Theory on whether to go Roth 401k

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SpartanBull
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Theory on whether to go Roth 401k

Post by SpartanBull » Mon Jan 30, 2017 8:32 pm

Hello,
This question is regarding the offering of a Roth 401k in an Solo 401k account for self employed people. Per my understanding, if you're in the 25% tax bracket,one should NOT take advantage of making their Employee portion a ROTH contribution. I'm wondering if below are reasons to go Roth, even if you're in the 25% tax bracket.
1) What if you think you'll still be making a similar (inflation adjusted) amount of money in your older age? In that case, does Roth make sense, or does traditional still make more sense?
2) Is getting different "tax buckets" a good reason to go roth on the employee portion?
3) Lastly, how substantial is the difference between the 2 in savings?
Example
person A is 25 years old, makes 100k, is in the 25% bracket, and goes ROTH for their 18k employer portion
person B is 25 years old, Makes 100k and does NOT go both, instead taking the 18k income deduction and investing the savings in a taxable account.
If the tax bracket stays the same in retirement is this a a wash? If the tax bracket goes down in retirement to 15% bracket or something, how substantial is the savings from doing the I401k?
Thanks.

DSInvestor
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Re: Theory on whether to go Roth 401k

Post by DSInvestor » Mon Jan 30, 2017 8:56 pm

I maxed out Traditional 401k and Traditional solo 401k later while self employed. While I was working, I lived in states with high state income tax and then moved to a state with no state income tax where my withdrawals and Roth conversions are not subject to state income tax. Had I made Roth 401k contributions, I would have pre-paid state income tax to my old states for no good reason.

I did not continue to work until old age. Once I stopped working, I lived off the taxable account which is extremely tax efficient - taking advantage of the 0% Fed tax rate for Long Term Capital Gains (LTCG) and Qualified Dividend Income (QDI). I do a series of Roth conversions for little or no tax. I avoided Fed and State income tax for my Traditional contributions and am now able to convert them to Roth IRA for no tax. No tax going in. No tax going out.

Note that Roth 401k contributions are irrevocable once made - you cannot change your mind later and say hey let me have the deduction. Traditional 401k contributions give you the deduction up front but you have the option to convert to Roth later (and the cost of conversion can be as low as ZERO).

If you make 100K gross income and max out Traditional 401k, you reduce your AGI and taxable income by 18K. You'd be in 25% tax bracket and save roughly 25% on that 18K reduction in ordinary income because it comes off the top of your income stack.

If you withdrew 100K from Traditional accounts, you'd also be in 25% tax bracket. However you do not pay 25K in Fed tax. Since you do not have a pension to consume the lower tax brackets, some of that 100K income is taxed at 0%, 10%, 15% and 25%. Under current brackets, 100K withdrawal as your only source of income has $18,145 Fed Tax. If you're married filing jointly and withdrew 100K, your Fed Tax would be 10K.

If you're young, there may be other considerations for Roth vs Traditional employee 401k contributions. Traditional 401k contributions give you more take home pay. 18K at 25% saves you 4.5K in Fed Tax and maybe more if you have a state income tax. This 4.5K of tax savings may help you attack other financial priorities - like saving for house/car, paying off student loans, paying credit cards, building up cash reserves, accelerating mortgage pay off, invest in taxable accounts.

IMO, the default plan should be to max out Traditional 401k, Roth IRA and then invest in taxable.
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KlangFool
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Re: Theory on whether to go Roth 401k

Post by KlangFool » Mon Jan 30, 2017 9:20 pm

`SpartanBull wrote:Hello,
This question is regarding the offering of a Roth 401k in an Solo 401k account for self employed people. Per my understanding, if you're in the 25% tax bracket,one should NOT take advantage of making their Employee portion a ROTH contribution. I'm wondering if below are reasons to go Roth, even if you're in the 25% tax bracket.
1) What if you think you'll still be making a similar (inflation adjusted) amount of money in your older age? In that case, does Roth make sense, or does traditional still make more sense?
2) Is getting different "tax buckets" a good reason to go roth on the employee portion?
3) Lastly, how substantial is the difference between the 2 in savings?
Example
person A is 25 years old, makes 100k, is in the 25% bracket, and goes ROTH for their 18k employer portion
person B is 25 years old, Makes 100k and does NOT go both, instead taking the 18k income deduction and investing the savings in a taxable account.
If the tax bracket stays the same in retirement is this a a wash? If the tax bracket goes down in retirement to 15% bracket or something, how substantial is the savings from doing the I401k?
Thanks.
SpartanBull,

It is very simple. You are at 25% bracket. When you retire, you could be at 25% or lower.

1) If you go with Trad. 401K and you retire at 25%, it is a wash. You lose and gain nothing. You pay the same amount of tax. If you retire at below 25%, you pay less tax.

2) If you go with Roth 401K and you retire at 25%, you lose nothing. But, if you retire at below 25%, you had paid more tax than necessary.

Why would anyone choose (2)? You could never do better than (1). It does not make any sense.

There is one additional advantage.

What if you retire early? Either voluntary or involuntary. (1) let you have more money in your pocket.

The decision is asymmetric.

<< person B is 25 years old, Makes 100k and does NOT go both, instead taking the 18k income deduction and investing the savings in a taxable account.>>

Why won't B contribute to Trad. 401K and put the tax savings into Roth IRA? That makes the most sense.

For 90+% of people, they pay more tax if they choose Roth 401K.

KlangFool

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Re: Theory on whether to go Roth 401k

Post by ofdollarsanddata » Tue Jan 31, 2017 8:14 pm

I agree with the answers above. There is one other thing that I think I should mention about the Roth option that hasn't been mentioned yet. I am talking about the possibility of future taxes on Roth withdrawals. I believe there is a low, but non-zero, chance that the government will impose a tax in the future on Roth contributions. Yes it isn't fair, but they may impose a tax on some portion of your Roth withdrawals (i.e. anything about 50k).

Keep this in mind when choosing Roth. I personally hedged and have done some Roth and some not Roth just in case.

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Re: Theory on whether to go Roth 401k

Post by Portfolio7 » Wed Feb 01, 2017 12:00 am

What about for use as a future emergency fund?

Virtually all of our savings are in T401Ks, with a tiny bit in TIRAs and RIRAs. I put $10K into an R401K at work, let it sit 5 years, and now between that and the RIRAs we have about $20 grand we can access if needed (much of it in Stable Value Funds). I like it because it's kind of a stealth emergency fund. Why I want to have a stealth EM... lets just say it boils down the psychology of spending and saving.
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Re: Theory on whether to go Roth 401k

Post by Nate79 » Wed Feb 01, 2017 1:08 am

Portfolio7 wrote:What about for use as a future emergency fund?

Virtually all of our savings are in T401Ks, with a tiny bit in TIRAs and RIRAs. I put $10K into an R401K at work, let it sit 5 years, and now between that and the RIRAs we have about $20 grand we can access if needed (much of it in Stable Value Funds). I like it because it's kind of a stealth emergency fund. Why I want to have a stealth EM... lets just say it boils down the psychology of spending and saving.
Can you withdraw your Roth 401k any time you need it? If not, it's not an emergency fund.

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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Wed Feb 01, 2017 1:23 am

SpartanBull wrote:Hello,
This question is regarding the offering of a Roth 401k in an Solo 401k account for self employed people. Per my understanding, if you're in the 25% tax bracket,one should NOT take advantage of making their Employee portion a ROTH contribution. I'm wondering if below are reasons to go Roth, even if you're in the 25% tax bracket.
1) What if you think you'll still be making a similar (inflation adjusted) amount of money in your older age? In that case, does Roth make sense, or does traditional still make more sense?
2) Is getting different "tax buckets" a good reason to go roth on the employee portion?
3) Lastly, how substantial is the difference between the 2 in savings?
Example
person A is 25 years old, makes 100k, is in the 25% bracket, and goes ROTH for their 18k employer portion
person B is 25 years old, Makes 100k and does NOT go both, instead taking the 18k income deduction and investing the savings in a taxable account.
If the tax bracket stays the same in retirement is this a a wash? If the tax bracket goes down in retirement to 15% bracket or something, how substantial is the savings from doing the I401k?
Thanks.
Depending on when you retire, begin SS payments, and any other income streams you may have at different points in time, you'll probably need quite a large nest egg to reach the 25% bracket. A married couple filing jointly would need around $100k income before reaching that. Even if SS gets you a quarter of that, that's still $75k your nest egg will need to yield. Using the 4% withdrawal rate, you would need a portfolio close to $2M to produce such an income. But even if you exceed this threshold somewhat, you will not be any better off with the Roth than the traditional; it would be a wash, as already noted by others.

