403b vs Roth 403b?

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florencenightingale
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403b vs Roth 403b?

Post by florencenightingale » Wed May 15, 2019 8:57 am

Hi all!

I have the choice from my hospital employer between a 403b and a Roth 403b to deduct from my paycheck. I am thinking of putting aside 20% of my paycheck into the 403b.

I'm 34, so a bit of a way till retirement age. What's the benefits/drawbacks of choosing either?

Thanks!

bloom2708
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Re: 403b vs Roth 403b?

Post by bloom2708 » Wed May 15, 2019 10:05 am

Pre-tax ($19k 2019 limit) unless you or spouse will have a pension that covers most of your expenses.

Defer the 22 or 24 or higher tax to 30 years down the road.

Pair with $6k to your Roth IRA every year (back door Roth if you are over the income phase out limits).
"We are not here to agree with you; we are here to provoke thoughtfulness." Unknown Boglehead

lakpr
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Re: 403b vs Roth 403b?

Post by lakpr » Wed May 15, 2019 10:11 am

It is pay taxes now vs pay taxes later issue. With Roth 403b, your money will never be taxed again, including its growth. But you pay taxes on the money you contribute now.

With regular 403b, you will get a tax break now; so if your salary is $100k and you contribute $15k to 403b, your year end W-2 will show only income of $85k and you will pay taxes on that income.

That is a gross oversimplification, but illustrates the point. You are not allowed access to this $15k until you reach age 59.5 AND retire from or leave the employer. At that time, every dollar you withdraw from the 403b account will be considered as income and taxed accordingly (first few dollars escape taxation, next few taxed at 10%, next few at 12%, etc).

ExitStageLeft
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Re: 403b vs Roth 403b?

Post by ExitStageLeft » Wed May 15, 2019 12:20 pm

20% savings is an impressive savings rate. Well done!

The wiki has a write-up on the benefits of Roth versus tradional retirement savings.
https://www.bogleheads.org/wiki/Traditional_versus_Roth

The big determinant is current vs future income tax rates. If you are in a low bracket now (say 12%) and have high confidence that your tax rate will be higher in retirement then you should prefer Roth retirement savings. If you are in a high bracket now like 35% then it's a good bet that you will have a lower tax rate in retirement and you should prefer tax-deferred savings.

If you are like most folks and fall somewhere in the middle of those extremes, then a mix of tax-deferred and Roth savings is a good strategy. Hence the advice above to save tax-deferred in your 403b and to also save in a Roth IRA.

EdLaFave
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Re: 403b vs Roth 403b?

Post by EdLaFave » Wed May 15, 2019 1:54 pm

You haven’t really given enough information to answer a question that is already unanswerable (it requires knowledge of future tax rates, age of death, future SS policy, market return, etc), but you should read this: https://thefinancebuff.com/case-against-roth-401k.html

I wrote software to model growth/spending/taxation in retirement with an eye towards reducing taxes and it confirmed my priors that Traditional is better than Roth for almost everybody.

Mathematically it doesn’t matter when you’re taxed. It only matters what percentage you’re taxed. If you contribute to a Roth every dollar will be taxed at the highest rate.

If you contribute to a Traditional, some dollars will not be taxed (I.e deductions, credits, etc), some will fill up the 10% bracket, some fill up the 12% bracket, etc. So even if you aren’t in a lower tax bracket in retirement (you probably will be), your Traditional will likely have a lower effective tax rate than your highest marginal bracket now (Roth).

Plus if you retire before forced ordinary income like SS, RMDs, and Pensions then you can convert quite a bit of your Traditional account to a Roth account without paying a cent in tax and if you want you can convert more by filling up the lowest bracket with conversions.

Your aim should be to have enough in Traditional such that when you eventually draw from it, you’ll (at most) meet or fill up your current marginal tax bracket. If you can accomplish that then every other dollar should go to Roth accounts.

Quaestner
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Re: 403b vs Roth 403b?

