Best option to max out 401k (Roth vs Traditional)

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nicetohave
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Joined: Wed Apr 11, 2018 9:29 pm

Best option to max out 401k (Roth vs Traditional)

Post by nicetohave » Thu May 10, 2018 10:59 pm

Reading about the difference between Roth 401k vs Traditional 401k.

Do I understand correctly, that 18500 limit is after tax (for Roth), so I can invest 18500 + 25% (example tax bracket) into Roth vs just 18500 in traditional 401k.

Assuming that tax bracket will be the same in the future as now, since I can invest more money in Roth, I will get better return?

Am I missing something?

UniversityEmployee9
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Re: Best option to max out 401k (Roth vs Traditional)

Post by UniversityEmployee9 » Thu May 10, 2018 11:07 pm

The money invested in the Roth is after taxes. So it is 18,500 after tax, or $23,125 before tax (at the 25% rate you mentioned). Sounds like you've got it backwards to me.

In general, a Roth only makes sense if you think you're going to be in a higher tax bracket in retirement than you are in now, which is very unusual.

Some people like that you can use a Roth IRA as a sort of "extra" savings account, since contributions can be withdrawn at any time, tax free, but then you could just use a regular brokerage account or savings account for that purpose.

rkhusky
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Re: Best option to max out 401k (Roth vs Traditional)

Post by rkhusky » Fri May 11, 2018 7:12 am

nicetohave wrote:
Thu May 10, 2018 10:59 pm
Reading about the difference between Roth 401k vs Traditional 401k.

Do I understand correctly, that 18500 limit is after tax (for Roth), so I can invest 18500 + 25% (example tax bracket) into Roth vs just 18500 in traditional 401k.

Assuming that tax bracket will be the same in the future as now, since I can invest more money in Roth, I will get better return?

Am I missing something?
Yes, if you are maxing all available tax-advantaged accounts (401k, IRA, etc) and the tax rate you would pay for Roth contributions now is the same as the tax rate you would pay for Traditional withdrawals in retirement, then Roth does have a slight advantage.

This is because, once you've maxed all available tax advantaged accounts, the tax savings from contributing to a Traditional account must be placed in a taxable account, which has tax drag on your returns. The last time I checked, the Roth advantage was about 5%, i.e. if your contribution tax rate is R% and the withdrawal rate is R-5%, the results are about the same.

But, before going 100% Roth, I would do a careful analysis of expected portfolio size, timing of retirement and receipt of pension and social security, expected spending, etc to make sure you will really be paying the same tax rate in retirement as when working. Also consider contingencies, such as getting laid off, injured, or sick, such that you have to retire sooner than expected.

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BL
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Re: Best option to max out 401k (Roth vs Traditional)

Post by BL » Fri May 11, 2018 11:59 am

The limit is 18500 whether it is Roth or traditional.
The 18500 in Roth is worth more because there will be no tax paid in future, assuming you follow the rules.

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FiveK
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Re: Best option to max out 401k (Roth vs Traditional)

Post by FiveK » Fri May 11, 2018 1:03 pm

nicetohave wrote:
Thu May 10, 2018 10:59 pm
Am I missing something?
Yes, in general: the commutative property of multiplication as it applies to this topic.

Because you are talking specifically about Maxing out your retirement account, the math is a bit less straightforward. See the write-up at that link and either of the two spreadsheets mentioned there to evaluate your situation.

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ruralavalon
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Re: Best option to max out 401k (Roth vs Traditional)

Post by ruralavalon » Sat May 12, 2018 8:48 am

nicetohave wrote:
Thu May 10, 2018 10:59 pm
Reading about the difference between Roth 401k vs Traditional 401k.

Do I understand correctly, that 18500 limit is after tax (for Roth), so I can invest 18500 + 25% (example tax bracket) into Roth vs just 18500 in traditional 401k.

Assuming that tax bracket will be the same in the future as now, since I can invest more money in Roth, I will get better return?

Am I missing something?
If under age 50 you can contribute up to $18.5k to your 401k annually, either traditional or Roth.


Most people are not in the same tax bracket in retirement. Retirement usually means that employment income has ended. Most people are in a lower tax bracket in retirement. The income tax code is progressive, with a lower tax rate for lower income. Therefore, for most people traditional 401k contributions will probably be better. 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)."

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

nicetohave
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Re: Best option to max out 401k (Roth vs Traditional)

Post by nicetohave » Wed May 16, 2018 3:51 pm

rkhusky wrote:
Fri May 11, 2018 7:12 am
Yes, if you are maxing all available tax-advantaged accounts (401k, IRA, etc) and the tax rate you would pay for Roth contributions now is the same as the tax rate you would pay for Traditional withdrawals in retirement, then Roth does have a slight advantage.

This is because, once you've maxed all available tax advantaged accounts, the tax savings from contributing to a Traditional account must be placed in a taxable account, which has tax drag on your returns. The last time I checked, the Roth advantage was about 5%, i.e. if your contribution tax rate is R% and the withdrawal rate is R-5%, the results are about the same.
Ok. I'm not crazy. It's the case, don't know why this line of thinking is NOT present in the page that describes decision process.
But, before going 100% Roth, I would do a careful analysis of expected portfolio size, timing of retirement and receipt of pension and social security, expected spending, etc to make sure you will really be paying the same tax rate in retirement as when working. Also consider contingencies, such as getting laid off, injured, or sick, such that you have to retire sooner than expected.
Yes, that's all true, though really hard to predict.

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FiveK
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Re: Best option to max out 401k (Roth vs Traditional)

Post by FiveK » Wed May 16, 2018 4:09 pm

nicetohave wrote:
Wed May 16, 2018 3:51 pm
Ok. I'm not crazy. It's the case, don't know why this line of thinking is NOT present in the page that describes decision process.
But it is. ;)

See the "Maxing out your retirement account" link:
FiveK wrote:
Fri May 11, 2018 1:03 pm
nicetohave wrote:
Thu May 10, 2018 10:59 pm
Am I missing something?
Yes, in general: the commutative property of multiplication as it applies to this topic.

Because you are talking specifically about Maxing out your retirement account, the math is a bit less straightforward. See the write-up at that link and either of the two spreadsheets mentioned there to evaluate your situation.

rkhusky
Posts: 5268
Joined: Thu Aug 18, 2011 8:09 pm

Re: Best option to max out 401k (Roth vs Traditional)

Post by rkhusky » Wed May 16, 2018 9:15 pm

nicetohave wrote:
Wed May 16, 2018 3:51 pm
rkhusky wrote:
Fri May 11, 2018 7:12 am
Yes, if you are maxing all available tax-advantaged accounts (401k, IRA, etc) and the tax rate you would pay for Roth contributions now is the same as the tax rate you would pay for Traditional withdrawals in retirement, then Roth does have a slight advantage.

This is because, once you've maxed all available tax advantaged accounts, the tax savings from contributing to a Traditional account must be placed in a taxable account, which has tax drag on your returns. The last time I checked, the Roth advantage was about 5%, i.e. if your contribution tax rate is R% and the withdrawal rate is R-5%, the results are about the same.
Ok. I'm not crazy. It's the case, don't know why this line of thinking is NOT present in the page that describes decision process.
For many people, the difference between contribution and withdrawal rates is more than 5%. For example, while working I maxed all available accounts since my federal marginal rate was 30%, but now in retirement I expect to withdraw at a 12% rate. Traditional has been the clear winner for me.

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