Roth 401K or not?

[lrodptl]

My company has started offering a 401K Roth to supplement the traditional 401K. Why would I contribute to this when my salary now is around 90K and my income from my retirement savings will be less,by about 30K? Thanks.

[MonkeyMama]

It depends on what tax bracket you are right now.

Reasons:

--current income tax rates are at historic lows (nowhere to go but up)
--By the time you retire you will probably have fewer tax deductions (if any)
--Going from married to single (widowed or divorced) will about double your taxes these days
--social security income is taxable, and will bump up your tax bracket (I don't think most people realize this)

I do a fair amount of tax returns, and my retired clients tend to pay some of the higher taxes. BUT, it just depends on the situation. At current, investments are taxed very favorably, and so early retirement can be pretty tax-free. If you are just living off of your reserves. But, if you end up widowed or divorced (most people do), and you were married before, the tax bite can be pretty shocking. Your home is paid off and you can't contribute to retirement any more to lower your taxable income. If you start receiving pensions, social security and required distributions from your IRA, it can be hard to control your income. & then you pay a lot of taxes.

If you are already single it probably doesn't make a huge difference. Young people with families and mortgages and yadda yadda will most certainly pay more taxes in the future.

I think contributing to a ROTH can also help you manage your taxes in the future. No required distributions, so gives you more flexibility. Tax law is always changing - investments will not also be so favorable.

All of the above said, whenever we are in the 25%+ tax bracket, we skip the ROTHs. Why? Because I think there are ample opportunities to do ROTH rollovers in lower income times. Unemployment, disability, early retirement. I personally could not stomach voluntarily paying 25% taxes when I was in my early 20s and we did the non-ROTH retirement savings. Then my spouse got laid off, stayed home with our kids, and we converted everything over in our lower tax bracket. My dad has been unemployed for several years, decided to just retire at some point, and has a long time to convert his nest egg into ROTHs (before his taxes take a hit from other retirement income sources). On the flip side, I am aware this is a gamble as ROTH conversions may not *always* be allowed.

I am sorry for the novel - but these are all real life examples.

[lrodptl]

Thanks,I'm married,age 54 and about 6 years from retirement. We have 2 401Ks equalling 450K,about 350K in savings and other funds and I have a pension. The house will be paid next year. Most guys in work are around the same age/circumstances and are not 401K Roth participants. They all argue that our retirement tax will be less due to less income.

[MonkeyMama]

I think most people probably do have less income when older. It's just, if you are a very prudent saver, you will likely have as much or more. I see a lot of people who aren't relying on social security who are receiving it anyway. & sometimes they are shocked by the tax ramifications, because they never thought they would ever receive it.

I think this conversation might be moot for the average American though. I am sure many many Americans are dealing with very low retirement incomes. & it appears you will not be one of those types - so good for you!

[lrodptl]

Still seems prudent to have some portion of retirement saving in an after tax position.

[bUU]

Roth is the flavor-of-the-moment so it gets a lot of airplay and championing. Along with the advantages, do keep in mind what you lose, most notably, compound interest on the money you pay in taxes now on the contributions to the Roth.

[kv968]

Thanks,I'm married,age 54 and about 6 years from retirement. We have 2 401Ks equalling 450K,about 350K in savings and other funds and I have a pension. The house will be paid next year. Most guys in work are around the same age/circumstances and are not 401K Roth participants. They all argue that our retirement tax will be less due to less income.

You probably won't make/need as much in retirement as when you're working, however you still likely may be in the marginal and effective 25% tax bracket and that's where a Roth would come in handy.

I look at it this way...In 2013 the 25% tax bracket starts at ~$72,500 for married filing jointly. When you add in two personal exemptions of $3900 and a standard deduction of $12,200, that'll add another $20,000 to the income while the MAGI will still be below the 25% tax bracket. So in other words, you could "make" ~$92,500 jointly and will be in the 25% tax bracket but your effective rate will be 15%. Anything over that will effectively be in the 25% bracket.

If you think you're going to need more than the $92,500 then that's where the Roth comes in. Once you hit that $92,500 number you'd stop taking money from the 401k (taxable income) and start taking it from the Roth so you don't have to pay the 25% on that extra money.

It's basically diversifying your tax exposure. Plus, as MonkeyMama added, there's no required distribution from a Roth so if you don't really need the money you don't have to take it and get taxed on it like you would in a regular 401k.

