Company Investing (401k) Question

[Vpxggmr17]

I have the option between a pre-tax 401k and a Roth 401k with a match up 6% of 50% where half is company stock, half is my investment direction.

That said, I've been working here since Jan. 2012 and have been doing 6% in the Roth 401k.

The question I have is should I be splitting between the pre-tax and the Roth? Or what?

I'm 24 years old and also contribute to a Roth IRA as well.

[bjl584]

If you already have a Roth IRA, then I'd go with a traditional 401K that way you have a tax advantage in the present while you are working and a tax advantage in the future when you retire.

[Vpxggmr17]

And I can just change the direction of that? For instance, when I go in it says my current contribution direction is 6% to the Roth 401k, I would just put that to 0% and put 6% for the pre-tax 401k?

What will that in turn do to the current balance within my account? Anything? Or will a percentage be tax free and from here on out it will be subject to taxes upon withdrawl?

[bjl584]

You can switch it. As you said, whatever portion of the account was contributed as a Roth 401K was already taxed, so it won't be subject to tax again upon withdrawl.

I'm not 100% sure on any gains made in the account that were contributed as Roth 401K however.

[Like2Plan]

I have the option between a pre-tax 401k and a Roth 401k with a match up 6% of 50% where half is company stock, half is my investment direction.

That said, I've been working here since Jan. 2012 and have been doing 6% in the Roth 401k.

The question I have is should I be splitting between the pre-tax and the Roth? Or what?

I'm 24 years old and also contribute to a Roth IRA as well.

Vpxggmr17,
A ROTH 401k is a wonderful thing. What is your current tax rate? If you are in a lower tax bracket, it may make more sense to contribute to the Roth 401k where your earnings will compound tax free over your entire career.
Is the company stock 50% of the match? So in other words--1.5%? That is not too bad, but you always want to make sure your 401K is not too heavily weighted by company stock. But, you should be able to rebalance if that happens.
Putting Too Much Stock in Your Company—A 401(k) Problem

I believe the match is considered pre-tax, so when you retire a certain percentage of what you pull out of your 401K will be taxable even if all your contributions were made into the Roth 401K.

[Vpxggmr17]

Vpxggmr17,
A ROTH 401k is a wonderful thing. What is your current tax rate? If you are in a lower tax bracket, it may make more sense to contribute to the Roth 401k where your earnings will compound tax free over your entire career.
Is the company stock 50% of the match? So in other words--1.5%? That is not too bad, but you always want to make sure your 401K is not too heavily weighted by company stock. But, you should be able to rebalance if that happens.
Putting Too Much Stock in Your Company—A 401(k) Problem

I believe the match is considered pre-tax, so when you retire a certain percentage of what you pull out of your 401K will be taxable even if all your contributions were made into the Roth 401K.

My current tax rate (I think!) is 25%. Not sure on that. My salary is $45,000 and I also take home roughly $35,000 from a second job.

And yes, 1.5% of my 6% contribution is company stock and the other 1.5% is matched to my investment direction. Of my 6%, only 10% makes up company stock, the rest is in large cap/growth/international mutual funds.

That said, I'm unsure on whether to be doing 6% in pre-tax or 6% in Roth...I had been doing Roth but was considering changing it over since I recently opened the Roth IRA and want some tax diversification...

[Like2Plan]

My current tax rate (I think!) is 25%. Not sure on that. My salary is $45,000 and I also take home roughly $35,000 from a second job.

And yes, 1.5% of my 6% contribution is company stock and the other 1.5% is matched to my investment direction. Of my 6%, only 10% makes up company stock, the rest is in large cap/growth/international mutual funds.

That said, I'm unsure on whether to be doing 6% in pre-tax or 6% in Roth...I had been doing Roth but was considering changing it over since I recently opened the Roth IRA and want some tax diversification...

It would take a lot to convince me to take the option to invest in a regular 401K (and defer paying taxes) if I were 24 years old and had the option to invest in a Roth 401K (with gains earned over the next 41 years never taxed).
If you are investing 6% of 45,000, that would be $2700.00 anually. So, this will most likely will not drop you down into another tax bracket. This would free up a little more money (with deferring the taxes on the contributions), but would you invest the difference?

[Vpxggmr17]

It would take a lot to convince me to take the option to invest in a regular 401K (and defer paying taxes) if I were 24 years old and had the option to invest in a Roth 401K (with gains earned over the next 41 years never taxed).
If you are investing 6% of 45,000, that would be $2700.00 anually. So, this will most likely will not drop you down into another tax bracket. This would free up a little more money (with deferring the taxes on the contributions), but would you invest the difference?

