Cut back on 401k for rothIRA sake?

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WilliamRice
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Cut back on 401k for rothIRA sake?

Post by WilliamRice »

I had a little question about retirement investing. I contribute 15% of my paycheck to my work 401k account. The company no longer matches anything and has stated that it does not intend to again. I would like to keep contributing to it but I was thinking of cutting back to 6 - 10% and using the newly freed up money in my paycheck to put into my rothIRA. I thought that since when I retire I will presumably be in a higher tax bracket than I am now I would want to get that money tax free in the future. Am I thinking about this rationally/correctly? Any input would be much appreciated. Thanks everyone!

william rice
Laura
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Post by Laura »

WilliamRice,

The general rule of thumb for investing priority is:

1. 401k up to the match
2. Max out roth
3. Max out 401k
4. Taxable investing

In your case it may be a good idea to reduce 401k contributions however we need more information. If you happen to have a very, very low cost 401k plan continuing to fund the 401k may make sense. This would be very unusual but you never know.

If you are close to retirement and expect to be in a much lower tax bracket in a few years then it doesn't make sense to fund the roth today while paying higher taxes on that income.

If you are very close to the income limit for funding a roth then using the 401k to reduce taxable income and to stay below the limit would also be a good idea.

These are just a few of the items to consider.

Laura
The views presented are my own and not necessarily those of the Department of State or the U.S. Government.
YDNAL
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Re: Cut back on 401k for rothIRA sake?

Post by YDNAL »

WR,
Last month you wrote:I am in my mid-20's and have a rothIRA and a 401k.
http://www.bogleheads.org/forum/viewtop ... ht=#593773
Have you done any subsequent reading?
WilliamRice wrote:I thought that since when I retire I will presumably be in a higher tax bracket than I am now I would want to get that money tax free in the future.
Why do you say that?

The investing "rule of thumb" is a good place to start, but I question - as a general rule - why anyone would choose to pay taxes today without specific and known reasons. Typically, during your working years your taxes are higher unless you are able to amass/inherit significant wealth for the future. You indicated saving 15% of your salary - not necessarily maxing the 401K - which is in no way excessive. Further, future tax laws are unknown and you could face something like VAT (consumption tax).

Please post the options available to you in the 401K. Better yet, follow the sticky to ask questions.
Asking Portfolio Questions
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
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greg24
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Post by greg24 »

A bird in hand is worth two in the bush.

I like taking the known tax deduction now, rather than planning on theoretical tax deductions 40 years down the road.
Buckeye
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Post by Buckeye »

Half our annual retirement savings go into Roth IRAs and the other half we save in our 401ks.
dbr
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Post by dbr »

I sometimes like to review this question from an intuitive point of view:

If I were in a 25% Federal and 7% state tax bracket, would I immediately and permanently abandon 32% (one third) of my assets against the risk that somewhere, sometime, somehow, someone will eventually get dinged for more than that in taxes?

If I were at 10% Federal and no state tax, how would the same decision look?

Do you have an impression where the changeover in attitude would take place?
SpecialK22
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Re: Cut back on 401k for rothIRA sake?

Post by SpecialK22 »

YDNAL wrote: Further, future tax laws are unknown and you could face something like VAT (consumption tax).
As you state: future tax laws are unknown. I personally feel that the OP has a decent plan by contributing both to a traditional 401(k) and Roth IRA for tax diversification purposes. Without being a considered a tax soothsayer, I feel that it is much more likely that we will see an increase in income taxes before we see a VAT.
GG
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Post by GG »

I would absolutely split the difference for some tax diversification.

And based on your assumed income if you are in the 15% bracket, then speculation aside, there's no chance you'll ever pay taxes at a lower rate. So, better to fully fund the Roth now and owe no taxes later in higher brackets.

If you were in the 35% bracket now, then probably the reverse it true.

And if taxes rates are the same on the front and back, then it's obviously a wash
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grabiner
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Re: Cut back on 401k for rothIRA sake?

Post by grabiner »

WilliamRice wrote:I had a little question about retirement investing. I contribute 15% of my paycheck to my work 401k account. The company no longer matches anything and has stated that it does not intend to again. I would like to keep contributing to it but I was thinking of cutting back to 6 - 10% and using the newly freed up money in my paycheck to put into my rothIRA. I thought that since when I retire I will presumably be in a higher tax bracket than I am now I would want to get that money tax free in the future.
This looks like the right idea, if you actually expect to retire in a higher bracket.

Even if you expect to retire in the same bracket, you should prefer the Roth IRA if it has better options than your 401(k) for something that you want to hold. For example, if your 401(k) has excellent stock and bonds funds but you would prefer Total International to anything the 401(k) offers, you can open a Roth to put Total International there.
Wiki David Grabiner
Doc7
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Post by Doc7 »

I don't think this detracts from the above discussion to post in this thread instead of starting a new one.

Due to college, salary increases, and new positions with additional overtime, my 'highest tax bracket achieved' has looked like this:

2007: 15%
2008: 25%
2009: 28%

I suspect it will hover between 25 and 28, as a) job security is lower than ever so a decline in salary may occur and b) possibility for becoming not-single within 3-4 years always exists.

I've been contributing 100% of my retirement savings to a ROTH 401(k) and a ROTH IRA. No tax-deferred 401(k) or IRA savings. Roth Roth Roth was all I heard when I was 23 but now that I approach 25 and am making double the income that my job-offer sheet had on it back when I graduated college, I think I need to at least re-evaluate.

Thank you

Doc7
SpecialK22
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Post by SpecialK22 »

There are a couple of situations I can think of off the top of my head that might still favor you contributing to a Roth:

1.) Do you contribute the max to the Roth 401(k) and Roth IRA? The Roth option allows more money to be sheltered in tax advantaged account.

2.) Will you have a pension?

3.) Since you are young, there are still many contribution years ahead. This can lead to quite a sizeable nest egg, especially if you are maxing out contributions.

Truthfully, there are so many unknowns that the only truly foolish thing to do is not contribute to any retirement account. I personally prefer the Roth option to traditional for both my IRA and 401(k) for the reasons I listed above.
livesoft
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Post by livesoft »

I think this whole Roth vs 401(k) is probably a red herring because the decision is often made for you. Here's why:

1. If you are high income, then you are not eligible for a Roth IRA unless you do the back door thing before the door is locked.

2. If you are high income, you should be able to max your 401(k) and any Roth IRA you may be eligible for anyways.

3. If are not high income, are eligible for a Roth and can't afford to contribute to both, then the maxim of 401(k) to match, then Roth is probably correct.

Of course, there are many other situations which don't match the above.
SpecialK22
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Post by SpecialK22 »

Unlike Roth IRA's, Roth 401(k)'s have no income restrictions. I think contributing to a Roth 401(k) vs traditional 401(k) is usually the debate.
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Boglenaut
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Post by Boglenaut »

Buckeye wrote:Half our annual retirement savings go into Roth IRAs and the other half we save in our 401ks.
I follow a similar bet-hedging strategy.
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