jon7417 wrote:Regarding the issue of should i move to 401k roth in future:
Age: 31 with estimated 25-30 years until full retirement.
Spouse: not working.
I have read some on this topic. Intuitively, I am having a difficult time understanding why it is better NOT to do Roth 401k. Since majority of earnings would be interest down the road vs contributions, wouldn't it be advantageous to pay tax now on contributions while letting the returns (larger portion) grow tax free? I am an investing novice, so forgive me if I am totally off base. I'm just trying to understand the thought process/logic. Thanks
Take a simple example for yourself where you only have one year to retirement.
Option 1: Pre-tax invest 10K, earn 8% return and pay 33% tax rate upon withdraw the following year.
Option 2: Pay 33% tax on 10K and then post-tax invest for one year, earn 8% and withdraw tax free the following year.
Under Option 1 You Have: 10,000 x 1.08 x 0.67 = Do the math
Under Option 2 You Have: 10,000 x 0.67 x 1.08 = Do the math again or recall the commutative law of multiplication which says this amount is equal to Do the Math.
There are two main differences between this example and your reality. First, you have more years between the initial investment and subsequent withdrawal and second, it is difficult to know the actual tax rate you will have during the withdrawal phase. I'm struggling with this now ( viewtopic.php?f=2&t=119006
). The difference between your current and future marginal tax rate is key to the whole decision.
EDIT: BTW, welcome to the forum!
A slight correction is in order to your calculations. What you say would work well if OP had $17,500 (or less) to invest or his decision to pay taxes up front would bump him to a higher tax bracket. If not ... let's look at the following scenario using your assumptions of 8% growth in one year.
Let's say OP has $17,500/0.67, i.e., $26,120 left over pre-tax income to invest.
Option 1) the standard 401(k) path: Put $17,500 into tax-deferred investments growing at 8%; pay taxes on the remainder (i.e., $8,620) - he would be left with $5,775 to invest in a taxable account.
After a year, pay taxes and he is left with $17,500*1.08*0.67 + $5,775*1.08 - $5,775*0.08*0.33 = $18,747
Option 2) Pay taxes on the $26,120; put the $17,500 left into the Roth 401(k).
After a year (not logical as you have to leave it a minimum five years - but my point is that this calculation will hold true for five years as well), pay 0 taxes and he is left with $17,500*1.08 = $18,900
So, he is better off with the Roth 401(k).