Roth 401k or 401k: diversify tax risk or hit SS limits

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
Thorsbane
Posts: 26
Joined: Tue Dec 18, 2018 2:57 pm

Roth 401k or 401k: diversify tax risk or hit SS limits

Post by Thorsbane »

Mid-30's, MFJ, 2 kids...

For my career, I've essentially split my retirement savings between Roth 401k and traditional 401k. I don't tend to believe folks who predict what the future effective tax rates will be so I decided that I could just hedge and jump on both sides.

Now, I'm in a rather interesting situation. I'm pushing over the social security contribution limits but my traditional 401k contributions are holding me back. If I pushed harder into my Roth, I would clearly exceed the limits and have some SS tax free dollars in my pocket while having the perk of tax-free holdings at retirement.

I feel like I'm not considering something or I'm missing a key point in this situation. Is pushing for the SS tax free dollars actually beneficial or have I lost sight of some benefit later in life?
Whakamole
Posts: 1210
Joined: Wed Jan 13, 2016 9:59 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by Whakamole »

Once you are past the second "bent point" for SS, each dollar you pay to SS gives a very marginal benefit. I don't think I would let that be a factor in your decision.

I "hedge" because my employer has the so-called mega backdoor Roth (after tax 401(k) contributions which can be rolled over to a Roth 401(k) or IRA), so effectively I have half my contributions in Traditional and half in Roth. Works well if you have the option.
terran
Posts: 1727
Joined: Sat Jan 10, 2015 10:50 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by terran »

Are you saying you expect your traditional 401(k) balances to cause your taxable income to be high enough such that (more of) your social security income will be taxable? That's certainly possible, although it's hard to predict exactly since it depends so much on how much your 401(k) grows.

Or are you saying that you're near the social security wage base cap and traditional 401(k) contributions are keeping your wages counted for social security down? Because that isn't how it works. Traditional 401(k) contributions reduce taxable income, but not income counted for social security. The only tax advantaged account that does that is an HSA (when contributed to by payroll deduction, usually).

Or I might be misunderstanding what you're saying entirely.
Spirit Rider
Posts: 13629
Joined: Fri Mar 02, 2007 2:39 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by Spirit Rider »

Thorsbane wrote: Mon Sep 30, 2019 9:30 am I'm pushing over the social security contribution limits but my traditional 401k contributions are holding me back. If I pushed harder into my Roth, I would clearly exceed the limits and have some SS tax free dollars in my pocket while having the perk of tax-free holdings at retirement.
As @terran stated; pre-tax retirement contributions reduce taxable income, but do not reduce SS wages.
KlangFool
Posts: 18210
Joined: Sat Oct 11, 2008 12:35 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by KlangFool »

Thorsbane wrote: Mon Sep 30, 2019 9:30 am Mid-30's, MFJ, 2 kids...

For my career, I've essentially split my retirement savings between Roth 401k and traditional 401k. I don't tend to believe folks who predict what the future effective tax rates will be so I decided that I could just hedge and jump on both sides.
Thorsbane,

<<so I decided that I could just hedge and jump on both sides.>>

1) Do you contribute to the Roth IRAs?

2) The proper way of hedging is to max up your Trad. 401K and put the tax savings into the Roth IRAs.

<<If I pushed harder into my Roth, I would clearly exceed the limits and have some SS tax free dollars in my pocket >>

3) This is irrelevant since your income tax amount would be significantly much more than the SS tax. How does paying 20+% of taxes in order to save 7.65% is a good idea?

KlangFool
WhiteMaxima
Posts: 2192
Joined: Thu May 19, 2016 5:04 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by WhiteMaxima »

Whakamole wrote: Mon Sep 30, 2019 9:36 am Once you are past the second "bent point" for SS, each dollar you pay to SS gives a very marginal benefit. I don't think I would let that be a factor in your decision.

I "hedge" because my employer has the so-called mega backdoor Roth (after tax 401(k) contributions which can be rolled over to a Roth 401(k) or IRA), so effectively I have half my contributions in Traditional and half in Roth. Works well if you have the option.
That's why there is FIRE movement. People save 50% or even 60% of their gross income and retire when they reached bend point. Then there is no SS tax and medcare tax. Healthcare will be covered by AHC. they do Roth conversion and living on aft-tax and don't even pay tax. Of course, you can't have a lavish lifestyle. I see many people doing it.
User avatar
Hub
Posts: 437
Joined: Fri Jul 13, 2012 8:56 am

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by Hub »

OP, I can see your logic. You've already made the decision to pre-pay taxes by contributing to Roth401k. So long as this doesn't cause any unforeseen phase-outs like child tax care credit, student loan interest credit, etc, then I could see going even heavier into roth401k to get some SS tax free money in there.

