Roth 401K vs Traditional 401K

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Drock3307
Posts: 13
Joined: Sat Aug 12, 2017 11:04 am

Roth 401K vs Traditional 401K

Post by Drock3307 » Sat Aug 12, 2017 11:11 am

Hello, my wife and I currently contribute to both. We have the traditional to earn some tax break now due to our income and assume our income will be less during retirement. However, I am worried tax rates will be much higher then. What is your strategy? Do you just put all in Roth now, pay the taxes now, so at least growth will be tax free? We are 35 yrs of age. Thanks!

retiredjg
Posts: 29724
Joined: Thu Jan 10, 2008 12:56 pm

Re: Roth 401K vs Traditional 401K

Post by retiredjg » Sat Aug 12, 2017 11:21 am

Welcome to the forum. There is a discussion on this topic in the Wiki (link upper center).

The usual suggestion is to use traditional 401k unless you have reason to believe your tax bracket will actually be higher during retirement. This is not impossible, but people are usually in a lower or the same bracket in retirement.

An exception might be if you are in a very low tax bracket now, such as 15%. If your income is about to go up a lot and stay there for decades, using Roth 401k in the 25% bracket might be a good idea.

This topic comes up at least once a week. Just stick around and read or use the google box upper right and find old threads.

Drock3307
Posts: 13
Joined: Sat Aug 12, 2017 11:04 am

Re: Roth 401K vs Traditional 401K

Post by Drock3307 » Sat Aug 12, 2017 11:43 am

Hi retiredjg!

Why is Roth better at 25% bracket? What if my rate is lower at retirement (though really hard to know)? Thanks!

KlangFool
Posts: 6189
Joined: Sat Oct 11, 2008 12:35 pm

Re: Roth 401K vs Traditional 401K

Post by KlangFool » Sat Aug 12, 2017 11:50 am

Drock3307 wrote:
Sat Aug 12, 2017 11:43 am
Hi retiredjg!

Why is Roth better at 25% bracket? What if my rate is lower at retirement (though really hard to know)? Thanks!
Drock3307,

Unless you have a good pension, why would your income tax rate at retirement be at 25%?

https://taxfoundation.org/2017-tax-brackets/

For a couple, the taxable income would need to be at least 75K. With personal exemption and deduction, the gross income needs to be at least 100K. In order to generate 100K of income without social security and/or pension, you need at least 25 times 100K = 2.5 million worth of investment.

This is before the tax bracket adjusted upward every year by inflation.

<<though really hard to know)?>>

It is not hard to know. 90% of the US household has a net worth less than 1 million.

KlangFool
Last edited by KlangFool on Sat Aug 12, 2017 12:07 pm, edited 1 time in total.

User avatar
FiveK
Posts: 2589
Joined: Sun Mar 16, 2014 2:43 pm

Re: Roth 401K vs Traditional 401K

Post by FiveK » Sat Aug 12, 2017 12:05 pm

retiredjg wrote:
Sat Aug 12, 2017 11:21 am
If your income is about to go up a lot and stay there for decades, using Roth 401k in the 25% bracket might be a good idea.
Drock3307 wrote:Why is Roth better at 25% bracket? What if my rate is lower at retirement (though really hard to know)? Thanks!
Need to look at retiredjg's suggestion in context.

Retiredjg's "if" and your "if" assume opposite things. Given opposite assumptions, opposite conclusions are not unexpected.

User avatar
ruralavalon
Posts: 10889
Joined: Sat Feb 02, 2008 10:29 am
Location: Illinois

Re: Roth 401K vs Traditional 401K

Post by ruralavalon » Sat Aug 12, 2017 12:13 pm

Drock3307 wrote:
Sat Aug 12, 2017 11:11 am
Hello, my wife and I currently contribute to both. We have the traditional to earn some tax break now due to our income and assume our income will be less during retirement. However, I am worried tax rates will be much higher then. What is your strategy? Do you just put all in Roth now, pay the taxes now, so at least growth will be tax free? We are 35 yrs of age. Thanks!
What is your current tax bracket, both federal and state? Will either or both of you be eligible for a substantial pension? You can simply add this to your original post using the edit button.

A low current tax bracket (15% or under) would mean that it costs you little (in tax deduction you passed up) to make Roth contributions. It is very difficult to predict what your tax bracket will be 30 years from now, or even predict what the tax brackets will be then.

A pension matters because of the progressive structure of the tax code.

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

CppCoder
Posts: 482
Joined: Sat Jan 23, 2016 9:16 pm

Re: Roth 401K vs Traditional 401K

Post by CppCoder » Sat Aug 12, 2017 1:09 pm

If you can't decide, hedge, and do some of both. I max my pretax 401k, my after-tax 401k (converted annually to Roth), and two (backdoor) Roth IRAs each year. Given that employer match goes to pre-tax, this ends up as approximately $28k Roth and $37k pretax. I have a significant pension promise for retirement, and I would probably be better off contributing to the Roth 401k. However, given that I can't bring myself to give up the pretax 401k tax deduction, at least I'm hedged with a fairly significant Roth contribution annually (that I assume will eventually just become an inheritance fund).

livesoft
Posts: 55514
Joined: Thu Mar 01, 2007 8:00 pm

Re: Roth 401K vs Traditional 401K

Post by livesoft » Sat Aug 12, 2017 1:11 pm

My strategy is to put it ALL in traditional 401(k). Then when I got to a lower tax bracket in retirement, I did Roth conversions. I saved tens of thousands of dollars doing that.

