Roth 401(k) versus 401(k) for high income investors?

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Roth 401(k) versus 401(k) for high income investors?

Postby rdl » Thu Dec 27, 2007 10:39 am

What are people's thoughts on putting money away in a Roth 401(k) versus a 401(k) for folks in higher income tax brackets?

The correct answer depends on forecasting the future of tax laws and your future retirement tax bracket, of course, so interested to hear what people actually are doing.

Vanguard has an excellent paper here: http://www.google.com/url?sa=t&ct=res&c ... AhDA2qSK9Q

which argues that most should do both as a way of diversifying tax risk.

Thoughts?
Last edited by rdl on Thu Dec 27, 2007 11:42 am, edited 1 time in total.
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Postby aainvestor » Thu Dec 27, 2007 10:59 am

I had been wondering about that. I read that paper before but I am not sure giving up the deduction now is worth the potential for tax free income in the future.

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Postby linenfort » Thu Dec 27, 2007 3:35 pm

The correct answer depends on forecasting the future of tax laws


Isn't that the truth. I had to take money out of my Roth last year, as Married_but_filing_Separately disqualified me. :x
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Postby nisiprius » Thu Dec 27, 2007 9:46 pm

Here is a really stupid and bad reason to go with the Roth.

I do my own taxes. (Wait for chorus of "You fool!" But my income isn't terribly high, my taxes aren't complicated, virtually all of my investments are in tax-advantaged accounts, there aren't any options for significant tax savings, and I'm good at following instructions and filling out forms. Plus, I think the annual exercise of getting my hands dirty with my financial details helps me to "keep the picture" in my head).

Roth IRAs, let alone Roth 401(k)'s, were not available when I started investing for retirement. Putting money into a traditional 401(k) or IRA is easy.

As the time approaches when I need to take it out, I am becoming aware that taking it out could get complicated with respect to the tax implications.

Everything I've read suggests that for most people the difference between a regular 401(k)/IRA and a Roth is both small and depends on so many imponderables it is hard to be sure which is better.

So, if I were faced with the choice between a regular and a Roth, I'd go with the Roth just because it will probably make it easier to fill out the tax forms.
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Postby EmergDoc » Thu Dec 27, 2007 10:15 pm

If you use a Roth 401K you are by default diversifying your tax risk, since the company contribution automatically goes into a regular 401K.

That said, I think those who are in their peak earning years are usually better off with a regular 401K because they are deducting taxes at their marginal rate that will later be paid at rates less than their marginal rate. Assuming a retiree is living off nothing but Roth 401K and 401K distributions, he won't pay anything on the Roth distributions and will pay nothing on the first $10K and little on the next 40K or so. In effect, he saves taxes at 33% and pays them at 25%. It is a good deal even if his tax bracket doesn't change (unless SS or a taxable pension makes the distribution completely taxed at his marginal rate).

The complicating factor, of course, is that you can save more money in a tax-protected manner using a Roth 401K since the contribution limits are the same. (15.5K after-tax > 15.5K pre-tax.)
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Postby arjking » Thu Dec 27, 2007 10:53 pm

EmergDoc wrote:The complicating factor, of course, is that you can save more money in a tax-protected manner using a Roth 401K since the contribution limits are the same. (15.5K after-tax > 15.5K pre-tax.)


Another way to look at it, if you live in a world of after-tax dollars, it only costs 11.5K in after-tax to save 15.5K in a regular 401K. That is a one-time instantaneous return of 35% on your money. Compare this to costing you 15.5k after-tax to invest 15.5k in a Roth.

I think for most people who have been successful in their careers will have their debts and children paid off and will not need draw down as much money as they did during their working years.

Having said that I invest 100% in a Roth 401k and in a Roth IRA because I am under 30 and that money has a long time to grow and more time to make up for the price I paid to invest in the Roth instead of the traditional. I think you should also consider how long the money has to grow.

Take this idea to the extreme and say you have 1 year to invest, would you rather pay the income tax now and not pay capital gains one year from now or defer the income tax for one year (and pay at a lower rate because you are no longer working in 1 year).
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Future tax rates

Postby crefwatch » Fri Dec 28, 2007 9:20 am

EmergDoc wrote:Assuming a retiree is living off nothing but Roth 401K and 401K distributions, he won't pay anything on the Roth distributions and will pay nothing on the first $10K and little on the next 40K or so.


My parents, for example, were not inclined to leave their long-term NY City apartment when they retired. So they still had a relatively high-cost location for their retirement. Luckily, they had saved enough to enjoy it. But they needed well over 10K+40K a year.

Nobody likes to see the names of political parties on these boards. But surely you'll concede that we are incurring huge deficits and have worse news ahead on Medicare and Social Security. And the trend in recent years (astonishingly, to me...) has been for the party that's currently in power to spend without bringing in enough in taxes, and for the party that's likely to win the next election to restore financial sanity at the expense of their own popularity.

