Roth or Traditional 401k in the 24% tax bracket?

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SlapShot48
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Joined: Sat Nov 23, 2013 9:01 pm

Roth or Traditional 401k in the 24% tax bracket?

Post by SlapShot48 »

In 2021 we were in the 35% tax bracket, but my wife recently took a new job and we should be in the 24% tax bracket for the next two years. However, we expect to be back in the 35% tax bracket in 2024 and beyond. Her new job allows for both Traditional and Roth 401k and 457 contributions.

Would it make sense to contribute to the Roth 401k and 457 plans for the next couple years or continue with traditional pre-tax contributions?

If it helps, our current retirement savings are below:

Taxable: $670,000
Traditional 'pre-tax': $960,000
Roth: $280,000

We're in our late 30's, expect to be working for another 15+ years. We max out all retirement options - $12,000 to backdoor Roth IRA and another $70,000 to tax deferred retirement accounts. Appreciate any insight on the Roth vs. Traditional decision.

Thanks.
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David Jay
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by David Jay »

It's a close call. You could split the difference - half in Roth, half in pre-tax.

Giving up a 24% (plus state?) deduction would be difficult for me, especially if I knew I had a number of years between retirement and start of SS when I could expect a similar or perhaps even lower tax rate.
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sailaway
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by sailaway »

You mention working another 15 years. If you plan to retire in your 50s, what kind of income do you expect then? An early retirement leaves a lot of time and space for mitigating taxes on traditional accounts, but your spending level has a big effect on that.
CommonsensePete
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by CommonsensePete »

Keep in mind that in 20 years that $960,000 in your 401K could be worth 4 million-plus, especially if you continue to contribute to the 401k during that time. When you hit age 72 you will have to start taking annual Required Mandatory Distributions of approximately 10 percent. On 4 million you would be looking at paying taxes on $400,000, which would put you in the 32 percent marginal tax bracket. It is because of RMDs that I favor Roth. I believe that taxes will most likely be higher in the future.
Last edited by CommonsensePete on Thu Jan 13, 2022 8:04 pm, edited 1 time in total.
pizzy
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by pizzy »

CommonsensePete wrote: Thu Jan 13, 2022 7:56 pm Keep in mind that in 20 years that $960,000 in your 401K could be worth 4 million-plus, especially if you continue to contribute to the 401k over the next 15 or 20 years. When you hit age 72 you will have to start taking annual Required Mandatory Distributions of approximately 10 percent. On 4 million you would be looking at paying taxes on $400,000 or more of income. In 2022 that would put you in the 32 percent marginal tax bracket. It is because of RMDs that I favor Roth.
They want to retire around 55 and will then have 17 low/no income years before RMDs start.
Late 30's | 90% VT | 10% Cash
Navillus1968
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by Navillus1968 »

SlapShot48 wrote: Thu Jan 13, 2022 5:33 pm In 2021 we were in the 35% tax bracket, but my wife recently took a new job and we should be in the 24% tax bracket for the next two years. However, we expect to be back in the 35% tax bracket in 2024 and beyond. Her new job allows for both Traditional and Roth 401k and 457 contributions.

Would it make sense to contribute to the Roth 401k and 457 plans for the next couple years or continue with traditional pre-tax contributions?

<snip>

Thanks.
You don't mention state income tax. If that's because you don't have one, great. OTOH, if you live in one of the 42 states that do impose an income tax, then your calculation shifts accordingly.
If a Roth contribution has a marginal rate approaching or in excess of 30% (24% Fed + 5-6-7% state), then the Trad accounts are more attractive.

Remember, you can use Roth conversions in your 50s & 60s at 12-15-25% Fed marginal rates (& zero state income tax if you move to FL/TX/NV/etc) to fix the over-weighted TIRA/401k account balances. Beats the heck out of paying 30-33% today on a Roth contribution.

Also, you should verify what your actual marginal tax rate is. Some online calculators look at your AGI & say "24% bracket" but when you back out QDI & LTCG (both taxed separately at 15% or 18.8% for your income level & taxable net worth), then apply deductions to ordinary income, you might find that your marginal rate is 'only' 22%.

At 22% Fed marginal rate + zero state income tax, Roth contributions (or a mix) become more reasonable. Run the numbers.

Both of the calculators linked below have their uses. The 1st is much more fine grained, but fails to accurately state your marginal ordinary income (OI) tax rate by conflating cap gains with OI in the "taxable income" summary (plug in 190k wages & 20K cap gains into both to see what I mean).
If none of my money is being taxed at 24%, then I find it meaningless to say I'm "in the 24% bracket." YMMV.

https://www.dinkytown.net/java/1040-tax-calculator.html#

The 2nd calculator is great for visually breaking out the 2 types of income, but fails to apply the NIIT to cap gains for MAGI >250K, among other limitations. NB- Neither calculator has yet been updated for 2022 tax rates.
https://engaging-data.com/tax-brackets/ ... 0&cg=20000
Topic Author
SlapShot48
Posts: 24
Joined: Sat Nov 23, 2013 9:01 pm

Re: Roth or Traditional 401k in the 24% tax bracket?