For most folks, tax deferred is the way to go.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Wed Feb 01, 2017 1:30 am

Nate79 wrote:
Portfolio7 wrote:What about for use as a future emergency fund?

Virtually all of our savings are in T401Ks, with a tiny bit in TIRAs and RIRAs. I put $10K into an R401K at work, let it sit 5 years, and now between that and the RIRAs we have about $20 grand we can access if needed (much of it in Stable Value Funds). I like it because it's kind of a stealth emergency fund. Why I want to have a stealth EM... lets just say it boils down the psychology of spending and saving.
Can you withdraw your Roth 401k any time you need it? If not, it's not an emergency fund.
Not really. You can't just withdraw your contributions like you can with a Roth IRA. If you put in $5k and now it's worth $10k and you pull out $5k, you pay no penalty or tax on 50% of the $5k withdrawal, but you must pay income taxes and potentially the 10% penalty on the other 50%. So that's no good at all.

http://www.obliviousinvestor.com/roth-4 ... ion-rules/

I've actually placed some of our 'emergency' fund in a Roth IRA because I know that I can pull the contributions out if needed, but I'm strongly motivated not to do so unless it's a real emergency because there's no putting previous years contributions back in (i.e. you can't catch back up later).
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Theory on whether to go Roth 401k

Post by Fishing50 » Wed Feb 01, 2017 2:20 am

IMO, the default plan should be to max out Traditional 401k, Roth IRA and then invest in taxable.
+1

Tax planning provides more detail: Contribute to Traditional 401k until taxable income drops from the 25% tax bracket to 15%, Roth IRA, then finish with Roth 401K to the max allowed.

In 3 years I'll be a retired military officer with a large pension. MFJ, we'll have room in the 15% tax bracket for 0% capital gains or 15% Roth conversions. With SS, we'll move into the 25% bracket. Deferring taxes has worked so far, so we'll take 0% capital gains and pay 25% on Traditional withdrawals (if needed). In 15 or 16 years, we'll need to ensure RMDs don't move us into a higher tax bracket.
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Re: Theory on whether to go Roth 401k

Post by Portfolio7 » Wed Feb 01, 2017 5:41 pm

Nate79 wrote:
Portfolio7 wrote:What about for use as a future emergency fund?

Virtually all of our savings are in T401Ks, with a tiny bit in TIRAs and RIRAs. I put $10K into an R401K at work, let it sit 5 years, and now between that and the RIRAs we have about $20 grand we can access if needed (much of it in Stable Value Funds). I like it because it's kind of a stealth emergency fund. Why I want to have a stealth EM... lets just say it boils down the psychology of spending and saving.
Can you withdraw your Roth 401k any time you need it? If not, it's not an emergency fund.
Nate79, thanks for the information, I wasn't aware that the 401K treatment was different than the IRA.
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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Fri Feb 03, 2017 6:40 pm

Since we can't predict what our tax rates will be for 30+ years of retirement it's always good to diversify your tax options, even if you think you may end up paying more tax.

A Roth account in retirement is always handy for those unforeseen large lump sum withdrawals, just can't do that from an IRA without getting a large tax hit.

Those are just two fairly common reasons for having some Roth by the time you get to retirement and not waiting with the "hopes" you can do some conversions.

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Re: Theory on whether to go Roth 401k

Post by DSInvestor » Fri Feb 03, 2017 7:19 pm

FinancialDave wrote:Since we can't predict what our tax rates will be for 30+ years of retirement it's always good to diversify your tax options, even if you think you may end up paying more tax.

A Roth account in retirement is always handy for those unforeseen large lump sum withdrawals, just can't do that from an IRA without getting a large tax hit.

Those are just two fairly common reasons for having some Roth by the time you get to retirement and not waiting with the "hopes" you can do some conversions.
One can get Roth space without making Roth 401k contributions by contributing to Roth IRA. I'd argue that one has excellent tax options and tax diversification by contributing to Traditional 401k, Roth IRA (via backdoor if necessary), and taxable accounts. This provides some Roth IRA space while maxing out tax deductions while working. The higher take home pay with Traditional 401k contributions makes it easier to save for home, car, pay off credit cards, student loans, attack mortgage, invest in taxable.
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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Sat Feb 04, 2017 2:26 pm

DS,
I make no distinction between Roth 401k and Roth IRA. I was just making a couple of cases that are common reasons to have some money in your Roth even if it doesn't seem to make "tax sense" at the time, as we can't predict the future.

Dave
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Re: Theory on whether to go Roth 401k

Post by DSInvestor » Sat Feb 04, 2017 2:43 pm

FinancialDave wrote:DS,
I make no distinction between Roth 401k and Roth IRA. I was just making a couple of cases that are common reasons to have some money in your Roth even if it doesn't seem to make "tax sense" at the time, as we can't predict the future.

Dave
I also like having a mix of Traditional, Roth and taxable space. I'm not as willing to give up a tax deduction while in high brackets.

While Roth 401k and Roth IRA are both Roth, there are some important differences. Roth 401k contributions require that you divert money away from Traditional 401k which means you ALWAYS give up a tax deduction to contribute to Roth 401k. While Roth IRA diverts money away from Traditional IRA, folks who are covered by an employer plan with income exceeding certain limits, are not eligible for TIRA deduction. As such, these folks are not giving up any tax deduction to contribute to Roth IRA since they were ineligible for the TIRA deduction. If covered by employer plan, TIRA deduction is not allowed if MAGI exceeds 71K (Single filer), 118K (MFJ), 10K (MFS).

Roth IRA may have a smaller contribution limit than Roth 401k but offers several advantages:
1) Roth IRA contribution basis (sum of Roth IRA contributions) can be withdrawn at any time without tax or penalty. This is not possible with Roth 401k employee salary deferrals.

2) Roth IRA contributions can be recharacterized to Traditional IRA contributions if the taxpayer changes his/her mind later. Roth 401k contributions are irrevocable once made. Traditional 401k contributions are more flexible as conversion or in-plan rollover to Roth 401k may be possible later.

3) Roth IRA is not subject to RMD. Roth 401k is subject to RMD but this can be avoided by a rollover to Roth IRA.

For these reasons, I feel the default choice should be to Max out Traditional 401k, Roth IRA (via backdoor if necessary) and invest in taxable. This gives you max deductions, Roth space without giving up deductions and tax diversification. If one feels that they need more Roth contribution than allowed by Roth IRA, they can always elect to contribute to Roth 401k understanding that they'll pay more Fed/State income tax to do so.
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Re: Theory on whether to go Roth 401k

Post by blaugranamd » Sun Feb 05, 2017 10:12 am

While I do tend to agree with the general recommendations of Trad 401k. I think we often overlook "tax rate risk" in choosing the allocation of retirement accounts. I know this is probably heresy up there with trying to predict future mutual fund returns, but a lot of the logic underlying our thinking operates on the assumption that tax rates in retirement will be equivalent to current rates. Historically, income tax rates have been pretty variable over the last century and, relatively speaking, the higher tax brackets now are fairly palatable compared to the middle of the last century. If, by the time you retire we end up with income tax rates akin to the 1940s to 1980s, you'll kick yourself for not paying that measly 25-28% marginal rate with Roth contributions. On the other hand, if we move to a national sales or consumption tax, the traditional folks will make off like bandits. I know this is why we advocate for "tax diversification" but Trad 401k + Roth IRA ends up allocating tax-advantaged space approximately 77% and 23%, respectively. This is essentially hedging that tax rates will be at least as favorable if not more favorable in the future than they are now. Personally, I think it's worth considering what you can afford into the mix as well: if paying a 25% marginal rate now is well within your means, it may be worth the peace of mind to potentially avoid an unaffordable rate in the future.