Of course, my point is that there is considerable uncertainty about the future tax structure. Other posters have even raised the possibility of a national sales or consumption tax as a reason not to use a Roth. I consider that to be much less likely than higher taxes on people who are below the influential "top 5%" of income-taxpayers.

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Re: Roth 401(k) versus 401(k) for high income investors?

Postby sambb » Sat Mar 30, 2013 8:54 pm

has the reasoing on this changed since the OP posted in 2007, and now tax rates are higher? If one is in the 35% or higher brackets, I assume that the traditional 401k is probably a better option, but the differences are minimal?
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby investor1 » Sat Mar 30, 2013 11:37 pm

The considerations around whether to use a Roth account or traditional account have not changed as the rules of the account haven't changed.

1. If you think your tax rate will be lower in retirement, defer taxes.
2. If you think your tax rate is lower now, pay taxes now rather than later.
3. Most people pay a lower tax rate in retirement.
4. Diversifying your investments across tax deferred, tax exempt, and taxable accounts will give you to most flexibility to control your income and tax rate in retirement.
5. Of course, there are other rules regarding each account that affect your decision as well such as the RMD rules and what happens to any money left after you die.

Tax rates recently went up for the upper brackets. The people affected could ask themselves whether or not they think the rates will go up or down during retirement. However, the answer is that nobody knows. Sizable tax deferred accounts (which someone in the affected brackets is in a position to obtain) result in higher income due to RMDs which makes it harder to control tax rates in retirement. If you don't expect that to push you into high tax brackets in retirement, deferring taxes makes sense.

IMHO, the best thing to do is to contribute to a traditional, Roth, and taxable account. As you climb the tax brackets, you will likely save more money. As this happens, it would make sense to defer more taxes in most cases due to expected lower income in retirement.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby grabiner » Mon Apr 01, 2013 10:21 pm

sambb wrote:has the reasoing on this changed since the OP posted in 2007, and now tax rates are higher? If one is in the 35% or higher brackets, I assume that the traditional 401k is probably a better option, but the differences are minimal?


Wiki article link: Traditional versus Roth

It still depends on your current and future tax brackets. If you are in a high bracket and expect to retire in the same bracket, the Roth is still better because you get to tax-defer more money (most investors in high brackets can max out Roths). If you are in a high bracket and expect to retire in a significantly lower bracket (39.6% to 33%, 33% to 28%), the traditional 401(k) may be worth more even though you have to invest the tax savings in a taxable account.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Tue Apr 02, 2013 8:29 am

Pensions also play a significant role in the choice. If you are not expecting a pension, you will want some tax-deferred savings to fill the lower tax brackets in retirement.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby donaldfair71 » Tue Apr 02, 2013 12:01 pm

investor1 wrote:The considerations around whether to use a Roth account or traditional account have not changed as the rules of the account haven't changed.

1. If you think your tax rate will be lower in retirement, defer taxes.
2. If you think your tax rate is lower now, pay taxes now rather than later.
3. Most people pay a lower tax rate in retirement.
4. Diversifying your investments across tax deferred, tax exempt, and taxable accounts will give you to most flexibility to control your income and tax rate in retirement.
5. Of course, there are other rules regarding each account that affect your decision as well such as the RMD rules and what happens to any money left after you die.

Tax rates recently went up for the upper brackets. The people affected could ask themselves whether or not they think the rates will go up or down during retirement. However, the answer is that nobody knows. Sizable tax deferred accounts (which someone in the affected brackets is in a position to obtain) result in higher income due to RMDs which makes it harder to control tax rates in retirement. If you don't expect that to push you into high tax brackets in retirement, deferring taxes makes sense.

IMHO, the best thing to do is to contribute to a traditional, Roth, and taxable account. As you climb the tax brackets, you will likely save more money. As this happens, it would make sense to defer more taxes in most cases due to expected lower income in retirement.


I did a personal inventory on my own predictive situations (using online calculators- not perfect, but a good estimate) and found that, while I am working in a 25% bracket and will likely retire in 15% (30 years from now), the break even point between Roth vs Traditional is 18%. That is, if that 15% current bracket is raised to 18%, I basically break even by using the Roth. I think it's important to understand (as you do) that tax rates could very well rise (or fall- but less likely IMO) in retirement, even if it brings you to a lower bracket.

Personally, I do 50/50 Trad. vs Roth, just to diversify.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Tue Apr 02, 2013 12:24 pm

donaldfair71 wrote:I did a personal inventory on my own predictive situations (using online calculators- not perfect, but a good estimate) and found that, while I am working in a 25% bracket and will likely retire in 15% (30 years from now), the break even point between Roth vs Traditional is 18%. That is, if that 15% current bracket is raised to 18%, I basically break even by using the Roth. I think it's important to understand (as you do) that tax rates could very well rise (or fall- but less likely IMO) in retirement, even if it brings you to a lower bracket.