Post by SlapShot48 »

David Jay wrote: Thu Jan 13, 2022 5:41 pm It's a close call. You could split the difference - half in Roth, half in pre-tax.

Giving up a 24% (plus state?) deduction would be difficult for me, especially if I knew I had a number of years between retirement and start of SS when I could expect a similar or perhaps even lower tax rate.
Splitting the difference is an option, but I think I will have some low income years between retirement and Soc Security and/or RMD's where tax rate will likely be lower than 24%. Forgot about the 5% state income tax as well.
sailaway wrote: Thu Jan 13, 2022 5:50 pm You mention working another 15 years. If you plan to retire in your 50s, what kind of income do you expect then? An early retirement leaves a lot of time and space for mitigating taxes on traditional accounts, but your spending level has a big effect on that.
I'll have some EE bonds maturing and will likely sell some investments from taxable if I retire early. Probably could do some Roth conversions during that period as well.
Navillus1968 wrote: Fri Jan 14, 2022 11:15 am
SlapShot48 wrote: Thu Jan 13, 2022 5:33 pm In 2021 we were in the 35% tax bracket, but my wife recently took a new job and we should be in the 24% tax bracket for the next two years. However, we expect to be back in the 35% tax bracket in 2024 and beyond. Her new job allows for both Traditional and Roth 401k and 457 contributions.

Would it make sense to contribute to the Roth 401k and 457 plans for the next couple years or continue with traditional pre-tax contributions?

<snip>

Thanks.
You don't mention state income tax. If that's because you don't have one, great. OTOH, if you live in one of the 42 states that do impose an income tax, then your calculation shifts accordingly.
If a Roth contribution has a marginal rate approaching or in excess of 30% (24% Fed + 5-6-7% state), then the Trad accounts are more attractive.

Remember, you can use Roth conversions in your 50s & 60s at 12-15-25% Fed marginal rates (& zero state income tax if you move to FL/TX/NV/etc) to fix the over-weighted TIRA/401k account balances. Beats the heck out of paying 30-33% today on a Roth contribution.

Also, you should verify what your actual marginal tax rate is. Some online calculators look at your AGI & say "24% bracket" but when you back out QDI & LTCG (both taxed separately at 15% or 18.8% for your income level & taxable net worth), then apply deductions to ordinary income, you might find that your marginal rate is 'only' 22%.

At 22% Fed marginal rate + zero state income tax, Roth contributions (or a mix) become more reasonable. Run the numbers.

Both of the calculators linked below have their uses. The 1st is much more fine grained, but fails to accurately state your marginal ordinary income (OI) tax rate by conflating cap gains with OI in the "taxable income" summary (plug in 190k wages & 20K cap gains into both to see what I mean).
If none of my money is being taxed at 24%, then I find it meaningless to say I'm "in the 24% bracket." YMMV.

https://www.dinkytown.net/java/1040-tax-calculator.html#

The 2nd calculator is great for visually breaking out the 2 types of income, but fails to apply the NIIT to cap gains for MAGI >250K, among other limitations. NB- Neither calculator has yet been updated for 2022 tax rates.
https://engaging-data.com/tax-brackets/ ... 0&cg=20000
Thanks for the detailed post and links. Our effective/average tax rate last year was only 23%, but the marginal rate was 35%. Also have the nearly 5% state income tax I didn't consider. Leaning towards continuing with traditional contributions to the 401k and 457.

Appreciate all the comments so far.
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willthrill81
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by willthrill81 »

Until you've already got at least $2 million in tax-deferred accounts, I would hesitate to do Roth contributions in the 24% (and especially in the 35%) bracket. Remember that it takes over $2 million, assuming 4% withdrawals, of portfolio income for a MFJ couple just to get to the top of the 12% bracket. SS benefits can significantly reduce this threshold, but I would recommend sticking with tax-deferred contributions for now. If you ever decide to retire early, tax-deferred contributions now are almost certain to come out ahead in the end since you'll have lots of time to do Roth conversions in lower tax brackets.
“Good and ill have not changed since yesteryear; nor are they one thing among Elves and Dwarves and another among Men.” J.R.R. Tolkien, The Lord of the Rings
Woodpecker
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by Woodpecker »

You can always test it out and see how it feels. We swapped from 100% traditional to 100% Roth in both of our 401ks last year but didn't like it. The tax break is too sweet right now and it helps fund our Roth IRAs and HSA. That said, we still want to grow some Roth space so for now we're going with 75% traditional and 25% Roth. You're probably better off with traditional but either way you're doing great. Grats!
smitcat
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by smitcat »

SlapShot48 wrote: Thu Jan 13, 2022 5:33 pm In 2021 we were in the 35% tax bracket, but my wife recently took a new job and we should be in the 24% tax bracket for the next two years. However, we expect to be back in the 35% tax bracket in 2024 and beyond. Her new job allows for both Traditional and Roth 401k and 457 contributions.

Would it make sense to contribute to the Roth 401k and 457 plans for the next couple years or continue with traditional pre-tax contributions?

