Roth 401k high income

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harry70nt
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Roth 401k high income

Post by harry70nt »

Having scoured forums regarding Roth vs 401k and Roth vs Traditional 401k, few have addressed high income individuals. Conventional wisdom seem to place Roth before 401k, especially when current tax rate is low. That debate is moot with high income as Roth isn't an option, but Roth 401k makes it relevant again.

What situations would one choose Roth vs Traditional 401k when current income is taxed at the highest bracket?
Does living in a high state income tax make Traditional 401k more desirable, especially considering moving to a no income tax state in retirement? (NYC -> Florida)
Seems like the reverse move would favor Roth 401k.
If no such changes is expected, and no future changes in tax rates and tax brackets are expected, and in retirement, income will be taxed at the highest brackets, do the two programs equalize?
In this case, how does a high income person split the yearly allowed contribution between Roth and Traditional 401k plans?
What other factors would lean one towards one or the other plan?

Thanks in advance for your comments, discussions and suggestions. Here are a couple of references extolling the benefits of having both Roth and tax deferred retirement accounts. Any input as to how much of each to end up would be helpful (more in the Roth vs more in the deferred, a little or a lot?).
http://www.rothira-advisor.com/radiosho ... rement.php
http://www.schwab.com/public/schwab/res ... ategy.html
JoeJohnson
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Re: Roth 401k high income

Post by JoeJohnson »

If you're in the top bracket and you live in NYC, I would think most people will recommend Traditional; especially if you are planning on moving to Florida in retirement.
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ThePrune
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Re: Roth 401k high income

Post by ThePrune »

harry70nt, The primary deciding factor for the choice between a traditonal or a Roth tax-advantaged account is your expectation for future tax bracket versus current tax bracket. This deciding factor doesn't change because you are currently in a high tax bracket.

If in retirement you anticipate being in a lower tax bracket than you are now, then definitely make use of traditional 401(k) and traditional IRA accounts. Why pay high tax rates on you income now when you could pay lower rates in the future?!

How might you know your tax bracket in retirement? By preparing a preliminary retirement plan! I'd recommend using the Optimal Retirement Planner ( http://www.i-orp.com) to examine this relative tax bracket issue. ORP includes a very complete federal tax calculation (although I don't think it has been updated for the Jan. 2, 2013 tax law changes).

On the state tax side of the equation, if you anticipate retiring to a low/no tax state (like Florida), then this would be another indication that traditional 401(k) and traditional IRA accounts would be more advantageous.

On the other hand, you might anticipate being able to maintain you current lifestyle throughout retirement. This might indicate that you would require about the same amount of taxable income during retirement as you require now. In cases where your future taxable income and corresponding future tax bracket would be the same (or higher) than your current tax bracket, then maxing out a Roth 401(k) would be advantageous.

For a very thorough discussion of all factors pertaining to the Traditional versus Roth decision, I recommend reading the article Roth Convesions - Pulling It All Together by Andrea Cohen.

Ultimately, you will need to do some calculations in order to make the best decision. Qualitative "talk" will not answer the question. Let me assure you answering this question correctly can lead to very large increases in your after-tax spending during retirement.
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NYBoglehead
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Re: Roth 401k high income

Post by NYBoglehead »

Recommend going with the Traditional 401k if you are in the higher tax brackets.
Topic Author
harry70nt
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Re: Roth 401k high income

Post by harry70nt »

Still no clear answers, but here's some additional background.

Dug back a little further and found this useful thread:
http://www.bogleheads.org/forum/viewtopic.php?t=10221

Vanguard article - Tax Diversification and the Roth 401k:
https://institutional.vanguard.com/iam/ ... h_401k.pdf


A couple of interesting articles about Backdoor Roth:
http://www.forbes.com/sites/josephstein ... gravation/
http://www.forbes.com/sites/ashleaebeli ... ent-kitty/

How does a 30 year old today saving $30k/year allocate retirement accounts? Another way to ask the question is if someone were to retire today with say $5M in retirement funds, how much of that would you want in Traditional 401k, Roth401k, and outside investments? (adjusting total amounts for taxes paid vs future tax liability)
livesoft
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Re: Roth 401k high income

Post by livesoft »

It wasn't that long ago that there was no such thing as a Roth IRA nor a Roth 401(k). Folks were able to accumulate big numbers for retirement without these types of accounts and even retire without problems.