Personally, I do 50/50 Trad. vs Roth, just to diversify.


Did your analysis take into account that in retirement some of your income will not be taxed and a portion will be taxed at 10%, even if you are in the 15% bracket?
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby burma7734 » Tue Apr 02, 2013 12:26 pm

I wrestled with this too and ultimately decided to split my 401k contribution - 30% to Roth 401k - just for some additional tax diversification. The Roth 401k assets are in Total Stock Market.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby donaldfair71 » Tue Apr 02, 2013 12:34 pm

rkhusky wrote:
donaldfair71 wrote:I did a personal inventory on my own predictive situations (using online calculators- not perfect, but a good estimate) and found that, while I am working in a 25% bracket and will likely retire in 15% (30 years from now), the break even point between Roth vs Traditional is 18%. That is, if that 15% current bracket is raised to 18%, I basically break even by using the Roth. I think it's important to understand (as you do) that tax rates could very well rise (or fall- but less likely IMO) in retirement, even if it brings you to a lower bracket.

Personally, I do 50/50 Trad. vs Roth, just to diversify.


Did your analysis take into account that in retirement some of your income will not be taxed and a portion will be taxed at 10%, even if you are in the 15% bracket?


I did not do that. The calculator I used was basically for Roth vs. Traditional, with a break even component. Thank you for pointing out the different way that Traditional will be taxed vs. Roth.

My next question... What % of my portfolio (I use a simple US + INT + REIT+ Total Bond portfolio) will be, today, subject to no taxes or the 10% in the traditional?
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby keystone » Tue Apr 02, 2013 12:45 pm

burma7734 wrote:I wrestled with this too and ultimately decided to split my 401k contribution - 30% to Roth 401k - just for some additional tax diversification. The Roth 401k assets are in Total Stock Market.


Same here. I thought about this a lot and my decision was to split it up a bit. I have been contributing 4K a year to the Roth 401K for years, with the rest to the traditional 401K, in addition to maxing my Roth IRA. I understand the arguments on both sides and for me it was all about giving me more tax flexibility in a cloud of uncertainty. Also, my wife will most likely be working for 10 years while I am retired, so anything I withdraw from a traditional account will be taxed at a rate no less than 25%. Furthermore, I really just like the idea of having a big pot of money that I can invest and withdraw and never have to worry about tax consequences.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Tue Apr 02, 2013 12:56 pm

donaldfair71 wrote:
rkhusky wrote:
donaldfair71 wrote:I did a personal inventory on my own predictive situations (using online calculators- not perfect, but a good estimate) and found that, while I am working in a 25% bracket and will likely retire in 15% (30 years from now), the break even point between Roth vs Traditional is 18%. That is, if that 15% current bracket is raised to 18%, I basically break even by using the Roth. I think it's important to understand (as you do) that tax rates could very well rise (or fall- but less likely IMO) in retirement, even if it brings you to a lower bracket.

Personally, I do 50/50 Trad. vs Roth, just to diversify.


Did your analysis take into account that in retirement some of your income will not be taxed and a portion will be taxed at 10%, even if you are in the 15% bracket?


I did not do that. The calculator I used was basically for Roth vs. Traditional, with a break even component. Thank you for pointing out the different way that Traditional will be taxed vs. Roth.

My next question... What % of my portfolio (I use a simple US + INT + REIT+ Total Bond portfolio) will be, today, subject to no taxes or the 10% in the traditional?


It depends on how much you will be withdrawing each year, your other sources of income, tax deductions, etc. It is basically just the tax brackets and deductions and exemptions. For example, if married, approximately $20K will not be taxed, the next $18K will be taxed at 10%.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby donaldfair71 » Tue Apr 02, 2013 1:19 pm

rkhusky wrote:
donaldfair71 wrote:
rkhusky wrote:
donaldfair71 wrote:I did a personal inventory on my own predictive situations (using online calculators- not perfect, but a good estimate) and found that, while I am working in a 25% bracket and will likely retire in 15% (30 years from now), the break even point between Roth vs Traditional is 18%. That is, if that 15% current bracket is raised to 18%, I basically break even by using the Roth. I think it's important to understand (as you do) that tax rates could very well rise (or fall- but less likely IMO) in retirement, even if it brings you to a lower bracket.

Personally, I do 50/50 Trad. vs Roth, just to diversify.


Did your analysis take into account that in retirement some of your income will not be taxed and a portion will be taxed at 10%, even if you are in the 15% bracket?


I did not do that. The calculator I used was basically for Roth vs. Traditional, with a break even component. Thank you for pointing out the different way that Traditional will be taxed vs. Roth.

My next question... What % of my portfolio (I use a simple US + INT + REIT+ Total Bond portfolio) will be, today, subject to no taxes or the 10% in the traditional?


It depends on how much you will be withdrawing each year, your other sources of income, tax deductions, etc. It is basically just the tax brackets and deductions and exemptions. For example, if married, approximately $20K will not be taxed, the next $18K will be taxed at 10%.


