Roth or traditional 401k and 457

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Recliner
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Joined: Sat Oct 06, 2018 12:23 pm

Roth or traditional 401k and 457

Post by Recliner »

I'm always struggling to choose between Roth or traditional for my wife's and my retirement accounts. We're planning on retiring in 12 years. Our gross household income is $210k and will roughly stay the same except for COLA raises. For 2023 we are currently planning on using traditional for both our 401k and 457 ($45k), Roth IRAs ($13k) and HSA ($7,350). We will also save $12k in a taxable account.

Currently we have about $1.75M in investments. $693k in traditional, $407k in Roth, $600k in taxable, and $50k in HSA.

In retirement we will have a $55k/year pension (inflation adjusting) Including our company match we will be investing about $7,200/month and expect that to remain the same for the next 12 years except for increases in the maxes allowed in tax deferred accounts.

Using a real annualized return of 4% has us having about $4.15M when we retire. $2M in traditional, $850k Roth, $1.15M taxable and $160k HSA.

We expect to spend roughly $200k/year in retirement (including the $55k pension). Should we continue to use all traditional in our 401k and 457 or shift some/all to the Roth option? We would reduce our $12k/year in taxable accounts to cover the increase in current taxes if we switch any to Roth.
Onlineid3089
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Re: Roth or traditional 401k and 457

Post by Onlineid3089 »

Given the pension will be taking up your no/low taxed income space I might push a little more into Roth. I don't see your ages, but if you're thinking of retiring early I'd keep the 457 traditional due to the ability to take penalty free withdrawals any time after separating employment.
lakpr
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Re: Roth or traditional 401k and 457

Post by lakpr »

I second the Roth option, at least for 2023 / 2024 / 2025 tax years. At the end of 2025, the tax rates are going to revert to 2017 levels, which means no more 22% or 24% tax brackets, they will become 25% and 28% brackets respectively.

Given that you already have $1.75 million in retirement assets, and they can be reasonably be expected to double in value (requires only 6% annualized growth rate between now and your retirement in 12 years), and a 4% safe-withdrawal-rate from $3.5 million is $140k plus $55k pension = $200k approximately (and thus enough to keep you in the now-22%-then-25% bracket, or may be even 28% bracket) -- my vote is to do Roth 401(k) / Roth 457 contributions for these three years. It is like getting a 3% cashback or 4% cashback on your purchases

There is one big caveat (there is always one, isn't it?). If your state levies income tax, and in your retirement you plan to move to a No-Income-Tax state. Or to Illinois, which does not tax Roth conversions. The difference in state income taxes can sway me to opt for Traditional now and Roth conversions later.

Re-evaluate in 2026, depending on the tax landscape then.
Last edited by lakpr on Mon Jan 23, 2023 12:13 pm, edited 1 time in total.
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retiredjg
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Re: Roth or traditional 401k and 457

Post by retiredjg »

If I understand correctly, you are currently in the 22% bracket (even without using tax-deferral) and will continue to have about the same income in retirement.

So your tax bracket will not go down in retirement if most or all that income is coming from pension and tax-deferred accounts (and SS eventually).

But your tax bracket could go down if a great deal of that income is coming from dividends and capital gains, ordinary cash savings and Roth accounts. However that would require a lot of income - maybe $100k a year in today's dollars - from from those sources. That seems unlikely to me.

It does not make sense to me to defer taxes at 22% only to pay 25% (scheduled rate starting in 2026) on the same money later on. So that argues for using Roth now.

But...the premise that your income will still be that high in retirement could be faulty. In order for that to happen, your expenses will have to go up significantly. Is that what you are expecting?
steadyosmosis
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Re: Roth or traditional 401k and 457

Post by steadyosmosis »

Recliner wrote: Mon Jan 23, 2023 11:50 am I'm always struggling to choose between Roth or traditional for my wife's and my retirement accounts. We're planning on retiring in 12 years. Our gross household income is $210k and will roughly stay the same except for COLA raises. For 2023 we are currently planning on using traditional for both our 401k and 457 ($45k), Roth IRAs ($13k) and HSA ($7,350). We will also save $12k in a taxable account.

Currently we have about $1.75M in investments. $693k in traditional, $407k in Roth, $600k in taxable, and $50k in HSA.

In retirement we will have a $55k/year pension (inflation adjusting) Including our company match we will be investing about $7,200/month and expect that to remain the same for the next 12 years except for increases in the maxes allowed in tax deferred accounts.