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Re: Theory on whether to go Roth 401k

Post by KlangFool » Sun Feb 05, 2017 10:27 am

willthrill81 wrote:
SpartanBull wrote:Hello,
This question is regarding the offering of a Roth 401k in an Solo 401k account for self employed people. Per my understanding, if you're in the 25% tax bracket,one should NOT take advantage of making their Employee portion a ROTH contribution. I'm wondering if below are reasons to go Roth, even if you're in the 25% tax bracket.
1) What if you think you'll still be making a similar (inflation adjusted) amount of money in your older age? In that case, does Roth make sense, or does traditional still make more sense?
2) Is getting different "tax buckets" a good reason to go roth on the employee portion?
3) Lastly, how substantial is the difference between the 2 in savings?
Example
person A is 25 years old, makes 100k, is in the 25% bracket, and goes ROTH for their 18k employer portion
person B is 25 years old, Makes 100k and does NOT go both, instead taking the 18k income deduction and investing the savings in a taxable account.
If the tax bracket stays the same in retirement is this a a wash? If the tax bracket goes down in retirement to 15% bracket or something, how substantial is the savings from doing the I401k?
Thanks.
Depending on when you retire, begin SS payments, and any other income streams you may have at different points in time, you'll probably need quite a large nest egg to reach the 25% bracket. A married couple filing jointly would need around $100k income before reaching that. Even if SS gets you a quarter of that, that's still $75k your nest egg will need to yield. Using the 4% withdrawal rate, you would need a portfolio close to $2M to produce such an income. But even if you exceed this threshold somewhat, you will not be any better off with the Roth than the traditional; it would be a wash, as already noted by others.

For most folks, tax deferred is the way to go.
willthrill81,

I had been corrected on the other thread. It is a lot more complicated than that. Not all SS income is taxable.

<< 2) It is probably not zero. For most people, SSI is about 20K per year. So, that eats up the zero bracket.

KlangFool

Comment #2 is way off. While I think it has already been refuted in this thread, it is precisely the kind of error that prompted this thread in the first place. So I want to make sure it is clear to random passers-by that the OP is correct: If your income consists entirely of Roth withdrawals and SS, you will pay no Federal income tax.

For example if your income consists of $20K SS plus any amount of Roth, none of your SS income will be taxable, nor will it be part of your AGI. Your AGI will be $0.

Given the rules for taxation of SS (which are not inflation adjusted BTW), you would have to have more than $120K of SS income in order for as much as $20K of it to be taxable for an MFJ filer. (Again, under the assumption that the rest of your income is from a Roth account.) It's not possible for an MFJ couple to receive $120K/yr from SS today, but it could be someday, given enough inflation. However, the standard deduction is also likely to adjust upward with inflation, raising the bar.
https://www.bogleheads.org/wiki/Taxatio ... y_benefits >>


https://www.bogleheads.org/wiki/Taxatio ... y_benefits

viewtopic.php?f=1&t=210101

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Re: Theory on whether to go Roth 401k

Post by cherijoh » Sun Feb 05, 2017 11:13 am

DSInvestor wrote:I maxed out Traditional 401k and Traditional solo 401k later while self employed. While I was working, I lived in states with high state income tax and then moved to a state with no state income tax where my withdrawals and Roth conversions are not subject to state income tax. Had I made Roth 401k contributions, I would have pre-paid state income tax to my old states for no good reason.

I did not continue to work until old age. Once I stopped working, I lived off the taxable account which is extremely tax efficient - taking advantage of the 0% Fed tax rate for Long Term Capital Gains (LTCG) and Qualified Dividend Income (QDI). I do a series of Roth conversions for little or no tax. I avoided Fed and State income tax for my Traditional contributions and am now able to convert them to Roth IRA for no tax. No tax going in. No tax going out.

Note that Roth 401k contributions are irrevocable once made - you cannot change your mind later and say hey let me have the deduction. Traditional 401k contributions give you the deduction up front but you have the option to convert to Roth later (and the cost of conversion can be as low as ZERO).

If you make 100K gross income and max out Traditional 401k, you reduce your AGI and taxable income by 18K. You'd be in 25% tax bracket and save roughly 25% on that 18K reduction in ordinary income because it comes off the top of your income stack.

If you withdrew 100K from Traditional accounts, you'd also be in 25% tax bracket. However you do not pay 25K in Fed tax. Since you do not have a pension to consume the lower tax brackets, some of that 100K income is taxed at 0%, 10%, 15% and 25%. Under current brackets, 100K withdrawal as your only source of income has $18,145 Fed Tax. If you're married filing jointly and withdrew 100K, your Fed Tax would be 10K.

If you're young, there may be other considerations for Roth vs Traditional employee 401k contributions. Traditional 401k contributions give you more take home pay. 18K at 25% saves you 4.5K in Fed Tax and maybe more if you have a state income tax. This 4.5K of tax savings may help you attack other financial priorities - like saving for house/car, paying off student loans, paying credit cards, building up cash reserves, accelerating mortgage pay off, invest in taxable accounts.

IMO, the default plan should be to max out Traditional 401k, Roth IRA and then invest in taxable.
+1
Good synopsis. My megacorp decided to offer a Roth 401k a few years ago. I considered switching to the Roth option for tax diversification, but then decided it made more sense to do some Roth conversions in early retirement before SS and RMDs kicked in.

IMO, a Roth 401k would be the better option in rare circumstances - if you were in a 15% tax bracket and could afford to fully fund your Roth 401k. This could happen if a young person early in his/her career (therefore in 15% tax bracket) receives a taxable inheritance which they could live off while maxing out their Roth 401k. That would be an efficient and low cost way to stuff as much value as possible into a tax-advantaged account.

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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Mon Feb 06, 2017 1:35 pm

blaugranamd wrote:
While I do tend to agree with the general recommendations of Trad 401k. I think we often overlook "tax rate risk" in choosing the allocation of retirement accounts.
While I understand what you are saying about "tax rate risk" you can't underestimate the other side of the coin which is "retirement rate differential." By this I mean the usual step change down in your tax rate based on the fact that a huge portion of your income is not being paid in SS & Medicare taxes, and not being saved. For my household this change went from around 28% to 15%.

Also the issue is for those of us that lived through the high marginal rates of the 80's it is now working to our favor for the IRA. If you are working and in the 15% tax bracket now, I would agree you should probably be doing the 401k Roth.

IMHO when you add all the risks together and factor in the fact that most of them are quite unknown - including if you will need to withdraw a "large" single lump sum for some life event, then I still think my case for a range of 40/60 to 60/40 (after-tax, if you are the purist type) of Roth to non-Roth funds is stil quite an appropriate retirement goal to shoot for. I personally fell quite short of that mainly because a 401k Roth was not available most of my working career, but I would certainly do it different if I could go back.

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Re: Theory on whether to go Roth 401k

Post by blaugranamd » Mon Feb 06, 2017 4:33 pm

FinancialDave wrote:
blaugranamd wrote:
While I do tend to agree with the general recommendations of Trad 401k. I think we often overlook "tax rate risk" in choosing the allocation of retirement accounts.
While I understand what you are saying about "tax rate risk" you can't underestimate the other side of the coin which is "retirement rate differential." By this I mean the usual step change down in your tax rate based on the fact that a huge portion of your income is not being paid in SS & Medicare taxes, and not being saved. For my household this change went from around 28% to 15%.

Also the issue is for those of us that lived through the high marginal rates of the 80's it is now working to our favor for the IRA. If you are working and in the 15% tax bracket now, I would agree you should probably be doing the 401k Roth.

IMHO when you add all the risks together and factor in the fact that most of them are quite unknown - including if you will need to withdraw a "large" single lump sum for some life event, then I still think my case for a range of 40/60 to 60/40 (after-tax, if you are the purist type) of Roth to non-Roth funds is stil quite an appropriate retirement goal to shoot for. I personally fell quite short of that mainly because a 401k Roth was not available most of my working career, but I would certainly do it different if I could go back.

Dave
Good points on the income step downs, I hadn't thought about the fact that the same income I have now would translate into a lot more expendable cash since there's $0 going to savings etc. that I'm currently needing to put money towards. Thus the same "lifestyle" puts you in a lower tax bracket by default. For us, we're loading up Roth space since we're early in our careers (maximize tax-free growth), in 25% marginal now, have a large portion of untaxed income from military allowances ("artificially" low tax burden), and will progressively move up to the 33% bracket over the next 8 years. To me, it makes sense to throw it all in Roth accounts (TSPs, IRAs) now and once our income increases we shift to traditional TSP/401k.
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Re: Theory on whether to go Roth 401k

Post by Noobvestor » Tue Feb 07, 2017 2:22 am

Roth 401k lets you put away more money in tax-advantaged space. Say what? "No, that's crazy! Both options allow 18K/year" you say! But wait, there's a catch: the 18K that goes into a traditional 401k is pre-tax, so that's 18K that will be taxed later. The 18K that goes into a Roth is post-tax, so 18K goes into tax-advantaged space and I pay the taxes on that with money that can't go into tax-advantaged space. In short: the 18K I can put in a Roth 401(k) is worth more than the 18K I can put in a regular 401(k).

