Max 401(k) before ROTH IRA?

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jdasch9
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Max 401(k) before ROTH IRA?

Post by jdasch9 » Fri Mar 30, 2018 11:00 am

Hi all,

I have recently switched my company's 401(k) plan from John Hancock, where we were being charged 180-250 BPS in expense ratios. 100 BPS was going to an investment advisor. I was led to this financial advisor, and by extension, John Hancock, by a well-intentioned yet misinformed family member. She is an accountant, so I had trusted her in this as I was, at the time, a 24 year with little to no financial knowledge. I quickly learned that my plan was less than ideal, but did not see an easy solution. Fast forward 4 years, and I begin with Guideline in May. They are an all in one 401(k) provider: they serve as the record keeper, advisor, and administrator. They do not charge an AUM fee, and the average portfolio has an ER of 6 bps (note that their portfolios are only recommendations and my participants have access to a full fund menu of about 40 Vanguard funds). As you can imagine, I am beyond thrilled with the coming change. Their support, technology, and product seem to be exactly what I need, and I won't be bleeding money due to expense ratios.

Back to my initial question: I wanted to check my understanding of the general rule of thumb that one should (1) contribute to a 401(k) up to company match, (2) max ROTH IRA, and then (3) finish maxing out the 401(k). My understanding was that contributing to a ROTH IRA before maxing out one's 401(k) contributions was preferable due to the expense ratios often associated with funds available in a 401(k) plan. This made complete sense to me, especially considering I was paying these exorbitant ERs. However, now that I have access to funds within my 401(k) for the same ERs as I have within my Vanguard ROTH IRA, should I be maxing my 401(k) before contributing a single dollar to my ROTH IRA for tax savings purposes?

A few pieces of personal information in case it helps.
Age: 28
Expected 2018 income: 90-100k
Savings: $35k cash
Vanguard Roth IRA: $26k in Vanguard Retirement Fund 2060 (90 equity/10 bond)
JH 401(k): $42k in JH Total Stock Market (97 equity/3 cash; will allocate this to 90 equity/10 bond when I invest at Guideline as I am in this fund simply for the "low" ER of 167 BPS)
Taxable: $6k (100 equity)
No debt

Current strategy is to contribute 10% ($9k-10k) to 401(k) pretax and $5.5k to Roth IRA. I could get pretty close to maxing if I allocated that $5.5k post tax to my 401(k).

I appreciate your thoughts and advice.

BloogleBird
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Re: Max 401(k) before ROTH IRA?

Post by BloogleBird » Fri Mar 30, 2018 11:15 am

You have a lot more flexibility with the funds in your Roth IRA than you do with your pre-tax 401k funds. Why not max out your 401k contributions but also make the full Roth IRA contribution (for 2017 if you haven't yet, and 2018)? Since you have adequate savings to fund those contributions, you could view the Roth IRA as a secondary emergency fund, since you can take your contributions out any time with no taxes and no penalties. If you have an emergency and end up needing it, it's there. If you don't, great, you have taken advantage of those valuable years of Roth IRA contributions.

bling
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Re: Max 401(k) before ROTH IRA?

Post by bling » Fri Mar 30, 2018 11:22 am

for most people they should max out their 401k before they max out their roth because they will likely retire at a lower income bracket than their working years.

SoCalT
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Re: Max 401(k) before ROTH IRA?

Post by SoCalT » Fri Mar 30, 2018 11:31 am

I do like the flexibility that a ROTH has for younger earners like yourself like the ability to withdraw contributions at any time. Of course I never do but there is always an outside chance for some dire dire emergency that would need me to drain my savings. Also since you're under 30 there is lots of time for growth to happen in an IRA making that tax-free growth extra juicy.

When you get to retirement you'll have more flexibility with a roth and your traditional IRAs to minimize higher income tax exposure with your withdrawls also.

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mhadden1
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Re: Max 401(k) before ROTH IRA?

Post by mhadden1 » Fri Mar 30, 2018 11:34 am

bling wrote:
Fri Mar 30, 2018 11:22 am
for most people they should max out their 401k before they max out their roth because they will likely retire at a lower income bracket than their working years.
+1

There are some cool things about Roth though, like the ability to withdraw contributions, and no RMDs. Some years I was able to max 401k and Roth which I am happy about now. :happy
Oh I can't, can I? That's what they said to Thomas Edison, mighty inventor, Thomas Lindberg, mighty flyer,and Thomas Shefsky, mighty like a rose.

TIAX
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Re: Max 401(k) before ROTH IRA?

Post by TIAX » Fri Mar 30, 2018 11:34 am

The best choice is often not to make a choice. Just max both so you don't have to worry about it. There's no reason not to max at your income level.

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BL
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Re: Max 401(k) before ROTH IRA?

Post by BL » Fri Mar 30, 2018 11:37 am

Are you single or mfj? The tax bracket is way different. If filing married, you may be in the 12% bracket where Roth would be advantage, but if single, you are at least in 22% bracket where saving on taxes is more productive. Actually, max both if possible.

chevca
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Re: Max 401(k) before ROTH IRA?

