Roth or 401k or mix?

[frugalgirl]

New here and looking for advice.

Just finished a review with a "financial adviser". The adviser turns out to be an insurance salesman. He tried to convince us to stop investing in our 401k and re-finance our mortgage in order to buy a whole life insurance policy as a non-taxable investment. We said "no way"! However, we did come away thinking that we should perhaps divert $5k of our retirement savings into a Roth IRA. Here is our situation:

Currently are contributing the max, $16,500 to 401k. That is the max total we can contribute to any plan. Employer contributes 8% regardless of whether or not we contribute.

Mortgage (P&I) of $1750/month will be paid in full in 11/2012.

First child starts college in 2015. Second one starts in 2018. Want to use the $1750 to save for college when mortgage is paid. Husband is a college professor so children (2 of them) will get major tuition assistance from his employer.

In 2 years will have an extra $500/month to contribute toward retirement savings.

Have combined $500k in 401k retirement savings accounts. Goal is $1.5 M in 20 years.

Should we start diverting $5k or $10k of the $16,500 to Roth to give us a more balanced taxable vs. untaxable retirement income since we are so heavy on the 401k?

What would you do?

[jIM_Ohio]

I would put money into the Roth (10k) and invest about $6500 into 401k, assuming the match does not decrease (you said match was 8% regardless, so match should not decrease).

Is the $16,500 you are contributing now more than 20% of gross income?
what is your marginal tax bracket?

[frugalgirl]

Is the $16,500 you are contributing now more than 20% of gross income?
what is your marginal tax bracket?

It is about 15% of gross. With deductions, I'd have to check, but I am thinking we end up paying less than 20% in taxes. Could you give your reasoning for your recommendation? Thanks!

[jIM_Ohio]

It is about 15% of gross. With deductions, I'd have to check, but I am thinking we end up paying less than 20% in taxes. Could you give your reasoning for your recommendation? Thanks!

If your tax bracket is 15% bracket, the Roth is a GREAT deal. Pay 15% now and not pay taxes later.

If your tax bracket is 25% the 401k deduction is a good deal, and Roth is a good deal.

I asked about the bracket you are in (10, 15, 25, 28, 33, 35) not your effective tax rate... I am not on my PC with a fairmark.com bookmark, but if you search fairmark reference room, there are tables to see your tax bracket.

[frugalgirl]

We are in the 25% bracket.

[jIM_Ohio]

We are in the 25% bracket.

This may change my advice some... and you will definitely get mixed advice.

Most conventional wisdom is 401k to match
max out the Roths
then 401 to max


My adjusted advice is this

401k to 15% tax bracket
max out both Roths
401k to max


Here is what I mean.

Reference Room

Married filing jointly 25% bracket is between $68,000 and $137,300.
what this means is you want taxable income of $67,999 (or less) then use Roths.


If you make 100k gross, to get to $67,999 taxable is not difficult. You can check taxable income on your tax return to see if you are in 15% bracket, or do some math.

Here is the math:

100k gross income (this is an assumption, I did not see you post your gross income anywhere)
$11,400 standard deduction (if you itemize, this is schedule A total which will be higher)

88,600

$3650 times 2 exemptions (if you have kids, add them in here too, 1 exemption per person)
$7300

$81300

then 401k and other "above the line" deductions like HSAs kick in (do you use an HSA?).

$81300 is your taxable income with no other deductions ($81,300 is your taxable income minus standard deductions and 2 personal exemptions)


$67,999 is the goal

$81,300-$67,999=$13,301

this means put $13301 into 401 (which is 14% of 100k gross)
then put whatever you can afford in the Roth.


What this allows you to do:
a) you get a 25% tax deduction all all monies going into 401k
b) you pay a 15% income tax on all monies going into Roth
c) you assume your taxes in retirement will be in 15% or 25% bracket... If retirement is in 15% bracket, the 401k saved you money, if retirement is in 25% bracket the Roth saved you money.

Reasons to tilt towards more going to Roth
a) If you KNOW with certainty that income is going up (like second spouse is entering workforce soon, or one working spouse is about to be named partner at a law firm or you will inherit a business which makes more money) then max out Roths while you are still allowed to contribute and max out Roths because your future tax bracket will likely be much higher than 25%.
b) If you have access to a pension, ditch the math above and get more into a Roth ASAP because Roths have more favorable withdraw rules than traditional IRAs/rollover IRAs.
c) You like paying more in taxes now, for any reason personal to you

[frugalgirl]

Thanks for the detailed advice. It is tricky for us because my husband's salary fluctuates. He has a guaranteed 9-month salary and can earn the other months through research grants. We usually count on 10 months. I will have to do the math. I am also trying to get full-time employment again after staying at home with the kids. All of your above advice makes it easy to devise a strategy. Thanks.

[jIM_Ohio]

The higher the bracket, the better the 401k is for you right now
if you make too much for a Roth, you can contribute to a traditional, then convert to a Roth during retirement (when taxes are lower).

Some of what you want is investment planning, and some of what you want to do is tax planning. If you know the taxes well, the investing decisions should be easier.