Should I Roth 401k or Trad 401k

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cusetownusa
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Should I Roth 401k or Trad 401k

Post by cusetownusa » Mon Jun 29, 2020 11:02 am

With the recent discussion/debate about what is better I thought I should start my own thread for advice on my specific situation.

For the last 2 years I have been contributing (max) to my Roth 401k and now I am starting to wonder if I should stop the Roth and go back to Trad.

The reason I started the Roth was because I don't get the Pass-Through deduction (20%) if I contribute to the Trad. I am in the 24% tax bracket, so with the 20% pass through deduction I am actually paying 19.2% on the Roth 401k contribution. However, I live in NYS, so I pay NYS income taxes on the entire amount. My thought is that I would max the Roth up until the pass-through deduction phases out in 2025.

We have about $900k in tax-deferred accounts and also max out my wifes Trad 403b and Trad 457b, as well as my match/profit sharing which is pre-tax. So this year we were able to contribute $76,500 in pre-tax accounts.

In addition, my wife will get a small pension ($35k per year in todays dollars if she continues working) at age 55. We plan on delaying SS until 70.

Am I stupid to be contributing to the Roth? I have read some of the discussions lately and it seems that the consensus is to always contribute to the Trad except in fringe cases...not sure I am considered fringe.
Last edited by cusetownusa on Mon Jun 29, 2020 12:03 pm, edited 1 time in total.

02nz
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Re: Should I Roth 401k or Trad 401k

Post by 02nz » Mon Jun 29, 2020 11:09 am

cusetownusa wrote:
Mon Jun 29, 2020 11:02 am
I am stupid to be contributing to the Roth? I have read some of the discussions lately and it seems that the consensus is to always contribute to the Trad except in fringe cases...not sure I am considered fringe.
There's no one consensus and certainly not for all cases. You didn't provide your ages, which can make a difference. But generally I think your current plan is fine, given the pension, sizable existing traditional balance, large tax-deferred contributions to other accounts, and temporary availability of the pass-through and lowered tax brackets. You won't know the exact optimal mix until you die, so having some of both is good. You can and should re-evaluate every year or so, based on any tax law changes, your own portfolio growth, retirement plans, etc.

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cusetownusa
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Re: Should I Roth 401k or Trad 401k

Post by cusetownusa » Mon Jun 29, 2020 12:07 pm

02nz wrote:
Mon Jun 29, 2020 11:09 am
cusetownusa wrote:
Mon Jun 29, 2020 11:02 am
I am stupid to be contributing to the Roth? I have read some of the discussions lately and it seems that the consensus is to always contribute to the Trad except in fringe cases...not sure I am considered fringe.
There's no one consensus and certainly not for all cases. You didn't provide your ages, which can make a difference. But generally I think your current plan is fine, given the pension, sizable existing traditional balance, large tax-deferred contributions to other accounts, and temporary availability of the pass-through and lowered tax brackets. You won't know the exact optimal mix until you die, so having some of both is good. You can and should re-evaluate every year or so, based on any tax law changes, your own portfolio growth, retirement plans, etc.
Thanks...this is what I was thinking as well. I normally lean toward Trad and typically recommend Trad if someone ask me but thought it may make sense to diversify a bit with the Roth and take advantage of the 20% pass through deduction.

FYI, we are 40 years old.

infotrader
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Re: Should I Roth 401k or Trad 401k

Post by infotrader » Mon Jun 29, 2020 12:14 pm

Do you contribute to Roth IRA? Why not contribute tax-deferred 401k and Roth IRA for both of you?

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cusetownusa
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Re: Should I Roth 401k or Trad 401k

Post by cusetownusa » Mon Jun 29, 2020 12:24 pm

infotrader wrote:
Mon Jun 29, 2020 12:14 pm
Do you contribute to Roth IRA? Why not contribute tax-deferred 401k and Roth IRA for both of you?
Yes, we max out a backdoor Roth IRA for both of us.

I wouldn't have even considered the Roth 401k if it wasn't for the 20% pass through deduction, and the fact we have an additional $75k+ of tax deferred space we contribute to.

But that still doesn't mean I necessary think I am making the correct decision which is why I started this thread. I read a good argument (think it was a kitces article), about people that receive a 20% pass through deduction should do the Roth but now I can't find it. But I believe this is what sparked me to make a change last year.