Oh, okay, I understand now. you mean, include the typical exemptions/first X amount will be taxed at X amount, then X amount... Basically, marginal rates.
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Re:

Postby dmcmahon » Tue Apr 02, 2013 1:54 pm

EmergDoc wrote:I think those who are in their peak earning years are usually better off with a regular 401K because they are deducting taxes at their marginal rate that will later be paid at rates less than their marginal rate. Assuming a retiree is living off nothing but Roth 401K and 401K distributions, he won't pay anything on the Roth distributions and will pay nothing on the first $10K and little on the next 40K or so. In effect, he saves taxes at 33% and pays them at 25%. It is a good deal even if his tax bracket doesn't change (unless SS or a taxable pension makes the distribution completely taxed at his marginal rate).


This is my thinking as well FWIW.

EmergDoc wrote:The complicating factor, of course, is that you can save more money in a tax-protected manner using a Roth 401K since the contribution limits are the same. (15.5K after-tax > 15.5K pre-tax.)


My plan is to convert the 401k to a Roth IRA after I retire. I'll do it gradually so as to avoid a higher tax bracket, and pay the tax out of other funds. This should partially make up for the issue you raise.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Tue Apr 02, 2013 1:55 pm

donaldfair71 wrote:Oh, okay, I understand now. you mean, include the typical exemptions/first X amount will be taxed at X amount, then X amount... Basically, marginal rates.


Marginal rate usually refers to how much your last dollar of income is taxed, which can be different from your tax bracket due to deduction phase out zones. When you are deciding between investing in 401K and Roth, you are dealing with marginal rates. When you are withdrawing, it is more like the average rate. Unless you have a large pension that fills the lower brackets.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby donaldfair71 » Tue Apr 02, 2013 9:14 pm

rkhusky wrote:
donaldfair71 wrote:Oh, okay, I understand now. you mean, include the typical exemptions/first X amount will be taxed at X amount, then X amount... Basically, marginal rates.


Marginal rate usually refers to how much your last dollar of income is taxed, which can be different from your tax bracket due to deduction phase out zones. When you are deciding between investing in 401K and Roth, you are dealing with marginal rates. When you are withdrawing, it is more like the average rate. Unless you have a large pension that fills the lower brackets.


That's one element that somewhat complicates my projections, that as of now, my wife and I will have pensions of about 50% our final salaries (both teachers). Until retirement, I am trying to save/invest as though this doesn't exist. We save a total of 24% toward our retirement in 403b and IRA between us, and anticipate saving more as financial changes and paid off loans free up more money. I see it best to let the pension, should it still be there, provide a pleasant surprise rather than a crutch. This, however, would likely make me glad to an extent that I paid some taxes now than delaying all until retirement.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby grabiner » Tue Apr 02, 2013 10:00 pm

rkhusky wrote:
donaldfair71 wrote:Oh, okay, I understand now. you mean, include the typical exemptions/first X amount will be taxed at X amount, then X amount... Basically, marginal rates.


Marginal rate usually refers to how much your last dollar of income is taxed, which can be different from your tax bracket due to deduction phase out zones. When you are deciding between investing in 401K and Roth, you are dealing with marginal rates. When you are withdrawing, it is more like the average rate. Unless you have a large pension that fills the lower brackets.


I would use the marginal rate even for taxes on withdrawals, because the traditional/Roth decision is made every year, for every dollar. If you expect to retire in the 15% tax bracket if you put $17,500 in your traditional 401(k), then you will probably still be in the 15% bracket if you put $17,400 in the traditional 401(k) and $100 in the Roth instead. You will pay $15 more in taxes this year, but you will avoid a 15% tax on whatever that last $100 grows into by the time you withdraw it. Now, you can decide whether $200 in the Roth is better than $100, and so on. And even the full $17,500 will only provide a small fraction of your retirement income, so it will likely all be taxed at 15%; most of your retirement income will come from money already invested, and from money invested in future years in which you make the Roth versus traditional decison based on your tax situation in those years.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Wed Apr 03, 2013 8:33 am

donaldfair71 wrote:
rkhusky wrote:
donaldfair71 wrote:Oh, okay, I understand now. you mean, include the typical exemptions/first X amount will be taxed at X amount, then X amount... Basically, marginal rates.


Marginal rate usually refers to how much your last dollar of income is taxed, which can be different from your tax bracket due to deduction phase out zones. When you are deciding between investing in 401K and Roth, you are dealing with marginal rates. When you are withdrawing, it is more like the average rate. Unless you have a large pension that fills the lower brackets.


That's one element that somewhat complicates my projections, that as of now, my wife and I will have pensions of about 50% our final salaries (both teachers). Until retirement, I am trying to save/invest as though this doesn't exist. We save a total of 24% toward our retirement in 403b and IRA between us, and anticipate saving more as financial changes and paid off loans free up more money. I see it best to let the pension, should it still be there, provide a pleasant surprise rather than a crutch. This, however, would likely make me glad to an extent that I paid some taxes now than delaying all until retirement.


