What allocation would you use for Roth vs non-Roth?

[bbqcoder]

One more consideration - does she have student loans? If yes, is she using any of the IBR plans?
Whole thing with those plans are in limbo right now, but hopefully will be sorted out in 2-3 months. Just in case if she in any of those plans, going full on t401k will significantly reduce her monthly payments next year.

Yes, she has a small amount of student loans. Around $25K to have some skin in the game as we paid for most of their private college education. No, she's not on a IBR plan and probably doesn't qualify for one.

I would do 100% pre-tax 401k, HSA, backdoor Roth, and taxable in that order. This is with the mindset that she should retire early and then start Roth conversions in a lower tax bracket.

I don't understand the big push for Roth. It is all about taxes now or taxes later. There is nothing magical about a Roth. Your DD is in a decently high tax bracket now.

Her employer does offer an HSA and I'll encourage her to sign up for it while she's young & healthy. The nice thing about having a mix of Roth & non-roth accounts is that it gives you flexibility on withdrawals in the future.

Employers don't provide any recommendations.. they just inform employees of their options.

Agreed. Her employer will match up to 6% of her contributions, dollar for dollar. They do automatically enroll all employees in the retirement plans at 6% contribution, increasing it by 1% each year. I'll encourage her to start with a higher amount than 6%.

Now that I'm back at my laptop I just wanted to provide some details.

Let's say someone is going to contribute $23,500 to either t401k or Roth 401k. OP's DD is well into the 22% tax bracket and slightly in th 24% tax bracket, so I'll use 22% to keep it simple. Also let's assume that contributions grow 10x over the next 30 years (that's about 8% annually) and that she is in the 22% tax bracket in retirement.

If she goes with Roth those $23,500 of contributions will grow to be $235,000 in 30 years that can be withdrawn and spent.

If she goes with the traditional the same thing, her $23,500 of contributions will grow the t401k to $235,000 and when she withdraws that then the tax will be $51,700. However, the $23,500 of tIRA contributions will result in a $5,170 tax benefit which will also grow over 30 years to $51,700 that can be used to pay the tax, leaving her $235,000 to spend ($235,000 t401k + $51,700 taxable account - $51,700 taxes paid).

So if her tax bracket is unchenged, either way she ends up the same there is no benefit from compounding.

The real benefit will come if it ends up that in retirement she is in the 12% tax bracket. In that case, the tax on the t401k withdrawal is only $28,300 and she comes out $23,400 ahead.

Some will pick a nit and say that the $51,700 of tax savings will not grow tax-free. There could be some leakage there unless she invests in municipal bonds or low/no dividend equities or something else with no-tax growth but at most the leakage is $11,374 if she is continually in the 22% tax bracket.

Based on my situation, I don't see how she'll end up in a lower tax bracket at retirement. I'm a few years away from retirement and I can see that I will be in the 24% tax bracket based on my current assets and the 4% rule.

 

[Tykimeister]

Now that I'm back at my laptop I just wanted to provide some details.

Let's say someone is going to contribute $23,500 to either t401k or Roth 401k. OP's DD is well into the 22% tax bracket and slightly in th 24% tax bracket, so I'll use 22% to keep it simple. Also let's assume that contributions grow 10x over the next 30 years (that's about 8% annually) and that she is in the 22% tax bracket in retirement.

If she goes with Roth those $23,500 of contributions will grow to be $235,000 in 30 years that can be withdrawn and spent.

If she goes with the traditional the same thing, her $23,500 of contributions will grow the t401k to $235,000 and when she withdraws that then the tax will be $51,700. However, the $23,500 of tIRA contributions will result in a $5,170 tax benefit which will also grow over 30 years to $51,700 that can be used to pay the tax, leaving her $235,000 to spend ($235,000 t401k + $51,700 taxable account - $51,700 taxes paid).

So if her tax bracket is unchenged, either way she ends up the same there is no benefit from compounding.

The real benefit will come if it ends up that in retirement she is in the 12% tax bracket. In that case, the tax on the t401k withdrawal is only $28,300 and she comes out $23,400 ahead.

Some will pick a nit and say that the $51,700 of tax savings will not grow tax-free. There could be some leakage there unless she invests in municipal bonds or low/no dividend equities or something else with no-tax growth but at most the leakage is $11,374 if she is continually in the 22% tax bracket.

From the nature of FIRE, I think it is the goal to have no earned income at the time of IRA withdrawals.

With your calculations, which are very helpful, how does this change if your earned income is very minimal at age 59 1/2? If you are a high-income earner now and still choose the ROTH option, you could potentially push back SS to age 70 and live your entire 60s with 0% taxable income if it is all coming from a ROTH account. Assuming there are not other brokerage accounts generating taxable income, to change the taxable income brackets that affect the IRA distributions.

 

[Koolau]

Work contributions should be enough to get any match. Then fill the Roth. And go back to work plan to max that account if possible.

