Roth 401k vs Traditional 401k

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nirvines88
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Roth 401k vs Traditional 401k

Post by nirvines88 » Sat Oct 05, 2013 9:14 am

Trying to figure out whether to use Roth 401k or Traditional 401k for the remainder of 2013. I just got a new job that offers both.

Here's my situation: 2013 income is ~40,000. I maxed out pre-tax SIMPLE IRA ($12,000) for 2013 at previous job. I also have already maxed out a Roth IRA for 2013. I will take the standard deduction/personal exemption @ 10,000 for 2013. My new job does include a pension (6% of salary automatically deducted toward fund). My math (hopefully correct) is below:

40,000

-12,000 (pre-tax SIMPLE IRA)
-10,000 (standard deduction/personal exemption)
-1,140 (pension contribution)

= 16,860

This puts me firmly in the 15% tax bracket, which, in addition to having a pension, makes me lean toward choosing Roth 401k for the rest of this year. However, I live in a high income tax state (NC @ approximately 7%). Also, I am trying to plan for these two benefits below:


1) Earned Income Tax Credit - Must have AGI less than $14,340 (just turned 25 so I'm old enough for the first time this year)
2) Saver's Credit - Income less than $29,500 in 2013 (I claimed this to my benefit last year)


Any analysis of whether it's better to get the credits or have more tax-free space for my future retirement would be appreciated. Or perhaps a combination of the two?
"Beware of little expenses, a small leak will sink a great ship" - Poor Richard

less
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Re: Roth 401k vs Traditional 401k

Post by less » Sat Oct 05, 2013 10:34 am

Remember that the tax deductions for the two pension items are not 'benefits'. So don't feel you are leaving 'something on the table' (other than tax-sheltered income) if you elect the save in a taxable account instead. At your age I would not be rushing to use these accounts when it is quite possible you will want a down-payment for a home, want to buy a car (with cash), prepare for a baby, get married, etc. There are lots of expenses when you are young.

Given your age and your ability to save, I would think it quite reasonable to conclude that your portfolio at retirement will be quite large either because you save so well, or because you move up the job ladder, or both. Conclude that your tax rate in retirement will be higher than today. So Roth is the preferable choice.

camaro327
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Re: Roth 401k vs Traditional 401k

Post by camaro327 » Sat Oct 05, 2013 11:10 am

I would lean roth, due to the 15% bracket. If you get a raise and any dollars are in the 25% bracket, make sure to make some contributions to traditional to get it back to the 15% bracket.

The 7% state tax is fairly high, but I would lean roth with the 15% bracket dollars.

Bob's not my name
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Re: Roth 401k vs Traditional 401k

Post by Bob's not my name » Sun Oct 06, 2013 7:06 am

  • Don't confuse AGI and taxable income. The $10,000 combined personal exemption and standard deduction don't reduce AGI.
  • The only way I can see you getting your AGI under $20,000 this year is to max your pre-tax 401k (as permitted in combination with the SIMPLE) and undo your Roth IRA contribution and make a TIRA contribution instead. I'm amazed at how much you're saving already, so maybe that's possible (especially considering you'll avoid the tax you're paying on the Roth IRA contribution).
  • Remember that FSA contributions and pre-tax health, dental, and disability insurance premiums withheld from your pay reduce AGI and taxable income.
  • The Saver's Credit you're aiming for is the 10% credit, worth $200. The credit is exasperatingly complicated (tfb's article is good: http://thefinancebuff.com/savers-credit ... o-get.html) and I'm not an expert on it, but I think you're already good for it without further pre-tax 401k contributions. You might get a higher credit with more extreme pre-tax saving -- but it's $10,000 down to the next step.
  • North Carolina favors traditional IRA over Roth because you can convert $2,000 to Roth tax-free regardless of age, and that 7% state tax is a significant portion of your tax burden. See http://www.bogleheads.org/forum/viewtop ... 10&t=86262 Here again it's a question of whether you want to go through the process to save $140/year in taxes. Even if you don't want to make new TIRA contributions, I wonder if the odd NC rule will make it attractive to convert your SIMPLE to Roth bit by bit.

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nirvines88
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Re: Roth 401k vs Traditional 401k

Post by nirvines88 » Sun Oct 06, 2013 8:33 am

Bob's not my name wrote:Don't confuse AGI and taxable income. The $10,000 combined personal exemption and standard deduction don't reduce AGI.
Ahh oops! Thanks for the heads up. This means I am unlikely to qualify for the Earned Income Tax Credit then.
Bob's not my name wrote:The only way I can see you getting your AGI under $20,000 this year is to max your pre-tax 401k (as permitted in combination with the SIMPLE) and undo your Roth IRA contribution and make a TIRA contribution instead. I'm amazed at how much you're saving already, so maybe that's possible (especially considering you'll avoid the tax you're paying on the Roth IRA contribution).
Graduated college debt free (thanks dad!) and have low living expenses because health insurance is covered by my employer and I rent with a roommate. I'm lucky that I am able to save a lot of a relatively modest salary.

