Future inheritance impacts on Trad/Roth 401k choice

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tigers174
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Future inheritance impacts on Trad/Roth 401k choice

Post by tigers174 » Thu May 02, 2019 7:01 am

I have a question on whether I should account for possible future inheritance when deciding how to contribute to my 401k.

I'm 36, single income family with SAHM, 3 young kids, firmly in the middle of the 22% MFJ bracket (7% state). I'd like to retire around 57 in 20 years or so.

For years I have been maxing out my 401k into Roth, with a 6% employee match to the traditional. We also have 2 Roth IRAs we contribute to. Right now our total portfolio is 58% Roth/42% Traditonal (~$600k).

Assuming just our retirement funds, I am currently projecting we would be in the lower to mid tier of the current 22% bracket in retirement, although a lot can change in 20 years. I know reading on this forum and wiki, the general thought is that I should be leaning towards all traditional in the 401k.

Both my parents and my in-laws have been great savers and have been retired for 15 years with just living on the interest while their accounts have grown. All of their tax advantaged money is pre-tax. While I hope they live for decades to come, there is a good chance of inheriting a pre-tax sum greater than my accounts from each.

In my planning, I have assumed no inheritance. As I've been focusing on it more, I've been evaluating whether I need to transition to traditional over Roth 401k.

So the question is, should I to try and account for the potential influx of pre-tax money or ignore it when deciding how to contribute.

Bobby206
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by Bobby206 » Thu May 02, 2019 7:21 am

No. Assume you will get zero. Seriously. Save with the assumption you are getting zero. Way too many variables.

bloom2708
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by bloom2708 » Thu May 02, 2019 7:33 am

All I know is you are paying 29% combined tax on those Roth dollars. Maybe a mix of Traditional and Roth going forward? Or build up Pre-tax and regular Roth IRA for a few years.

Let's say you stay in the 22% bracket but now live in a no tax state when drawing out. 7% tax saved simply by deferring the decision.

We can't know the future. If I could choose to not pay 29% today and pay 29% 30 years down the road or 25% or 22% or 12%, I would defer.

I will not be miffed to be alive and pay tax in my late 70s and 80s. Many worse paths.
"We are not here to agree with you; we are here to provoke thoughtfulness." Unknown Boglehead

MotoTrojan
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by MotoTrojan » Thu May 02, 2019 7:37 am

If they’ve spent all their interest (gains) the last decade, odds are they’ll run out. My point isn’t that they actually will but that you probably don’t know enough about their withdrawal parameters or worth to really judge things and estimate even a conservative amount you’ll see. Now a trust is another story.

retiringwhen
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by retiringwhen » Thu May 02, 2019 7:58 am

Bobby206 wrote:
Thu May 02, 2019 7:21 am
No. Assume you will get zero. Seriously. Save with the assumption you are getting zero. Way too many variables.
I would qualify this statement as follows.

1.) Savings rate and AA probably should be calculated without regard to any future inheritance. Don't count your chickens before their hatched. They could live a very long time thus even if a sum comes along, it may be later than your own retirement horizon. I have friend in their 70s with both parents still alive. They have very good longevity genes.

2.) BUT, when looking at the Roth vs. Traditional, I would do some what if scenarios for different growth rates on your own savings and potential inheritance at various reasonable timeframe guesses, then use them to look at marginal rates for taxation of your current savings choices and the retirement scenarios. In my case, we never considered the impact of an inheritance during the accumulation years so the numbers always showed Traditional as the better choice. An inheritance was unexpectedly (by at least a decade) received. When I did the math, I wish we had done more Roth (any actually) savings and conversions. We are now playing catch up while in the red zone before retirement. If I had it to do over, I would have had at least a quarter of our retirement funds in Roth vehicles if possible as a hedge against marginal taxation, but because the inheritance was not considered, that choice never bubbled to the top of my thinking. Of course your particular situation and the form of the inheritance (tax-deferred, Roth or taxable) has a big impact on this situation as well (our case it was a significant inherited IRA and the rest taxable assets and life insurance).

As an aside, sizeable inherited IRAs while still working have the unintuitive impact of making current (as in after the inheritance) Traditional tax-deferred savings more attractive since your marginal tax rates are almost surely going to up. Roth savings was more attractive before the inheritance. Don't over think this as there are a ton of contingencies. But if there are some reasonable parameters to consider, do the math.

You can also just throw your hands up and say "I don't know how this will work out so I'll put a portion in Roth and a portion in Traditional to hedge my bets" and you will likely come out very well, if not 100% optimized.

With the limited info you have provided I would guess your bias toward Roth now is not too out of whack, but only you know all the details.