Edit: I think this is the Kitces article I read a few years ago...there were a few articles like this at the time.

https://www.kitces.com/blog/199a-qbi-de ... ions-roth/

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FiveK
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Re: Should I Roth 401k or Trad 401k

Post by FiveK » Mon Jun 29, 2020 4:16 pm

cusetownusa wrote:
Mon Jun 29, 2020 11:02 am
I have read some of the discussions lately and it seems that the consensus is to always contribute to the Trad except in fringe cases...not sure I am considered fringe.
You might be. ;)

Compare your marginal tax saving rate on a traditional contribution this year, to what you expect for a marginal tax rate when withdrawing that contribution and its gains.

Estimating the future marginal tax rate is your ante to get into the game. If you don't want to do that, you could flip a coin, go 50/50, assume you're not fringe, etc.

infotrader
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Re: Should I Roth 401k or Trad 401k

Post by infotrader » Mon Jun 29, 2020 11:03 pm

cusetownusa wrote:
Mon Jun 29, 2020 12:24 pm
infotrader wrote:
Mon Jun 29, 2020 12:14 pm
Do you contribute to Roth IRA? Why not contribute tax-deferred 401k and Roth IRA for both of you?
Yes, we max out a backdoor Roth IRA for both of us.

I wouldn't have even considered the Roth 401k if it wasn't for the 20% pass through deduction, and the fact we have an additional $75k+ of tax deferred space we contribute to.

But that still doesn't mean I necessary think I am making the correct decision which is why I started this thread. I read a good argument (think it was a kitces article), about people that receive a 20% pass through deduction should do the Roth but now I can't find it. But I believe this is what sparked me to make a change last year.

Edit: I think this is the Kitces article I read a few years ago...there were a few articles like this at the time.

https://www.kitces.com/blog/199a-qbi-de ... ions-roth/
Although I am a strong advocate for Roth, I think it is a toss in your case.

babystep
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Re: Should I Roth 401k or Trad 401k

Post by babystep » Tue Jun 30, 2020 12:27 am

cusetownusa wrote:
Mon Jun 29, 2020 11:02 am
With the recent discussion/debate about what is better I thought I should start my own thread for advice on my specific situation.

For the last 2 years I have been contributing (max) to my Roth 401k and now I am starting to wonder if I should stop the Roth and go back to Trad.

The reason I started the Roth was because I don't get the Pass-Through deduction (20%) if I contribute to the Trad. I am in the 24% tax bracket, so with the 20% pass through deduction I am actually paying 19.2% on the Roth 401k contribution. However, I live in NYS, so I pay NYS income taxes on the entire amount. My thought is that I would max the Roth up until the pass-through deduction phases out in 2025.

We have about $900k in tax-deferred accounts and also max out my wifes Trad 403b and Trad 457b, as well as my match/profit sharing which is pre-tax. So this year we were able to contribute $76,500 in pre-tax accounts.

In addition, my wife will get a small pension ($35k per year in todays dollars if she continues working) at age 55. We plan on delaying SS until 70.

Am I stupid to be contributing to the Roth? I have read some of the discussions lately and it seems that the consensus is to always contribute to the Trad except in fringe cases...not sure I am considered fringe.
It depends on when you retire or stop working. If you don't and let it continue like this for another 15 years then

Back of the envelope calculation:
pre-tax contributions of 76,500 per year will grow to 1.6M with a 4% real return.
Say 900k with a 4% real return in 15 years will be 1.6M

The total pre-tax will be 1.6+1.6 = 3.2M

If you withdraw 68k per year from 55 to 70 so that you could stay under 12% bracket then you could get 1M to Roth but you will still have more than 3M in 401k which will still push you in 22% when RMDs+SS starts.

The very rough weighted tax rate will be 12*0.25+22*0.75 = 19.5%.

We can clearly see there are so many variables that can change in the future like tax rates, stock market returns, and how long contributions happen and tax laws.

You can see that if you contributed like this for 25 years then it changes in the favor of Roth now.

Assuming the plan is to continue to work till 60 then I would lean towards Roth when Tax rate is 19.2% to get the diversification of account types.

Edit: Thanks 02nz for pointing out the mistake that we should use real return instead of nominal since tax rates are indexed to inflation.
Last edited by babystep on Tue Jun 30, 2020 11:23 pm, edited 1 time in total.