A taxable account can be rather tax efficient and used for anything including retirement and college. I would go traditional 401(k) in the off chance that the future will have a lower tax bracket ... perhaps because of retiring early or a disability. Use I-bonds for some more tax-advantaged space, then load into taxable. One can have tax-exempt muni bond funds in taxable if one needs to. All-in-all you are in a great financial position.

And perhaps you or your employer has a deferred compensation plan that is worthwhile.
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Topic Author
harry70nt
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Re: Roth 401k high income

Post by harry70nt »

ThePrune wrote:harry70nt, The primary deciding factor for the choice between a traditonal or a Roth tax-advantaged account is your expectation for future tax bracket versus current tax bracket. This deciding factor doesn't change because you are currently in a high tax bracket.
Thanks for some great ideas. I believe the recent changes to the tax code do increase tax rates and tax brackets, benefiting (not harming) those that were in Roth programs, but going forward, more taxes are paid to get those same benefits for the top brackets. No change in tax bracket (already highest and staying in highest) or state is expected, but likelihood of higher tax rates/brackets is greater than lower.
On the other hand, you might anticipate being able to maintain you current lifestyle throughout retirement. This might indicate that you would require about the same amount of taxable income during retirement as you require now. In cases where your future taxable income and corresponding future tax bracket would be the same (or higher) than your current tax bracket, then maxing out a Roth 401(k) would be advantageous.
Exactly, a very possible situation.
For a very thorough discussion of all factors pertaining to the Traditional versus Roth decision, I recommend reading the article Roth Convesions - Pulling It All Together by Andrea Cohen.
Interesting article, contrasting to: http://thefinancebuff.com/case-against-roth-401k.html
Ultimately, you will need to do some calculations in order to make the best decision. Qualitative "talk" will not answer the question. Let me assure you answering this question correctly can lead to very large increases in your after-tax spending during retirement.
Yes, calculations help, but which assumptions to keep? Ultimately, it seems splitting some for diversification is the way to go. Doing a 50/50 split of the $17k limit means only paying taxes today on $8.5k, so about $3.5k vs $7k on full amount. That still leaves about 1/3 of the $30k annual that is in the outside account that's taxable now and later. Correctly keeping track of the tax savings today vs future tax savings/sheltering from a Roth is challenging to make equivalent comparisons. The 50/50 is pretty much arbitrary, so is there a smarter way to figure out a cap to how much should be in a Roth vs Traditional 401k and/or if there is a better ratio? And is that pre-tax or after tax?
Alan S. wrote:If things look generally good for you, and you intend to save aggressively, then you should have a mix of both IRA types. As time passes you can make adjustments as needed, but for the time being contributing perhaps 2/3 to TIRA and 1/3 to a Roth will give you some tax diversification in the future and you will have your bets hedged either way.
http://www.bogleheads.org/forum/viewtopic.php?t=75804

Why or why not the other way?
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archbish99
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Re: Roth 401k high income

Post by archbish99 »

WRT Roth vs. Traditional, when I was thinking about this, I concluded that I never want to shift so much into Roth than my withdrawals from Traditional wouldn't be enough to fully use deductions, either standard or projected itemized. Again, this requires a (highly hypothetical) retirement plan.

As a more general rule of thumb, though, I tend to believe I can probably get funds out of my Traditional accounts at a tax rate of no/little more than 25% if my parents' current finances are any indication. Thus, I'll always take Traditional in 25% or higher bracket, though of course a Roth IRA is better than a taxable account if deductible Traditional isn't an option. In the 15% bracket, it starts to seem worth considering for the 401k.
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Bill M
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Re: Roth 401k high income

Post by Bill M »

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. And the 401k, which still has RMDs, will be rolled over into a Roth IRA without RMDs.
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grabiner
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Re: Roth 401k high income

Post by grabiner »

harry70nt wrote:What situations would one choose Roth vs Traditional 401k when current income is taxed at the highest bracket?
If you expect to retire in the same bracket, the Roth has the usual advantage that it lets you tax-defer more money and is less subject to the risk of changing tax rates. (Presumably, if you expect to retire in a very high bracket, most of your income is subject to the risk of changing rates.)