Using a real annualized return of 4% has us having about $4.15M when we retire. $2M in traditional, $850k Roth, $1.15M taxable and $160k HSA.

We expect to spend roughly $200k/year in retirement (including the $55k pension). Should we continue to use all traditional in our 401k and 457 or shift some/all to the Roth option? We would reduce our $12k/year in taxable accounts to cover the increase in current taxes if we switch any to Roth.
One can retard growth in tax-deferred by holding all of their fixed income there.
When I early-retired, I rolled my pension lump-sum into a rollover IRA (alternatively I could have delayed pension start), so as not to have that income hindering my Roth conversions.
So now I am annually Roth-converting at a tax cost of 12% and less, whereas I contributed those dollars at a tax savings of 22%-plus.
Topic Author
Recliner
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Re: Roth or traditional 401k and 457

Post by Recliner »

We'll be 55 and 53 when we retire.

Using current 2023 tax brackets the 12% bracket goes up to $83,550 and adding in the $27,700 standard deduction allows it to go up to $111,250. The pension would take up about half of that amount.

How does spending from our taxable brokerage account factor in? We'd have roughly $90k in spending beyond the 12% bracket to account for (using current bracket figures). Could some come from our Roth and the rest from the taxable account that would have a 10% long term capital gains tax right? Using a 4% withdrawal rate from Roth and taxable would get us $80k.
Topic Author
Recliner
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Re: Roth or traditional 401k and 457

Post by Recliner »

lakpr wrote: Mon Jan 23, 2023 12:11 pm There is one big caveat (there is always one, isn't it?). If your state levies income tax, and in your retirement you plan to move to a No-Income-Tax state. Or to Illinois, which does not tax Roth conversions. The difference in state income taxes can sway me to opt for Traditional now and Roth conversions later.

Re-evaluate in 2026, depending on the tax landscape then.
We currently live in a state with 3.23% state income tax. In retirement we'll either stay here or move to a state with no income tax. 50/50 odds depending on where our kids end up living
Topic Author
Recliner
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Re: Roth or traditional 401k and 457

Post by Recliner »

retiredjg wrote: Mon Jan 23, 2023 12:12 pm But...the premise that your income will still be that high in retirement could be faulty. In order for that to happen, your expenses will have to go up significantly. Is that what you are expecting?
We are planning on spending a lot more in retirement. Lots of travel and vacations. Plus we want to be able to pay for our kids (and their future families) to come on a yearly vacation with us.
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Recliner
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Re: Roth or traditional 401k and 457

Post by Recliner »

steadyosmosis wrote: Mon Jan 23, 2023 12:16 pm One can retard growth in tax-deferred by holding all of their fixed income there.
When I early-retired, I rolled my pension lump-sum into a rollover IRA (alternatively I could have delayed pension start), so as not to have that income hindering my Roth conversions.
So now I am annually Roth-converting at a tax cost of 12% and less, whereas I contributed those dollars at a tax savings of 22%-plus.
The pension will be paid monthly starting immediately and can not be converted. There is an option of entering a drop program that will pay about $160k at retirement and reduce the pension by about $5k/year. If the spouse with the pension dies the surviving spouse will get 70% of the pension for the rest of their life.
lakpr
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Re: Roth or traditional 401k and 457

Post by lakpr »

Recliner wrote: Mon Jan 23, 2023 12:21 pm
lakpr wrote: Mon Jan 23, 2023 12:11 pm There is one big caveat (there is always one, isn't it?). If your state levies income tax, and in your retirement you plan to move to a No-Income-Tax state. Or to Illinois, which does not tax Roth conversions. The difference in state income taxes can sway me to opt for Traditional now and Roth conversions later.

Re-evaluate in 2026, depending on the tax landscape then.
We currently live in a state with 3.23% state income tax. In retirement we'll either stay here or move to a state with no income tax. 50/50 odds depending on where our kids end up living
No difference either way, so I'd err on the side of Roth.
Current tax rate = 22% + 3.23% = 25.23%
Future tax rate, *IF* you move to a no-income-tax rate state = 25%.

Difference is only 0.23%, I'd rather take the Roth option than be subject to higher taxes in the future of 25% + state income tax if your kids end up living in a state with income tax and you plan to move there.
lakpr
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Re: Roth or traditional 401k and 457

Post by lakpr »

Recliner wrote: Mon Jan 23, 2023 12:17 pm We'll be 55 and 53 when we retire.

