When to switch from Roth 401k to traditional 401k

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StephL210
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When to switch from Roth 401k to traditional 401k

Post by StephL210 » Fri Jul 21, 2017 9:12 pm

I am currently doing a Roth 401k and am wondering if it is time to switch to a traditional 401k. I currently max out at 18,000 a year. Our combined household income $240,000. Leave it as is in a Roth or change it to traditional?

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ruralavalon
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Re: When to switch from Roth 401k to traditional 401k

Post by ruralavalon » Sat Jul 22, 2017 12:59 pm

Welcome to the forum :) .

That's impossible to answer in the abstract.
StephL210 wrote:I am currently doing a Roth 401k and am wondering if it is time to switch to a traditional 401k. I currently max out at 18,000 a year. Our combined household income $240,000. Leave it as is in a Roth or change it to traditional?
Some additional information would be helpful.

What is your age? What is your tax bracket, both federal and state? What is your tax filing status?

Do you or your spouse have any other accounts?

How much is in each account?

Will either you or your spouse, or both of you, be eligible for a substantial pension?

You can simply add this to your original post using the edit button, it helps a lot if all of your information is in one place.

For most people traditional 401k contributions will probably be better. TFB blog post, "The case against Roth 401k". "I think for most people the majority, if not 100%, of the contribution should go to a Traditional 401(k)."

Ordinarily most people are likely better off making traditional contributions to their work-based plans. A pension changes that analysis, so that Roth contributions are likely better if you have a significant pension coming. TFB blog post, "Most TSP participants should switch to the Roth TSP". That post discussed the effect of a federal pension, but the analysis should hold for other pensions.

Wiki article, "Traditional vs Roth".
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

Nate79
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Re: When to switch from Roth 401k to traditional 401k

Post by Nate79 » Sat Jul 22, 2017 1:42 pm

It's very hard to imagine in your tax bracket that Roth was the right choice. Unless you post more information it's highly highly likely you should be choosing traditional.

retiredjg
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Re: When to switch from Roth 401k to traditional 401k

Post by retiredjg » Sat Jul 22, 2017 3:13 pm

You are probably in the 33% bracket. Might squeak into the 28% bracket....don't know. Either way, for most people it is (past) time to move into traditional IRA. There are some exceptions that involve the issues brought up by ruralavalon.

mhalley
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Re: When to switch from Roth 401k to traditional 401k

Post by mhalley » Sat Jul 22, 2017 3:20 pm

I would say that it is time to switch to regular 401k. You can always do some Roth conversions after retirement, or if you still have some leftover money to save do a backdoor Roth.

Finance-MD
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Re: When to switch from Roth 401k to traditional 401k

Post by Finance-MD » Sat Jul 22, 2017 3:34 pm

Will you invest the difference in taxable? If not, continue putting Roth. If yes, depends on things said above, but likely switching to pretax will be superior for most people meeting the criteria you indicated.

Edit: sentence 2 assumes you're already maxing out all other Tax advantaged accounts already.

shermanpie
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Re: When to switch from Roth 401k to traditional 401k

Post by shermanpie » Sat Jul 22, 2017 3:46 pm

Here's the more relevant TFB article: Roth 401(k) for People Who Contribute the Max

Maxing your Roth 401k can make sense at higher incomes, but conditions need to be just right.

Roth is probably a bad idea right now if any of the following apply:
  • You are actually in the 33% bracket (instead of top end of 28%)
  • You will withdraw/retire soon
  • You will retire in a state with much lower income taxes
  • You other earnings at retirement won't get you solidly into the 25% bracket (instead of 15% or less)
If none of those apply than continuing Roth is probably the slightly better choice.

Incendiary
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Re: When to switch from Roth 401k to traditional 401k

Post by Incendiary » Sun Jul 23, 2017 2:08 am

ruralavalon wrote:Welcome to the forum :) .

That's impossible to answer in the abstract.
StephL210 wrote:I am currently doing a Roth 401k and am wondering if it is time to switch to a traditional 401k. I currently max out at 18,000 a year. Our combined household income $240,000. Leave it as is in a Roth or change it to traditional?
Some additional information would be helpful.

What is your age? What is your tax bracket, both federal and state? What is your tax filing status?

Do you or your spouse have any other accounts?

How much is in each account?

Will either you or your spouse, or both of you, be eligible for a substantial pension?

You can simply add this to your original post using the edit button, it helps a lot if all of your information is in one place.

For most people traditional 401k contributions will probably be better. TFB blog post, "The case against Roth 401k". "I think for most people the majority, if not 100%, of the contribution should go to a Traditional 401(k)."