Post by Quaestner » Wed May 15, 2019 5:17 pm

If you're an optimist, assume you will move on up the hospital hierarchy and make much more money later in your career. If this is true, and you've saved as you plan, you'll have a hefty RMD from the 403b (that's taxable, as may be your SS income). For that reason, you might like the Roth. Pay your taxes at a lower rate now and avoid the higher rates when your old and rich! However, it's difficult (to say the least) to be able to predict your future income and tax rates/tax laws! So, you might opt to hedge your bets and have some tax diversity. Can you do both a Roth and the traditional? Alternate every few years? (I'm glad I have both - gives me options.)
Last edited by Quaestner on Wed May 15, 2019 6:13 pm, edited 1 time in total.

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MNGopher
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Re: 403b vs Roth 403b?

Post by MNGopher » Wed May 15, 2019 5:49 pm

lakpr wrote:
Wed May 15, 2019 10:11 am
It is pay taxes now vs pay taxes later issue. With Roth 403b, your money will never be taxed again, including its growth. But you pay taxes on the money you contribute now.

With regular 403b, you will get a tax break now; so if your salary is $100k and you contribute $15k to 403b, your year end W-2 will show only income of $85k and you will pay taxes on that income.

That is a gross oversimplification, but illustrates the point. You are not allowed access to this $15k until you reach age 59.5 AND retire from or leave the employer. At that time, every dollar you withdraw from the 403b account will be considered as income and taxed accordingly (first few dollars escape taxation, next few taxed at 10%, next few at 12%, etc).
I agree with what you are saying, except I believe you can take 403b distributions the year you turn 55 if you have separated services from your employer.
https://www.bogleheads.org/wiki/403(b)

lakpr
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Re: 403b vs Roth 403b?

Post by lakpr » Wed May 15, 2019 6:21 pm

MNGopher wrote:
Wed May 15, 2019 5:49 pm
I agree with what you are saying, except I believe you can take 403b distributions the year you turn 55 if you have separated services from your employer.
https://www.bogleheads.org/wiki/403(b)
True, it is called Rule of 55, but not all employers are required to offer it. There is also the SEPP rule (Substantially Equal Periodic Payments) that you can use for withdrawing even earlier than age 55, if you separate from the employer, but you have to withdraw for a minimum period of 5 years.

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FiveK
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Re: 403b vs Roth 403b?

Post by FiveK » Thu May 16, 2019 1:41 am

EdLaFave wrote:
Wed May 15, 2019 1:54 pm
If you contribute to a Traditional, some dollars will not be taxed (I.e deductions, credits, etc), some will fill up the 10% bracket, some fill up the 12% bracket, etc. So even if you aren’t in a lower tax bracket in retirement (you probably will be), your Traditional will likely have a lower effective tax rate than your highest marginal bracket now (Roth).
But the future effective rate is irrelevant, because:
Your aim should be to have enough in Traditional such that when you eventually draw from it, you’ll (at most) meet or fill up your current marginal tax bracket. If you can accomplish that then every other dollar should go to Roth accounts.
That's the way to look at it.

Withdrawals from this year's traditional account contributions always come "on top of" withdrawals from previous years' contributions. In other words, comparing marginal rate now vs. expected marginal rate (based on contributions to date, pension, etc.) later is the way to look at this.

EdLaFave
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Re: 403b vs Roth 403b?

Post by EdLaFave » Thu May 16, 2019 6:26 am

Yes, as I suggested the effective tax rate is ultimately “irrelevant”. However, it is especially difficult to predict the marginal tax rate of each individual Traditional dollar in retirement. My point in bringing up the effective tax rate was:

1. If one was choosing between 100% Roth or 100% Traditional then the progressive nature of our tax code means that going Traditional is likely to generate smaller tax bills. So if you aren’t going to try to optimize every dollar then the benefits of Traditional are difficult to beat.

2. Quite a few people are given the incomplete advice to “invest in Roth if you’ll be in a higher tax bracket in retirement” and those folks often don’t understand the progressive nature of the tax code. It can open their eyes a bit to the laziness of this incomplete advice if they understand that even in this “worst case scenario” they’re still likely to have a lower effective tax rate had they chosen Traditional.

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FiveK
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Re: 403b vs Roth 403b?

