Roth 401K Confusion

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betashmeta
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Roth 401K Confusion

Post by betashmeta » Mon Jan 21, 2013 5:41 pm

I recently noticed that I am able to make after-tax contributions into a roth 401K. My 25% match applies to both the roth and regular plans. I feel like this should be straightforward just like comparing an IRA vs a Roth IRA, but for some reason I'm finding it perplexing. Notwithstanding making regular 401K contributions for MAGI purposes, can someone please muse on the topic to help me clarify my thinking? As with an IRA, my temptation is to put as much into the Roth 401K as possible. I guess one big difference is that I wouldn't be able to contribute nearly as much money into the Roth 401K on account of the taxes. Should I consider a wholesale switch to Roth 401K contributions or split them 50/50 between the regular and roth? Or ignore the roth?

I should add that I fully expect to be in a higher tax bracket when I retire. In fact, I'll probably be in a much higher one within the next 10 years.

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bottlecap
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Re: Roth 401K Confusion

Post by bottlecap » Mon Jan 21, 2013 5:59 pm

betashmeta wrote:Should I consider a wholesale switch to Roth 401K contributions or split them 50/50 between the regular and roth? Or ignore the roth?

I should add that I fully expect to be in a higher tax bracket when I retire. In fact, I'll probably be in a much higher one within the next 10 years.
Sounds like you may be better off in the Roth, but it's hard to be certain without knowing your specific situation.

JT

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betashmeta
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Re: Roth 401K Confusion

Post by betashmeta » Mon Jan 21, 2013 6:04 pm

Would you mind saying what about my specific situation might affect the decision?

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bottlecap
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Re: Roth 401K Confusion

Post by bottlecap » Mon Jan 21, 2013 6:26 pm

betashmeta wrote:Would you mind saying what about my specific situation might affect the decision?
What is your marginal tax bracket now and what do you expect it to be when you retire?

JT

sscritic
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Re: Roth 401K Confusion

Post by sscritic » Mon Jan 21, 2013 6:37 pm

betashmeta wrote: my temptation is to put as much into the Roth 401K as possible. I guess one big difference is that I wouldn't be able to contribute nearly as much money into the Roth 401K on account of the taxes.
Well, you just answered your own question. Here is how someone else might answer it.

My employer will match $10,000 of my contributions. If I put my $10k into my 401(k) and my employer puts $10k into my 401(k), I will be able to take out $15,000 (25% bracket). If I put my $10k into my Roth 401(k) and my employer puts $10k into my 401(k), I will be able to take out $17,500. In the former case, you have to make $10k, in the latter, you have to make $13,333.33. In the former case, you save less and have less saved; in the latter you save more and have more saved. If your goal is to maximize your share of deferred/free space, the Roth gets you more.

Tax brackets now and in the future make a difference, but on straight savings, you save $10k one way and $13 1/3 k the other (or maybe I should say $7.5k and $10k).

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betashmeta
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Re: Roth 401K Confusion

Post by betashmeta » Mon Jan 21, 2013 6:45 pm

My marginal income rate is 28% but on account of my recent marriage I may have dropped to 25% for 2012. However, about 20% of my AGI is bonus and faces supplemental taxes, so my actual tax rate is a bit higher. In the future, my taxes may actually go down (starting business) because I will be able to take a fair amount as distributions. EDIT: I'm not sure what my retirement tax bracket will be.
Last edited by betashmeta on Mon Jan 21, 2013 7:08 pm, edited 1 time in total.

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betashmeta
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Re: Roth 401K Confusion

Post by betashmeta » Mon Jan 21, 2013 6:53 pm

sscritic wrote:
betashmeta wrote: my temptation is to put as much into the Roth 401K as possible. I guess one big difference is that I wouldn't be able to contribute nearly as much money into the Roth 401K on account of the taxes.
Well, you just answered your own question. Here is how someone else might answer it.

My employer will match $10,000 of my contributions. If I put my $10k into my 401(k) and my employer puts $10k into my 401(k), I will be able to take out $15,000 (25% bracket). If I put my $10k into my Roth 401(k) and my employer puts $10k into my 401(k), I will be able to take out $17,500. In the former case, you have to make $10k, in the latter, you have to make $13,333.33. In the former case, you save less and have less saved; in the latter you save more and have more saved. If your goal is to maximize your share of deferred/free space, the Roth gets you more.

Tax brackets now and in the future make a difference, but on straight savings, you save $10k one way and $13 1/3 k the other (or maybe I should say $7.5k and $10k).
But if I can only afford to put $7.5K into the Roth on account of taxes, and my employer matches with $7.5K pre-tax, then I can take out my $7.5K but only $5625 from the regular 401K. Of course, I can earn tax-free on my $7.5K. I guess I should go do some more math to see how this looks over the long run. Am I missing something?

dbr
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Re: Roth 401K Confusion

Post by dbr » Mon Jan 21, 2013 6:59 pm

betashmeta wrote:My marginal income rate is 28% but on account of my recent marriage I may have dropped to 25% for 2012. However, about 20% of my AGI is bonus and faces supplemental taxes, so my actual tax rate is a bit higher. In the future, my taxes may actually go down (starting business) because I will be able to take a fair amount as distributions. By retirement age I will probably be 33%, possibly 35%.
It would be unusual for a person no longer employed to be in such high tax brackets. I'm curious why you are estimating this.

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betashmeta
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Re: Roth 401K Confusion

Post by betashmeta » Mon Jan 21, 2013 7:08 pm

dbr wrote:
betashmeta wrote:My marginal income rate is 28% but on account of my recent marriage I may have dropped to 25% for 2012. However, about 20% of my AGI is bonus and faces supplemental taxes, so my actual tax rate is a bit higher. In the future, my taxes may actually go down (starting business) because I will be able to take a fair amount as distributions. By retirement age I will probably be 33%, possibly 35%.
It would be unusual for a person no longer employed to be in such high tax brackets. I'm curious why you are estimating this.
That is a good question, and I should correct myself. I have no idea what my tax bracket will be when I'm retired. That probably makes me an idiot retirement planner. Time to go do some math!

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bottlecap
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Re: Roth 401K Confusion

Post by bottlecap » Mon Jan 21, 2013 7:53 pm

25% and above usually favors the traditional. But the other assumptions are important.

JT

sscritic
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Re: Roth 401K Confusion

Post by sscritic » Mon Jan 21, 2013 8:28 pm

There are two ways of looking at this: one is how much tax will you pay over your lifetime and the other is how much will you have available in retirement. Let's switch to IRAs for illustrative purposes.

Every year you put $5000 into a traditional IRA; your twin sister puts $5000 into a Roth IRA. When you reach 65, you have $1 million and so does your twin sister (you did use the same investments as twins often do). You probably have $750k to $850k to spend in retirement while your twin sister has $1 million. The reason is that your twin sister paid more taxes every year along the way than you did and went to Starbucks less often. She may in fact have paid more in total taxes than you will, but she will be able to live it up in retirement. Her taxes are pre-paid; yours are not.

The Roth can be thought of as a forced savings plan if, and this is a big if, you put in the same dollar amount either way. As I pointed out before, it takes more income set aside for retirement (meaning less for immediate consumption) to fund the Roth, but you end up with more in the end as a result.

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Duckie
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Re: Roth 401K Confusion

Post by Duckie » Tue Jan 22, 2013 12:33 am

betashmeta, read these two articles by tfb who posts here frequently:
The Case Against Roth 401(k)
Roth 401(k) for People Who Contribute the Max

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