Ordinarily most people are likely better off making traditional contributions to their work-based plans. A pension changes that analysis, so that Roth contributions are likely better if you have a significant pension coming. TFB blog post, "Most TSP participants should switch to the Roth TSP". That post discussed the effect of a federal pension, but the analysis should hold for other pensions.

Wiki article, "Traditional vs Roth".
How do pensions affect the calculus?

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Re: When to switch from Roth 401k to traditional 401k

Post by Spirit Rider » Sun Jul 23, 2017 8:20 am

Incendiary wrote:How do pensions affect the calculus?
There is more to the pre-tax/post-tax question than just whether your current marginal tax rate will be higher than your retirement marginal tax rate. The ability to adjust your MAGI can have a significant effect on your total retirement outlays.

Health insurance costs in early retirement can be a significant portion of your expenses. Roth IRA distributions let me control my ACA MAGI. I keep my MAGI between 138% and 150% of the Federal Poverty Level. This allows me to maximize my ACA premium subsidy and maximize my ACA cost sharing. This saves me > $10K/year in ACA premiums and out-of-pocket costs. We don't know what the future may bring, but early retirement health insurance costs will most certainly continue to be MAGI based.

After you enroll in Medicare, your Part B and Part D premiums are subject to IRMAA. These surcharges are based on your MAGI. Especially when subject to RMDs, if all of your accounts are pre-tax that can drive you into higher IRMA tiers.

If you will have substantial pension income, it will make both of these problems worse.

With that said most people in the >= 33% marginal tax bracket should be making traditional (pre-tax) retirement contributions where possible and doing a Backdoor Roth IRA for post-tax contributions.

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grabiner
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Re: When to switch from Roth 401k to traditional 401k

Post by grabiner » Sun Jul 23, 2017 8:22 am

Incendiary wrote:
ruralavalon wrote: Ordinarily most people are likely better off making traditional contributions to their work-based plans. A pension changes that analysis, so that Roth contributions are likely better if you have a significant pension coming. TFB blog post, "Most TSP participants should switch to the Roth TSP". That post discussed the effect of a federal pension, but the analysis should hold for other pensions.

Wiki article, "Traditional vs Roth".
How do pensions affect the calculus?
Pensions create taxable income in retirement, which may force you into a higher tax bracket. If you retire with a taxable pension of $30,000 per year, and have $20,000 per year in Social Security and a bit of other income, then 85% of your Social Security will be taxed, so you will have $47,000 in taxable income from the pension and Social Security. The 25% tax bracket for singles over 65 begins at a total income of $49,900 (taxable income of $37,950, plus exemption and standard deduction), so you will be in the 25% tax bracket in retirement even if you take very little from your investments. Thus, if you are in the 25% bracket now, a Roth 401(k)/TSP is as good as a traditional 401(k)/TSP if you can't max out, and better if you can max out. Even in the 28% bracket, it's a close decision between maxing out a Roth 401(k), or maxing out a traditional 401(k) and investing the tax savings in a taxable account.

If you don't have a pension, you will need to get more money in retirement from your investments, but much of that money will not be taxed. Roth withdrawals in retirement are non-taxable. If you sell assets from your taxable account, you pay tax on only the capital gain.
David Grabiner

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welderwannabe
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Re: When to switch from Roth 401k to traditional 401k

Post by welderwannabe » Sun Jul 23, 2017 8:30 am

I am in the same situation as you including income.

I just switched into the traditional 401k a few weeks back and am investing the tax savings (since my paycheck went up due to my contributions being tax free now) in a non-deductible IRA. I am then doing backdoor roth conversion.
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

Incendiary
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Re: When to switch from Roth 401k to traditional 401k

Post by Incendiary » Sun Jul 23, 2017 8:50 am

I'm in the 33-35% bracket and my accountant has been telling me to do Roth 401k. I guess this is why.

That TFB link with an Excel sheet of Roth vs traditional was very helpful as well. Based on that, I created my own spreadsheet, and it seems clear that for those who max out their 401k, it's better to do Roth if you will be in a tax bracket where capital gains is an issue, even if you're in a slightly lower bracket at retirement?

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flamesabers
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Re: When to switch from Roth 401k to traditional 401k

Post by flamesabers » Sun Jul 23, 2017 9:01 am

Nate79 wrote:It's very hard to imagine in your tax bracket that Roth was the right choice. Unless you post more information it's highly highly likely you should be choosing traditional.
OP,

I'm in agreement with Nate's statement. Unless you'll be getting a substantial pension or other taxable income in retirement, in all likelihood you'll be in a lower tax bracket then you are currently.

