401k T or Roth & dependence with tax bracket

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401k T or Roth & dependence with tax bracket

Postby quanuec » Mon Jul 01, 2013 8:34 am

When should you contribute to 401k Roth instead of 401k Traditional? Are there any rule of thumbs which relate tax bracket to this decision? Assume that one makes a contribution towards retirement in taxable of atleast the same amount as the tax saved on 401k T.

Fox example, say the marginal tax rate is 30%. Mr. X contributed 17,500. He also contributes 5250 in his taxable account towards his retirement. Now which would be better (a) or (b):

(a): 17,500+5250 invested for 30 years with returns on 17,500 as ordinary income and returns on 5250 as long term cap gains.
(b): 17500 growing tax free.

We need the rate of return, time horizon, tax rate at withdrawal to crunch real numbers here. Curious to know if there is any already defined wisdom on this already.
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Re: 401k T or Roth & dependence with tax bracket

Postby livesoft » Mon Jul 01, 2013 8:37 am

Unfortunately, there are no rules of thumb, except perhaps one:

When one can convert a traditional in the future to a Roth while in a future lower tax bracket, use a traditional. Otherwise, use a traditional.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: 401k T or Roth & dependence with tax bracket

Postby Ketawa » Mon Jul 01, 2013 8:38 am

Use the spreadsheet that TFB linked in this post, and run your own numbers.

http://thefinancebuff.com/roth-401k-for-people-who-contribute-max.html

At a 30% marginal tax rate, I think almost everyone should be making deductible contributions.
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Re: 401k T or Roth & dependence with tax bracket

Postby quanuec » Mon Jul 01, 2013 8:38 am

So choosing a 401k Roth is a pure gamble?
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Re: 401k T or Roth & dependence with tax bracket

Postby livesoft » Mon Jul 01, 2013 8:39 am

It is a losing gamble for 99% of folks.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: 401k T or Roth & dependence with tax bracket

Postby grabiner » Mon Jul 01, 2013 6:57 pm

Wiki article link: Traditional versus Roth

Here are the general guidelines from that article (which also deals with the common choice between a traditional 401(k) and a Roth IRA if your employer doesn't offer a Roth 401(k).)

If your employer matches 401(k) contributions, put enough to get the maximum match in the 401(k) before contributing to any IRA.
If you have inferior options in the 401(k), prefer an IRA to the 401(k), even if the IRA must be Roth and you would prefer a traditional account.
Always prefer a Roth IRA over a non-deductible IRA.
If you are in the 15% tax bracket, prefer a Roth.
If you expect to be in a higher tax bracket than your current bracket for most of your career, prefer a Roth.
If you can max out a Roth account and will have a large traditional account or a pension, prefer a Roth.
Otherwise, prefer a traditional account.

In your example, in which Mr. X can max out a Roth 401(k), the Roth is likely to be better if he retires in an equal or nearly equal tax bracket; whether this happens depends on how much of his retirement income comes from already-made traditional contributions or pensions. (Note that the cost of the taxable investment is slightly more than the long-term capital gains, since dividends on the taxable invstment are taxed annually.)
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Re: 401k T or Roth & dependence with tax bracket

Postby dharrythomas » Tue Jul 02, 2013 8:00 pm

I prefer the Roth:

1. No RMD.
2. No income impact on the taxability of SS and increased Medicare B premiums.
3. No guessing (sorry 'estimating') on future tax rates to calculate how much of the account is mine and how much is the Governments.
4. If there is any money to be left to the kids, it really supercharges the account to have paid the taxes in advance. (If a traditional account is large enough to trigger estate taxes or for some reason you have to make a large withdrawal to pay estate taxes, the taxes on the money withdrawn plus estate tax can devour an account). You get a step up in basis for a taxable account, not an IRA.
5. I can convince my wife to save a certain dollar amount. She's willing (in fact prefers even though she knows it less money now) to let me make it a Roth, thus effectively more saved.

Since any matching contributions go into Traditional and since I'm no longer young, we've got a significant (for us) and growing balance in traditional. My intent is to live off pensions and the traditional accounts while letting the Roth money continue to compound. If we need it it'll be there, if we don't great--we're making an underappreciated contribution to the economy by saving and investing instead of spending and our kids and charity will get a nice bonus.

I also paid off my house and don't understand math of a higher order than probability and statistics and algebra. You may do better with traditional, but I'll do fine.

Good Luck

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Re: 401k T or Roth & dependence with tax bracket

Postby MN Finance » Tue Jul 02, 2013 9:21 pm

There aren't great rules of thumb because it depends mostly on bracket going in vs coming out (with some nuances like estate tax on estate size which is smaller with a roth, etc) If the bracket is the same is precisely a wash.

(Picky clarification, Roth 401s have RMDs, but it can be rolled to an IRA and avoided).
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Re: 401k T or Roth & dependence with tax bracket

Postby grabiner » Wed Jul 03, 2013 12:25 am

dharrythomas wrote:4. If there is any money to be left to the kids, it really supercharges the account to have paid the taxes in advance. (If a traditional account is large enough to trigger estate taxes or for some reason you have to make a large withdrawal to pay estate taxes, the taxes on the money withdrawn plus estate tax can devour an account).


The heirs can get the extra tax back when they withdraw; look up "income in respect of a decdent." (Essentially, if you inherit $400K on which estate tax is paid, but you then pay $100K in tax on that $400K, you get a tax credit for 1/4 of the estate tax.)

5. I can convince my wife to save a certain dollar amount. She's willing (in fact prefers even though she knows it less money now) to let me make it a Roth, thus effectively more saved.


This is actually an important advantage of the Roth for many investors; if you have decided to save 10% of your income and don't distinguish between pre-tax and post-tax saving, you'll have a better retirement if much of that saving is pre-tax.
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Re: 401k T or Roth & dependence with tax bracket

Postby burma7734 » Wed Jul 03, 2013 12:49 am

I decided to "tax diversify" and contribute my 401k to both Trad and Roth. I max my annual 401ka and IRA (backdoor roth) contribution. I have been putting 30% 401k contribution as Roth.

My assumptions:
1) Tax rates might be higher in the future than today
2) Most of my retirement assets are taxable (t401k+pension >> rIRA)
3) Ability to tax manage distributions might give me a lower average tax rate
4) The r401k contribution lets me contribute slightly more each year
5) Tax changes might result loss of backdoor roth

I would go higher with the r401k portion, but I get bit by CA state tax on that contribution that I might not have to pay if I move before retiring.

I have both stock and bonds in my 401k. I allocate the roth money to total stock market.
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