I also agree with the sentiment about tax rate risk - taxes could well go up between now and retirement. Better to hedge your bets.

Also, no required minimum distributions last I checked for Roths.
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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Tue Feb 07, 2017 10:47 am

Noobvestor wrote:Roth 401k lets you put away more money in tax-advantaged space. Say what? "No, that's crazy! Both options allow 18K/year" you say! But wait, there's a catch: the 18K that goes into a traditional 401k is pre-tax, so that's 18K that will be taxed later. The 18K that goes into a Roth is post-tax, so 18K goes into tax-advantaged space and I pay the taxes on that with money that can't go into tax-advantaged space. In short: the 18K I can put in a Roth 401(k) is worth more than the 18K I can put in a regular 401(k).
Strictly speaking, that's true, but it's not the whole story. It will cost you more to the tune of $18k plus your marginal taxes on that money to put that $18k in your Roth 401k. What could have been done instead is to deposit $18k into a traditional 401k and then invest the tax savings into a traditional IRA, a Roth IRA, or a taxable account.
Noobvestor wrote:I also agree with the sentiment about tax rate risk - taxes could well go up between now and retirement. Better to hedge your bets.
It would take more than a slight increase in income taxes to swing the Roth in front of the traditional for most people most of the time.
Last edited by willthrill81 on Tue Feb 07, 2017 2:10 pm, edited 1 time in total.
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Re: Theory on whether to go Roth 401k

Post by DSInvestor » Tue Feb 07, 2017 1:19 pm

Noobvestor wrote:Also, no required minimum distributions last I checked for Roths.
Roth IRA has no RMD.
Roth 401k/403b/457b have RMD - but a rollover to Roth IRA would work around that.
Wiki

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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Tue Feb 07, 2017 2:21 pm

Noobvestor wrote:Roth 401k lets you put away more money in tax-advantaged space. Say what? "No, that's crazy! Both options allow 18K/year" you say! But wait, there's a catch: the 18K that goes into a traditional 401k is pre-tax, so that's 18K that will be taxed later. The 18K that goes into a Roth is post-tax, so 18K goes into tax-advantaged space and I pay the taxes on that with money that can't go into tax-advantaged space. In short: the 18K I can put in a Roth 401(k) is worth more than the 18K I can put in a regular 401(k).

I also agree with the sentiment about tax rate risk - taxes could well go up between now and retirement. Better to hedge your bets.

Also, no required minimum distributions last I checked for Roths.
Noob,
Also remember I have done a number of returns where the taxpayer actually had zero tax due in retirement. In fact I did one just last week that left around $5,000 on the table with only SS income and some other income. In that case had the retiree actually had $18k of IRA money, it actually would be $18k if it could be spread over a few years of zero tax rate.

Remember in retirement zero tax rate can actually equate to some $30k to $50k in actual income depending on what type of income it is, whether you are married and the number of dependents in the household.
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Re: Theory on whether to go Roth 401k

Post by Noobvestor » Wed Feb 08, 2017 12:14 am

willthrill81 wrote:
Noobvestor wrote:Roth 401k lets you put away more money in tax-advantaged space. Say what? "No, that's crazy! Both options allow 18K/year" you say! But wait, there's a catch: the 18K that goes into a traditional 401k is pre-tax, so that's 18K that will be taxed later. The 18K that goes into a Roth is post-tax, so 18K goes into tax-advantaged space and I pay the taxes on that with money that can't go into tax-advantaged space. In short: the 18K I can put in a Roth 401(k) is worth more than the 18K I can put in a regular 401(k).
Strictly speaking, that's true, but it's not the whole story. It will cost you more to the tune of $18k plus your marginal taxes on that money to put that $18k in your Roth 401k. What could have been done instead is to deposit $18k into a traditional 401k and then invest the tax savings into a traditional IRA, a Roth IRA, or a taxable account.
I'm maxing out every available tax-advantaged account so anything that doesn't go into retirement gets stuck in taxable (Roth IRA and SEP IRA already being filled up). I agree it's different for people doing otherwise. But if you are maxing out everything, then it's a question of whether you want (simplifying numbers for example): 18K to grow and later be taxed + 6K suffering from tax drag in taxable -or- 18K that will grow tax-free forever.

I've run the math on a few spreadsheets with different results (including the one in the wiki). If your tax rate drops a few percent it generally seems to be a win. If it drops a lot it's potentially a loss - but even dropping from 25% to 15% Roth only comes out 6% behind in total according to the wiki sheet - and that's a pretty big drop in today's brackets (92K to 38K for single).

Meanwhile, for me personally: I've got a lot in taxable I'm trying to shovel away one way or another, plus I'm buying I and EE bonds which will have taxes due at the end of their lifespan (upping my future tax baseline) - I figure maxing out the Roth hedges rising per-bracket rates even if I drop a bracket. Everyone should run their own math of course, but I also see tax rate risk as a pretty serious (but hard to quantify) risk.
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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Wed Feb 08, 2017 10:21 am

Noobvestor wrote:I'm maxing out every available tax-advantaged account so anything that doesn't go into retirement gets stuck in taxable (Roth IRA and SEP IRA already being filled up). I agree it's different for people doing otherwise. But if you are maxing out everything, then it's a question of whether you want (simplifying numbers for example): 18K to grow and later be taxed + 6K suffering from tax drag in taxable -or- 18K that will grow tax-free forever.

I've run the math on a few spreadsheets with different results (including the one in the wiki). If your tax rate drops a few percent it generally seems to be a win. If it drops a lot it's potentially a loss - but even dropping from 25% to 15% Roth only comes out 6% behind in total according to the wiki sheet - and that's a pretty big drop in today's brackets (92K to 38K for single).

Meanwhile, for me personally: I've got a lot in taxable I'm trying to shovel away one way or another, plus I'm buying I and EE bonds which will have taxes due at the end of their lifespan (upping my future tax baseline) - I figure maxing out the Roth hedges rising per-bracket rates even if I drop a bracket. Everyone should run their own math of course, but I also see tax rate risk as a pretty serious (but hard to quantify) risk.
Based on all the math I've seen, it seems that the only way that the Roth will even come close to tax deferred accounts is if you either have significant assets already and/or your retirement income will be greater than your career income. I don't see how you'll come out ahead with the Roth if the contributions are taxed at 25%, but your withdrawals from a tax deferred account would be taxed at 15%.

Perhaps you could share your spreadsheet?
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Re: Theory on whether to go Roth 401k

Post by Swelfie » Wed Feb 08, 2017 10:46 am

willthrill81 wrote:
Nate79 wrote:
Portfolio7 wrote:What about for use as a future emergency fund?

Virtually all of our savings are in T401Ks, with a tiny bit in TIRAs and RIRAs. I put $10K into an R401K at work, let it sit 5 years, and now between that and the RIRAs we have about $20 grand we can access if needed (much of it in Stable Value Funds). I like it because it's kind of a stealth emergency fund. Why I want to have a stealth EM... lets just say it boils down the psychology of spending and saving.
Can you withdraw your Roth 401k any time you need it? If not, it's not an emergency fund.
Not really. You can't just withdraw your contributions like you can with a Roth IRA. If you put in $5k and now it's worth $10k and you pull out $5k, you pay no penalty or tax on 50% of the $5k withdrawal, but you must pay income taxes and potentially the 10% penalty on the other 50%. So that's no good at all.

http://www.obliviousinvestor.com/roth-4 ... ion-rules/

I've actually placed some of our 'emergency' fund in a Roth IRA because I know that I can pull the contributions out if needed, but I'm strongly motivated not to do so unless it's a real emergency because there's no putting previous years contributions back in (i.e. you can't catch back up later).
You can, however, take a loan out on up to 50% or $50k max on your Roth 401k balance. You pay it back with interest that is never taxed again, so it doesn't run into the double taxation of interest problem traditional 401k loans do.

I actually ran the numbers a while back and taking out a $50k loan every year against Roth, investing it and paying it all back at the end of the year only to take it out again actually looked pretty promising just as a way to get more into Roth. If you've got your own solo 401k you can even charge yourself higher interest rates. Too bad I have no Roth 401k funds or I'd think about it.

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Re: Theory on whether to go Roth 401k

Post by MrNewEngland » Wed Feb 08, 2017 10:55 am

Someone threw a curveball at me about my theory recently.

