Roth 401K

[JinCO]

My wife's company just added a Roth 401K option. We are currently investing in pre-tax 401K funds. At what point does a Roth 401K make sense? We are in the 33% tax bracket.

[maat55]

I found this on Wikipedia:

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. The Roth 401(k) offers the advantage of tax free distribution, but is not constrained by income limitations. For example, normal Roth IRA contributions are limited to $5,000; whereas, up to $15,500 could be contributed to a Roth 401(k) account, provided no other elective deferrals were taken for the tax year (no traditional 401(k) deferrals taken).

[jIM_Ohio]

Lower tax brackets=Roth
Higher tax brackets (like you)= take a 33 percent deduction

[JinCO]

Thanks -- that is kind of what I was thinking but thought I would check with the experts.

[jIM_Ohio]

JinCo-

I do not remember your age, amount invested, or retirement plan.

There might be reasons to consider a Roth, I am guessing none or only one of these might apply, but here are some considerations:

1) will the RMD from your current deductable/tax deferred accounts be higher than expenses needed in retirement?
2) will you be moving to a high tax area during retirement?
3) will you have a need to access retirement accounts prior to age 59.5? How much earlier?

[simpletron]

it might also be advantageous to choose to put some into the roth if you are going to save more than the limit. roth always beats taxable when it comes to taxes. but normal 401k doesn't always beat roth even if you are in the 33% tax bracket, this is highly dependent on what will be your taxes during retirement.

[tripods68]

Do you supposed it is better to effective tax rate instead than the 33% tax bracket as guide? Or does it really matter?

[jIM_Ohio]

Do you supposed it is better to effective tax rate instead than the 33% tax bracket as guide? Or does it really matter?

It matters.

Because the IRA money comes from the top (which is 33%). Other money (like payroll) starts at bottom (which is 10-15-25-28-then 33%).

Much of this would then depend on JinCo's expenses- let's say his expenses each month were in the 28% bracket (around 166k per year of expenses), it might make sense for him to use 401k deduction at 33% to lower himself into 28% range, then pay taxes on income at 28%. Not what I would do, but if JinCo was confident he knew his expenses in retirement would stay at that level, it might make sense.

This does not make sense to me for 2 reasons
1) He could get a better tax rate than 28% or 33% in a taxable account. Even if taxes go up, the worst case is the rates equal what he is paying at the time, best case is a tax rate which might be more than 50% less what he is paying now.
2) Most retirees with a diversified portfolio can position themself in the 15% (second lowest) tax bracket and live very well. This is my plan.

[JinCO]

JinCo-

I do not remember your age, amount invested, or retirement plan.

There might be reasons to consider a Roth, I am guessing none or only one of these might apply, but here are some considerations:

1) will the RMD from your current deductable/tax deferred accounts be higher than expenses needed in retirement?
2) will you be moving to a high tax area during retirement?
3) will you have a need to access retirement accounts prior to age 59.5? How much earlier?

jIM - I am 32, have about $130K invested between my 401K and wife's 401K. We are in about 80% stocks / 20% bonds. We are planning to max the 401Ks between now and retirement.

I'm not sure what your 1st question means. I expect our expenses to be lower in retirment due to house being paid off and no childcare costs. I would like to figure out a way to be in 15% bracket upon retirement.

Not sure where we will live in retirement at this point. I'm not planning to need access to retirement accounts prior to age 59.5.

[JinCO]

it might also be advantageous to choose to put some into the roth if you are going to save more than the limit. roth always beats taxable when it comes to taxes. but normal 401k doesn't always beat roth even if you are in the 33% tax bracket, this is highly dependent on what will be your taxes during retirement.

What do you mean when you say more than the limit? I was under the impression that the limit is $16.5K per person. If we invested $16.5K into a pre-tax 401K can we invest additional money into a roth 401K?

[LivingAlmostLarge]

Depends on where you live as well. If you are living in a state with income tax but plan on moving to a place without state income tax. Ideally I'd like to move to WA without state income tax so I can save on income tax now as well.

[sweeps]

If we invested $16.5K into a pre-tax 401K can we invest additional money into a roth 401K?

No, the limit is for pre-tax 401k and Roth 401k contributions combined.

[jIM_Ohio]

jIM - I am 32, have about $130K invested between my 401K and wife's 401K. We are in about 80% stocks / 20% bonds. We are planning to max the 401Ks between now and retirement.

I'm not sure what your 1st question means. I expect our expenses to be lower in retirment due to house being paid off and no childcare costs. I would like to figure out a way to be in 15% bracket upon retirement.

Not sure where we will live in retirement at this point. I'm not planning to need access to retirement accounts prior to age 59.5.

RMD is required minimum distribution. It is very possible that the government will require you to withdraw more than you need from the 401k/rollover IRA in retirement.

You are 32.
I assumed you had 200k invested already.
I assumed an 8% return on the 80-20 from now until age 59.5.
I assumed 16500 of deposits (one person).
I came up with a portfolio of $3.5M, which has NOT been taxed. Contributions not taxed, earnings not taxed.

RMD is the governments way of telling you how much to withdraw. Today a 70 yo would need to take out 127k from the IRA BY REQUIREMENT.

As we know this is well into the 25% bracket. If your expenses were in the 60k range (15% bracket) you are withdrawing too much and paying excess tax on what you do not need.

Bump that up to 2 people contributing 16500 and you would have double the withdraw (250k) which clearly NOW is taxed quite high.

The Roth has no RMD (all the money put in was taxed, government is not as anxious to require you to withdraw this).

The issue is I am comparing growth and a future value to todays tax brackets without any inflation. The tax brackets will be inflated (so a 60k cap today might be 120k or 180 cap when you retire in 30 years).

The best thing to do is defer taxes now- you know you save 33% federal+state taxes too.

As you approach retirement you will have a better idea of your expenses for retirement, your investment performance, and timing.

If you ever project an RMD on current value to be above your current tax bracket, you want to start using the Roth. Meaning if you are around age 50 and see you have "enough" to retire on, but want to keep saving anyway, that would be when Roth saves you- because it removes the RMD requirement.

Other tricks would be to withdraw before RMD starts when you turn 70.5. RMDs kick in at age 70.5, if you take money out of the IRA before then, you can control the amount and by reducing the IRA balance, it lowers the following years RMD.

[jIM_Ohio]

What do you mean when you say more than the limit? I was under the impression that the limit is $16.5K per person. If we invested $16.5K into a pre-tax 401K can we invest additional money into a roth 401K?

I was waiting for someone to reply to that post before I ripped that poster to shreads.

The comment about dependant on taxes in retirement (vs working) is accurate, the rest of the post was gibberish I think.

I highly doubt the 2nd lowest tax bracket (where you project retirement expenses to be) will double in percentage without some revolt of the tax payers- because that also means the taxes on the very rich would approach around 60-80% as well.

Roth beats 401k on taxes only when taxes go up when you withdraw. Being in top 20% of all taxpayers now, I think you can predict that you will not be in top 20% when you retire.

[LivingAlmostLarge]

I agree with Jim and that's what my DH and I are betting on.