Exactly (though YMMV).

 

[old medic]

Congrats! That is $100k more than I made in my first job.

We together have never made that much in a year....
I think the 50/50 would be a good choice.

 

[Jerry1]

If I were to go back in time, the most I would put in my 401k would be enough to get the max company match. If available, I’d do Roth up to the max allowed. I’d concentrate more in my brokerage account. Instead I ended up with most of my wealth in tax deferred accounts and I’m having a hard time getting the funds out at a lower rate than what is saved going in.

 

[sengsational]

This is popular misconception. The math says otherwise. It is all tax rate/bracket arbitrage. If the tax rate is the same then compounding doesn't do a thing.

You're right. It's the same if tax rates stay the same. I have a built in bias that rates will increase.

One thing is absolutely true though about compounding, and it's why I was confused. I tell all the kids just starting out investigating "the first 100 years are the hardest"

 

[VanWinkle]

Can you use t401k or tIRA tax free for medical? I never heard of that.

You can deduct everything over 7.5% of your income in medical- long term care is a good example of how every dollar pulled for the expenses will help eliminate taxes on the IRA withdrawal.

 

[sengsational]

Oh, yeah, that deduction. Given I've had insurance, I've never got anywhere close to that for medical. I was thinking of the direct no taxes medical, like HSA, not the deductions with the big percentage before they kick-in.

 

[MarieIG]

If I were to go back in time, the most I would put in my 401k would be enough to get the max company match. If available, I’d do Roth up to the max allowed. I’d concentrate more in my brokerage account. Instead I ended up with most of my wealth in tax deferred accounts and I’m having a hard time getting the funds out at a lower rate than what is saved going in.

I didn't get a match, so that wasn't an issue for me. I must say, I have never regretted the funds that I put into the Roth 401(k) - after it was finally established by my employer after much foot dragging. I also wish I had known/ understood Roth conversions much earlier in the game.

 

[pb4uski]

From the nature of FIRE, I think it is the goal to have no earned income at the time of IRA withdrawals.

With your calculations, which are very helpful, how does this change if your earned income is very minimal at age 59 1/2? If you are a high-income earner now and still choose the ROTH option, you could potentially push back SS to age 70 and live your entire 60s with 0% taxable income if it is all coming from a ROTH account. Assuming there are not other brokerage accounts generating taxable income, to change the taxable income brackets that affect the IRA distributions.

While I don't see a goal of no earned income at the time of IRA withdrawals as important, the reality is that it happens naturally in most cases since if you're retired and not working then you have no earned income.

The calculations are in isolation simply to prove that if the tax is the same when contributed and when withdrawn that there is no real benefit from "compounding" since it is a popular misconception that there is benefit from compounding.

The real juice is differences in the taxes avoided when contributions are made and the taxes paid when withdrawn. For me, most of my contributions avoided 28% federal and 6% state, or 34%. My Roth conversions over the past decade have been at ~10% federal and ~5% state so I'm ahead 19% on those contributions. When RMDs start in 5 years or so I project I'll pay 17-18% federal (a mix of 12% and 22%) and 0% state since we now live in a no income tax state, so I'll be ahead by 16-17%.

IMO, 0% taxable income in your 60s is probably a suboptimal goal, especially if you expect to be in a higher tax bracket once you start SS and later when RMDs kick in. In those circumstances, you would want to do annual Roth conversions to cover your deductions and probably the 10% tax bracket and the 12% tax bracket as well rather than let those low tax brackets get wasted unused.

My analysis indicates that we will be towards the top of the 12% tax bracket before RMDs based on my small pension, SS and taxable account interest and RMDs will push us into the 22% tax bracket, so I do Roth conversions to the top of the 12% tax bracket because it is better to pay 12% now than to pay 12% and 22% later.

 

[Zona]

I agree that if the expected tax rate is unchanged, pb4uski's analysis is accurate. Something to consider (and that I advise younger relatives) is that if you think you might want to retire early, be sure to put some money in either a taxable brokerage or Roth early on. If you end up with only pre-tax 401k/IRA money you are kind of painted into a corner. I know a SEPP/72t is an option but when we started planning our E-R I felt a bit intimidated about taking a 72t and potentially making a mistake and paying a penalty. Luckily for us we had good growth in our brokerage and it's looking like we'll make it to 59.5 without running short.

Of course, there's always the supersaver route -- she could max out the work 401k, contribute the max to a Roth IRA (since she is well under the income limit), then set aside some amount in a brokerage invested in a tax-efficient index ETF. That's what my current self would advise my past self, if I had a time machine. Like your daughter I was 24 (also in IT) when I started contributing to my 401k but wish I'd opened a brokerage and a Roth back then, too. It took another few years before I opened those accounts, so your daughter is already ahead of where I was! A lot easier at age 24 to just keep living like a college kid for a few more years before inflating the lifestyle. She is lucky to have you looking out for her!