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Watty
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by Watty » Thu May 02, 2019 8:39 am

Bobby206 wrote:
Thu May 02, 2019 7:21 am
No. Assume you will get zero.
+1

Especially from your inlaws. If you get divorced or widowed before they die then it is unlikely that you would get anything from them. Your spouse also needs to be concerned about inheriting anything from your parents.

Lots of things can also happen with the inheritance from your parents like;

1) One of them lives to be 100 and there is a realistic chance of that. If you retire when you are 57 you could have been retired a long time by then.

https://personal.vanguard.com/us/insigh ... ol?lang=en

2) One of them survives the other and then remarries.(I have seen this happen)

3) They change their will to leave their money to a charity, or to the grandkids.

4) They have higher than expected expenses, like living 10+ years in a memory care facility because they have alzheimer's.
tigers174 wrote:
Thu May 02, 2019 7:01 am
on Trad/Roth 401k choice.......middle of the 22% MFJ bracket (7% state)
Currently the next federal tax bracket above the 22% federal tax bracket is 24%.

That is all of 2% higher :oops:

If a large inheritance pushes you a tax bracket that is 2% higher that is hardly a catastrophe worth paying a lot of taxes now to try to avoid paying the taxes later.

You would have to have a lot of income to get above the 24% federal tax bracket.

All that said if your relationship with your parents or in laws would be OK with talking about finances then you might suggest to them that they do Roth conversions up to the top of the 12% federal tax bracket if they are not already above that. That would also help them since when one of them dies the survivor will be filing tax returns in the higher federal tax brackets. It could save the survivor taxes while they are still alive. That would also reduce future unneeded RMDs which can get high when they get to be in their 90s.

Topic Author
tigers174
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by tigers174 » Thu May 02, 2019 8:48 am

I would qualify this statement as follows.

1.) Savings rate and AA probably should be calculated without regard to any future inheritance. Don't count your chickens before their hatched. They could live a very long time thus even if a sum comes along, it may be later than your own retirement horizon. I have friend in their 70s with both parents still alive. They have very good longevity genes.

2.) BUT, when looking at the Roth vs. Traditional, I would do some what if scenarios for different growth rates on your own savings and potential inheritance at various reasonable timeframe guesses, then use them to look at marginal rates for taxation of your current savings choices and the retirement scenarios. In my case, we never considered the impact of an inheritance during the accumulation years so the numbers always showed Traditional as the better choice. An inheritance was unexpectedly (by at least a decade) received. When I did the math, I wish we had done more Roth (any actually) savings and conversions. We are now playing catch up while in the red zone before retirement. If I had it to do over, I would have had at least a quarter of our retirement funds in Roth vehicles if possible as a hedge against marginal taxation, but because the inheritance was not considered, that choice never bubbled to the top of my thinking. Of course your particular situation and the form of the inheritance (tax-deferred, Roth or taxable) has a big impact on this situation as well (our case it was a significant inherited IRA and the rest taxable assets and life insurance).

As an aside, sizeable inherited IRAs while still working have the unintuitive impact of making current (as in after the inheritance) Traditional tax-deferred savings more attractive since your marginal tax rates are almost surely going to up. Roth savings was more attractive before the inheritance. Don't over think this as there are a ton of contingencies. But if there are some reasonable parameters to consider, do the math.

You can also just throw your hands up and say "I don't know how this will work out so I'll put a portion in Roth and a portion in Traditional to hedge my bets" and you will likely come out very well, if not 100% optimized.

With the limited info you have provided I would guess your bias toward Roth now is not too out of whack, but only you know all the details.
This is pretty much how my approach has been. Savings rate and allocation have always assumed no inheritance. I'd been doing all contributions in my 401k to Roth since it was made available.

I had never really consider any inheritance until I've recently started paying more attention to my savings other than just dumping money in. Recently I've found this forum and wiki and started reevaluating that approach. I've also talked with my parents and in-laws more in-depth on how they approached savings and retirement, so I have a pretty good idea where they are at.

I will probably lean to all traditional in my 401k going forward to go along with the Roth IRAs continuing to assume no inheritance or SS.

Thanks for the input everyone.
Last edited by tigers174 on Thu May 02, 2019 9:07 am, edited 2 times in total.

Dottie57
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by Dottie57 » Thu May 02, 2019 8:57 am

Bobby206 wrote:
Thu May 02, 2019 7:21 am
No. Assume you will get zero. Seriously. Save with the assumption you are getting zero. Way too many variables.
+100.

Never count on an inheritance.