I think most people will find advantages to being "tax diversified" so that one has added flexibility when withdrawing funds. If you expect your investment withdrawals will be at about the same marginal rate as you are now, then it is pretty much a wash which is better. I think there is a slight advantage to the 401K if you are not maximizing your contributions and a slight advantage to the Roth if you are.

One other thing to consider is whether there will be time between when you retire and when you start taking pensions and SS. If there are, you can convert part of your 401K to a Roth each year (or live on the withdrawals) and effectively pay no tax now and little to no tax later.
Last edited by rkhusky on Wed Apr 03, 2013 8:42 am, edited 2 times in total.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Wed Apr 03, 2013 8:35 am

grabiner wrote:
rkhusky wrote:
donaldfair71 wrote:Oh, okay, I understand now. you mean, include the typical exemptions/first X amount will be taxed at X amount, then X amount... Basically, marginal rates.


Marginal rate usually refers to how much your last dollar of income is taxed, which can be different from your tax bracket due to deduction phase out zones. When you are deciding between investing in 401K and Roth, you are dealing with marginal rates. When you are withdrawing, it is more like the average rate. Unless you have a large pension that fills the lower brackets.


I would use the marginal rate even for taxes on withdrawals, because the traditional/Roth decision is made every year, for every dollar. If you expect to retire in the 15% tax bracket if you put $17,500 in your traditional 401(k), then you will probably still be in the 15% bracket if you put $17,400 in the traditional 401(k) and $100 in the Roth instead. You will pay $15 more in taxes this year, but you will avoid a 15% tax on whatever that last $100 grows into by the time you withdraw it. Now, you can decide whether $200 in the Roth is better than $100, and so on. And even the full $17,500 will only provide a small fraction of your retirement income, so it will likely all be taxed at 15%; most of your retirement income will come from money already invested, and from money invested in future years in which you make the Roth versus traditional decison based on your tax situation in those years.


When taking into account that the lower brackets are filled by the pension?
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby learning_head » Wed Apr 03, 2013 11:01 am

If you have a high income and are paying AMT, don't forget to use proper AMT marginal tax rate. If your AMT exemption (line 29 of 6251) is > 0, then your federal marginal rate is either 32.5% or 35%. Then, add any state taxes and local ones (depending on how they tax 401(k)). I suspect in many cases, regular 401(k) will be better in such cases.

Regarding diversification, you can still have Roth IRA, which would be ~1/3 of your 401k amount if your 401k max is ~17k / person.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby Iorek » Wed Apr 03, 2013 11:51 am

donaldfair71 wrote:
I did a personal inventory on my own predictive situations (using online calculators- not perfect, but a good estimate) and found that, while I am working in a 25% bracket and will likely retire in 15% (30 years from now), the break even point between Roth vs Traditional is 18%. That is, if that 15% current bracket is raised to 18%, I basically break even by using the Roth. I think it's important to understand (as you do) that tax rates could very well rise (or fall- but less likely IMO) in retirement, even if it brings you to a lower bracket.



I don't understand why the break even point isn't 25%? Is it because you are disregarding the $ used to pay tax on the Roth contributions, or am I missing something?
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby CMartel2 » Wed Apr 03, 2013 12:15 pm

Some of this would depend on which state you plan on living in and in which state you plan on retiring, correct?

For instance, retiring in Pennsylvania means no taxes on 401k distributions. It wouldn't make much sense to use a ROTH there. If you planned on moving from a low tax state to a high tax state at retirement, a ROTH makes more sense, correct?
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby donaldfair71 » Wed Apr 03, 2013 1:45 pm

Iorek wrote:
donaldfair71 wrote:
I did a personal inventory on my own predictive situations (using online calculators- not perfect, but a good estimate) and found that, while I am working in a 25% bracket and will likely retire in 15% (30 years from now), the break even point between Roth vs Traditional is 18%. That is, if that 15% current bracket is raised to 18%, I basically break even by using the Roth. I think it's important to understand (as you do) that tax rates could very well rise (or fall- but less likely IMO) in retirement, even if it brings you to a lower bracket.



I don't understand why the break even point isn't 25%? Is it because you are disregarding the $ used to pay tax on the Roth contributions, or am I missing something?



My methodology (and I could be wrong on this-- again, just used a simple Roth Vs traditional calculator found here: http://www.dinkytown.net/java/RothvsRegular.html)..

I took the maximum contribution (5,500), my tax bracket (25%), and my potential tax bracket in retirement (15%) With this calculation (7% return), my amount would be:

Roth $514,034
Traditional + Tax Savings $530,928

If I go to 25% at both levels:

Roth is still $514,034
Traditional + tax Savings $479,525

I think this is due to the tax-free growth of the Roth overcoming the tax savings provided up-front.

