Roth favored over traditional in PA?

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renner
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Roth favored over traditional in PA?

Post by renner » Sat Jan 20, 2018 2:50 pm

Hi Bogleheads,

I've learned a lot from the forum, and thank you for sharing your thoughts and suggestions. I'd appreciate your advice about the choice between Roth and traditional 401(k).

I know that the traditional is usually preferred for those in the 28% or higher brackets, but my situation is that the PA state and the county do not follow the federal practice on 401(k) contribution; they tax the gross income (minus nothing) at a combined rate of ~5.5%. We didn't know this until mid-year in 2017. There is a good chance that we might not live in PA in 10 years and/or after retirement, which would leave our contribution double taxed (now by PA and later by whatever state we happen to live) unless the later state doesn't have income tax. So we switched to a Roth 401(k).

What do you think? Should we stick to Roth as long as we are in PA? Thanks!

Other basic information; happy to provide more if helpful.
Married filed jointly at the federal tax bracket of 25-28% depending on a few deductible things. We are in our mid-30s and just started our career, so higher income is expected.

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FiveK
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Re: Roth favored over traditional in PA?

Post by FiveK » Sat Jan 20, 2018 7:20 pm

PA's treatment will make Roth more appealing than if PA followed federal rules. Appealing enough? Your choice still comes down to your marginal tax saving rate on traditional contributions now (federal + state + local) vs. your likely marginal rate on when withdrawing those contributions and associated gains (again, federal + state + local).

E.g., if you would save 28% now but pay 12%+5.5%=17.5% later, traditional would still be better. If you would save 28% now but pay 24%+5.5%=29.5% later, Roth would be better.

Admiral
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Re: Roth favored over traditional in PA?

Post by Admiral » Sat Jan 20, 2018 7:40 pm

renner wrote:
Sat Jan 20, 2018 2:50 pm
Hi Bogleheads,

I've learned a lot from the forum, and thank you for sharing your thoughts and suggestions. I'd appreciate your advice about the choice between Roth and traditional 401(k).

I know that the traditional is usually preferred for those in the 28% or higher brackets, but my situation is that the PA state and the county do not follow the federal practice on 401(k) contribution; they tax the gross income (minus nothing) at a combined rate of ~5.5%. We didn't know this until mid-year in 2017. There is a good chance that we might not live in PA in 10 years and/or after retirement, which would leave our contribution double taxed (now by PA and later by whatever state we happen to live) unless the later state doesn't have income tax. So we switched to a Roth 401(k).

What do you think? Should we stick to Roth as long as we are in PA? Thanks!

Other basic information; happy to provide more if helpful.
Married filed jointly at the federal tax bracket of 25-28% depending on a few deductible things. We are in our mid-30s and just started our career, so higher income is expected.
Welcome to the forum. I live in PA, and yes, we too pay the 3.01% tax on wages, even tax deferred monies, plus local taxes., totaling 7%. (PA also taxes pre-tax pension and 457 monies too...how nice!) Our marginal fed rate is 27-28% (as of last year) though of course this is now changing.

For many years in the 25% bracket, we used Roth. Now, we don't.

The way I see it, I'd rather save the 28% now than pay 7%+28%. When I reach FI, though I still plan to keep a residence here, I may end up having a residence in a lower tax state also. I'm guessing/gambling that marginal rates will be lower when not working, which is the case for the vast majority of people.

That said, within 4-5 years (or 5-6 years from FI), I plan to reevaluate what our tax situation will be in retirement, since by that point a pension may well fill up a lower bracket, driving our marginal rate up.

One of the things this past year has taught me is that tax laws and rates do change. Anyone who put away money while at 28% may now easily be paying just 22 or 24% on that money. That's a big savings. I guess the moral is to save the taxes now, when you know what they are, versus hoping for some hazy possible benefit down the road.

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obafgkm
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Re: Roth favored over traditional in PA?

Post by obafgkm » Sat Jan 20, 2018 7:56 pm

Unless I'm missing something in this thread, it appears everybody is assuming that Pennsylvania has income tax on IRAs.

There is no Pennsylvania state income tax on IRA or 403(b) or 401(k) distributions.

Admiral
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Re: Roth favored over traditional in PA?

Post by Admiral » Sat Jan 20, 2018 8:11 pm

obafgkm wrote:
Sat Jan 20, 2018 7:56 pm
Unless I'm missing something in this thread, it appears everybody is assuming that Pennsylvania has income tax on IRAs.

There is no Pennsylvania state income tax on IRA or 403(b) or 401(k) distributions.
Good point!

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samsoes
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Re: Roth favored over traditional in PA?