The Roth also has the advantage that you may not need the money in retirement; Roth IRAs (including rollovers from Roth 401(k)s) are exempt from RMDs while you are alive, which will allow your children to inherit the money tax-free. (On the other hand, if your children inherit your traditional IRA or 401(k), they may be in a lower tax bracket and thus pay less in tax than you would have paid.)
Does living in a high state income tax make Traditional 401k more desirable, especially considering moving to a no income tax state in retirement? (NYC -> Florida)
Seems like the reverse move would favor Roth 401k.
Absolutely, as these are effectively changes in your retirement tax bracket. If you live in New York City, your marginal tax rate is about 46% (10% state tax is deductible from 39.6% federal tax). If you intend to retire to Florida, even if you are still in the top bracket, it will only be 39.6%.

If you expect to retire in a very high tax bracket, the Roth isn't going to have much affect on your retirement tax bracket, so you should probably go all-Roth or all-traditional, whichever makes more sense.
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retiredjg
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Re: Roth 401k high income

Post by retiredjg »

harry70nt wrote:That debate is moot with high income as Roth isn't an option...
Not necessarily.

Check this out. http://thefinancebuff.com/the-backdoor- ... ow-to.html
letsgobobby
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Re: Roth 401k high income

Post by letsgobobby »

We are in the 33% tax bracket and are very aggressive savers. The traditional 403b remains a no brainer for us. Why would I choose to pay 33% taxes now when I don't have to? We save in 403b, 401a, 457b, 457f, backdoor Roth IRA, taxable accounts, 529s, I bonds - the whole gamut. There is still no way my average tax rate in retirement will be as high or higher than 33%, assuming I want to withdraw only 3% per year or even less in the form of RMD from those pretax accounts. Remember all that Roth income and taxable income will be minimally taxed.

The exception to this general rule of thumb is if you are expecting a big defined benefit pension in retirement, that serves as a floor for your future income. In that case more Rth might be nice. but I don't count SS as a "big" pension, especially if you are high nome, based on my own presumptions about the likelihood of receiving promised benefits.
bsteiner
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Re: Roth 401k high income

Post by bsteiner »

harry70nt wrote:What situations would one choose Roth vs Traditional 401k when current income is taxed at the highest bracket?
Does living in a high state income tax make Traditional 401k more desirable, especially considering moving to a no income tax state in retirement? (NYC -> Florida)
Seems like the reverse move would favor Roth 401k.
If no such changes is expected, and no future changes in tax rates and tax brackets are expected, and in retirement, income will be taxed at the highest brackets, do the two programs equalize?
At a constant tax rate, they're the same. For example, at a 40% tax rate, if you earn an extra $1,000, you can put $1,000 into a traditional 401(k), or you can pay $400 tax and put $600 into a Roth 401(k). In the first case, if the $1,000 grows to $10,000, you can take it out, pay $4,000 tax, and have $6,000 left. In the second case, the $600 will grow to $6,000.

Looking at it that way, the difference is that the Roth is effectively larger. At a 40% tax rate, putting $17,500 into a Roth 401(k) is equivalent to putting $29,167 into a traditional 401(k). However, you can't put $29,167 into a traditional 401(k). The $17,500 limit is the same regardless of whether you put it into a traditional 401(k) or a Roth 401(k).

Without running the numbers, the Roth 401(k) will be more attractive to younger people, and to people who don't expect their tax bracket to drop substantially upon retirement. The traditional 401(k) will be more attractive to older people, and to people who expect their tax bracket to drop by more than a little bit upon retirement.

Given the amount involved, it may be worth spending a few hours creating a spreadsheet, making some reasonable assumptions as to the rate of return in the plan, the after-tax rate of return in the taxable account, current and expected future tax brackets, etc.
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