Using current 2023 tax brackets the 12% bracket goes up to $83,550 and adding in the $27,700 standard deduction allows it to go up to $111,250. The pension would take up about half of that amount.

How does spending from our taxable brokerage account factor in? We'd have roughly $90k in spending beyond the 12% bracket to account for (using current bracket figures). Could some come from our Roth and the rest from the taxable account that would have a 10% long term capital gains tax right? Using a 4% withdrawal rate from Roth and taxable would get us $80k.
Bold red is incorrect. Correcting only that, and no comment on your plan of 4% SWR -- If you exceed the 12% bracket, the capital gains rate applicable is 15%.

You do not want to withdraw from Roth even in retirement, unless it is going to give you advantages such as reduced Medicare premiums / ACA credits, etc. Roth accounts should essentially be your kids' inheritance.
[edited for grammar]
Last edited by lakpr on Mon Jan 23, 2023 12:36 pm, edited 1 time in total.
steadyosmosis
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Re: Roth or traditional 401k and 457

Post by steadyosmosis »

Recliner wrote: Mon Jan 23, 2023 12:17 pm We'll be 55 and 53 when we retire.

Using current 2023 tax brackets the 12% bracket goes up to $83,550 and adding in the $27,700 standard deduction allows it to go up to $111,250. The pension would take up about half of that amount.

How does spending from our taxable brokerage account factor in? We'd have roughly $90k in spending beyond the 12% bracket to account for (using current bracket figures). Could some come from our Roth and the rest from the taxable account that would have a 10% long term capital gains tax right? Using a 4% withdrawal rate from Roth and taxable would get us $80k.
As a retiree, I minimize taxable income to save room for larger Roth conversions.
No taxable interest, minimal taxable dividends, no taxable capital gains realized, etc.
My spending is less than yours, but when I need spending money, I sell a few shares in taxable, hopefully at a loss.
If I must realize a gain, it is almost always negated by carry-over losses from previous tax loss harvesting.
Topic Author
Recliner
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Re: Roth or traditional 401k and 457

Post by Recliner »

lakpr wrote: Mon Jan 23, 2023 12:31 pm
Recliner wrote: Mon Jan 23, 2023 12:17 pm We'll be 55 and 53 when we retire.

Using current 2023 tax brackets the 12% bracket goes up to $83,550 and adding in the $27,700 standard deduction allows it to go up to $111,250. The pension would take up about half of that amount.

How does spending from our taxable brokerage account factor in? We'd have roughly $90k in spending beyond the 12% bracket to account for (using current bracket figures). Could some come from our Roth and the rest from the taxable account that would have a 10% long term capital gains tax right? Using a 4% withdrawal rate from Roth and taxable would get us $80k.
Bold red is incorrect. Correcting only that, and no comment on your plan of 4% SWR -- If you exceed the 12% bracket, the capital gains rate applicable is 15%.

You do not want to withdraw from Roth even in retirement, unless it is going to give you advantages such as reduced Medicare premiums / ACA credits, etc. Roth accounts should essentially be your kids' inheritance.
[edited for grammar]
The long term capital gains is where my understanding is the weakest. I'm going to give 2 guesses for how it works and hopefully you can let me know if one of them is right.

Between the pension and our traditional retirement accounts our income fills up the 12% bracket. We don't have any in the next bracket. We then spend from our taxable account. Since our income was in the 12% bracket the spending from the taxable account is 10% or is it 15% since what we spend from it would put us over the 12% income bracket?
lakpr
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Re: Roth or traditional 401k and 457

Post by lakpr »

Recliner wrote: Mon Jan 23, 2023 12:57 pmThe long term capital gains is where my understanding is the weakest. I'm going to give 2 guesses for how it works and hopefully you can let me know if one of them is right.

Between the pension and our traditional retirement accounts our income fills up the 12% bracket. We don't have any in the next bracket. We then spend from our taxable account. Since our income was in the 12% bracket the spending from the taxable account is 10% or is it 15% since what we spend from it would put us over the 12% income bracket?
If your pension and tIRA withdrawals completely fill up the 12% bracket (and I recommend that it should, doing Roth conversions for any room left in that 12% bracket even if you don't want to withdraw it), then every dollar that's exceeding the 12% threshold in capital gains will incur a 15% tax.

There is an additional 3.8% Net Investment Income Tax if your Married Filing Jointly adjusted gross income exceeds $250k (and I do NOT believe this threshold is indexed for inflation).

