaChris]

What is your support for on “can be the better long term move”?

Also I think there are provisions that allow you access to tax deferred dollars allowing someone to still retire early.

Just trying to fill in the mental gaps I am experiencing in your post

I'll do what I can. In addition to the factors I mentioned initially, for someone in their 20's or 30's a 529 plan is a better place to redirect that extra $282 per $1K of tax deferred retirement savings. This assumes they have (or will have) children and they are in favor of a college education. The time horizon of when you will access those funds is more favorable.

But my real bias is based on the assumption that someone in the modest to moderate income range is often in a position of juggling cash flow. And it is likely they can't avoid debt to live their desired lifestyle. So in the case of someone who can manage of what remains after the ROTH (IRA or 401k) contribution, directing the cash into another bucket gives more breathing room. For someone earning $50K and choosing an 8% contribution, that $282/$1K is $1,128 per year. Earning maybe 6% compounded quarterly would grow to $6,522 in 5 years. That money would available to respond to emergencies, pay down debt, etc.

And in my system of mental accounting, I would have likely chosen a 10% traditional 401k contribution over an 8% ROTH 401k contribution because I'd see it as an instant 25% increase in my investment while still netting some additional available cash if I was in the 22% or higher marginal tax bracket. I would hope time and compounding would still leave me with sufficient retirement assets.

Best regards,
Chris

 

[JDARNELL]

I'll do what I can. In addition to the factors I mentioned initially, for someone in their 20's or 30's a 529 plan is a better place to redirect that extra $282 per $1K of tax deferred retirement savings. This assumes they have (or will have) children and they are in favor of a college education. The time horizon of when you will access those funds is more favorable.

But my real bias is based on the assumption that someone in the modest to moderate income range is often in a position of juggling cash flow. And it is likely they can't avoid debt to live their desired lifestyle. So in the case of someone who can manage of what remains after the ROTH (IRA or 401k) contribution, directing the cash into another bucket gives more breathing room. For someone earning $50K and choosing an 8% contribution, that $282/$1K is $1,128 per year. Earning maybe 6% compounded quarterly would grow to $6,522 in 5 years. That money would available to respond to emergencies, pay down debt, etc.

And in my system of mental accounting, I would have likely chosen a 10% traditional 401k contribution over an 8% ROTH 401k contribution because I'd see it as an instant 25% increase in my investment while still netting some additional available cash if I was in the 22% or higher marginal tax bracket. I would hope time and compounding would still leave me with sufficient retirement assets.

Best regards,
Chris

Thanks! The 529 POV makes sense if that is the scenario. In our case all future college is taken care of for at least the next two generations assuming they are responsible kids.

Emergency funds are in place for our recent college graduates as they saved that already and have been contributing to 401Ks in their jobs up to the match level. With their new salary rates it is worth looking at the Roth vs traditional option. There is also the HSA option

The view of the Traditional Vs Roth comparison makes sense in some ways. I need to run a tax estimator with my sons to see what this looks like. My wife and I didn't have access to Roth 401Ks just traditional and we now have a 7 figure traditional to try and liquidate before RMDs. We haven't started due to current tax bracket. It is going to be painful and I am sure rates are going up. I anticipate we will start this in 2024.

It will be interesting when DILs enter the picture one day on how that will change things. For now it's all about putting the systems in place and reinforcing the habits.