Post by FiveK » Thu May 16, 2019 7:37 am

EdLaFave wrote:
Thu May 16, 2019 6:26 am
Yes, as I suggested the effective tax rate is ultimately “irrelevant”. However, it is especially difficult to predict the marginal tax rate of each individual Traditional dollar in retirement. My point in bringing up the effective tax rate was:

1. If one was choosing between 100% Roth or 100% Traditional then the progressive nature of our tax code means that going Traditional is likely to generate smaller tax bills. So if you aren’t going to try to optimize every dollar then the benefits of Traditional are difficult to beat.
No argument that for most, traditional will be better, because the marginal rate paid on withdrawals will be less than the marginal rate saved by contributions. Fortunately for financial optimization, however, the tax code doesn't force one to choose between 100% one or the other for an entire career.

Once the expected marginal rate on withdrawals exceeds (or even equals - see Maxing out your retirement accounts) the marginal rate on savings, one should switch to Roth. The switch should occur even though at that point it is very likely the expected retirement effective rate remains lower than the contribution marginal rate - agreed?
2. Quite a few people are given the incomplete advice to “invest in Roth if you’ll be in a higher tax bracket in retirement” and those folks often don’t understand the progressive nature of the tax code. It can open their eyes a bit to the laziness of this incomplete advice if they understand that even in this “worst case scenario” they’re still likely to have a lower effective tax rate had they chosen Traditional.
What about that advice strikes you as either lazy or incomplete? If it's the absence of a caution about the self-defeating prophecy (as noted in Investment Order):
a) predict high taxable retirement income > contribute to Roth > get low taxable retirement income
b) predict low taxable retirement income > contribute to traditional > get high taxable retirement income
then we agree. Otherwise, ...?

EdLaFave
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Re: 403b vs Roth 403b?

Post by EdLaFave » Thu May 16, 2019 8:15 am

FiveK wrote:
Thu May 16, 2019 7:37 am

Fortunately for financial optimization, however, the tax code doesn't force one to choose between 100% one or the other for an entire career.
It is nice to have that flexibility. I wonder how many need and/or use it (I don’t).
FiveK wrote:
Thu May 16, 2019 7:37 am
Once the expected marginal rate on withdrawals exceeds (or even equals - see Maxing out your retirement accounts) the marginal rate on savings, one should switch to Roth. The switch should occur even though at that point it is very likely the expected retirement effective rate remains lower than the contribution marginal rate - agreed?
Agreed. Folks could argue around the margins of this (should you switch to Roth when you meet or exceed your expected marginal tax bracket), but you’re basically stating a fact.
FiveK wrote:
Thu May 16, 2019 7:37 am
What about that advice strikes you as either lazy or incomplete?
It is lazy/incomplete because I don’t think people have the assumed knowledge behind a statement like, “invest in a Roth if your expected tax bracket in retirement is higher than your current marginal bracket.”

I think lots of people don’t understand the progressive nature of the tax code and when they hear this statement they use it to go 100% Roth or 100% Traditional. I don’t think they understand that what’s really being said is, “invest enough in Traditional so that when you make withdrawals for the year, you fill up each bracket up to and possibly including your current marginal bracket, and then put the rest in Roth.”

I also think people are really bad at even identifying what information they’ll need to predict their tax bracket in retirement (assuming tax law is constant). So I think some mention of pensions, SS, RMDs, unqualified dividends from taxable accounts, progressive tax code, and so forth is worth at least mentioning.

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FiveK
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Re: 403b vs Roth 403b?

Post by FiveK » Thu May 16, 2019 8:30 am

EdLaFave wrote:
Thu May 16, 2019 8:15 am
FiveK wrote:
Thu May 16, 2019 7:37 am

Fortunately for financial optimization, however, the tax code doesn't force one to choose between 100% one or the other for an entire career.
It is nice to have that flexibility. I wonder how many need and/or use it (I don’t).
Don't know. Some will. Based on comments in similar threads, a sizeable minority of Bogleheads. Probably a smaller percentage in the general population. ;)
It is lazy/incomplete because I don’t think people have the assumed knowledge behind a statement like, “invest in a Roth if your expected tax bracket in retirement is higher than your current marginal bracket.”