Beyond that, if your MFJ AGI exceeds $500k (this figure is also not adjusted for inflation), your long term capital gains rate is 20% + 3.8% NIIT

If your ordinary income (which is pension + tIRA withdrawals + Roth conversions) + taxable gains < 12% bracket threshold, THEN you will incur 0% taxes on the long term capital gains. But as I said above already, the 12% tax bracket threshold is better utilized by Roth conversions from tIRA than for long term capital gains. Reason being that the taxable investments can be passed on to heirs with step-up at death, so essentially a 0% tax on LTCG. No such provision for assets left in tIRA, and it might even be the case that the heirs would pay substantially higher taxes than you would at 12%, even accounting for the LTCG taxes at 15%. They would be asked to empty that tIRA within 10 years from the year of death.
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FiveK
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Re: Roth or traditional 401k and 457

Post by FiveK »

Recliner wrote: Mon Jan 23, 2023 11:50 am I'm always struggling to choose between Roth or traditional for my wife's and my retirement accounts. We're planning on retiring in 12 years. Our gross household income is $210k and will roughly stay the same except for COLA raises. For 2023 we are currently planning on using traditional for both our 401k and 457 ($45k), Roth IRAs ($13k) and HSA ($7,350). We will also save $12k in a taxable account.

Currently we have about $1.75M in investments. $693k in traditional, $407k in Roth, $600k in taxable, and $50k in HSA.
...
Using a real annualized return of 4% has us having about $4.15M when we retire. $2M in traditional, $850k Roth, $1.15M taxable and $160k HSA.
Careful with assumptions: to reach $2M in 12 years, starting with $693K and earning 4%/yr, you would have to invest $57K/yr. That works if you contribute $45K/yr and get a company match of $12K/yr. But if you change to Roth now, you get $1.3M if the $12K/yr company contribution is correct and goes to traditional, or $1.1M if there is no company contribution to traditional.
We expect to spend roughly $200k/year in retirement (including the $55k pension). Should we continue to use all traditional in our 401k and 457 or shift some/all to the Roth option? We would reduce our $12k/year in taxable accounts to cover the increase in current taxes if we switch any to Roth.
Slightly different numbers, and a different state, but you may be in "coin flip" territory similar to this summary.

With you being younger and further from expected retirement than the couple in that thread, the death of a spouse scenario, in any case less likely, could favor traditional or Roth, depending on the effect it would have on income before retirement.
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Recliner
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Re: Roth or traditional 401k and 457

Post by Recliner »

Plus is there any consideration for using traditional to keep my AGI lower to qualify for any possible stimulus or child tax credits? I lucked into those in the last couple of years using traditional instead of Roth.

Predictions on if another type of income based credit happening again?

Also to keep the full Roth IRA I think my MAGI needs to stay under $218k. I'll likely have about $10k in dividends and RMD from an inherited IRA
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FiveK
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Re: Roth or traditional 401k and 457

Post by FiveK »

Recliner wrote: Fri Jan 27, 2023 3:37 pm Plus is there any consideration for using traditional to keep my AGI lower to qualify for any possible stimulus or child tax credits? I lucked into those in the last couple of years using traditional instead of Roth.
The occurrence of any such situation would affect your current marginal tax rate and thus affect whether traditional or Roth contributions are likely to be best for you
Predictions on if another type of income based credit happening again?
Cannot predict now.
Also to keep the full Roth IRA I think my MAGI needs to stay under $218k. I'll likely have about $10k in dividends and RMD from an inherited IRA
You don't mention any traditional IRAs. In the absence of those, each of you may use the Backdoor Roth process to get the full amount into your respective Roth IRAs.
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retiredjg
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Re: Roth or traditional 401k and 457

Post by retiredjg »

Recliner wrote: Fri Jan 27, 2023 3:37 pm Plus is there any consideration for using traditional to keep my AGI lower to qualify for any possible stimulus or child tax credits? I lucked into those in the last couple of years using traditional instead of Roth.
I'm under the impression that child tax credits are available to everyone and not based on AGI. Child tax credits replaced exemptions for kids in earlier tax law. Is that wrong? (There are a number of different credits that apply to kids and dependents, so maybe you are talking about one and I'm talking about another.)

I have not heard anything about stimulus checks and would be surprised if that is even being discussed.
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ruralavalon
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Re: Roth or traditional 401k and 457

Post by ruralavalon »

Recliner wrote: Mon Jan 23, 2023 11:50 am I'm always struggling to choose between Roth or traditional for my wife's and my retirement accounts. We're planning on retiring in 12 years. Our gross household income is $210k and will roughly stay the same except for COLA raises. For 2023 we are currently planning on using traditional for both our 401k and 457 ($45k), Roth IRAs ($13k) and HSA ($7,350). We will also save $12k in a taxable account.