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Ketawa
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Re: When to switch from Roth 401k to traditional 401k

Post by Ketawa » Sun Jul 23, 2017 9:25 am

Incendiary wrote:I'm in the 33-35% bracket and my accountant has been telling me to do Roth 401k. I guess this is why.

That TFB link with an Excel sheet of Roth vs traditional was very helpful as well. Based on that, I created my own spreadsheet, and it seems clear that for those who max out their 401k, it's better to do Roth if you will be in a tax bracket where capital gains is an issue, even if you're in a slightly lower bracket at retirement?
For people who max out tax advantaged accounts, the ability to pack a little more money into Roth accounts is worth only a few extra percent in tax rates. So for example, top marginal tax rate now of 28% on Roth contributions vs top marginal rate in retirement of 25% on traditional withdrawals would be basically break-even.

Incendiary
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Re: When to switch from Roth 401k to traditional 401k

Post by Incendiary » Sun Jul 23, 2017 9:34 am

Ketawa wrote:
Incendiary wrote:I'm in the 33-35% bracket and my accountant has been telling me to do Roth 401k. I guess this is why.

That TFB link with an Excel sheet of Roth vs traditional was very helpful as well. Based on that, I created my own spreadsheet, and it seems clear that for those who max out their 401k, it's better to do Roth if you will be in a tax bracket where capital gains is an issue, even if you're in a slightly lower bracket at retirement?
For people who max out tax advantaged accounts, the ability to pack a little more money into Roth accounts is worth only a few extra percent in tax rates. So for example, top marginal tax rate now of 28% on Roth contributions vs top marginal rate in retirement of 25% on traditional withdrawals would be basically break-even.
Per my assumptions (contribution of $18,000, yearly return of 7%, 30 year horizon, investing the tax savings in a taxable account), you end up with almost $2,000 more by doing Roth (1.21% better). Do that every year for 30 years and you have a decent amount more at the end.

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Ketawa
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Re: When to switch from Roth 401k to traditional 401k

Post by Ketawa » Sun Jul 23, 2017 9:46 am

Incendiary wrote:
Ketawa wrote:
Incendiary wrote:I'm in the 33-35% bracket and my accountant has been telling me to do Roth 401k. I guess this is why.

That TFB link with an Excel sheet of Roth vs traditional was very helpful as well. Based on that, I created my own spreadsheet, and it seems clear that for those who max out their 401k, it's better to do Roth if you will be in a tax bracket where capital gains is an issue, even if you're in a slightly lower bracket at retirement?
For people who max out tax advantaged accounts, the ability to pack a little more money into Roth accounts is worth only a few extra percent in tax rates. So for example, top marginal tax rate now of 28% on Roth contributions vs top marginal rate in retirement of 25% on traditional withdrawals would be basically break-even.
Per my assumptions (contribution of $18,000, yearly return of 7%, 30 year horizon, investing the tax savings in a taxable account), you end up with almost $2,000 more by doing Roth (1.21% better). Do that every year for 30 years and you have a decent amount more at the end.
I don't know the particulars of your situation, but using the full contribution amount can be very misleading, because most people probably need to have a substantial amount of dollars in Traditional in order to fill up all the lower tax brackets in retirement. The Traditional vs Roth decision is made on the marginal dollar invested and the advantage of Roth only materializes once all the lower brackets are filled up.

Personally, I expect to have a military pension, but it will only be close to the top of the 15% bracket if I am still unmarried in 12+ years and don't have substantial itemized deductions. I have been making Traditional contributions now deducted at 25% until I reach the top of the 15% bracket, then switch to Roth.

Incendiary
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Re: When to switch from Roth 401k to traditional 401k

Post by Incendiary » Sun Jul 23, 2017 10:00 am

I admit I don't fully understand the whole "fill up the brackets" and converting to Roth over one's working career (or even in retirement) discussion. However, my assumptions are income will be enough to put one in a high tax bracket whether now or in retirement, state income tax similar, and one will have this income in perpetuity (meaning, no years where one is unemployed or otherwise has a lower marginal bracket in which to convert to Roth). In this case, the higher one goes in marginal tax bracket, the more favorable contributing to a Roth 401k now becomes.

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FiveK
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Re: When to switch from Roth 401k to traditional 401k

Post by FiveK » Sun Jul 23, 2017 10:17 am

Incendiary wrote:...my assumptions are income will be enough to put one in a high tax bracket whether now or in retirement...
That is an important assumption to validate, because it can become self-defeating.

I.e., if one assumes a high retirement income and thus contributes to Roth, the retirement income becomes lower. If one assumes a low retirement income and contributes to traditional, the retirement income becomes higher.