And the money I saved on taxes by contributing all to traditional 401(k) was used to contribute to Roth IRAs when they became available.
This signature message sponsored by sscritic: Learn to fish.

DSInvestor
Posts: 10514
Joined: Sat Oct 04, 2008 11:42 am

Re: Roth 401K vs Traditional 401K

Post by DSInvestor » Sat Aug 12, 2017 1:28 pm

I agree with livesoft. The tax savings gave me more take home pay gave me more options to a) fund Roth IRA, b) invest in taxable, c) pay extra mortgage principal and many other financial priorities.

State income tax is another issue to consider. If you currently live in a state with a high state income tax, Traditional 401k contributions may save you substantial amounts of state income tax. I worked in states with high state income taxes and moved to state with no state income tax in retirement. Traditional 401k contributions helped me avoid Fed and state taxes. Once I moved to no state income tax state, I was able to do Roth conversions with no state income tax liability.

Drock3307
Posts: 13
Joined: Sat Aug 12, 2017 11:04 am

Re: Roth 401K vs Traditional 401K

Post by Drock3307 » Sat Aug 12, 2017 7:43 pm

Thank you all! I thought we were at 25% but we are actually at 28% plus CA state. I expect we will be at a lower bracket at retirement unless the rates increase so seems traditional is the way to go then convert when our rate goes down in the future. But since we don't know where tax rates will be in 30 years, I'll do some Roth as well though heavier on traditional.

Drock3307
Posts: 13
Joined: Sat Aug 12, 2017 11:04 am

Re: Roth 401K vs Traditional 401K

Post by Drock3307 » Sat Aug 12, 2017 8:13 pm

KlangFool wrote:
Sat Aug 12, 2017 11:50 am
Drock3307 wrote:
Sat Aug 12, 2017 11:43 am
Hi retiredjg!

Why is Roth better at 25% bracket? What if my rate is lower at retirement (though really hard to know)? Thanks!
Drock3307,

Unless you have a good pension, why would your income tax rate at retirement be at 25%?

https://taxfoundation.org/2017-tax-brackets/

For a couple, the taxable income would need to be at least 75K. With personal exemption and deduction, the gross income needs to be at least 100K. In order to generate 100K of income without social security and/or pension, you need at least 25 times 100K = 2.5 million worth of investment.

This is before the tax bracket adjusted upward every year by inflation.

<<though really hard to know)?>>

It is not hard to know. 90% of the US household has a net worth less than 1 million.

KlangFool

We will not be at 25% at retirement. I expect it to be lower so long as rates do not change. We do not have pension.

Drock3307
Posts: 13
Joined: Sat Aug 12, 2017 11:04 am

Re: Roth 401K vs Traditional 401K

Post by Drock3307 » Sat Aug 12, 2017 8:17 pm

CppCoder wrote:
Sat Aug 12, 2017 1:09 pm
If you can't decide, hedge, and do some of both. I max my pretax 401k, my after-tax 401k (converted annually to Roth), and two (backdoor) Roth IRAs each year. Given that employer match goes to pre-tax, this ends up as approximately $28k Roth and $37k pretax. I have a significant pension promise for retirement, and I would probably be better off contributing to the Roth 401k. However, given that I can't bring myself to give up the pretax 401k tax deduction, at least I'm hedged with a fairly significant Roth contribution annually (that I assume will eventually just become an inheritance fund).
Sorry I am not very good at this. You mentioned you do traditional 401k then convert annually to Roth. Making the same contributions annually and with same tax rate, don't you end up paying tax on Roth conversion the same deduction on pre tax contribution so it's a wash? Thanks for clarifying. I'm sure this is not the case or else you won't do it but I am missing something. Thanks for educating me here!

CppCoder
Posts: 482
Joined: Sat Jan 23, 2016 9:16 pm

Re: Roth 401K vs Traditional 401K

Post by CppCoder » Sat Aug 12, 2017 8:23 pm

Drock3307 wrote:
Sat Aug 12, 2017 8:17 pm
CppCoder wrote:
Sat Aug 12, 2017 1:09 pm
If you can't decide, hedge, and do some of both. I max my pretax 401k, my after-tax 401k (converted annually to Roth), and two (backdoor) Roth IRAs each year. Given that employer match goes to pre-tax, this ends up as approximately $28k Roth and $37k pretax. I have a significant pension promise for retirement, and I would probably be better off contributing to the Roth 401k. However, given that I can't bring myself to give up the pretax 401k tax deduction, at least I'm hedged with a fairly significant Roth contribution annually (that I assume will eventually just become an inheritance fund).
Sorry I am not very good at this. You mentioned you do traditional 401k then convert annually to Roth. Making the same contributions annually and with same tax rate, don't you end up paying tax on Roth conversion the same deduction on pre tax contribution so it's a wash? Thanks for clarifying. I'm sure this is not the case or else you won't do it but I am missing something. Thanks for educating me here!
My 401k has many buckets: pretax contribution, after-tax contribution, Roth contribution, employer match, Roth conversion account. I only convert the after-tax contribution, on which I've already paid taxes, which then goes into the Roth conversion account. This is money above the $18k pre-tax contribution. If the after-tax has any gains at year end, I do pay additional taxes only on the gains. This is essentially the mega backdoor Roth IRA (you can search for that term to find threads) except I keep the money in my 401k instead of using an in service distribution to roll it over to a Roth IRA.

Post Reply