Currently we have about $1.75M in investments. $693k in traditional, $407k in Roth, $600k in taxable, and $50k in HSA.

In retirement we will have a $55k/year pension (inflation adjusting) Including our company match we will be investing about $7,200/month and expect that to remain the same for the next 12 years except for increases in the maxes allowed in tax deferred accounts.

Using a real annualized return of 4% has us having about $4.15M when we retire. $2M in traditional, $850k Roth, $1.15M taxable and $160k HSA.

We expect to spend roughly $200k/year in retirement (including the $55k pension). Should we continue to use all traditional in our 401k and 457 or shift some/all to the Roth option? We would reduce our $12k/year in taxable accounts to cover the increase in current taxes if we switch any to Roth.
Why do you expect to have $200k spending during retirement? Is that based on current spending adjusted for wherever will change with retirement?

In my opinion switching some of the 401k and 457b contributions to Roth contributions makes sense given your pension.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
mariezzz
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Re: Roth or traditional 401k and 457

Post by mariezzz »

Recliner wrote: Mon Jan 23, 2023 12:17 pm We'll be 55 and 53 when we retire.

Using current 2023 tax brackets the 12% bracket goes up to $83,550 and adding in the $27,700 standard deduction allows it to go up to $111,250. The pension would take up about half of that amount.

How does spending from our taxable brokerage account factor in? We'd have roughly $90k in spending beyond the 12% bracket to account for (using current bracket figures). Could some come from our Roth and the rest from the taxable account that would have a 10% long term capital gains tax right? Using a 4% withdrawal rate from Roth and taxable would get us $80k.
If you stay in your job until the year in which you turn 55, you can access your 401k _from that job_ without being subject to the 10% penalty for withdrawals before age 55 (frequently referred to as the year of 55). It may not matter to you, given your 457 and other savings, but I thought I'd mention this.

Also, I didn't see this mentioned: hopefully your 457 is a governmental 457 - non-governmental 457s come with more risk (see the wiki on 457s for discussion of the difference).

Once you retire (or, as the case may be, cut back dramatically on hours worked), as long as you have the minimum earned income needed, you could contribute to a Roth, or convert some of your traditional IRA funds to Roth. It can be advantageous to work the first couple to few months of the year before you quit your full time job - you can contribute most of your paycheck to a Roth 401K and Roth IRA, without incurring much tax liability (since your income for that year will be relatively low).
Topic Author
Recliner
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Re: Roth or traditional 401k and 457

Post by Recliner »

ruralavalon wrote: Fri Jan 27, 2023 4:28 pm Why do you expect to have $200k spending during retirement? Is that based on current spending adjusted for wherever will change with retirement?

In my opinion switching some of the 401k and 457b contributions to Roth contributions makes sense given your pension.
Using a 4% real return from now until we retire has us at $4.15M. Using a 3.5% SWR and the pension gets us to $200k. That's about 2.5 times as much as our current spending but we want to extensively travel and also pay for large family vacations every year
Topic Author
Recliner
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Re: Roth or traditional 401k and 457

Post by Recliner »

mariezzz wrote: Fri Jan 27, 2023 4:34 pm
If you stay in your job until the year in which you turn 55, you can access your 401k _from that job_ without being subject to the 10% penalty for withdrawals before age 55 (frequently referred to as the year of 55). It may not matter to you, given your 457 and other savings, but I thought I'd mention this.

Also, I didn't see this mentioned: hopefully your 457 is a governmental 457 - non-governmental 457s come with more risk (see the wiki on 457s for discussion of the difference).

Once you retire (or, as the case may be, cut back dramatically on hours worked), as long as you have the minimum earned income needed, you could contribute to a Roth, or convert some of your traditional IRA funds to Roth. It can be advantageous to work the first couple to few months of the year before you quit your full time job - you can contribute most of your paycheck to a Roth 401K and Roth IRA, without incurring much tax liability (since your income for that year will be relatively low).
The 457 will easily handle our spending from our retirement accounts until we're over 59.5

It is a government 457

Due to the anniversary date for years in service for the pension the retirement date will be in late Feb of the year we retire. However I don't expect my tax bracket to go down since we're planning on spending 2.5 times as much as we are while working
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