The break even point for retirement tax rate (or roughly) is 18%:

Roth is still at the $514,034
Traditional + Tax Savings $515,507

So, at 18% in retirement, the contributions are (roughly) moot. If I am still at the 25% when I retire, the Roth was a good move. If I lower to anything below 18%, I guess I should have attempted to stash away more in traditional.

2 Things I should have noted:

1. I am less than a thousand dollars away from hitting the threshold where I cannot give to a traditional IRA, since I have a 403b available to me. So going forward, contributing 5,500 to a traditional IRA is not viable. And I cannot properly diversify internationally with my district's 403b (the lowest ER on an international fund is actively-managed at .86).

2. Contributing more to a traditional would not lower my marginal tax rate, since taking the 11,000 (my wife and I both contribute and file jointly) wouldn't bring us down to the next lowest bracket.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby donaldfair71 » Wed Apr 03, 2013 1:56 pm

CMartel2 wrote:Some of this would depend on which state you plan on living in and in which state you plan on retiring, correct?

For instance, retiring in Pennsylvania means no taxes on 401k distributions. It wouldn't make much sense to use a ROTH there. If you planned on moving from a low tax state to a high tax state at retirement, a ROTH makes more sense, correct?


Great points, and Pennsylvania (where my wife and I are from) is a possible landing spot, with the 401k/pension benefits for retirees. Virginia, where we currently work (and provides fewer benefits to retirees) could be a spot just as well, since our kid(s) could wind up setting up their own roots here, which may or may not make it tough to leave. Because of our indecision on this matter, we tend to not pay too much attention to it because we feel, at this point (30 years from retirement), it's out of our control.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Wed Apr 03, 2013 2:04 pm

CMartel2 wrote:Some of this would depend on which state you plan on living in and in which state you plan on retiring, correct?

For instance, retiring in Pennsylvania means no taxes on 401k distributions. It wouldn't make much sense to use a ROTH there. If you planned on moving from a low tax state to a high tax state at retirement, a ROTH makes more sense, correct?


There is still the federal income tax, which is usually higher than the state tax.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Wed Apr 03, 2013 2:21 pm

donaldfair71 wrote:My methodology (and I could be wrong on this-- again, just used a simple Roth Vs traditional calculator found here: http://www.dinkytown.net/java/RothvsRegular.html)..


It is not clear how the taxes on the withdrawals are calculated. Are they calculated as if all the withdrawals occur at the marginal rate?
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby sesq » Wed Apr 03, 2013 5:35 pm

CMartel2 wrote:Some of this would depend on which state you plan on living in and in which state you plan on retiring, correct?

For instance, retiring in Pennsylvania means no taxes on 401k distributions. It wouldn't make much sense to use a ROTH there. If you planned on moving from a low tax state to a high tax state at retirement, a ROTH makes more sense, correct?


Well, as a counter-point, contributions to traditional 401(k)'s in PA get no deduction from the state tax base. I max a Roth 401(k), and live in PA. My rationale is two-fold, since a tax free dollar is worth more than a tax deferred dollar I view this as a means to effectively make larger contributions to statutory limited retirement funds. Also, since think its very possible I won't live in PA in retirement, if the new state has an income tax my expected future state tax rate will be higher. Since the match is tax deferred I also ensure tax diversification if I am in lower rates one day.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby FinancialDave » Wed Apr 03, 2013 6:15 pm

I am in the Vanguard camp of do both, especially from a very young age.

If you do that you can literally control your tax rate down to zero, or almost zero in retirement, making the non-Roth money much more valuable, to make up in most cases for the higher taxes you had to pay on the Roth money to begin with.

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Re: Roth 401(k) versus 401(k) for high income investors?

Postby donaldfair71 » Thu Apr 04, 2013 7:37 am

rkhusky wrote:
donaldfair71 wrote:My methodology (and I could be wrong on this-- again, just used a simple Roth Vs traditional calculator found here: http://www.dinkytown.net/java/RothvsRegular.html)..


It is not clear how the taxes on the withdrawals are calculated. Are they calculated as if all the withdrawals occur at the marginal rate?


I'm not sure about that. I looked at the calculator, and withdrawal rates/procedures are not there (or I can't find them).

I believe that the calculator takes into account current rates/marginal levels and, on the end side (retirement), takes into account marginal rates as well. Of course, it may not (though I am not sure how useful such a calculator would be if it did not.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby rkhusky » Thu Apr 04, 2013 8:04 am

donaldfair71 wrote:
rkhusky wrote:
donaldfair71 wrote:My methodology (and I could be wrong on this-- again, just used a simple Roth Vs traditional calculator found here: http://www.dinkytown.net/java/RothvsRegular.html)..


It is not clear how the taxes on the withdrawals are calculated. Are they calculated as if all the withdrawals occur at the marginal rate?