Personally I max traditional at every turn and then just do normal Roth IRA contributions. I don't like to pre-pay taxes above the 15% bracket.
KlangFool
Posts: 18210
Joined: Sat Oct 11, 2008 12:35 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by KlangFool »

Hub wrote: Mon Sep 30, 2019 11:42 am OP, I can see your logic. You've already made the decision to pre-pay taxes by contributing to Roth401k. So long as this doesn't cause any unforeseen phase-outs like child tax care credit, student loan interest credit, etc, then I could see going even heavier into roth401k to get some SS tax free money in there.

Personally I max traditional at every turn and then just do normal Roth IRA contributions. I don't like to pre-pay taxes above the 15% bracket.
Hub,

Social Security tax limit for 2019 is $132,900. So, OP should be above the 15% bracket.

https://www.ssa.gov/policy/docs/quickfa ... s2019.html

KlangFool
Spirit Rider
Posts: 13629
Joined: Fri Mar 02, 2007 2:39 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by Spirit Rider »

I don't know why people are continuing to ignore @terran's and my post.

401k contributions no matter what the type, have no effect on SS wages and thus the SS component of FICA taxes.
mcraepat9
Posts: 1619
Joined: Thu Jul 16, 2015 11:46 am

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by mcraepat9 »

I don’t understand what is occurring here. You cannot avoid OASDI taxes by using a traditional 401K.

OP, you should be using a traditional 401K for 100% of your contributions for a litany of reasons, but OASDI taxes is not one of them. They are what they are. You will pay them regardless of your choice. If you want tax diversification, use a Roth IRA as KlangFool recommended. A Roth 401K doesn’t make sense for you absent unusual circumstances.
Amateur investors are not cool-headed logicians.
Topic Author
Thorsbane
Posts: 26
Joined: Tue Dec 18, 2018 2:57 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by Thorsbane »

Spirit Rider wrote: Mon Sep 30, 2019 12:55 pm I don't know why people are continuing to ignore @terran's and my post.

401k contributions no matter what the type, have no effect on SS wages and thus the SS component of FICA taxes.
Thank you @Spirit Rider and @Terran for the insight. I didn't realize that this is the case and makes my concerns void. My original intent was to increase my taxable base by using Roth401k, thereby avoiding future tax liabilities but also being over SS limits. With your points, I see there is no basis in this.

@Klangfool recommends putting all my money into 401k and savings into roth IRA. This makes sense, though we're bordering phase out of IRA contributions. What would the next recommended option be?
User avatar
FiveK
Posts: 10547
Joined: Sun Mar 16, 2014 2:43 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by FiveK »

Thorsbane wrote: Tue Oct 01, 2019 1:10 pm What would the next recommended option be?
See Prioritizing investments and Investment Order for some thoughts on that.
Spirit Rider
Posts: 13629
Joined: Fri Mar 02, 2007 2:39 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by Spirit Rider »

Thorsbane wrote: Tue Oct 01, 2019 1:10 pm @Klangfool recommends putting all my money into 401k and savings into roth IRA. This makes sense, though we're bordering phase out of IRA contributions. What would the next recommended option be?
You may be bordering the phaseout of direct Roth IRA contributions, but there are no income limits to make non-deductible traditional IRA contributions and Roth conversions of same. This is the so-called Backdoor Roth.
mcraepat9
Posts: 1619
Joined: Thu Jul 16, 2015 11:46 am

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by mcraepat9 »

Spirit Rider wrote: Tue Oct 01, 2019 2:49 pm
Thorsbane wrote: Tue Oct 01, 2019 1:10 pm @Klangfool recommends putting all my money into 401k and savings into roth IRA. This makes sense, though we're bordering phase out of IRA contributions. What would the next recommended option be?
You may be bordering the phaseout of direct Roth IRA contributions, but there are no income limits to make non-deductible traditional IRA contributions and Roth conversions of same. This is the so-called Backdoor Roth.
+1
Amateur investors are not cool-headed logicians.
User avatar
JoeRetire
Posts: 6001
Joined: Tue Jan 16, 2018 2:44 pm

Re: Roth 401k or 401k: diversify tax risk or hit SS limits

Post by JoeRetire »

Thorsbane wrote: Mon Sep 30, 2019 9:30 amIs pushing for the SS tax free dollars actually beneficial or have I lost sight of some benefit later in life?
It's not worth "pushing" for.
It's the end of the world as we know it. | It's the end of the world as we know it. | It's the end of the world as we know it. | And I feel fine.
Post Reply