I've always done Roth contributions to my 401k, 457, and IRA. My employer offers a pension that will be taxed and the 401k match (3%) will be taxed when I withdraw. My theory is that I'm towards the middle/top of the 25% tax bracket now, and I'll probably be towards the middle/bottom of the 25% tax bracket with just my pension and taxable moneys.

The point that someone brought up to me recently is that I am single and always have been. What happens if I get married later in life to someone without much in retirement saving? It could push me into a lower tax bracket making my Roth savings less valuable.

Plus if I move to a state without state income taxes I am just paying NC taxes on this money for no reason.

I've been thinking about switching and would like to hear your thoughts.

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Re: Theory on whether to go Roth 401k

Post by jazman12 » Wed Feb 08, 2017 10:59 am

willthrill81 wrote:
SpartanBull wrote:Hello,
This question is regarding the offering of a Roth 401k in an Solo 401k account for self employed people. Per my understanding, if you're in the 25% tax bracket,one should NOT take advantage of making their Employee portion a ROTH contribution. I'm wondering if below are reasons to go Roth, even if you're in the 25% tax bracket.
1) What if you think you'll still be making a similar (inflation adjusted) amount of money in your older age? In that case, does Roth make sense, or does traditional still make more sense?
2) Is getting different "tax buckets" a good reason to go roth on the employee portion?
3) Lastly, how substantial is the difference between the 2 in savings?
Example
person A is 25 years old, makes 100k, is in the 25% bracket, and goes ROTH for their 18k employer portion
person B is 25 years old, Makes 100k and does NOT go both, instead taking the 18k income deduction and investing the savings in a taxable account.
If the tax bracket stays the same in retirement is this a a wash? If the tax bracket goes down in retirement to 15% bracket or something, how substantial is the savings from doing the I401k?
Thanks.
Depending on when you retire, begin SS payments, and any other income streams you may have at different points in time, you'll probably need quite a large nest egg to reach the 25% bracket. A married couple filing jointly would need around $100k income before reaching that. Even if SS gets you a quarter of that, that's still $75k your nest egg will need to yield. Using the 4% withdrawal rate, you would need a portfolio close to $2M to produce such an income. But even if you exceed this threshold somewhat, you will not be any better off with the Roth than the traditional; it would be a wash, as already noted by others.

For most folks, tax deferred is the way to go.
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Re: Theory on whether to go Roth 401k

Post by KlangFool » Wed Feb 08, 2017 11:08 am

MrNewEngland wrote:Someone threw a curveball at me about my theory recently.

I've always done Roth contributions to my 401k, 457, and IRA. My employer offers a pension that will be taxed and the 401k match (3%) will be taxed when I withdraw. My theory is that I'm towards the middle/top of the 25% tax bracket now, and I'll probably be towards the middle/bottom of the 25% tax bracket with just my pension and taxable moneys.

The point that someone brought up to me recently is that I am single and always have been. What happens if I get married later in life to someone without much in retirement saving? It could push me into a lower tax bracket making my Roth savings less valuable.

Plus if I move to a state without state income taxes I am just paying NC taxes on this money for no reason.

I've been thinking about switching and would like to hear your thoughts.
MrNewEngland,

1) Unless your pension is substantial like 100K per year or higher and pushes you into the 28% tax bracket, why would you contribute to Roth 401K?

2) Even if your retirement tax bracket is 25%, it is the same as what you are paying now. So, what is the problem with contributing to Trad. 401K?

A) If you go with Trad. 401K, in the worst case, you pay 25% tax as you are now. It is not too bad. In most cases, you will pay less.

B) If you go with Roth 401K, you pay 25% tax. You cannot do better than (A).

Why would anyone choose (B)? (B) can never do better than (A).

Furthermore, if you go with (A), you can put your tax savings into taxable account. That means you could spend from your taxable account while generating little to no taxable income at retirement. This lowered your tax bracket further.

For 90+% of people, it is wrong to contribute to Roth 401K. You are probably one of them.

<<taxable moneys.>>

You only pay for the gain / dividend / interest income. You only need to sell enough to cover your annual expense. So, why would this generate a lot of taxable income?

You should read this thread.

viewtopic.php?t=87471

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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Wed Feb 08, 2017 11:35 am

Klangfool,

Don't "what-if" yourself into sleepless nights trying to "know" things that are "unknowable."

If you are still many years from retirement just do some of both Roth and non-Roth to diversify your options. As you get closer (within 5 yr) of retirement you should have a better idea of which way to "tilt" right now I say it is a toss-up.

Dave
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Re: Theory on whether to go Roth 401k

Post by KlangFool » Wed Feb 08, 2017 2:35 pm

FinancialDave wrote:Klangfool,

Don't "what-if" yourself into sleepless nights trying to "know" things that are "unknowable."

If you are still many years from retirement just do some of both Roth and non-Roth to diversify your options. As you get closer (within 5 yr) of retirement you should have a better idea of which way to "tilt" right now I say it is a toss-up.

Dave
FinancialDave,

<< If you are still many years from retirement just do some of both Roth and non-Roth to diversify your options. >>

And, for most people, they can only do this if they max up their contribution to Trad. 401K and put their tax savings into Roth IRA.

In my case, I max up my Trad.401Ks, Roth IRAs, and substantial investment in the taxable account. I have all 3 options. And, my portfolio is 45/45/10 (401K/Taxable/Roth). I could spend from any pools and generate the right amount of taxable income at my retirement.

<<Don't "what-if" yourself into sleepless nights trying to "know" things that are "unknowable.">.

I don't. I have all 3 bases covered: Tax deferred, Roth, and Taxable.

It is very simple.

Max up your Trad.401K is the right answer 90+% of the time. Even if you are wrong, it is not too bad.

Roth 401K is a bad idea most of the time. Even if you are right, it may not matter. If you are wrong, you are paying way too much tax.

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Re: Theory on whether to go Roth 401k

Post by MrNewEngland » Wed Feb 08, 2017 2:41 pm

KlangFool wrote:
MrNewEngland wrote:Someone threw a curveball at me about my theory recently.

I've always done Roth contributions to my 401k, 457, and IRA. My employer offers a pension that will be taxed and the 401k match (3%) will be taxed when I withdraw. My theory is that I'm towards the middle/top of the 25% tax bracket now, and I'll probably be towards the middle/bottom of the 25% tax bracket with just my pension and taxable moneys.

The point that someone brought up to me recently is that I am single and always have been. What happens if I get married later in life to someone without much in retirement saving? It could push me into a lower tax bracket making my Roth savings less valuable.

Plus if I move to a state without state income taxes I am just paying NC taxes on this money for no reason.

I've been thinking about switching and would like to hear your thoughts.
MrNewEngland,

1) Unless your pension is substantial like 100K per year or higher and pushes you into the 28% tax bracket, why would you contribute to Roth 401K?

2) Even if your retirement tax bracket is 25%, it is the same as what you are paying now. So, what is the problem with contributing to Trad. 401K?

A) If you go with Trad. 401K, in the worst case, you pay 25% tax as you are now. It is not too bad. In most cases, you will pay less.

B) If you go with Roth 401K, you pay 25% tax. You cannot do better than (A).

Why would anyone choose (B)? (B) can never do better than (A).

Furthermore, if you go with (A), you can put your tax savings into taxable account. That means you could spend from your taxable account while generating little to no taxable income at retirement. This lowered your tax bracket further.

For 90+% of people, it is wrong to contribute to Roth 401K. You are probably one of them.

<<taxable moneys.>>

You only pay for the gain / dividend / interest income. You only need to sell enough to cover your annual expense. So, why would this generate a lot of taxable income?

You should read this thread.

viewtopic.php?t=87471

KlangFool
Thank you for the thoughtful and helpful reply.

I did have some reasoning behind putting my money in Roth when I started... first I was terrified of the national debt at the time and was completely convinced tax rates would have to go way up by the time I retire. Second, I really would like to retire at 55 (when I am eligible for my pension). There are a lot of things that I would need to buy (insurance for example) that is charged base on income. If I am using Roth money my income is shown as low so I creating savings there.

I have fallen in line with the thinking of your post recently though... but I want to wait and see if this new administration drops taxes the way they said they would. If that's the case I am leaning towards continuing to contribute Roth money to my accounts.

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Re: Theory on whether to go Roth 401k

Post by KlangFool » Wed Feb 08, 2017 3:04 pm

MrNewEngland wrote:
Thank you for the thoughtful and helpful reply.