I'm not sure about that. I looked at the calculator, and withdrawal rates/procedures are not there (or I can't find them).

I believe that the calculator takes into account current rates/marginal levels and, on the end side (retirement), takes into account marginal rates as well. Of course, it may not (though I am not sure how useful such a calculator would be if it did not.


To get an accurate estimate of taxes in retirement, it seems like you would need to account for the expected amount withdrawn from retirement accounts and expected pensions and Social Security payments.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby JW Nearly Retired » Thu Apr 04, 2013 9:24 am

rkhusky wrote:
donaldfair71 wrote:
rkhusky wrote:
donaldfair71 wrote:My methodology (and I could be wrong on this-- again, just used a simple Roth Vs traditional calculator found here: http://www.dinkytown.net/java/RothvsRegular.html)..


It is not clear how the taxes on the withdrawals are calculated. Are they calculated as if all the withdrawals occur at the marginal rate?


I'm not sure about that. I looked at the calculator, and withdrawal rates/procedures are not there (or I can't find them).

I believe that the calculator takes into account current rates/marginal levels and, on the end side (retirement), takes into account marginal rates as well. Of course, it may not (though I am not sure how useful such a calculator would be if it did not.


To get an accurate estimate of taxes in retirement, it seems like you would need to account for the expected amount withdrawn from retirement accounts and expected pensions and Social Security payments.

Looks like dinkytown is comparing after tax retirement income between $5k/yr in the roth and $5k/yr traditional + yearly tax savings put in a taxable account. The traditional does less well at 25% bracket because the taxable account earnings are taxed yearly. IMO this comparison is fine if you are already maxing out all your 401k like accounts and have plenty of extra money to invest.

The other way to look at it is as if you can't afford to max out everything. Probably that's the more likely case. In that case, (at 25% marginal bracket) the choice is really between putting $5k in traditional or 0.75x5 = $3.75k in the roth. This is the case that leads to exactly the same after-tax retirement income from either account if the marginal brackets are the same going in as coming out.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby FinancialDave » Thu Apr 04, 2013 11:39 am

My suggestion as always is not to try to predict the future --- ie using some dubious tax calculator.

Use a plan that allows you to cover your bases and minimize your taxes no matter what your income needs.

One other thing to realize is that it is very possible that a married couple could have $30,000 to $40,000 dollars of tax free income due to both Social Security and tax standard deduction and exemptions, so trying to make a prediction of this model requires you, not only to predict the future, but that you know how the tax structure will look in the future. That is why the best plan than anyone could suggest (IMHO) is a balanced plan of doing some of both, and throw the calculator out the window, until you actually get to requirement and what to execute the correct plan.

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Re: Roth 401(k) versus 401(k) for high income investors?

Postby pastafarian » Thu Apr 04, 2013 11:58 am

FinancialDave wrote:One other thing to realize is that it is very possible that a married couple could have $30,000 to $40,000 dollars of tax free income due to both Social Security and tax standard deduction and exemptions...

Refresh my memory, if the standard deduction and 2 personal exemptions total $20k how does a couple get $30k-$40k tax free. Sign me up! :D
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby Bill M » Thu Apr 04, 2013 12:17 pm

High taxes now, versus low taxes in retirement. Sounds like a no-brainer. But I don't think it is. There are two aspects in my decision to go with the Roth 401(k): I prefer to pay taxes out of income rather than out of savings, and secondly, planning for required minimum distributions adds lots of complexity to what is otherwise a simple plan for our 70's and later. To the extent possible, I'd prefer to draw down the taxable savings first, leaving the tax deferred and tax-free alone as long as possible. Being able to do that for 10-15 years made the future net-worth higher with the Roth option. In addition to contributing to the Roth 401(k) now, I'm also doing in-plan Roth conversions of the pre-tax portions.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby Doc » Thu Apr 04, 2013 12:23 pm

pastafarian wrote:
FinancialDave wrote:One other thing to realize is that it is very possible that a married couple could have $30,000 to $40,000 dollars of tax free income due to both Social Security and tax standard deduction and exemptions...

Refresh my memory, if the standard deduction and 2 personal exemptions total $20k how does a couple get $30k-$40k tax free. Sign me up! :D


You are already signed up.

SS is not taxable until 1/2 your SS + almost everything else exceeds $32k. And then you still have your standard deduction plus exemptions before you get to the bottom of the ten percent bracket.

And at the point you get to that level your marginal rate climbs very rapidly to 27.5%. :(
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby pastafarian » Thu Apr 04, 2013 12:33 pm

Bill M wrote:High taxes now, versus low taxes in retirement. Sounds like a no-brainer. But I don't think it is. There are two aspects in my decision to go with the Roth 401(k): I prefer to pay taxes out of income rather than out of savings, and secondly, planning for required minimum distributions adds lots of complexity to what is otherwise a simple plan for our 70's and later.

