Roth 401k becuase of house deduction and pension?

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Topic Author
RickandMorty368
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Joined: Sat Jun 06, 2020 9:14 am

Roth 401k becuase of house deduction and pension?

Post by RickandMorty368 »

Hello,

I am a LONG time reader of Bogleheads. Due to all your advice I have switched to all Vanguard in a simple fund portfolio. I have a very specific question regarding whether to use a Roth 401k due to my changed (positive) financial situation.
Stats:
15 years from retirement.
Federal Worker currently maxing out TSP/401K
Self Salary $137,000
Spouse Salary $50,000 from Sole Proprietorship on 1099s
Rental costs are $2300 a month
Maxing out Roth IRA for self
Maxing out Roth IRA for spouse
Currently taking additional $1500 a month and investing with vanguard
State tax is 5%
Pension from federal employment will be about $24,000 a year when I retire in 15 years.


I am now purchasing a house (moving from rental) so will now be able to entertain the use of the mortgage interest and property tax deductions (1% property tax here). Monthly housing payment going from rental (2300) to $3,500 for house. The loan amount is $600,000. Property taxes are about $6,000 per year.


My question is this: Since the standard deduction is around $24,000, would it be prudent to increase my tax liability by using a Roth 401k, continuing to max out of course instead of my traditional 401k(TSP). From what I understand, most people dont get to use the house and state tax deduction because the standard deduction is so high right now and tax rates are relatively low. My theory is that by going to roth 401k I will be able to take better advantage of the new home mortgage interest deduction more so by increasing my taxable income (by using Roth instead of Traditional 401k).

Is my thinking correct on that or am I off? I am aware of The Financial Buff's suggestion to use Roth 401k in the event that Pensions (I will get FERS) is on the table. I think even more so because of the home owners deduction. I contribute $750 per pay, so I estimate this will cost me about $200 in federal and state taxes up front, but I should have a better chance of getting more back from the house deduction, right?
Last edited by RickandMorty368 on Sat Jun 06, 2020 1:53 pm, edited 1 time in total.
nolesrule
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Joined: Thu Feb 26, 2015 10:59 am

Re: Roth 401k becuase of house deduction and pension?

Post by nolesrule »

RickandMorty368 wrote: Sat Jun 06, 2020 9:30 am I contribute $750 per pay, so I estimate this will cost me about $200 in federal and state taxes up front, but I should have a better chance of getting more back from the house deduction, right?
No.

Switching from traditional to Roth doesn't change the amount of money you can itemize versus the standard deduction. It might affect the tax bracket by putting you into a higher tax bracket which would increase the amount saved in taxes on the delta between itemized and standard deduction, but in that case you are also paying more to put the money into Roth.

The choice between Traditional and Roth is the marginal tax rate now to put the money into Roth vs. the marginal tax rate on withdrawal of the money if you put it in traditional.

You appear to be firmly in the 22% marginal tax rate right now. Switching between Roth and traditional won't change tax brackets.
Flora
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Re: Roth 401k becuase of house deduction and pension?

Post by Flora »

As an aside, you mention 'house deduction'.

Are you aware of the $10,000 SALT limit?

Will your mortgage interest (and charitable contributions) exceed $14,800 annually?
JBTX
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Re: Roth 401k becuase of house deduction and pension?

Post by JBTX »

Agree with all the above points.

You look to be in the 22% federal bracket and going Roth isn't going to change that where you are.

Whether you exceed the standard deduction or not, and it appears you will, is not dependent on how much income you make (excepting itemized deduction phase outs at much higher incomes than yours)

Even if your tax bracket changed, you wouldnt want to have more income just to have more deductions. You are still paying more taxes.

You are correct, a future pension is a factor in favor of Roth vs traditional, however your pension is comparatively modest. With that pension you will never be in the zero percent tax bracket covered by standard deduction. But if that was your only income in retirement you would be in the 10/12% brackets (which are scheduled to go up to 15% in 2026, plus any state income tax, if applicable ) which is lower than your current marginal rate of 22+5%=27%.

As it stands now, your future retirement rate will likely be lower than your current rate, which favors traditional. But it isn't always that simple:

- Once you receive social security, that income becomes taxable the more you make Within a range. This can increase your marginal rate in retirement.