What would the advantage be to getting my AGI under $20,000 as opposed to utilizing more future tax-free Roth space? I've tried running the numbers but my conclusions are a bit hazy due to being unsure how a future pension would fill up the lower part (0%, 10%) of the progressive tax brackets.
Bob's not my name wrote:Remember that FSA contributions and pre-tax health, dental, and disability insurance premiums withheld from your pay reduce AGI and taxable income.
I do have access to a FSA at my new job. However, I am unsure whether or not to use it because I rarely go to the doctor or buy medication (knock on wood). I wish my employer offered a HSA since it's not "use it or lose it" like the FSA is.

My health insurance is completely covered by my employer because I use the higher deductible version of their offered insurance (meaning I pay no premiums but may pay a bit more if I actually go to the doctor). I do however, have a small amount taken out for dental (~$70/year) and vision (~$120/year). I am not buying disability because it's actually automatically covered after a year of service and I have no dependents.
Bob's not my name wrote:The Saver's Credit you're aiming for is the 10% credit, worth $200. The credit is exasperatingly complicated (tfb's article is good: http://thefinancebuff.com/savers-credit ... o-get.html) and I'm not an expert on it, but I think you're already good for it without further pre-tax 401k contributions. You might get a higher credit with more extreme pre-tax saving -- but it's $10,000 down to the next step.
I maxed this credit out last year, but I also made less money (transitioned from part-time teaching to full-time in 2012). Thanks for the link, the chart makes it a little more clear. Definitely won't be maxing out this year, but I'll take what I can get!
Bob's not my name wrote:North Carolina favors traditional IRA over Roth because you can convert $2,000 to Roth tax-free regardless of age, and that 7% state tax is a significant portion of your tax burden. See viewtopic.php?f=10&t=86262 Here again it's a question of whether you want to go through the process to save $140/year in taxes. Even if you don't want to make new TIRA contributions, I wonder if the odd NC rule will make it attractive to convert your SIMPLE to Roth bit by bit.
I remember you told me about this a couple of years ago. The SIMPLE IRA may be a good use of it in the future, but it can't be moved until 2 years after the last contribution. I currently have a rollover traditional IRA from an old 401k. Would strategically converting up to $2,000 a year from the traditional rollover IRA to a Roth IRA be a good use of this process? (Assuming I make sure it doesn't bump me up too much in terms of AGI and disqualify me from the saver's credit).

Here's my overall portfolio if that makes things clearer at all: http://www.bogleheads.org/forum/viewtop ... 1&t=122808
"Beware of little expenses, a small leak will sink a great ship" - Poor Richard

Bob's not my name
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Re: Roth 401k vs Traditional 401k

Post by Bob's not my name » Sun Oct 06, 2013 8:51 am

nirvines88 wrote:What would the advantage be to getting my AGI under $20,000
$16,000 is about as low as you could get starting at $40,000 gross and contributing $23,000 combined to employer and individual pre-tax savings vehicles and $1,000 to the pension plan. Without undoing your Roth IRA contribution, $21,000 is about as low as you could get. So by doing some extreme things you could get a larger Saver's credit, but I'm not advocating that, and as tfb points out you may not get the whole credit anyway.

I agree that an FSA may not be worth the trouble for a young single person. Here's a post I wrote on it and the use-it-or-lose-it rule, which people frequently sensationalize: http://www.bogleheads.org/forum/viewtop ... 0&t=101267

Your thinking on the rollover IRA seems sound to me. You should check on whether the SIMPLE is affected by the pro rata rule and any of the SIMPLE's special restrictions -- I'm not very knowledgeable on SIMPLEs.

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nirvines88
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Re: Roth 401k vs Traditional 401k

Post by nirvines88 » Mon Oct 14, 2013 5:03 pm

I'll look into the pro rata rule and decide whether to convert a bit of my traditional rollover IRA in order to get NC's preferable treatment of Traditional IRAs. If the pro rate rule is too annoying in terms of tax liability, I'll probably just wait until a low income year and convert then.

I'm going to use the Roth 401k for the remainder of this year and try to do $5,500 in addition to the $12,000 I contributed to a SIMPLE IRA earlier in the year. Next year I'll reassess and likely do a combo of traditional and Roth 401k.

Thanks for the help everyone!
"Beware of little expenses, a small leak will sink a great ship" - Poor Richard

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