I did have some reasoning behind putting my money in Roth when I started... first I was terrified of the national debt at the time and was completely convinced tax rates would have to go way up by the time I retire. Second, I really would like to retire at 55 (when I am eligible for my pension). There are a lot of things that I would need to buy (insurance for example) that is charged base on income. If I am using Roth money my income is shown as low so I creating savings there.

I have fallen in line with the thinking of your post recently though... but I want to wait and see if this new administration drops taxes the way they said they would. If that's the case I am leaning towards continuing to contribute Roth money to my accounts.
MrNewEngland,

1) Why? That does not make any sense to me. I would like to know why that makes any difference.

2) In any case, you can make a different decision every year and/or every paycheck. To me, nothing changes. The breakeven point is 25%.

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Re: Theory on whether to go Roth 401k

Post by MrNewEngland » Wed Feb 08, 2017 3:45 pm

KlangFool wrote:
MrNewEngland wrote:
Thank you for the thoughtful and helpful reply.

I did have some reasoning behind putting my money in Roth when I started... first I was terrified of the national debt at the time and was completely convinced tax rates would have to go way up by the time I retire. Second, I really would like to retire at 55 (when I am eligible for my pension). There are a lot of things that I would need to buy (insurance for example) that is charged base on income. If I am using Roth money my income is shown as low so I creating savings there.

I have fallen in line with the thinking of your post recently though... but I want to wait and see if this new administration drops taxes the way they said they would. If that's the case I am leaning towards continuing to contribute Roth money to my accounts.
MrNewEngland,

1) Why? That does not make any sense to me. I would like to know why that makes any difference.

2) In any case, you can make a different decision every year and/or every paycheck. To me, nothing changes. The breakeven point is 25%.

KlangFool

1) Because the goal is to pay taxes when they'll be lower. If taxes get lowered and I believe they'll be raised by the time I retire it makes sense to pay the taxes now. Right? I think my logic is solid.

2) I don't like switching up contributions a lot. I feel like that is a habit that would be abused, I don't want to feel like I can take home extra for a few weeks to buy something frivolous. And the breakeven point is only 25% if the tax brackets stay the same from now through retirement.

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Re: Theory on whether to go Roth 401k

Post by KlangFool » Wed Feb 08, 2017 4:18 pm

MrNewEngland wrote:
1) Because the goal is to pay taxes when they'll be lower. If taxes get lowered and I believe they'll be raised by the time I retire it makes sense to pay the taxes now. Right? I think my logic is solid.

2) I don't like switching up contributions a lot. I feel like that is a habit that would be abused, I don't want to feel like I can take home extra for a few weeks to buy something frivolous. And the breakeven point is only 25% if the tax brackets stay the same from now through retirement
.
MrNewEngland,

1) Your logic is flawed at 2 levels.

A) If the tax needs to be raised, why do you think it will be the income tax? In fact, the worldwide trend is to lower income tax and increase sales/ consumption/VAT tax.

B) You do not generate the same amount of income between now and retirement time. In fact, for most people, it will be significantly lower. So, unless the tax is increased significantly, it would not matter.

Let's take an example, a person with a household gross income of 120K with an annual expense of 60K. At retirement, the person at most only need to generate 60K of income to cover the annual expense. The current marginal tax rate for 120K is 25%. So, unless the marginal tax rate for 60K gross income is at 25%, why would this matters? The tax will be lower at retirement.

2) Then, don't switch. Only do this once per year.

<<And the breakeven point is only 25% if the tax brackets stay the same from now through retirement>>

If that is true, you will be paying less than 25% tax at retirement. See (B).

KlangFool

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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Wed Feb 08, 2017 4:24 pm

KlangFool wrote:B) You do not generate the same amount of income between now and retirement time. In fact, for most people, it will be significantly lower. So, unless the tax is increased significantly, it would not matter.

Let's take an example, a person with a household gross income of 120K with an annual expense of 60K. At retirement, the person at most only need to generate 60K of income to cover the annual expense. The current marginal tax rate for 120K is 25%. So, unless the marginal tax rate for 60K gross income is at 25%, why would this matters? The tax will be lower at retirement.
Precisely. Unless someone has a sizable pension or other significant income sources during retirement, making Roth contributions when you have anything less than $1M currently invested is unlikely to make financial sense (for married couples, half that for singles).

That's what I don't like about people just saying "marginal vs. marginal." It leads uninformed people down this path of thinking that if tax rates go up even a little bit that the Roth would have been a better choice. But that's simply false. For one, most of your retirement income will almost certainly not be taxed at your current marginal rate. Second, for typical retirees, the benefit of tax deferment beats the Roth option by a significant margin.
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Re: Theory on whether to go Roth 401k

Post by Nate79 » Wed Feb 08, 2017 6:23 pm

willthrill81 wrote:
KlangFool wrote:B) You do not generate the same amount of income between now and retirement time. In fact, for most people, it will be significantly lower. So, unless the tax is increased significantly, it would not matter.

Let's take an example, a person with a household gross income of 120K with an annual expense of 60K. At retirement, the person at most only need to generate 60K of income to cover the annual expense. The current marginal tax rate for 120K is 25%. So, unless the marginal tax rate for 60K gross income is at 25%, why would this matters? The tax will be lower at retirement.
Precisely. Unless someone has a sizable pension or other significant income sources during retirement, making Roth contributions when you have anything less than $1M currently invested is unlikely to make financial sense (for married couples, half that for singles).

That's what I don't like about people just saying "marginal vs. marginal." It leads uninformed people down this path of thinking that if tax rates go up even a little bit that the Roth would have been a better choice. But that's simply false. For one, most of your retirement income will almost certainly not be taxed at your current marginal rate. Second, for typical retirees, the benefit of tax deferment beats the Roth option by a significant margin.
This is very good point. marginal vs marginal is very misleading at best or even false because it is like telling half the story and leaving out the important part. It should say marginal contribution vs marginal withdrawal. Meaning the marginal tax rate at the time you are making the contribution today and the marginal rate of that specific money when you withdraw it in retirement. If your traditional account is at very low balance the contribution when withdrawn will be in the very low tax bracket. On the other hand as your traditional account grows and grows you will be slowly filling up the lower tax brackets and if the account gets large enough you may reach a point where the marginal tax rate for the withdrawal of the contributions become equal or greater than the marginal rate of the contribution. However, you still have to fill up the lower brackets to reach that point. And it takes a very large account to do so.

4% of $2M (real) traditional account will put you right at the current 25% bracket. As an example $36k of traditional contributions for 30years @ 4% real return puts the account at $2M real. Maxing 2 401k accounts for 30 years would be a great feat for a couple and only gets you right at the $2M value. Of course who knows what the future return will be, then need to account for stock/bond ratio of the entire account history, add in any matching funds, etc.

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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Wed Feb 08, 2017 6:33 pm

Nate79 wrote:
willthrill81 wrote:
KlangFool wrote:B) You do not generate the same amount of income between now and retirement time. In fact, for most people, it will be significantly lower. So, unless the tax is increased significantly, it would not matter.

Let's take an example, a person with a household gross income of 120K with an annual expense of 60K. At retirement, the person at most only need to generate 60K of income to cover the annual expense. The current marginal tax rate for 120K is 25%. So, unless the marginal tax rate for 60K gross income is at 25%, why would this matters? The tax will be lower at retirement.
Precisely. Unless someone has a sizable pension or other significant income sources during retirement, making Roth contributions when you have anything less than $1M currently invested is unlikely to make financial sense (for married couples, half that for singles).

That's what I don't like about people just saying "marginal vs. marginal." It leads uninformed people down this path of thinking that if tax rates go up even a little bit that the Roth would have been a better choice. But that's simply false. For one, most of your retirement income will almost certainly not be taxed at your current marginal rate. Second, for typical retirees, the benefit of tax deferment beats the Roth option by a significant margin.
This is very good point. marginal vs marginal is very misleading at best or even false because it is like telling half the story and leaving out the important part. It should say marginal contribution vs marginal withdrawal. Meaning the marginal tax rate at the time you are making the contribution today and the marginal rate of that specific money when you withdraw it in retirement. If your traditional account is at very low balance the contribution when withdrawn will be in the very low tax bracket. On the other hand as your traditional account grows and grows you will be slowly filling up the lower tax brackets and if the account gets large enough you may reach a point where the marginal tax rate for the withdrawal of the contributions become equal or greater than the marginal rate of the contribution. However, you still have to fill up the lower brackets to reach that point. And it takes a very large account to do so.