- RMDS will be taxable income

- if you planned on using ACA policies after you retire, if you retire early, but before Medicare, to the extent you take do Roth conversions, or pull money out of your traditional 401k for living expenses, that will decrease your ACA subsidies

- increased retirement income can increase payments on Medicare, although at your retirement income that likely won't be a factor.

- Roth in retirement does give you more flexibility and may have estate planning advantages.

Bottom line, with the facts presented and if you assume present tax law prevails, contributions to traditional 401k are probably computationally more favorable, but future tax rates almost certainly will change-they always do, and you have to decide if you think it is more likely they'll go up or down.

If it were me, with facts given, I'd probably favor traditional contributions, but Id possibly hedge my bets and direct a portion of it to Roth. That's just me.

Also, are you aware your spouse could likely open a self employment 401k and contribute a good chunk of it to that plan?

https://www.bogleheads.org/wiki/Solo_401(k)_plan
Topic Author
RickandMorty368
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Joined: Sat Jun 06, 2020 9:14 am

Re: Roth 401k becuase of house deduction and pension?

Post by RickandMorty368 »

Great responses and thank you very much. I happen to open a traditional individual (Solo) 401k for my souse yesterday, it’s actually what started this whole chain of event thinking about Roth TSP vs Traditional. I’ve long been an advocate of traditional, but seeing the added flexibility in retirement and the possibility of then mortgage deduction had me thinking.

I am aware of the SALT max deduction. I estimate my SALT to be just about $10,000.

Interest payments on the house will be $19,000 years 1-6.

No ACA in retirement I will use FERS (federal employee health insurance).

Do those numbers change anybody’s recommendations of Roth 401k vs Traditional?
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FiveK
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Re: Roth 401k becuase of house deduction and pension?

Post by FiveK »

RickandMorty368 wrote: Sat Jun 06, 2020 1:48 pm Do those numbers change anybody’s recommendations of Roth 401k vs Traditional?
I think you have received good advice already. What do you expect for your marginal tax rate
- in 2020, and
- when you will be withdrawing from traditional accounts in the future?
Topic Author
RickandMorty368
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Joined: Sat Jun 06, 2020 9:14 am

Re: Roth 401k becuase of house deduction and pension?

Post by RickandMorty368 »

FiveK wrote: Sat Jun 06, 2020 2:05 pm
RickandMorty368 wrote: Sat Jun 06, 2020 1:48 pm Do those numbers change anybody’s recommendations of Roth 401k vs Traditional?
I think you have received good advice already. What do you expect for your marginal tax rate
- in 2020, and
- when you will be withdrawing from traditional accounts in the future?

1. Marginal Tax Tax rate is 24% in 2020. State Tax is 5%

2. Withdraw would be in about 15 years.

3. I will be living in retirement in a state with comparable state tax 4-5%
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FiveK
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Re: Roth 401k becuase of house deduction and pension?

Post by FiveK »

RickandMorty368 wrote: Sat Jun 06, 2020 2:30 pm
FiveK wrote: Sat Jun 06, 2020 2:05 pm I think you have received good advice already. What do you expect for your marginal tax rate when you will be withdrawing from traditional accounts in the future?
2. Withdraw would be in about 15 years.
And in 15 years, what do you expect your marginal tax rate on those withdrawals will be? See the "in the future" link above for one way to estimate it.
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grabiner
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Re: Roth 401k becuase of house deduction and pension?

Post by grabiner »

RickandMorty368 wrote: Sat Jun 06, 2020 2:30 pm 1. Marginal Tax Tax rate is 24% in 2020. State Tax is 5%

2. Withdraw would be in about 15 years.

3. I will be living in retirement in a state with comparable state tax 4-5%
These numbers suggest the Roth TSP is likely better. Your marginal tax rate is 29%, and under current tax law, it will still be 29% when you retire (22% bracket will become 25% in 2026). If the current tax cuts are made permanent, you can switch to traditional then; if not, you will move to the 28% tax bracket in 2026 and can switch then.

With equal or near-equal tax rates, Roth is better than traditional for you because you are maxing out, so using a Roth allows you to effectively tax-defer more money.
Wiki David Grabiner
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