401(k): Allocation between Roth & Trad Components

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
targetdemographic
Posts: 12
Joined: Sun Feb 27, 2011 10:19 pm

401(k): Allocation between Roth & Trad Components

Post by targetdemographic »

Much shorter question this time:
Assuming you have a long (30yr) time horizon (which I do, target retirement 65 in 2040), for the near term does it matter how you allocate the assets between the Roth and Traditional components of a 401(k)?
grberry
Posts: 234
Joined: Fri Jul 20, 2007 1:16 pm
Location: Boston, MA

Post by grberry »

If you have the choice, put the assets with the higher expected future growth in the Roth, keep the lower expected growth in the Traditional.

Roth should be tax fee on withdrawal. Traditional will be taxed on withdrawal. You would prefer to have more of your money completely tax free in the withdrawal phase.

Some 401(k) providers don't let you have different allocations for the Roth than you do for the Traditional, in which case you won't get a choice.
Topic Author
targetdemographic
Posts: 12
Joined: Sun Feb 27, 2011 10:19 pm

Post by targetdemographic »

My plan is completely "self-directed", so I can choose any funds, and the Trad & Roth components do not need to mirror each other, as far as I know. I will certainly check with our TPA (third party administrator) before I screw something up.
I guess I was thinking about capital gains near the time of retirement, but of course what you say makes simple sense, the more in the tax-free bucket, the better.
Further, I suppose this issue is a reason to use index funds as opposed to target date funds, so that I can be a little more tactical in asset allocation between the 401(k) components. Would you agree with that, or do I have faulty logic there?
Bob's not my name
Posts: 7407
Joined: Sun Nov 15, 2009 9:24 am

Post by Bob's not my name »

grberry wrote:If you have the choice, put the assets with the higher expected future growth in the Roth, keep the lower expected growth in the Traditional.

Roth should be tax fee on withdrawal. Traditional will be taxed on withdrawal. You would prefer to have more of your money completely tax free in the withdrawal phase.
This is false logic. The Roth is not a magic kingdom in which more return can be had without more risk.
wiki wrote:For example, suppose you have $4,000 in a 401(k) and $3,000 in a Roth IRA, and you will be in a 25% tax bracket when you retire. You might choose to invest the entire 401(k) in stock and the entire Roth in bonds. If you do this, and the stock market gains 10% while the bond market gains 5%, your 401(k) would be worth $4,400, and your Roth would be worth $3,150. The IRS will take 25% of your 401(k) when you withdraw it , so you could now withdraw your investments for $6,450. Similarly, if you invested the 401(k) in bonds and the Roth in stock, your 401(k) would be worth $4,200, and your Roth would be worth $3,300. After taxes, you would have the same $6,450. Since both portfolios give you the same 7.5% return that you would expect from a portfolio which was 50% stock and 50% bonds, it is reasonable to treat both portfolios as having a 50/50 asset allocation, rather than the 57/43 and 43/57 which would result from the nominal values.
The tax adjustment also adjusts for the effective difference in risk between the two accounts. In the example above, suppose that the stock market loses half its value. If your 401(k) was entirely in stock, it would drop from $4,000 to $2,000, which would cost you $1,500 in after-tax value; if your Roth was entirely in stock, it would drop from $3,000 to $1,500. Either way, you lose 25% of the value of your portfolio, so your portfolio has the risk of a portfolio which is 50% stock.
Once you understand that, see this thread for various considerations that might affect how you split: http://www.bogleheads.org/forum/viewtop ... sc&start=0

Far more important: Why are you doing Roth at all?
Topic Author
targetdemographic
Posts: 12
Joined: Sun Feb 27, 2011 10:19 pm

Post by targetdemographic »

Thanks for the link to prior thread, I will definitely check it out.

To clarify:
1) I am not discussing Roth IRA (I have a Roth IRA $4K in USAA 2040 target fund. By income, I am totally aced out of further contributions to Roth IRA, so I parked it there and am going to forget about it.)
2) I am talking about Roth 401(k) - which I think you understood. The reason I am putting my full personal contribution ($16.5K) in this way as post-tax dollars is because I have the flexibility to do so based on my income, and I thought it a prudent way to mitigate risk of future tax increases in the US.

To your point about false logic: I slept on my own comments and grberry's comments and I agree with you. There is no free lunch.

Question remains: Is there a reason to have different pattern of asset allocation between Trad 401(k) and Roth 401(k)?

Off to the prior thread I go...Anyone have any other old threads on this topic to help me out?
YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: 401(k): Allocation between Roth & Trad Components

Post by YDNAL »

targetdemographic wrote:Much shorter question this time:
Assuming you have a long (30yr) time horizon (which I do, target retirement 65 in 2040), for the near term does it matter how you allocate the assets between the Roth and Traditional components of a 401(k)?
TD,

I read your other (longer) thread also and will respond to both here.

1) In your income tax bracket, you should defer taxes until retirement and avoid the Roth 401K. While you do that, the income taxes that would otherwise go to Uncle Sam are invested and compounding over a long period. In retirement, you pay an average tax rate, that starts at 0%, then 10%, etc.