I'm in a similar frame of mind. Last year started making modest Roth conversions, 3% of TD assets. Plan to continue that. This year and going forward making only Roth 401(k) contributions. The idea being it's easier (less stressful) to pay taxes with current cash flow rather than tapping savings after I retire.
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby pastafarian » Thu Apr 04, 2013 12:40 pm

Doc wrote:You are already signed up.

SS is not taxable until 1/2 your SS + almost everything else exceeds $32k. And then you still have your standard deduction plus exemptions before you get to the bottom of the ten percent bracket.

And at the point you get to that level your marginal rate climbs very rapidly to 27.5%. :(

This I understand. I'll be over that threshold before I collect SS. Was simply trying to find some additional tax free money beyond the stand deduction + 2 personal exemptions. So my request to sign me up remains :D
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby FinancialDave » Thu Apr 04, 2013 10:24 pm

Doc wrote:
pastafarian wrote:
FinancialDave wrote:One other thing to realize is that it is very possible that a married couple could have $30,000 to $40,000 dollars of tax free income due to both Social Security and tax standard deduction and exemptions...

Refresh my memory, if the standard deduction and 2 personal exemptions total $20k how does a couple get $30k-$40k tax free. Sign me up! :D


You are already signed up.

SS is not taxable until 1/2 your SS + almost everything else exceeds $32k. And then you still have your standard deduction plus exemptions before you get to the bottom of the ten percent bracket.

And at the point you get to that level your marginal rate climbs very rapidly to 27.5%. :(


OK,
Here's the actual math which I confirmed with 2012 TurboTax, for a married couple.

Scenario #1, extremely rich couple both waited to age 70 to withdraw large social security -- maximum tax-free amount they can withdraw is just north of $125,000 tax-free! Clarification - this is 100% SS -- highly unlikely, but shows how little SS is taxed, if that is all you have.

Scenario #2, more normal couple, both age 65 or older with pension income and Social Security. Let's look at the basic tax minimums.

Pension $21,800 (exactly equal to deductions and exemption) - 0 tax.
Soc Sec $20,400 (1/2 of SS + above $21,800 must stay under $32k) - 0 tax.
In this case $42,200 is the normal tax free income from this particular case.

This is for the person wanting more tax-free income!


Scenario #3, you have a more normal SS combined income of $3000 a month or $36,000 -- how do I get to $100,000 of tax free income, provided I have no pension and am just using my Roth / Standard IRA money.

SS = $36,000
Std IRA = $19,000
So far this is $55,000 of tax-free money, $19,000 of which came from that IRA, for which you paid no tax on originally.
Now to get up to $100k income just add $45,000 from your Roth account.

This is why I always stress it is so important to have a good Roth / non Roth retirement split -- here you got a sizable chunk of tax-free IRA money before you even needed to use your Roth.


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Re: Roth 401(k) versus 401(k) for high income investors?

Postby Doc » Fri Apr 05, 2013 11:43 am

FinancialDave wrote:OK,
Here's the actual math which I confirmed with 2012 TurboTax, for a married couple.

Scenario #1, extremely rich couple both waited to age 70 to withdraw large social security -- maximum tax-free amount they can withdraw is just north of $125,000 tax-free!

Scenario #2, more normal couple, both age 65 or older with pension income and Social Security. Let's look at the basic tax minimums.


I can't duplicate you #1. The bottom of the MFJ 10% tax bracket in 2012 is $17400. Add the $21800 deduction and exemptions gets you to only $39200 not your $125000+. What am I missing? Did you assume that the $125000 was all qualified dividends or LTCG?

(I like the way you used the pension to "eat up" the standard deduction/exemption. It makes the understanding of the tax forms much clearer. Good idea.)
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Re: Roth 401(k) versus 401(k) for high income investors?

Postby FinancialDave » Fri Apr 05, 2013 1:28 pm

Doc wrote:
FinancialDave wrote:OK,
Here's the actual math which I confirmed with 2012 TurboTax, for a married couple.

Scenario #1, extremely rich couple both waited to age 70 to withdraw large social security -- maximum tax-free amount they can withdraw is just north of $125,000 tax-free!

Scenario #2, more normal couple, both age 65 or older with pension income and Social Security. Let's look at the basic tax minimums.


I can't duplicate you #1. The bottom of the MFJ 10% tax bracket in 2012 is $17400. Add the $21800 deduction and exemptions gets you to only $39200 not your $125000+. What am I missing? Did you assume that the $125000 was all qualified dividends or LTCG?

(I like the way you used the pension to "eat up" the standard deduction/exemption. It makes the understanding of the tax forms much clearer. Good idea.)



It was 100% SS, just to show how little SS is taxed. I realize with limits of SS I don't think anyone could even get there, but I just wanted to put an upper limit on 100% SS income. You obviously could get above that number with everything else tax-free, either from Roth, municipals, or even a taxable account with zero gains, qualified dividends or LTCG.

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