 

[Pointby2]

When I first read this headline I thought it referred to asset allocations. Since no one has mentioned it, I'll throw it out there. If she is funding both and she wants a 80/20 asset allocation, the 80% stock part should fill the Roth first and the 20% bonds and cash should all go into the 401k.
I'm in the middle or re-balancing my accounts since this never occurred to me while I was saving.

 

[Dtail]

Roth's came into my life too late. My tax deferred is 10X my tax free. 50/50 sounds really sweet to me!

Somewhat similar and in agreement.

 

[Taco]

She's will be making $120K in a remote job, 24% tax bracket.

Congrats to both you and your daughter!!!

Not that 22 vs 24 is a huge difference, but I think you should consider her as being in the 22% tax bracket as you are debating Roth vs Traditional.

Standard deduction for 2025 will be $15K, so that brings her down to $105K. You mentioned an HSA - just a little bit in there will get her below the threshold to be in the 22% bracket.

 

[Phroig]

I believe that employers now have the option of putting a Roth 401K match into the Roth account in which case it's taxable. Since your daughter is right at the end of the 22% threshold, additional income will be taxed at 24%. It might be worthwhile to find out where the match goes.

 

[Koolau]

If I were to go back in time, the most I would put in my 401k would be enough to get the max company match. If available, I’d do Roth up to the max allowed. I’d concentrate more in my brokerage account. Instead I ended up with most of my wealth in tax deferred accounts and I’m having a hard time getting the funds out at a lower rate than what is saved going in.

Yeah, I made the classic mistake of maxing out the 401(k) to save taxes when w*rking. Turns out I "make" a lot more taxable now. Who knew?

 

[Retired2021]

One should also consider the potential State income tax benefits for a t401k. The current law in Illinois mandates a 4.5% tax on annual income. However, withdrawals from t401k accounts after age 59.5 are not subject to income tax. In my case, we've avoided paying that 4.5% for 30+ years, grown significant earnings tax free and are now converting it into our Roth accounts tax free.

 

[ponyboy]

She should max her traditional 401k and max a Roth IRA.

My wife has access to Roth 401k and every calculator I've used said it was better to do a t401k.

We also plan on retiring early, doing Roth conversion at the 12% rate, or whatever it is in 10 years from now.

 

[Koolau]

She should max her traditional 401k and max a Roth IRA.

My wife has access to Roth 401k and every calculator I've used said it was better to do a t401k.

We also plan on retiring early, doing Roth conversion at the 12% rate, or whatever it is in 10 years from now.

I was never offered a Roth 401(k) so I'm ignorant. My gut tells me that it's better to keep the 401(k) separate from Roth (IOW, as ponyboy suggests, do a 401(k) and a Roth IRA but not a Roth 401(k)).

What do others think about the 401(k) Roth?

 

[sengsational]

Whatever you think about Roth, you probably should think about Roth 401k. The limits differ, but it's just tax rate arbitrage.

My thinking suggests that just based on demographics, which can be predicted pretty accurately, the proportion of retirees to workers will be getting less favorable for income tax revenues, and so there's upward pressure on income tax rates going forward. That suggests paying tax now, while it's cheaper (going Roth instead of deferring). But things change, and this could be a completely inaccurate prediction.

 

[Gumby]

I would put money into the traditional 401k to get the company match. If I were then close to the boundary between tax brackets, I would contribute more to to the 401k to get to the lower bracket (for example, to get from the 24% bracket down to the top of the 22% bracket). Then I would go to the Roth up to the limit. If there were anything left for saving after that, I would do it in taxable. If I later changed jobs to one without a 401k match, I would roll the old 401k into a tIRA, then use the after tax savings to pay the taxes on Roth conversions from the tIRA.

 

[Taxman59]

My recommendation would be to go 100% Roth, knowing that the company match will be in the t401K. That will give her a large tax free ROTH and a smaller taxable 401K that she can use for income if needed in her retirement.

 

[Gumby]

My recommendation would be to go 100% Roth, knowing that the company match will be in the t401K. That will give her a large tax free ROTH and a smaller taxable 401K that she can use for income if needed in her retirement.

Although that may be the case, I did not see that specified by the OP. I never had a match, but the people I knew who did were matched in the 401k for contributions to the 401k.

 

[Montecfo]

I would tilt toward tax deferred and HSA and leave Roth 3rd.

She is single correct? So she could very easily be in a lower bracket at retirement if she married and say there is only one income for a large portion of working career.

Deferred accounts provide optionality. You can do Roth conversions-or not-when the tax consequences are more clear.

Having said that, having some in Roth is not a bad thing. But tax deferred could be better.

 

[Al18]

I would go with your initial suggestion of 50% 401K/50% Roth

There is no perfect answer without knowing tax rates 30 years from now.

Don’t let perfect be the enemy of good.