Post by chevca » Fri Mar 30, 2018 11:39 am

Making about $100k, can you not do both easily?

Simple way of doing it I see from your posted finances, adjust 401k contributions to max that out, take $5.5k from savings to max Roth, and then plus the savings back up with extra monthly income. Repeat next year, the year after that, and so on.

LOLC2k
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Re: Max 401(k) before ROTH IRA?

Post by LOLC2k » Fri Mar 30, 2018 11:44 am

BL wrote:
Fri Mar 30, 2018 11:37 am
Are you single or mfj? The tax bracket is way different. If filing married, you may be in the 12% bracket where Roth would be advantage, but if single, you are at least in 22% bracket where saving on taxes is more productive. Actually, max both if possible.
Definitely a good question. Of course, if you're making 90-100k at 28 (good on you) you might find yourself having to utilize backdoor roths later... in which case I really don't recommend having a traditional IRA mucking things up, and would still do roth.

Edit: actually, if he's single, he might already be ineligible to get full tIRA deductions anyhow depending on how much he stashes into the 401k, and where he actually falls in "90-100k".

jdasch9
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Re: Max 401(k) before ROTH IRA?

Post by jdasch9 » Fri Mar 30, 2018 11:48 am

BL wrote:
Fri Mar 30, 2018 11:37 am
Are you single or mfj? The tax bracket is way different. If filing married, you may be in the 12% bracket where Roth would be advantage, but if single, you are at least in 22% bracket where saving on taxes is more productive. Actually, max both if possible.
I file single, but split rent/living expenses with a boyfriend. I will be able to max both soon, I imagine, but I do live in a very high cost of living area (New York City), so my salary does not go as far as most areas.

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Artsdoctor
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Re: Max 401(k) before ROTH IRA?

Post by Artsdoctor » Fri Mar 30, 2018 12:14 pm

bling wrote:
Fri Mar 30, 2018 11:22 am
for most people they should max out their 401k before they max out their roth because they will likely retire at a lower income bracket than their working years.
Not necessarily. The marginal tax brackets are very different now than they were a year ago, so I cannot agree with your comment.

The OP's income is going to be in the $100,000 range which would be no higher than 24%. That is pretty low by historical standards. Also, you're trying to predict tax brackets many decades in the future, which is always a risky prospect.

If we're going to make generalities, the primary generality would be that younger people will probably be better off making use of a Roth than older people (potentially in their peak earning years). Here, I would argue that contributing to the 401k in order to receive the maximum match would be the highest priority, and then the Roth.

Remember that all of these "tax cuts" and bracket changes will expire well before the OP retires. You could argue that have a huge tax hike would be politically untenable when these current rates expire and that will not be possible. However, they are set to expire nonetheless.

bling
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Re: Max 401(k) before ROTH IRA?

Post by bling » Fri Mar 30, 2018 1:00 pm

Artsdoctor wrote:
Fri Mar 30, 2018 12:14 pm
bling wrote:
Fri Mar 30, 2018 11:22 am
for most people they should max out their 401k before they max out their roth because they will likely retire at a lower income bracket than their working years.
Not necessarily. The marginal tax brackets are very different now than they were a year ago, so I cannot agree with your comment.

The OP's income is going to be in the $100,000 range which would be no higher than 24%. That is pretty low by historical standards. Also, you're trying to predict tax brackets many decades in the future, which is always a risky prospect.

If we're going to make generalities, the primary generality would be that younger people will probably be better off making use of a Roth than older people (potentially in their peak earning years). Here, I would argue that contributing to the 401k in order to receive the maximum match would be the highest priority, and then the Roth.

Remember that all of these "tax cuts" and bracket changes will expire well before the OP retires. You could argue that have a huge tax hike would be politically untenable when these current rates expire and that will not be possible. However, they are set to expire nonetheless.
using your own argument that's even more reason to max out your 401k first because you get the tax deduction immediately. that is a known quantity. who's to say that the lawmakers couldn't get rid of the roth and make it taxable in the future?

mathematically 401k first then roth is still the best course of action, assuming you retire at a lower bracket, which is still true under the new tax brackets. granted, the 22% bracket eats up a much larger portion of your income now, but it's still less than 24%.

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Artsdoctor
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Re: Max 401(k) before ROTH IRA?

Post by Artsdoctor » Fri Mar 30, 2018 5:28 pm

^ At the end of the day, you're going to want tax diversification. You're going to ideally have a taxable account, a tax-deferred account, a Roth, and an HSA. The whole idea is to pick and choose how you want to tap your resources later. It doesn't matter to me how you get those accounts, but you're going to want them all if you can manage it.

For the majority of the population, pay increases with time and the marginal tax rate does as well. It's going to be far easier for most to contribute to a Roth when young than middle age. Of course there are exceptions, but the trajectory for most is clear.

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