Chadnudj
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by Chadnudj » Thu May 02, 2019 9:10 am

tigers174 wrote:
Thu May 02, 2019 7:01 am
For years I have been maxing out my 401k into Roth, with a 6% employee match to the traditional. We also have 2 Roth IRAs we contribute to. Right now our total portfolio is 58% Roth/42% Traditonal (~$600k).
Assuming just our retirement funds, I am currently projecting we would be in the lower to mid tier of the current 22% bracket in retirement
, although a lot can change in 20 years. I know reading on this forum and wiki, the general thought is that I should be leaning towards all traditional in the 401k.
I'm a bit confused. If all your retirement funds (save that 6% match by your employer) is now going to a Roth 401k, you pay zero tax when you withdraw from that Roth 401k in retirement (you're paying the income tax now). And you're planning on retiring at 57.

Couldn't you spend much of that 57-70.5 time period doing Roth conversions on the traditional portion of the 401k below the lowest brackets and living off your Roth accounts (which, keep in mind, will be getting the bulk of your contributions between now and 57?)? Or otherwise using your traditional portion of your portfolio (currently less than $300k) to fill/stay in low brackets but supplementing above that with Roth?

No one is omniscient about how future tax policies will work, but based on current policies and what will be a sizeable (and much more rapidly growing) portion of your retirement portfolio in Roth accounts, you should be able to find a path to maximize your withdrawal strategy between 57-70.5 to stay in a tax bracket below even 22%.

I'd also suggest you consider optimizing your Roth vs. traditional asset allocation within your 401k -- not sure what other Bogleheads would say about it, but there may be a good reason to be all stocks in one, all bonds in the other (or something like that), but I'm not sure how to break down that analysis.

Topic Author
tigers174
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by tigers174 » Thu May 02, 2019 9:19 am

Chadnudj wrote:
Thu May 02, 2019 9:10 am
I'm a bit confused. If all your retirement funds (save that 6% match by your employer) is now going to a Roth 401k, you pay zero tax when you withdraw from that Roth 401k in retirement (you're paying the income tax now). And you're planning on retiring at 57.

Couldn't you spend much of that 57-70.5 time period doing Roth conversions on the traditional portion of the 401k below the lowest brackets and living off your Roth accounts (which, keep in mind, will be getting the bulk of your contributions between now and 57?)? Or otherwise using your traditional portion of your portfolio (currently less than $300k) to fill/stay in low brackets but supplementing above that with Roth?

No one is omniscient about how future tax policies will work, but based on current policies and what will be a sizeable (and much more rapidly growing) portion of your retirement portfolio in Roth accounts, you should be able to find a path to maximize your withdrawal strategy between 57-70.5 to stay in a tax bracket below even 22%.

I'd also suggest you consider optimizing your Roth vs. traditional asset allocation within your 401k -- not sure what other Bogleheads would say about it, but there may be a good reason to be all stocks in one, all bonds in the other (or something like that), but I'm not sure how to break down that analysis.
That's where part of my question came from. I have been blindly doing all Roth 401k. As I started researching more, I found this site and started seeing that it is probably better to do traditional. I just had a question on whether to consider any impacts of inheritance on my choice or not.

As far as trying to allocate funds between pre- and post-tax within the 401k, I guess that's another thing to research. I don't see an option online for that (Fidelity), but I'm sure I can call and figure that out.

Admiral
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by Admiral » Thu May 02, 2019 9:22 am

If you are 37, your parents and inlaws may be...60? Slightly older? That means they could be alive for 30 MORE YEARS.

I've posted my own thread about planning for an inheritance (here: viewtopic.php?f=2&t=279559) but I am older than you and my parents and inlaws are late 70s/80s.

Until you are much, much closer to actually receiving this windfall, do nothing. Pretend you won't get it.

I agree with those upthread: You should not be saving in Roth (or at least not very much) And particularly not if you plan to retire early. Unless you have a large vested pension that will fill up lower brackets, Roth probably is not for you (for now).

Most (not all) 401ks now have a Roth option. (Employee Employer contrib is only pre-tax pretty much always.) You should use i-ORP to help you see tax results of doing Roth vs pre-tax. You can always switch to Roth in 10 years or so, if your pre-tax account balance at that time warrants it.

Admiral
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by Admiral » Thu May 02, 2019 9:35 am

Chadnudj wrote:
Thu May 02, 2019 9:10 am
tigers174 wrote:
Thu May 02, 2019 7:01 am
For years I have been maxing out my 401k into Roth, with a 6% employee match to the traditional. We also have 2 Roth IRAs we contribute to. Right now our total portfolio is 58% Roth/42% Traditonal (~$600k).
Assuming just our retirement funds, I am currently projecting we would be in the lower to mid tier of the current 22% bracket in retirement
, although a lot can change in 20 years. I know reading on this forum and wiki, the general thought is that I should be leaning towards all traditional in the 401k.
I'm a bit confused. If all your retirement funds (save that 6% match by your employer) is now going to a Roth 401k, you pay zero tax when you withdraw from that Roth 401k in retirement (you're paying the income tax now). And you're planning on retiring at 57.