I think lots of people don’t understand the progressive nature of the tax code and when they hear this statement they use it to go 100% Roth or 100% Traditional. I don’t think they understand that what’s really being said is, “invest enough in Traditional so that when you make withdrawals for the year, you fill up each bracket up to and possibly including your current marginal bracket, and then put the rest in Roth.”

I also think people are really bad at even identifying what information they’ll need to predict their tax bracket in retirement (assuming tax law is constant). So I think some mention of pensions, SS, RMDs, unqualified dividends from taxable accounts, progressive tax code, and so forth is worth at least mentioning.
OK, no argument there. I'll sometimes point people toward the bottom of that Investment Order post for this approach:
Estimating withdrawal tax rates is not an exact science, but here is one approach:
1) Estimate any guaranteed income. E.g., pension you can't defer in return for higher payments when you do start, rentals, etc.
2) Take current traditional balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so. Take 4% of that value as an annual withdrawal.
3) Take current taxable balance and predict value at retirement (e.g., with Excel's FV function) using a conservative real return, maybe 3% or so. Take 2% of that value as qualified dividends.
4a) Decide whether SS income should be considered, or whether you will be able to do enough traditional->Roth conversions before taking SS.
4b) Include SS income projections (using today's dollars) if needed from step 4a.
5) Calculate marginal rate on withdrawals from traditional accounts using today's tax law on the numbers from step 1-4.
6) Make your traditional vs. Roth decision for this year's contribution
7) Repeat steps 1-6 every year until retirement

The steps above may look complicated at first, but you don't need great precision. The answer will either be "obvious" or "difficult to choose". If the latter, it likely won't make much difference which you pick anyway.
Anyway, seems we agree on things. :sharebeer

aristotelian
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Re: 403b vs Roth 403b?

Post by aristotelian » Thu May 16, 2019 8:41 am

In general, retirement tax rate is lower than your marginal rate while working. Therefore, pre-tax is better for most people.

Keep in mind that retirement spending is not the same as taxable income. You need a good reason (pension, inheritance etc) to assume that retirement tax will be higher.

Topic Author
florencenightingale
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Re: 403b vs Roth 403b?

Post by florencenightingale » Fri May 17, 2019 6:46 am

Wow, you guys have brought up some great information and tips, and have given me a lot to think about.

One more question: What portfolio ratio of tax-free Roth to Taxable would you recommend I strive for as I get closer to retirement? As now I realize I can contribute more than the standard $6k with the Roth 403b.

Thanks!

EdLaFave
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Re: 403b vs Roth 403b?

Post by EdLaFave » Fri May 17, 2019 9:11 am

FiveK wrote:
Thu May 16, 2019 8:30 am
Anyway, seems we agree on things. :sharebeer
Absolutely :sharebeer

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FiveK
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Re: 403b vs Roth 403b?

Post by FiveK » Fri May 17, 2019 9:34 am

florencenightingale wrote:
Fri May 17, 2019 6:46 am
Wow, you guys have brought up some great information and tips, and have given me a lot to think about.

One more question: What portfolio ratio of tax-free Roth to Taxable would you recommend I strive for as I get closer to retirement? As now I realize I can contribute more than the standard $6k with the Roth 403b.

Thanks!
A ratio isn't as useful a target as is the absolute amount of traditional. When/if you reach a traditional balance high enough that you expect no difference in your contribution and withdrawal tax rates (see previous posts for one way to estimate that), the rest (however much that is) can go to Roth.

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ruralavalon
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Re: 403b vs Roth 403b?

Post by ruralavalon » Fri May 17, 2019 9:39 am

A contributing 20% is an excellent savings,rate in my opinion. Good choice.

A little more information will be helpful. Please simply add this to your original post using the edit button (the pencil icon near the upper right corner of your post), it helps a lot if all of your information is in one place.

Will you be eligible for a significant pension (in addition to Social Security)?

What is your tax bracket, both federal and state?

florencenightingale wrote:
Wed May 15, 2019 8:57 am
Hi all!