Well if I understand correctly with Roth 401k, the gains are taxed but the intial contributions are not. Again, all these things are why I am torn.

To address your other points, yes 6% is roughly that and with my company match bumps up close to $3600 a year.

If I do the traditional at 6% it is the same amount while taking about $35 less a paycheck to do so. I can bump it to 8% and keep the same ammount coming out as my 6% does with the Roth.

For example:

Roth IRA at 6% is a $155 contribution (after-tax $103 from me, $52 match, $103 from paycheck)

Traditional IRA at 6% is a $155 contribution (pre-tax $103 from me, $51 match, $78 from paycheck)

Traditional IRA at 8% is a $190 contribution (pre-tax $138 from me, $52 company match, $103 from paycheck)

[Like2Plan]

Well if I understand correctly with Roth 401k, the gains are taxed but the intial contributions are not. Again, all these things are why I am torn.

"In general, the difference between a Roth 401(k) and a traditional 401(k) is that the Roth version is funded with after-tax dollars while the traditional 401(k) is funded with pre-tax dollars. After-tax dollars represent money for which taxes are paid in the current year, and pre-tax dollars are those that do not represent federal taxable income in the current year. Typically, the earnings on Roth contributions will be tax free as long as the distribution is made at least 5 years after the first Roth contribution and the attainment of age 59 1/2, unless an exception applies.
A Roth 401(k) plan will probably be most advantageous to those who might otherwise choose a Roth IRA, for example, younger workers who are currently taxed in a lower tax bracket, but expect to be taxed in a higher bracket upon reaching retirement age. Higher-income workers who wish to save the maximum amount allowed may favor the Roth 401(k) because it effectively allows greater real contributions, as post-tax dollars are more valuable than pre-tax dollars; however, those near the Roth IRA income limits may prefer a traditional 401(k), since its pre-tax contributions lowers Modified Adjusted Gross Income (MAGI) and thus increases eligibility for Roth IRA contributions. Another consideration for those currently in higher tax brackets is the future of income tax rates in the U.S. (if income tax rates increase, current taxation would be desirable for a wider group). The Roth 401(k) offers the advantage of tax free distribution, but is not constrained by the same income limitations."

link to Wikipedia Roth 401(k)

[Like2Plan]

I just wanted to add that the company match and the earnings on the match will be taxable either way.

[Vpxggmr17]

Great information! Though I'm a tad embarrassed I didn't think to turn to wikipedia myself.

I had left my account type unchanged as the Roth 401k and I think I will be doing so with that information. Tax-diversification or not, 45 years of growth tax-free is a no brainer and I do not expect that my tax bracket will in fact lower. Between my two jobs, my pre-tax income sits somewhere around $78-$81k. Do I see that going up in time? Absolutely (though hopefully only due to a increase in my career track and not always needing the second job hah).

My student loans will be non-existant come mid-January if everything stays on track and I will then be able to take 2 months savings and fully fund my Roth IRA as well. With a standard raise (roughly 2.5%) in Feb. I should also be able to put that towards the 401k as opposed to just taking home more since I don't need it to live on.

Anyone have advice on the best direction to take the Roth IRA? I've noticed that the initial purchases have high limits compared to my 401k. I.E. - a lot of the growth mutual funds I've looked at have a minimum $1000-2500 purchase required. I prefer Dollar cost averaging my mutual fund purchases and a big up front lump sum seems to go against that.

[jpg7n16]

It would take a lot to convince me to take the option to invest in a regular 401K (and defer paying taxes) if I were 24 years old and had the option to invest in a Roth 401K (with gains earned over the next 41 years never taxed).

I think you're forgetting that a portion of 401k withdrawals will also not be taxed (due to deductions, credits and exemptions).

Every year we each get at least the standard deduction and 1 personal exemption. That is used to offset income, making it tax free. If 100% of your money is in Roth accounts, you do not get this benefit.

And if you're 24, since the amounts are typically subject to annual adjustments, by the time you retire, this could easily be $25-35k/year of deductions you would miss out on if you only have Roth money. (unless you're still working or something)

Furthermore, if 401k withdrawals are your only income in retirement, not only do you get the benefit of taking deductions against your money, you also get the benefit of withdrawing to the lower brackets first.

Federal Income Tax Brackets for 2012

Based on today's rates, a married couple retired with no income besides 401k w/d's would get the first (St Ded 11900 + Personal Exemp 2*3800) $19,500 completely tax free. The next 17,100 at 10%, and the next 53,300 at 15%.