Post by samsoes » Sat Jan 20, 2018 8:14 pm

obafgkm wrote:
Sat Jan 20, 2018 7:56 pm
Unless I'm missing something in this thread, it appears everybody is assuming that Pennsylvania has income tax on IRAs.

There is no Pennsylvania state income tax on IRA or 403(b) or 401(k) distributions.
The OP stated that s/he won't be PA residents when Traditional IRA/401(k) distributions occur and wants to avoid double taxation by another state. Subsequent replies were geared toward the specifics of the OP's query and situation.
"Happiness Is Not My Companion" - Gen. Gouverneur K. Warren. | (Avatar is the statue of Gen. Warren at Little Round Top @ Gettysburg National Military Park.)

Admiral
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Re: Roth favored over traditional in PA?

Post by Admiral » Sat Jan 20, 2018 8:20 pm

Also don't forget you can always defer the tax now and then convert to Roth when you have no earned income, and pay zero tax on the conversion to the top of the bottom bracket. Yes, at some point you will have to pay tax on some of the money, but you can control when that occurs. Again, assuming the laws don't change.

Also, not for nothing, but 3% of $18,000 is $540/per year. Not nothing...but not a ton when compared to the $5040 you're saving in a 28% fed bracket.

renner
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Re: Roth favored over traditional in PA?

Post by renner » Sat Jan 20, 2018 8:38 pm

FiveK wrote:
Sat Jan 20, 2018 7:20 pm
PA's treatment will make Roth more appealing than if PA followed federal rules. Appealing enough? Your choice still comes down to your marginal tax saving rate on traditional contributions now (federal + state + local) vs. your likely marginal rate on when withdrawing those contributions and associated gains (again, federal + state + local).

E.g., if you would save 28% now but pay 12%+5.5%=17.5% later, traditional would still be better. If you would save 28% now but pay 24%+5.5%=29.5% later, Roth would be better.
Right re: it really comes down to the now tax rate vs future tax rate.
Minor point: It should be 28% (saving on now federal) vs x% (future federal) + y% (future state and local), and y% is not necessarily 5.5.

renner
Posts: 9
Joined: Sat Jan 20, 2018 2:25 pm

Re: Roth favored over traditional in PA?

Post by renner » Sat Jan 20, 2018 8:40 pm

[/quote]

Welcome to the forum. I live in PA, and yes, we too pay the 3.01% tax on wages, even tax deferred monies, plus local taxes., totaling 7%. (PA also taxes pre-tax pension and 457 monies too...how nice!) Our marginal fed rate is 27-28% (as of last year) though of course this is now changing.

For many years in the 25% bracket, we used Roth. Now, we don't.

The way I see it, I'd rather save the 28% now than pay 7%+28%. When I reach FI, though I still plan to keep a residence here, I may end up having a residence in a lower tax state also. I'm guessing/gambling that marginal rates will be lower when not working, which is the case for the vast majority of people.

That said, within 4-5 years (or 5-6 years from FI), I plan to reevaluate what our tax situation will be in retirement, since by that point a pension may well fill up a lower bracket, driving our marginal rate up.

One of the things this past year has taught me is that tax laws and rates do change. Anyone who put away money while at 28% may now easily be paying just 22 or 24% on that money. That's a big savings. I guess the moral is to save the taxes now, when you know what they are, versus hoping for some hazy possible benefit down the road.
[/quote]

Thank you for sharing your thoughts and experience. I appreciate the point about tax uncertainty. I figure I will at least make some contribution to the traditional 401(k).

renner
Posts: 9
Joined: Sat Jan 20, 2018 2:25 pm

Re: Roth favored over traditional in PA?

Post by renner » Sat Jan 20, 2018 8:42 pm

samsoes wrote:
Sat Jan 20, 2018 8:14 pm
obafgkm wrote:
Sat Jan 20, 2018 7:56 pm
Unless I'm missing something in this thread, it appears everybody is assuming that Pennsylvania has income tax on IRAs.

There is no Pennsylvania state income tax on IRA or 403(b) or 401(k) distributions.
The OP stated that s/he won't be PA residents when Traditional IRA/401(k) distributions occur and wants to avoid double taxation by another state. Subsequent replies were geared toward the specifics of the OP's query and situation.
Right, my best knowledge is that we are unlikely (<35%) to be PA resident in 30 or 35 years.

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FiveK
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Re: Roth favored over traditional in PA?

Post by FiveK » Sat Jan 20, 2018 8:44 pm

renner wrote:
Sat Jan 20, 2018 8:38 pm
Minor point: It should be 28% (saving on now federal) vs x% (future federal) + y% (future state and local), and y% is not necessarily 5.5.
Yes. Could be 0%, or 9.3%, or....

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