Max out 401K or 2/3 401k and 1/3 Roth?

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xpat73
Posts: 57
Joined: Sat Jan 15, 2011 10:47 pm

Max out 401K or 2/3 401k and 1/3 Roth?

Post by xpat73 »

Here is my situation:

1. I already have a Roth IRA with $30k in it in cheap index funds with Fidelity.
2. I have recently become eligible for my company 401k – I am using self directed so I have access to all the good Fidelity funds I want.
3. So fund choice is not a problem.
4. Right now I can still contribute the max to the Roth IRA given my income.
5. My 401k does not match.
6. Assume I will be in a higher tax bracket when I retire..I am 39.
7. I am in the 28% federal income tax bracket now.
8. Simple questions:
a. I can afford to contribute $1458 a month to the 401k for the max of $17,500 per year
b. Or I can contribute $900 a month to the 401k and $458 to my Roth IRA (maxing to $5500 for 2013)
c. But I cannot afford to do contribute to both at the max!
d. What should I do? Is a) better than b)? Should the rule be…max out the 401k for the tax break and then any excess goes to the Roth IRA. Or is it ok to contribute 2/3 to 401k 1/3 to Roth?

Thanks in advance for your expertise!
NYBoglehead
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Joined: Fri May 25, 2012 9:38 am

Re: Max out 401K or 2/3 401k and 1/3 Roth?

Post by NYBoglehead »

Well the good thing right off the bat is there really isn't a wrong answer given that you can put away that much per month!

The 28% bracket is pretty high, and depending on your state, you might be forking over more than 1/3 of each additional dollar in that bracket to the federal and state governments. Would maxing out your 401k pull your taxable income enough to get you in the 25% bracket by any chance? If it does than I recommend maxing out the 401k.

That said, I like the Roth since it removes a degree of uncertainty over future tax rates. If it were me, I'd max out the Roth IRA and then contribute whatever else I could to the 401k.
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yoshald
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Joined: Fri Dec 30, 2011 2:18 pm

Re: Max out 401K or 2/3 401k and 1/3 Roth?

Post by yoshald »

I was in the same bracket, same age as you. Do you like your job and think you'll stay in that bracket? You partially answered that already. I was lucky enough to be able to max both out for several years, and decided I wanted to go back to school full time. Now that I have no planned income for the next 2 years, I have rolled my 401k to a traditional IRA, and now I can convert chunks to Roth IRA at the lowest bracket the next couple years. So do you see periods of time where you're making low income?

I think I-bonds are another good place to save money. My uncle thinks now is a good time to buy silver coins.

I used to work with a someone who happened to also be a CFA who put 50% in Roth and 50% traditional 401k. His feeling was there's no way to tell what will happen in the future, so he just split it down the middle.
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retiredjg
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Re: Max out 401K or 2/3 401k and 1/3 Roth?

Post by retiredjg »

I am in the 28% federal income tax bracket now.
You should max out your 401k before using Roth IRA in my opinion.

6. Assume I will be in a higher tax bracket when I retire..I am 39.
Based on what? Most people figure their tax bracket will go up because they have more money. Nothing could be further from the truth. Most people's bracket goes down or at least stays the same. Even if the bracket stays the same, you would be unlikely to pay 28% on money coming out of a 401k/IRA. And even if you did, it would be the exact same thing as paying 28% to get money into Roth status now.

Or is it ok to contribute 2/3 to 401k 1/3 to Roth?
It's ok, but I don't think it is your best choice.
gt4715b
Posts: 534
Joined: Mon Jun 11, 2007 10:29 am

Re: Max out 401K or 2/3 401k and 1/3 Roth?

Post by gt4715b »

Can you afford to contribute $1458/month AFTER tax? If so, you can do both. On an after-tax basis, assuming 5% state/local income tax the $1458/month 401k contribution is $977. That means you have $481/month in after-tax money to max out the Roth IRA as well.

If you can contribute $1458 on an PRE-tax basis, you would have to contribute something like $970/month to the 401k and $325 to the Roth IRA.

If you can't max out both with your tax bracket I would contribute entirely to the 401k, unless you needed to build up emergency funds in which case I would contribute to the Roth (the Roth funds would need be invested more conservatively in that case)
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grabiner
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Re: Max out 401K or 2/3 401k and 1/3 Roth?

Post by grabiner »

Wiki article link: Traditional versus Roth

If you expect to move into the 33% tax bracket soon, you will probably have a large enough 401(k) that you will retire in the 25% or 28% bracket. In that situation, maxing out a Roth in the 28% bracket is better than maxing out a traditional account (and investing the tax savings in a taxable account), but the traditional 401(k) is still better in the 33% bracket, Thus, if you can afford to max out the Roth now (remember that you will pay $4900 more tax on that $17,500 contribution) you might do that while you are still in the 28% bracket, and then switch to traditional when you move up to the 33% bracket.

If you expect to be in the 28% tax bracket for most of your career, it's a close decision; you are already making 1/4 of your contributions to a Roth because you have a Roth IRA, so you are likely to retire in a lower tax bracket.

You should also check for phase-outs of tax benefits; if you are in the child tax credit phase-out, your marginal tax rate is 33%, not 28%, so the traditional 401(k) is better.
Wiki David Grabiner
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