At today's rates, they could take out nearly $90k before they start to pay the 25% they would have paid back when they were 24. And that's with today's brackets, which are also increased over time. No telling how much you'll be able to do 40 years from now.

Moral of the story: there are very valid reasons for why someone age 24 should use a traditional 401k while they are in the 25% bracket.

If you are investing 6% of 45,000, that would be $2700.00 anually. So, this will most likely will not drop you down into another tax bracket.

Agreed.

Federal Income Tax Brackets for 2012

Based on that you earn $45k + 35k = 80k and are single, you are in the upper 25% bracket before deductions. Unless you have some unreal deductions out there, you are very likely to stay in the 25% bracket.

Well if I understand correctly with Roth 401k, the gains are taxed but the intial contributions are not. Again, all these things are why I am torn.

Roth money is taxed on the way in, and then not taxed on the way out.
Traditional 401k money is not taxed on the way in, and then taxed on the way out.


The goal is really to reduce the tax rate you will pay on those assets. You can lock in 25% today, or you can w/d like the schedule listed above.

What I would do is to have 1 portion in the 401k, and another portion in Roth money. Then you have much more flexibility with your withdrawals during retirement.

[Vpxggmr17]

What I would do is to have 1 portion in the 401k, and another portion in Roth money. Then you have much more flexibility with your withdrawals during retirement.

So for instance, I can split up my account and distinguish 3% to pre-tax and 3% to Roth...is that what you are describing?

Since all of this is so new to me I really want to get things set up on a solid footing for the long haul if that makes sense so all the information everyone has provided thus far has been immensely helpful thus far.

[Like2Plan]

I think you're forgetting that a portion of 401k withdrawals will also not be taxed (due to deductions, credits and exemptions).

Every year we each get at least the standard deduction and 1 personal exemption. That is used to offset income, making it tax free. If 100% of your money is in Roth accounts, you do not get this benefit.

And if you're 24, since the amounts are typically subject to annual adjustments, by the time you retire, this could easily be $25-35k/year of deductions you would miss out on if you only have Roth money. (unless you're still working or something)

Furthermore, if 401k withdrawals are your only income in retirement, not only do you get the benefit of taking deductions against your money, you also get the benefit of withdrawing to the lower brackets first.

jpg7n16,
But since he has a 3% pre tax match (and he is contributing 6%), 100% of the money will not be in a Roth account. Also, presumably over a 40 year career it may make more sense to put more investment money into a traditional pretax 401K. It is hard to predict what the tax law will be in 40 years, but I have a hard time imagining the tax rates will be lower than what they are now.

Assuming there is social security in 40 years, the OP will be collecting SS in addition to the 401K. Currently SS benefits are taxed if your income exceeds a relatively low threshold. I can't imagine that will become any more favorable over 40 years.

As the OPs income increases over time, he will have no choice but to invest in taxable investments in order to make up the 15-20% savings needed to fund retirement. OP is already eaning 80K and is only 24 years old--I think he will only see that go higher.

[jpg7n16]

But since he has a 3% pre tax match (and he is contributing 6%), 100% of the money will not be in a Roth account.

The 100% figure was to make a point about the benefits of trad 401k, not a calculation for the OP's situation.

Assuming there is social security in 40 years, the OP will be collecting SS in addition to the 401K. Currently SS benefits are taxed if your income exceeds a relatively low threshold. I can't imagine that will become any more favorable over 40 years.

Although this is true, it's besides the point. You can postpone SS to age 70 (currently. this may rise over the next 40 years). If you retire at say age 63, that gives you 7 years w/o SS to worry about. And even then, there are still amounts you can take that do not make your SS taxable. You still get all the deductions, and the amount up to the threshold.

If all your money is in Roth accounts you don't get to use any of that. If the majority of your money is in Roth accounts, you may run out of 401k money before taking full advantage, and waste at least your deductions for the rest of your life.

How many deductions do you get from age 65-90? Beyond that, how much could be taken into 10% brackets? If only 20-30% of your money is in Trad 401k, do you get to benefit from all of that?

So for instance, I can split up my account and distinguish 3% to pre-tax and 3% to Roth...is that what you are describing?

Possibly. I was more thinking, take your company match, max a Roth, and then up your 401k percent to where you're saving enough.

Based on $80k salary and 15% savings, that would look like so:
$80k * .15 = $12,000
5,000 to Roth
7,000 to 401k ( = 8.75%)
2,400 empl match

That gets you a good chunk in Roth money, and another good chunk in 401k money. That would benefit you because you would get to take advantage down the line of deductions/low brackets, but still hedge against rising taxes, and have more flexibility with your w/d's in retirement.