Bogleheads

[henry]

Does a Roth 403b make sense for me?

I got news that my employer will offer a Roth 403b starting in 2010.

Currently, I am maxing out contributions to a traditional 403b as well as a 457. I get a match equal to 3% of salary in the 403b and another 4% of salary in a 401a. For the last 4 years, I have also made maximum contributions to a nondeductible IRA which I am planning to convert to a Roth IRA in 2010. In addition, I am making contributions to a taxable Vanguard account.

I have been able to save more than 40% of my gross income each year for the last 4 years and am expecting that to continue for the foreseeable future. That savings rate includes all contributions to all my accounts, made by myself (taxable and nontaxable) and my employer matches.

My current marginal tax rates are 33% federal and 5.75% state and I expect to stay in those brackets as long as I am working. I am 34 years old and am thinking about early retirement in about 20 years. I do not have a pension/defined benefit plan.

I am leaning toward directing all new 403b contributions to a Roth 403b for the following reasons:
1. I feel I am on track and well positioned for retirement.
2. I am already maxing out tax-deferred space and the ability to create additional tax-FREE space is appealing.
3. I like the idea of tax diversification. I will continue to max out a 457 and the matches I get from my employer will go into the traditional 403b and 401a. So even if I direct 100% of new 403b contributions to the Roth 403b, I’ll still have money going to both tax-deferred space and tax-FREE space.
4. I can afford to pay the taxes now. I should still have enough to contribute to my taxable account as I did this year (but won’t be able to increase it next year as much as I had planned).
5. Future tax rates are uncertain and I’m saving a sizable amount and I’m not sure I’ll be in a lower tax bracket when I retire.

Is my reasoning sound?

[livesoft]

Nope, Roth 403(b) doesn't make sense. You would pay income taxes at 39% which would be very hard to match in retirement.

You have a taxable account that you can use for expenses when retired from age 54 to age 70, so you will be in the nearly 0% tax bracket. During that time, you can convert your traditional 403(b) piecemeal at a sub-39% tax rate to a Roth IRA.

Nope, Roth 403(b) doesn't make sense. Save your 39% for yourself.

[SpecialK22]

Henry, I have similar reasons to you although I am in a lower tax bracket. On one hand livesoft makes a good point that that your taxes would be difficult to match in retirement, but if you continue to save aggressively and the portfolio performs well you could find you have enough to replace or even increase income in retirement. Livesoft does make a good suggestion that you could slowly convert to a Roth IRA in the early years of retirement when you may be paying less taxes. A lot depends on how much you think you will have available and be able to live on in retirement and future taxes. Tax diversification between Roth and traditional doesn't sound like a bad idea. I don't think you have bad reasoning, particularly since you think you will have a sizeable amount in retirement and want to hedge against potential higher income tax rates. I wouldn't think putting some of your contributions in a Roth now would be a bad idea. I'm only an amateur at this so take my opinion for what it's worth.

[AnimalCrackers]

henry,

You may find these two articles by tfb helpful:

http://thefinancebuff.com/2008....-401k.html

http://thefinancebuff.com/2008....e-max.html
_________________
"Everybody has a plan until they get punched in the face." -- philosopher Mike Tyson

[livesoft]

tfb's articles are good, but I believe the second one does not take into account a lower tax rate when doing conversions of traditional 401(k) to Roth IRA that can occur for someone in retirement living off the taxable account and delaying social security.

I know that I am in my 50's and semi-retired. We now pay tax at a marginal rate of about 25% instead of the 33% that we paid when I was working full-time. Our effective rate is about 7%.

When my spouse and I fully retire, we will likely drop to an even lower tax bracket (due to carryover capital losses) while living off our taxable accounts, so conversion to Roth will occur at the 0% to 15% rate.

Since henry mentioned possibly retiring in his 50's, I think his scenario is a reasonable match to what we have done and will do. I just cannot imagine paying 39% tax now when there is a very good possibility of paying 0% in the future.

[henry]

Thanks for the replies. The links to TFB's articles were helpful as well.

After reading your replies, paying 39% tax upfront does seem foolish.

TFB's articles were enlightening, especially the discussion about marginal tax rates versus effective tax rates. Future tax rates are unknowable but I'm not sure I'll ever save enough where my effective tax rate will exceed 39%.

[tfb]