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BoglesRazor
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Re: Should I Roth 401k or Trad 401k

Post by BoglesRazor » Tue Jun 30, 2020 9:02 am

cusetownusa wrote:
Mon Jun 29, 2020 11:02 am
With the recent discussion/debate about what is better I thought I should start my own thread for advice on my specific situation.

For the last 2 years I have been contributing (max) to my Roth 401k and now I am starting to wonder if I should stop the Roth and go back to Trad.

The reason I started the Roth was because I don't get the Pass-Through deduction (20%) if I contribute to the Trad. I am in the 24% tax bracket, so with the 20% pass through deduction I am actually paying 19.2% on the Roth 401k contribution. However, I live in NYS, so I pay NYS income taxes on the entire amount. My thought is that I would max the Roth up until the pass-through deduction phases out in 2025.

We have about $900k in tax-deferred accounts and also max out my wifes Trad 403b and Trad 457b, as well as my match/profit sharing which is pre-tax. So this year we were able to contribute $76,500 in pre-tax accounts.

In addition, my wife will get a small pension ($35k per year in todays dollars if she continues working) at age 55. We plan on delaying SS until 70.

Am I stupid to be contributing to the Roth? I have read some of the discussions lately and it seems that the consensus is to always contribute to the Trad except in fringe cases...not sure I am considered fringe.
I'm also employed by NYS (although PA resident) and I have a Roth 401K (no traditional either). What is this 20% Pass-Through deduction you speak of? I am in the 22% tax bracket, but I chose Roth 401K because I am slightly younger than you and I want to focus on growth since its tax free (I didn't start investing until fairly recently). What is a fringe case?

02nz
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Re: Should I Roth 401k or Trad 401k

Post by 02nz » Tue Jun 30, 2020 10:58 am

babystep wrote:
Tue Jun 30, 2020 12:27 am
It depends on when you retire or stop working. If you don't and let it continue like this for another 15 years then

Back of the envelope calculation:
pre-tax contributions of 76,500 per year will grow to 1.8M with a 6% return.
Say 900k with a 6% return in 15 years will be 2.1M

The total pre-tax will be 1.8+2.1 = 3.9M
I agree with the conclusion and point about depending on when OP retires, but the calculation makes a common error with the return assumption. Income tax brackets are indexed for inflation, and so you should use real not nominal returns when projecting portfolio size. And, both to be on the "safe side" and because investors generally increase their bond allocations as they approach retirement (and so get lower returns, on average), I would assume something closer to 3-4% real rather than 6%. Using 4% produces a total tax-deferred balance of about $2.0 M instead of 3.9 M.

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1789
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Re: Should I Roth 401k or Trad 401k

Post by 1789 » Tue Jun 30, 2020 4:55 pm

I think lakpr made some calculations to answer to this endless question. That might be a sticky note somewhere in the forum, or in wiki.
"My conscience wants vegetarianism to win over the world. And my subconscious is yearning for a piece of juicy meat. But what do i want?" (Andrei Tarkovsky)

JBTX
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Re: Should I Roth 401k or Trad 401k

Post by JBTX » Tue Jun 30, 2020 6:31 pm

cusetownusa wrote:
Mon Jun 29, 2020 11:02 am
With the recent discussion/debate about what is better I thought I should start my own thread for advice on my specific situation.

For the last 2 years I have been contributing (max) to my Roth 401k and now I am starting to wonder if I should stop the Roth and go back to Trad.

The reason I started the Roth was because I don't get the Pass-Through deduction (20%) if I contribute to the Trad. I am in the 24% tax bracket, so with the 20% pass through deduction I am actually paying 19.2% on the Roth 401k contribution. However, I live in NYS, so I pay NYS income taxes on the entire amount. My thought is that I would max the Roth up until the pass-through deduction phases out in 2025.

We have about $900k in tax-deferred accounts and also max out my wifes Trad 403b and Trad 457b, as well as my match/profit sharing which is pre-tax. So this year we were able to contribute $76,500 in pre-tax accounts.

In addition, my wife will get a small pension ($35k per year in todays dollars if she continues working) at age 55. We plan on delaying SS until 70.