Couldn't you spend much of that 57-70.5 time period doing Roth conversions on the traditional portion of the 401k below the lowest brackets and living off your Roth accounts (which, keep in mind, will be getting the bulk of your contributions between now and 57?)? Or otherwise using your traditional portion of your portfolio (currently less than $300k) to fill/stay in low brackets but supplementing above that with Roth?

No one is omniscient about how future tax policies will work, but based on current policies and what will be a sizeable (and much more rapidly growing) portion of your retirement portfolio in Roth accounts, you should be able to find a path to maximize your withdrawal strategy between 57-70.5 to stay in a tax bracket below even 22%.

I'd also suggest you consider optimizing your Roth vs. traditional asset allocation within your 401k -- not sure what other Bogleheads would say about it, but there may be a good reason to be all stocks in one, all bonds in the other (or something like that), but I'm not sure how to break down that analysis.
In general terms, you want the assets in the account that will not be taxed in the future (AKA Roth) to have the highest growth potential (ie stocks, and especially things like REITs) while you want the accounts that will be taxed to grow more slowly (resulting in less future tax): aka bonds. Some will give you an argument, I'm sure.

I don't have enough room in my Roth accounts to hold all my stock allocation, so some is in pre-tax (and some in taxable). But all my Roth accounts are stock only, and my pre-tax accounts hold bonds.

Another generality: You should not plan to take Roth distributions (as opposed to conversions, which are OK) until your taxable and pre-tax accounts are depleted. Assuming you will have heirs, you want them to pay as little tax as possible.

Topic Author
tigers174
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by tigers174 » Thu May 02, 2019 9:36 am

Admiral wrote:
Thu May 02, 2019 9:22 am
If you are 37, your parents and inlaws may be...60? Slightly older? That means they could be alive for 30 MORE YEARS.

Unless you have a large vested pension that will fill up lower brackets, Roth probably is not for you (for now).
They are all in their early 70s.

I also get a cash balance plan through work that would be worth ~$550k lump or over $3000/month as an annuity at that time. This is per the company calculators. I don't include that in any calculations at this time either, but will as I get closer to my 50s.

Figaro
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by Figaro » Thu May 02, 2019 10:18 am

absolutely you should rethink going ROTH in your 401k.
Go all Pre-Tax including your IRA's if you could still deduct since you guys SAHM
Why pay the tax now? Kick the can down the road - let the money grow and then your tax savings today will pay the taxes you pay in the future.

You've already built up a nice ROTH account - so you're already diversified in your retirement accounts.
Convert the pretax to ROTH all the way 57-70 before you have those RMD's.

Live well and prosper - you're saving well - but you could do better with the Pre-tax contribution instead of ROTH contribution.

Chadnudj
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Re: Future inheritance impacts on Trad/Roth 401k choice

Post by Chadnudj » Thu May 02, 2019 10:31 am

tigers174 wrote:
Thu May 02, 2019 9:36 am
Admiral wrote:
Thu May 02, 2019 9:22 am
If you are 37, your parents and inlaws may be...60? Slightly older? That means they could be alive for 30 MORE YEARS.

Unless you have a large vested pension that will fill up lower brackets, Roth probably is not for you (for now).
They are all in their early 70s.

I also get a cash balance plan through work that would be worth ~$550k lump or over $3000/month as an annuity at that time. This is per the company calculators. I don't include that in any calculations at this time either, but will as I get closer to my 50s.
I'd suggest sticking with Roth 401k/Roth IRA, then. It looks like you'll be able to fill lower tax brackets with traditional/SS/this annuity (or lump sum -- if lump sum, I assume it's pre-tax). Allocate as Admiral indicated (stocks in Roth accounts, bonds in Traditional), and keep an eye on optimizing withdrawals/doing Roth conversions in that 57-70.5 space.

And, as other indicated, don't consider the potential inheritances. If you receive them, they will allow you to (a) retire sooner than 57, and/or (b) have an even better retirement/be more giving to charitable causes. There's also option (c) you could decline the inheritance and have it go to your children to help them out if you don't need it (presuming they are next in line per your state's rules/the terms of any will/estate plan). Obviously consult an attorney on that last path.

But I think if you're happy with cashflow, etc. right now, I'd just keep on doing the Roth 401k/Roth IRAs.

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