If it helps, our current retirement savings are below:

Taxable: $670,000
Traditional 'pre-tax': $960,000
Roth: $280,000

We're in our late 30's, expect to be working for another 15+ years. We max out all retirement options - $12,000 to backdoor Roth IRA and another $70,000 to tax deferred retirement accounts. Appreciate any insight on the Roth vs. Traditional decision.

Thanks.
Will either of you be getting any pensions?
Are there any potential inheritances?
Any possible delayed income due to RSU's, deferred compensation or bonus?
What is your best projection for your taxable account total savings 15 years from now in today's dollars?
KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Roth or Traditional 401k in the 24% tax bracket?

Post by KlangFool »

OP,

Trad 401K. You are retiring early. If you have too much money, you could retire even earlier.

As per Roth 401K, you cannot get the IRS to give your money back if you pay too much.

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willthrill81
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by willthrill81 »

SlapShot48 wrote: Fri Jan 14, 2022 12:42 pm Thanks for the detailed post and links. Our effective/average tax rate last year was only 23%, but the marginal rate was 35%. Also have the nearly 5% state income tax I didn't consider. Leaning towards continuing with traditional contributions to the 401k and 457.
Effective/average tax rates are of no value at all in determining whether to use traditional or Roth. Rather, it's all about marginal tax rates, both going in and coming out.
“Good and ill have not changed since yesteryear; nor are they one thing among Elves and Dwarves and another among Men.” J.R.R. Tolkien, The Lord of the Rings
pizzy
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by pizzy »

Traditional.

Don’t pay taxes until you have to.
Late 30's | 90% VT | 10% Cash
Hannibal Barca
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by Hannibal Barca »

I'm a big believer in having a mix of Roth and pre-tax accounts.

Assuming your state tax rate is the same now and in retirement (big assumption) and you continue to be a big saver, I'd keep doing Roth contributions at the 24% marginal rate. Keep in mind that the 2017 tax law expires after 2025. Depending on your income, that could mean that if you MFJ pay 24% MTR now, you could end up at 28% or 33% starting in 2026. At that point you'd likely want to switch back to pre-tax contributions. Net net that will give you a mix of Roth and pre-tax portfolio that will help you keep your MTR reasonable in retirement.
gclancer
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by gclancer »

David Jay wrote: Thu Jan 13, 2022 5:41 pm It's a close call.
Agreed that it’s close. If I were in this scenario I would probably do 100% Roth and switch back to Traditional in two years rather than analyzing it to death. Sometimes good enough is good enough and all else equal I’d error toward Roth. Starting in two years they’re going to be saving $70k or so per year in Traditional accounts which will cause the Roth to get dwarfed over time.
wetgear
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by wetgear »

Trad. Check out the wiki here about this topic.
TwoBitsCA
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by TwoBitsCA »

It seems that if you're retiring in your mid-50s and will be relying on your taxable for income, you would be able to do many years of sizable Roth conversions. The question would be is the 24% (plus state) tax you'd save now be more than, less than, or the same as whatever the tax you'd be looking at doing the conversion at?
Topic Author
SlapShot48
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by SlapShot48 »

smitcat wrote: Fri Jan 14, 2022 1:10 pm
Will either of you be getting any pensions?
Are there any potential inheritances?
Any possible delayed income due to RSU's, deferred compensation or bonus?
What is your best projection for your taxable account total savings 15 years from now in today's dollars?
No to all the questions above. Not really sure how big that taxable account will be in 15 years. Maybe $2M+ if we keep plowing money into it and investing fairly aggressively. Probably enough that if we retired in our mid-50's it would cover any expenses until SS and RMD's and allow us to do some Roth conversions during those years as others have mentioned.
Topic Author
SlapShot48
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by SlapShot48 »

TwoBitsCA wrote: Fri Jan 14, 2022 4:46 pm It seems that if you're retiring in your mid-50s and will be relying on your taxable for income, you would be able to do many years of sizable Roth conversions. The question would be is the 24% (plus state) tax you'd save now be more than, less than, or the same as whatever the tax you'd be looking at doing the conversion at?
Yeah that's what it boils down to. And I really don't know when we will retire or what life will throw our way, but I would guess there will be some low/no income years that will allow us to do some conversions at a lower rate than 24%. Still leaning towards the traditional contributions.

Thanks for all the responses everyone.
RyeBourbon
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Re: Roth or Traditional 401k in the 24% tax bracket?

Post by RyeBourbon »

CommonsensePete wrote: Thu Jan 13, 2022 7:56 pm Keep in mind that in 20 years that $960,000 in your 401K could be worth 4 million-plus, especially if you continue to contribute to the 401k during that time. When you hit age 72 you will have to start taking annual Required Mandatory Distributions of approximately 10 percent. On 4 million you would be looking at paying taxes on $400,000, which would put you in the 32 percent marginal tax bracket. It is because of RMDs that I favor Roth. I believe that taxes will most likely be higher in the future.
RMD at 72 is just under 4%, not 10%.
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