4% of $2M (real) traditional account will put you right at the current 25% bracket. As an example $36k of traditional contributions for 30years @ 4% real return puts the account at $2M real. Maxing 2 401k accounts for 30 years would be a great feat for a couple and only gets you right at the $2M value. Of course who knows what the future return will be, then need to account for stock/bond ratio of the entire account history, add in any matching funds, etc.
Exactly. In most circumstances, most of one's career contributions should be made to tax deferred accounts. Yet most financial 'gurus' are obsessed with Roth accounts for some inexplicable reason.

And people go on and on about Roth accounts not needing RMDs, but they aren't a problem for those who actually need the money from their tax deferred accounts. Withdrawing nothing but the RMDs from tax deferred accounts is recognized as a very conservative withdrawal strategy.
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Re: Theory on whether to go Roth 401k

Post by KlangFool » Wed Feb 08, 2017 7:38 pm

Nate79 wrote:
This is very good point. marginal vs marginal is very misleading at best or even false because it is like telling half the story and leaving out the important part. It should say marginal contribution vs marginal withdrawal. Meaning the marginal tax rate at the time you are making the contribution today and the marginal rate of that specific money when you withdraw it in retirement. If your traditional account is at very low balance the contribution when withdrawn will be in the very low tax bracket. On the other hand as your traditional account grows and grows you will be slowly filling up the lower tax brackets and if the account gets large enough you may reach a point where the marginal tax rate for the withdrawal of the contributions become equal or greater than the marginal rate of the contribution. However, you still have to fill up the lower brackets to reach that point. And it takes a very large account to do so.

4% of $2M (real) traditional account will put you right at the current 25% bracket. As an example $36k of traditional contributions for 30years @ 4% real return puts the account at $2M real. Maxing 2 401k accounts for 30 years would be a great feat for a couple and only gets you right at the $2M value. Of course who knows what the future return will be, then need to account for stock/bond ratio of the entire account history, add in any matching funds, etc.
Nate79,

This is not necessarily true either. It is only true if and only if you only have Trad. 401K money to spend. But, for many people, when they contribute to Trad. 401K, they contribute their tax savings to Roth IRA and taxable account at the same time. They could spend from their taxable and Roth with almost zero taxable income and while doing Roth conversion from their Trad. 401K. They have until 70 1/2 years old before RMD hits.

This is especially for people with a lower annual expense (40K to 60K). They could literary live on their Roth and taxable account while doing Roth conversion of their Trad. 401K at 0% until RMD.

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Re: Theory on whether to go Roth 401k

Post by Noobvestor » Fri Feb 10, 2017 4:20 pm

willthrill81 wrote:
Based on all the math I've seen, it seems that the only way that the Roth will even come close to tax deferred accounts is if you either have significant assets already and/or your retirement income will be greater than your career income. I don't see how you'll come out ahead with the Roth if the contributions are taxed at 25%, but your withdrawals from a tax deferred account would be taxed at 15%.

Perhaps you could share your spreadsheet?
One of the spreadsheets I used is listed at the bottom of this wiki page: https://www.bogleheads.org/wiki/Traditional_versus_Roth - direct link: https://docs.zoho.com/sheet/published.d ... 37d6fddfc7

Variables that make a difference include: (1) current and expected tax rates, (2) expected return in taxable versus tax-advantaged space. So let's toy with those variables a bit and just see what happens.

Holding (2) constant (same expected 401k and taxable returns), expected tax rates can drop a few percent from present tax rates and still favor the Roth (though not from 25% to 15%). Still, even 25% to 15% only yields a 7% Roth disadvantage for total returns. Basically, if you tax rate drops slightly, Roth has advantage. If it drops a lot, Roth is at a disadvantage, it's true, but it's not devastating.

Holding (1) constant, things start to get interesting. If we assume equal tax rates - 25% now and 25% later - but assume tax-advantaged returns of 7% (e.g. slightly more risky/rewardy stuff in the 401k) and taxable returns of 5% (not much lower!) I come out with Roth beating Traditional by 13.5%. So as soon as we start to figure we'll optimize fund placement even a little around expected returns the equation starts shifting.

Now let's try a hybrid experiment addressing your question - let's let tax rates drop from 25% to 15%. At the same time, let's again assume slightly more return in the 401k than in taxable - just 7% versus 5%. We find in this scenario that the Roth comes out with a 3% advantage. Not huge - pretty much a toss up - but still, it illustrates how slightly different tax-advantaged vs. taxable optimization makes a big difference.

The thing this spreadsheet doesn't seem to facilitate but that would be helpful is different expected returns for different types of 401k accounts - for instance, if hold some of each and I stuff my traditional 401k with safe bonds (low yield) to avoid future taxes, and stuff my Roth 401k with risky stuff (small/value/emerging), I gain some advantages that way, too. Right now, I can't see any way on the sheet (unless I'm missing it) to vary the Traditional versus Roth expected return rates (seems like it could be added easily, though).

My general conclusion is this: it oversimplifies things too much to just assume similar rates of return for taxable and tax-advantaged. I'd love to see a calculator that allows for even more detailed examination of things, like: what if I have a Traditional 401(k) with low-yield bonds, and Roth 401(k) with small/value/emerging, and a taxable account with a combination of total-market stocks and tax-exempt bonds?

In the meantime, though, if you're putting slightly higher risk/return in Roth accounts relative to taxable, again: it makes a big difference. What was most surprising to me in doing these experiments was how much more of an impact that made than even big swings in tax rates!
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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Fri Feb 10, 2017 4:39 pm

Noobvestor wrote:
willthrill81 wrote:
Based on all the math I've seen, it seems that the only way that the Roth will even come close to tax deferred accounts is if you either have significant assets already and/or your retirement income will be greater than your career income. I don't see how you'll come out ahead with the Roth if the contributions are taxed at 25%, but your withdrawals from a tax deferred account would be taxed at 15%.

Perhaps you could share your spreadsheet?
Variables that make a difference include: (1) current and expected tax rates, (2) expected return in taxable versus tax-advantaged space. So let's toy with those variables a bit and just see what happens.

Holding (2) constant (same expected 401k and taxable returns), expected tax rates can drop a few percent from present tax rates and still favor the Roth (though not from 25% to 15%). Still, even 25% to 15% only yields a 7% Roth disadvantage for total returns. Basically, if you tax rate drops slightly, Roth has advantage. If it drops a lot, Roth is at a disadvantage, it's true, but it's not devastating. But that's the case for the overwhelming majority of retirees. Few will be at the same marginal rate, and even if they are at the same rate, their lower tax rates should be filled up with income from a tax deferred account. Only the income that would be taxed at the marginal rate could come from a Roth and it be a net wash.
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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Fri Feb 10, 2017 5:37 pm

willthrill81 wrote:
That's what I don't like about people just saying "marginal vs. marginal." It leads uninformed people down this path of thinking that if tax rates go up even a little bit that the Roth would have been a better choice. But that's simply false. For one, most of your retirement income will almost certainly not be taxed at your current marginal rate.
I normally would not use the term marginal as the true math would have to track ALL your contributions and compare that to any current withdrawals you are considering, if you wanted to use the average tax cost. However, if you were a real nerd you would probably try to convince me you were going to figure it out on a tax lot basis and compare one particular lot in with one particular lot out. That is not really what matters in most cases because you can't predict the future anyway so how do you know where to put 100% of your money.

The above being said their is some basis for using the term marginal because of the relative size of your yearly contribution vs your salary and the fact that you must make a choice on whether the funds go to traditional or Roth, so in that regard those funds are either taxed or not taxed on strictly a marginal basis. In other words if you decide you aren't going to put the $5500 in the 401k and you are going to put it in your Roth, that adds $5500 of MARGINAL income to your tax bill that year. This is actually how some people decide where that money is going on an annual basis, to raise or lower their taxes.


What IS important in the whole Roth / non-Roth tax discussion is to realize the basics -- IF tax rate IS higher when you put the money in during your working years and lower later, the traditional IRA or 401k wins. Simple fact - but as pointed out hard to calculate exactly --- but it does NOT matter unless you have a time machine. It only matters that you understand the principals.