Am I stupid to be contributing to the Roth? I have read some of the discussions lately and it seems that the consensus is to always contribute to the Trad except in fringe cases...not sure I am considered fringe.
My take is what you are doing makes sense. You already have a good base of traditional, and still adding substantial amounts to it such that you have ample amounts to fill up the lowest tax brackets in retirement.

A scenario where it may not make as much sense is if you decide to retire early, live on a shoe string budget, and don't plan on using ACA. Then you could possibly Roth convert before retirement.

Topic Author
cusetownusa
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Re: Should I Roth 401k or Trad 401k

Post by cusetownusa » Tue Jun 30, 2020 8:31 pm

BoglesRazor wrote:
Tue Jun 30, 2020 9:02 am

I'm also employed by NYS (although PA resident) and I have a Roth 401K (no traditional either). What is this 20% Pass-Through deduction you speak of? I am in the 22% tax bracket, but I chose Roth 401K because I am slightly younger than you and I want to focus on growth since its tax free (I didn't start investing until fairly recently). What is a fringe case?
The 20% pass through deduction is for small business owners.

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BoglesRazor
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Re: Should I Roth 401k or Trad 401k

Post by BoglesRazor » Tue Jun 30, 2020 11:24 pm

cusetownusa wrote:
Tue Jun 30, 2020 8:31 pm
BoglesRazor wrote:
Tue Jun 30, 2020 9:02 am

I'm also employed by NYS (although PA resident) and I have a Roth 401K (no traditional either). What is this 20% Pass-Through deduction you speak of? I am in the 22% tax bracket, but I chose Roth 401K because I am slightly younger than you and I want to focus on growth since its tax free (I didn't start investing until fairly recently). What is a fringe case?
The 20% pass through deduction is for small business owners.
I am a small business owner (LLC in PA) though. To be clear, I am fully employed in NYS, but I own an LLC in PA (I'm a commuter). Basically, I work for someone else and myself in two different states. Is the 20% pass through deduction only valid for NYS small business owners? I have had my LLC for 6 years now and I don't remember any pass through deductions...

babystep
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Re: Should I Roth 401k or Trad 401k

Post by babystep » Tue Jun 30, 2020 11:25 pm

02nz wrote:
Tue Jun 30, 2020 10:58 am
babystep wrote:
Tue Jun 30, 2020 12:27 am
It depends on when you retire or stop working. If you don't and let it continue like this for another 15 years then

Back of the envelope calculation:
pre-tax contributions of 76,500 per year will grow to 1.8M with a 6% return.
Say 900k with a 6% return in 15 years will be 2.1M

The total pre-tax will be 1.8+2.1 = 3.9M
I agree with the conclusion and point about depending on when OP retires, but the calculation makes a common error with the return assumption. Income tax brackets are indexed for inflation, and so you should use real not nominal returns when projecting portfolio size. And, both to be on the "safe side" and because investors generally increase their bond allocations as they approach retirement (and so get lower returns, on average), I would assume something closer to 3-4% real rather than 6%. Using 4% produces a total tax-deferred balance of about $2.0 M instead of 3.9 M.
:oops: Thank you 02nz. I edited the post to make the correction.

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FiveK
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Re: Should I Roth 401k or Trad 401k

Post by FiveK » Tue Jun 30, 2020 11:38 pm

BoglesRazor wrote:
Tue Jun 30, 2020 11:24 pm
Is the 20% pass through deduction only valid for NYS small business owners? I have had my LLC for 6 years now and I don't remember any pass through deductions...
You may know it by a different name. See Tax Cuts and Jobs Act, Provision 11011 Section 199A - Qualified Business Income Deduction FAQs | Internal Revenue Service

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cusetownusa
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Re: Should I Roth 401k or Trad 401k

Post by cusetownusa » Wed Jul 01, 2020 7:58 am

FiveK wrote:
Tue Jun 30, 2020 11:38 pm
BoglesRazor wrote:
Tue Jun 30, 2020 11:24 pm
Is the 20% pass through deduction only valid for NYS small business owners? I have had my LLC for 6 years now and I don't remember any pass through deductions...
You may know it by a different name. See Tax Cuts and Jobs Act, Provision 11011 Section 199A - Qualified Business Income Deduction FAQs | Internal Revenue Service
Check with your accountant, but I would assume you are getting the 20% pass through deduction on your federal taxes. Any money you put into a pre-tax account does count toward the 20% deduction.

Read the above IRS link and the Kitces articles on this.

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