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Re: When to switch from Roth 401k to traditional 401k

Post by 9liner » Sun Jul 23, 2017 10:21 am

flamesabers wrote:
Nate79 wrote:It's very hard to imagine in your tax bracket that Roth was the right choice. Unless you post more information it's highly highly likely you should be choosing traditional.
OP,

I'm in agreement with Nate's statement. Unless you'll be getting a substantial pension or other taxable income in retirement, in all likelihood you'll be in a lower tax bracket then you are currently.

What do Bogleheads consider a "substantial pension"? For instance, I will be eligible for an active duty pension beginning at age 53. At age 50, I will begin collecting a pension from a previous employer. Both pensions would equate to approximately $60-70K per year, combined. Would a $60k pension be considered "substantial"?

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Re: When to switch from Roth 401k to traditional 401k

Post by Ketawa » Sun Jul 23, 2017 10:28 am

9liner wrote:What do Bogleheads consider a "substantial pension"? For instance, I will be eligible for an active duty pension beginning at age 53. At age 50, I will begin collecting a pension from a previous employer. Both pensions would equate to approximately $60-70K per year, combined. Would a $60k pension be considered "substantial"?
Only you can determine that based on your expected standard of living, your expected income until retirement, your expected expenses in retirement, etc.

If single, about $50K is taxable after the standard deduction and 1 personal exemption. That is near the bottom of the 25% bracket.

If married, about $40K is taxable after the standard deduction and 2 personal exemptions. That is around the middle of the 15% bracket.

deskjockey
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Re: When to switch from Roth 401k to traditional 401k

Post by deskjockey » Sun Jul 23, 2017 11:13 am

9liner wrote:What do Bogleheads consider a "substantial pension"? For instance, I will be eligible for an active duty pension beginning at age 53. At age 50, I will begin collecting a pension from a previous employer. Both pensions would equate to approximately $60-70K per year, combined. Would a $60k pension be considered "substantial"?
Yes, that's substantial because it fills up most of the 15% tax bracket if you're married or puts you into the 25% bracket if you're single. EDIT: Ketawa beat me to this with greater fidelity.
Incendiary wrote:Per my assumptions (contribution of $18,000, yearly return of 7%, 30 year horizon, investing the tax savings in a taxable account), you end up with almost $2,000 more by doing Roth (1.21% better). Do that every year for 30 years and you have a decent amount more at the end.
.

Incendiary--You're correct, IF you are putting the tax savings in taxable. It would make more sense to put the tax savings in a backdoor Roth or a mega backdoor Roth. If you take that approach, traditional has an advantage of around 2%, assuming a slightly lower tax bracket in retirement (which I believe is what you assumed). I rarely see this discussed--most people assume that tax savings will go into a taxable account, but the logical thing to do would be to put it into a Roth via either of the backdoors. It allows you to have some of your cake and eat some of it, too.

Now, if you're the sort who maxes out all of your tax-advantaged space (401k, backdoor, and, if available, mega backdoor), then yes, chances are you may be better off going with a Roth 401k contribution, but I'd crunch the numbers just in case.

Incendiary
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Re: When to switch from Roth 401k to traditional 401k

Post by Incendiary » Sun Jul 23, 2017 2:17 pm

deskjockey wrote:
9liner wrote:What do Bogleheads consider a "substantial pension"? For instance, I will be eligible for an active duty pension beginning at age 53. At age 50, I will begin collecting a pension from a previous employer. Both pensions would equate to approximately $60-70K per year, combined. Would a $60k pension be considered "substantial"?
Yes, that's substantial because it fills up most of the 15% tax bracket if you're married or puts you into the 25% bracket if you're single. EDIT: Ketawa beat me to this with greater fidelity.
Incendiary wrote:Per my assumptions (contribution of $18,000, yearly return of 7%, 30 year horizon, investing the tax savings in a taxable account), you end up with almost $2,000 more by doing Roth (1.21% better). Do that every year for 30 years and you have a decent amount more at the end.
.

Incendiary--You're correct, IF you are putting the tax savings in taxable. It would make more sense to put the tax savings in a backdoor Roth or a mega backdoor Roth. If you take that approach, traditional has an advantage of around 2%, assuming a slightly lower tax bracket in retirement (which I believe is what you assumed). I rarely see this discussed--most people assume that tax savings will go into a taxable account, but the logical thing to do would be to put it into a Roth via either of the backdoors. It allows you to have some of your cake and eat some of it, too.

Now, if you're the sort who maxes out all of your tax-advantaged space (401k, backdoor, and, if available, mega backdoor), then yes, chances are you may be better off going with a Roth 401k contribution, but I'd crunch the numbers just in case.
Thanks for pointing that out. Yes, I was assuming backdoor and all that was being done in both scenarios.

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