Everyone's situation is different and you'd have to figure out for yourself what you and your wife will need as far as income in retirement, but it might not be a bad idea to have at least a little bit of your savings go into the Roth IMO.

[thesimplemoneyblog]

My personal preference is to have some 'tax-diversification' by having a mix of assets in taxable (regular brokerage or investment accounts), tax-deferred (like a traditional IRA or traditional 401(k)), and tax-exempt accounts (Roth IRA or Roth 401(k)). No one knows what taxes will do in the future - they are at historic lows, but who knows when/if they will increase in the future and to what amount - so it's good to have a mix of assets to draw from while in retirement depending on your need to minimize taxes, maximize the lower tax brackets, have asset readily available for emergencies, etc.

[lrodptl]

Thanks all.

[Like2Plan]

My company has started offering a 401K Roth to supplement the traditional 401K. Why would I contribute to this when my salary now is around 90K and my income from my retirement savings will be less,by about 30K? Thanks.

There are a couple of reasons that I can think of.

1. You believe tax rates will go up when you are in retirement.
2. If you are maxing out your 401K, you are technically putting more $$ into the Roth contribution since in addition to the contributions you are also paying the income taxes outside of the 401K contributions.

The reason that I would be hesitant to mix traditional and roth 401K contributions is because when you pull the $$ out, it comes out as a percentage of pre-tax, post-tax $$ and you have no control over that (other than when you intially make the contributions). Also, the Roth 401k has required minimum distributions whereas the Roth IRA does not. I would be more inclined to keep the 401k contributions traditional and make separate contributions to Roth IRAs for maximum flexibility.

[Vpxggmr17]

I have a Roth IRA and a Roth 401k...just started both within the past 12 months.

I'm 25, single with a pre-tax income of roughly $75-80k. Best set up?

[elessar78]

It depends on what tax bracket you are right now.

Reasons:

--current income tax rates are at historic lows (nowhere to go but up)
--By the time you retire you will probably have fewer tax deductions (if any)
--Going from married to single (widowed or divorced) will about double your taxes these days
--social security income is taxable, and will bump up your tax bracket (I don't think most people realize this)

I do a fair amount of tax returns, and my retired clients tend to pay some of the higher taxes. BUT, it just depends on the situation. At current, investments are taxed very favorably, and so early retirement can be pretty tax-free. If you are just living off of your reserves. But, if you end up widowed or divorced (most people do), and you were married before, the tax bite can be pretty shocking. Your home is paid off and you can't contribute to retirement any more to lower your taxable income. If you start receiving pensions, social security and required distributions from your IRA, it can be hard to control your income. & then you pay a lot of taxes.

If you are already single it probably doesn't make a huge difference. Young people with families and mortgages and yadda yadda will most certainly pay more taxes in the future.

I think contributing to a ROTH can also help you manage your taxes in the future. No required distributions, so gives you more flexibility. Tax law is always changing - investments will not also be so favorable.

All of the above said, whenever we are in the 25%+ tax bracket, we skip the ROTHs. Why? Because I think there are ample opportunities to do ROTH rollovers in lower income times. Unemployment, disability, early retirement. I personally could not stomach voluntarily paying 25% taxes when I was in my early 20s and we did the non-ROTH retirement savings. Then my spouse got laid off, stayed home with our kids, and we converted everything over in our lower tax bracket. My dad has been unemployed for several years, decided to just retire at some point, and has a long time to convert his nest egg into ROTHs (before his taxes take a hit from other retirement income sources). On the flip side, I am aware this is a gamble as ROTH conversions may not *always* be allowed.

I am sorry for the novel - but these are all real life examples.

Fantastic post, MM.

I ponder this a lot too and some thoughts.

-Baby boomers retiring will force medicare to go up since a majority of them will not have health insurance. Which means higher taxes for those of us who are on the younger end.

-True, taxes are historically at their lowest but one party is advocating strongly to drive them even lower.

-If tax loop holes are closed, how will that affect "my" tax bill. Not sure if there's a one-size fits all answer.

-Is it all within the realm of possibility that the gov't will renege on the Roth rules and cause them to be taxable in the future. Yes, knowing full well that they have been taxed already? In which case any sense in hedging bets on both sides?