Second, for typical retirees, the benefit of tax deferment beats the Roth option by a significant margin.
This indicates you don't understand the principals as it absolutely doesn't matter how long the funds are in any account. Go back to rule number one as only the tax rates matter.
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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Fri Feb 10, 2017 5:54 pm

FinancialDave wrote:
willthrill81 wrote:Second, for typical retirees, the benefit of tax deferment beats the Roth option by a significant margin.
This indicates you don't understand the principals as it absolutely doesn't matter how long the funds are in any account. Go back to rule number one as only the tax rates matter.
You misunderstood me. I never said anything about how long the funds are in the account, which is of course irrelevant. Most retirees (at least 80%) are in a lower tax bracket in retirement. As such, these people would be significantly better off deferring the taxes until then rather than pay a higher marginal rate in their career. This is not true of everyone, but it is certainly true for most.
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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Fri Feb 10, 2017 5:57 pm

Noobvestor wrote:
My general conclusion is this: it oversimplifies things too much to just assume similar rates of return for taxable and tax-advantaged. I'd love to see a calculator that allows for even more detailed examination of things, like: what if I have a Traditional 401(k) with low-yield bonds, and Roth 401(k) with small/value/emerging, and a taxable account with a combination of total-market stocks and tax-exempt bonds?

In the meantime, though, if you're putting slightly higher risk/return in Roth accounts relative to taxable, again: it makes a big difference. What was most surprising to me in doing these experiments was how much more of an impact that made than even big swings in tax rates!
Noob,

You don't need a calculator to know that it doesn't matter what return is in which account. You can do this math on a napkin. Earn $5,000 and put it in apple stock earning 20% a year for 30 years and then withdraw it at a 25% tax rate - what do you have left.

Earn $5,000 and put $3750 (the after-tax amount) into a Roth and invest it in bonds at 2% return for 30 years then withdraw the tax-free funds.


Add the two sums above together -- this is your retirement nest egg!

Now reverse the above excercise putting the Apple stock into the Roth (thinking of course this will give you more money in retirement) and the bonds in the traditional.

All it does really is make your Roth / non-Roth split different, which of course could affect your tax rate, but we are holding tax rates constant here, because you need to understand the basics.

NO more money in retirement by moving your assests around --- this myth is quoted way too often.

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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Fri Feb 10, 2017 6:00 pm

willthrill81 wrote:
FinancialDave wrote:
willthrill81 wrote:Second, for typical retirees, the benefit of tax deferment beats the Roth option by a significant margin.
This indicates you don't understand the principals as it absolutely doesn't matter how long the funds are in any account. Go back to rule number one as only the tax rates matter.
You misunderstood me. I never said anything about how long the funds are in the account, which is of course irrelevant. Most retirees (at least 80%) are in a lower tax bracket in retirement. As such, these people would be significantly better off deferring the taxes until then rather than pay a higher marginal rate in their career. This is not true of everyone, but it is certainly true for most.
Ok, that is certainly possible and I even agree with the fact that retirees will most often have a lower overall tax rate, however during my first two years of retirement I paid off a $180k mortgage -- how do you do that if you only have tax-deferred money without affecting your tax rate?
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Re: Theory on whether to go Roth 401k

Post by willthrill81 » Fri Feb 10, 2017 6:03 pm

FinancialDave wrote:
willthrill81 wrote:
FinancialDave wrote:
willthrill81 wrote:Second, for typical retirees, the benefit of tax deferment beats the Roth option by a significant margin.
This indicates you don't understand the principals as it absolutely doesn't matter how long the funds are in any account. Go back to rule number one as only the tax rates matter.
You misunderstood me. I never said anything about how long the funds are in the account, which is of course irrelevant. Most retirees (at least 80%) are in a lower tax bracket in retirement. As such, these people would be significantly better off deferring the taxes until then rather than pay a higher marginal rate in their career. This is not true of everyone, but it is certainly true for most.
Ok, that is certainly possible and I even agree with the fact that retirees will most often have a lower overall tax rate, however during my first two years of retirement I paid off a $180k mortgage -- how do you do that if you only have tax-deferred money without affecting your tax rate?
I never said that tax deferred accounts are a one-size-fits-all panacea.
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Re: Theory on whether to go Roth 401k

Post by Bastiat » Fri Feb 10, 2017 6:25 pm

willthrill81 wrote:Precisely. Unless someone has a sizable pension or other significant income sources during retirement, making Roth contributions when you have anything less than $1M currently invested is unlikely to make financial sense (for married couples, half that for singles).

That's what I don't like about people just saying "marginal vs. marginal." It leads uninformed people down this path of thinking that if tax rates go up even a little bit that the Roth would have been a better choice. But that's simply false. For one, most of your retirement income will almost certainly not be taxed at your current marginal rate. Second, for typical retirees, the benefit of tax deferment beats the Roth option by a significant margin.
What do you consider a sizable pension?

I'm almost 30, just over 10 years away from a (military) pension that should, at minimum, be $3,840/mo (and will be adjusted with inflation). I'll also have medical benefits.

Right now I'm on the border of the 25/28 tax bracket, with $75K in a Roth IRA, $50K in Roth TSP, and $25K in Trad TSP, with $150K in taxable accounts. Rental properties generate $40K/year which will continue/grow through retirement.

I max out RIRA and TSP every year; not sure if I should continue to favor Roth TSP or move more to Traditional. My income in retirement will be significant, which is why I've favored Roth.

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Re: Theory on whether to go Roth 401k

Post by DSInvestor » Fri Feb 10, 2017 6:32 pm

FinancialDave wrote: Ok, that is certainly possible and I even agree with the fact that retirees will most often have a lower overall tax rate, however during my first two years of retirement I paid off a $180k mortgage -- how do you do that if you only have tax-deferred money without affecting your tax rate?
I'd argue that by making traditional 401k contributions rather than Roth 401k while working, you'd have more take home pay with which to attack the mortgage and allow you to start retirement with no mortgage or much smaller mortgage.

If concerned about large expenditures in retirement, having assets in taxable accounts help as well. Avoiding Roth 401k contributions gives you more take home pay which may make it easier to invest in taxable accounts. IMO, it's great to have assets in Traditional 401k, Roth IRA, and taxable accounts. Withdrawing from a taxable account can be very tax efficient as return of capital is not taxable and there are preferential tax rates for QDI and LTCG. IMO Roth IRA contributions are better than Roth 401k contributions as one probably does not have to give up a tax deduction for Roth IRA (if covered by employer plan and high income).
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Re: Theory on whether to go Roth 401k

Post by FinancialDave » Fri Feb 10, 2017 6:43 pm

DSInvestor wrote:
FinancialDave wrote: Ok, that is certainly possible and I even agree with the fact that retirees will most often have a lower overall tax rate, however during my first two years of retirement I paid off a $180k mortgage -- how do you do that if you only have tax-deferred money without affecting your tax rate?
I'd argue that by making traditional 401k contributions rather than Roth 401k while working, you'd have more take home pay with which to attack the mortgage and allow you to start retirement with no mortgage or much smaller mortgage.

If concerned about large expenditures, having assets in taxable accounts help as well. Avoiding Roth 401k contributions gives you more take home pay which may make it easier to invest in taxable accounts. IMO, it's great to have assets in Traditional, Roth IRA, and taxable accounts. Withdrawing from a taxable account can be very tax efficient as return of capital is not taxable and there are preferential tax rates for QDI and LTCG.
I basically did only 401k traditional, some taxable, and small Roth IRA, because Roth 401k was not available until about the last two years. Not paying down the mortgage actually allowed me to grow my retirement much more than I would have saved by paying down the mortgage. My taxable account was used up to pay off the mortgage.

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Re: Theory on whether to go Roth 401k

Post by Watty » Fri Feb 10, 2017 7:11 pm

I might have missed it but here are some factors I have not seen mentioned are;

1) Your age. If you are in your late 50s then you likely have a pretty good picture of what your retirement finances will look like. If you are in your 30s or 40s your retirement situation is much less predictable. I have seen lots of people run into career or life setbacks in that cause them to retire in a lower than expected tax bracket.

2) When you get to be in your 50's and have a paid off house then deciding to retire ten years early in the 15% tax bracket can look pretty good.

3) If you are married or not. Single people get into the 25% tax bracket pretty quick. You could also change your filing status when you are retired by being widowed, divorced, or getting married.

4) Your state tax laws. Many states exempt some retirement income from state taxes. Here in Georgia you can exempt $65K($130K for a couple) but you can deduct your 401k contributions while you are working. This can make prepaying the taxes in a Roth much less favorable.

5) The consequences of selecting the wrong type are not the same. If you are in the 25% tax bracket and guess wrong then you would be likely be in the 28% tax bracket which in effect only a 3% penalty and you were already doing better than expected. If you drop down to the 15% tax bracket that is a 10% penalty when you are not doing as well as hoped for.

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