I have the choice from my hospital employer between a 403b and a Roth 403b to deduct from my paycheck. I am thinking of putting aside 20% of my paycheck into the 403b.

I'm 34, so a bit of a way till retirement age. What's the benefits/drawbacks of choosing either?

Thanks!
Traditional contributions give you a tax deduction, but withdrawals are taxed. Roth contributions do not give a tax deduction, but withdrawals are not taxed.

For most people traditional 403b contributions will likely be better.

The income tax code is progressive, with a lower tax rate for lower income. Retirement usually means that employment income has ended. Therefore, most people are in a lower tax bracket in retirement and for most people traditional contributions will probably be better. In addition when you withdraw from your 403b in retirement, your income is not all taxed at your marginal tax rate specified for your tax bracket. TFB blog post, "The case against Roth 401k". "I think for most people the majority, if not 100%, of the contribution should go to a Traditional 401(k)."

Will you be eligible for a substantial pension? A pension changes that analysis, so that Roth contributions are likely better if you have a significant pension coming in addition to Social Security. TFB blog post, "Most TSP participants should switch to the Roth TSP". That post discussed the effect of a federal pension, but the analysis should hold for other pensions.

Wiki article, "Traditional vs Roth".
"Tax considerations:
* If your current marginal tax rate is 15% or less, prefer a Roth.
* If you expect to have higher marginal rates than your current marginal rate for most of your career, prefer a Roth.
* If you will have a traditional account or a pension large enough to meet your expected retirement expenses (and you expect to take that pension shortly after retiring), prefer a Roth.
* Otherwise, prefer a traditional account."
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

lakpr
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Re: 403b vs Roth 403b?

Post by lakpr » Fri May 17, 2019 9:49 am

+1 to FiveK’s post.

Just adding some concrete numbers: currently the 22% tax bracket ends at a taxable income of $168,000 for Married Filing Jointly. Add the standard exemption of $24,600 to it, so annual income can be as high as $192,600 annually, and you can still be in 22% tax bracket (now and in retirement).

If you assume a 4% withdrawal rate in retirement, we are essentially saying that hypothetical couple needs to have a nest egg of $192,600 * 1/0.04 = $4.82 million in tax deferred accounts, before putting any money in Roth makes sense.

Half that amount, if you are single.

THAT SAID,

the current tax rates are only going to last until 2025. Starting 2026, the tax rates revert to 2017 levels. For most Americans, this means a tax increase. If you feel your career is going to be spanning at least 25 years beyond 2026, it may still be a wise decision to contribute to Roth for now, and revert to traditional 401k starting 2026. The same income that gets taxed at 22% now could be taxed at 25% if you are lucky, and 28% if you are unlucky and AMT bites you in the rear. So taking the Roth route now *could* save you 3% to 6% in taxes. But you would not know it now, only 25 years later when it is time to withdraw.

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ruralavalon
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Re: 403b vs Roth 403b?

Post by ruralavalon » Fri May 17, 2019 10:50 am

Don't get too twisted up trying to calculate your exact tax situation 30-60 years from now. In my opinion the tax code will almost certainly change by then, but no one knows what the changes will be.

Instead operate on general principles, as in the TFB blog posts I linked for you.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

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FiveK
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Re: 403b vs Roth 403b?

Post by FiveK » Fri May 17, 2019 3:51 pm

General principles are good. The primary quote is from The Case Against Roth 401(k), with modifications paraphrased from Most TSP Participants Should Switch To the Roth TSP:
Until you know you can generate from [the combination of] your Traditional 401(k) [and other "unavoidable" income such as pension, SS, etc.] enough income to fill the lower brackets, it doesn’t make sense to contribute to a Roth 401(k).
It does take a little work and guesswork to estimate how much income one's existing traditional balance will generate (say, at a 4% withdrawal rate) come retirement (and the consequent marginal withdrawal rate expected for any future traditional contributions). As noted in Investment Order,
The steps above may look complicated at first, but you don't need great precision. The answer will either be "obvious" or "difficult to choose". If the latter, it likely won't make much difference which you pick anyway.

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