2) A target date fund's date is often useless. So, a target 2040 (the year of projected retirement) that has a 90/10 Stock/Bond split may be inappropriate for someone retiring in 2040. Pick the target fund with the appropriate Stock/Bond split for your ability and need for risk.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
joppy
Posts: 527
Joined: Thu Feb 22, 2007 3:45 am

backdoor roth ira

Post by joppy »

targetdemographic wrote:By income, I am totally aced out of further contributions to Roth IRA, so I parked it there and am going to forget about it.)
Take a look at the threads of backdoor Roth IRA on this forum. If you don't have any other traditional IRAs, you can put your contribution in a non-deductible IRA and then convert it immediately into a Roth IRA.

If you have other traditional IRAs, then the tax implications are a bit more complicated. See the other threads for explanations.

- Joppy
Topic Author
targetdemographic
Posts: 12
Joined: Sun Feb 27, 2011 10:19 pm

Post by targetdemographic »

Landy-
Thanks, I see my two threads are a little too related.
Maybe I can pose a more refined question, see what people think, then close this thread.

Question:
When (if ever) is it appropriate to personally contribute post-tax dollars to a Roth 401(k) instead of personally contributing pre-tax dollars in the Traditional 401(k)?
(I assume there will be an interplay of taxes now, taxes then, current market conditions, and personal debt obligations - mortgage/medschooldebt)
User avatar
CassiusKing
Posts: 121
Joined: Tue Mar 23, 2010 10:23 am
Location: Ohio

Post by CassiusKing »

I'm gonna piggy back on this thread a bit. I have a Roth 401k available at my work as well.
Am I understanding it correctly that I should put the max in my traditional 401k and if I want to fund a Roth after that do it in a regular Roth account, not my Roth 401k? Thanks.
"Who cares how time advances? I'm drinking ale today." -Edgar Allan Poe
YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: 401(k): Allocation between Roth & Trad Components

Post by YDNAL »

targetdemographic wrote:Landy-
Thanks, I see my two threads are a little too related.
Maybe I can pose a more refined question, see what people think, then close this thread.

Question:
When (if ever) is it appropriate to personally contribute post-tax dollars to a Roth 401(k) instead of personally contributing pre-tax dollars in the Traditional 401(k)?
(I assume there will be an interplay of taxes now, taxes then, current market conditions, and personal debt obligations - mortgage/medschooldebt)
When you have a crystal ball that's not foggy and works well! :)

TAXES.
  • Are income taxes today lower/higher than tomorrow? (rhetorical)
  • Paying up-front taxes may be appropriate for those that pay less taxes today than they will pay tomorrow. See my previous post about deferral and compounding.
  • Most people benefit from deferral and paying lower (average) taxes in retirement. Are you a "most" people?
Last edited by YDNAL on Mon Feb 28, 2011 10:54 am, edited 1 time in total.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
User avatar
kenyan
Posts: 3002
Joined: Thu Jan 13, 2011 12:16 am

Post by kenyan »

CassiusKing wrote:I'm gonna piggy back on this thread a bit. I have a Roth 401k available at my work as well.
Am I understanding it correctly that I should put the max in my traditional 401k and if I want to fund a Roth after that do it in a regular Roth account, not my Roth 401k? Thanks.
Cassius, there's no "one size fits all" answer for your question. You'd probably best be served by starting a new thread and including all of your relevant financial information.
YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: 401(k): Allocation between Roth & Trad Components

Post by YDNAL »

CassiusKing wrote:I'm gonna piggy back on this thread a bit. I have a Roth 401k available at my work as well.
Am I understanding it correctly that I should put the max in my traditional 401k and if I want to fund a Roth after that do it in a regular Roth account, not my Roth 401k? Thanks.
CK,

If you read my last post, the 3 bullets apply to everyone. Where do you fall in the range of possibilities?
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
Topic Author
targetdemographic
Posts: 12
Joined: Sun Feb 27, 2011 10:19 pm

Post by targetdemographic »

Bob's not my name-
Thanks for the link to the thread: Roth vs Traditional asset location - advanced discussion
That discussion is exactly what I was looking for.

I am not familiar with closing threads, other than them just dying out. It seems like this one has answered my question. Thanks everyone!

If you have any other thoughts, I would appreciate some input on my other thread (I know some of you have already addressed this):

Launching Self-directed 401(k): Index funds vs Target funds?
Bob's not my name
Posts: 7407
Joined: Sun Nov 15, 2009 9:24 am

Post by Bob's not my name »

targetdemographic wrote:When (if ever) is it appropriate to personally contribute post-tax dollars to a Roth 401(k) instead of personally contributing pre-tax dollars in the Traditional 401(k)?
Maybe if you're in the lowest bracket, but maybe never. Two things to read:

http://thefinancebuff.com/case-against-roth-401k.html
http://www.bogleheads.org/forum/viewtopic.php?p=846067
Post Reply