401k vs Roth 401k?

[jIM_Ohio]

As others have stated, this is a tax question, and unfortunately there is no clear cut answer. It all comes down to whether you think the current tax rates are higher or lower than they will be when withdrawals are made in retirement. In essence, you are speculating and just making an educated guess.

If a person can contribute to Roth in 15% bracket now, and project to withdraw money at a rate equal to 25% bracket, that is one way to make this true. Even if tax rates are the same, a Roth IRA has many other characteristics which make it more favorable (no RMDs, better for inheritance).

The basic rule of thumb is pretty simple. If you have a high income and pay high tax rates, take the tax benefits of a traditional account and lower your taxes now. If you have a lower income and pay relatively low taxes, then take the tax hit now and invest in an account where all distributions will be tax free in the future.

agreed. Younger people pay lower tax rates (this appears to be a good example of this). When you have access to a Roth when younger, use it, as in 20 years you might make too much to have access to it

Since the couple appears to be making a decent income, and they are already contributing to Roth IRAs, I would suggest they make contributions to a traditional 401K. This will give them exposure in both pre-tax and post-tax accounts. When in doubt, a best of both worlds approach can work best.

Tax diversification is good. Realize tax diversification is a marathon, not a sprint, so it's OK to use 100% Roth one year if a person knows in 5 years they will use 100% traditional, as long as when person retires they have access to both accounts, a person is diversified.

If the wife stops working in a few years, they can always re-evaluate the situation. If their tax burden decreases substantially, it might make sense to go more heavily into the Roth accounts.

Too much of this thread is "if this, then this", and I suggest making sure the current situation is the most efficient way, then dealing with only the next set of changes (job change/Roth 401k), if someone decides to stop working then solve that problem at that moment. Too many factors change from one solution to the other that the matrix of information and inputs from one decision to the other makes financial planning complex. Simplify, the OP needs to focus on making sure the exact current situation is understood.

[parafly]

Does it matter to you that they currently save about 3x more money each year in their traditional 401k than their Roths? Is that a good ratio or would you rather see that more 50-50?

At their current income level, I would recommend more in traditional vs. Roth accounts since they should be trying to bring down their overall tax burden. As to the exact ratio, it's really comes down to what makes them feel comfortable, and again, what they think their tax rates will look like in retirement compared to today.

[parafly]

If a person can contribute to Roth in 15% bracket now, and project to withdraw money at a rate equal to 25% bracket, that is one way to make this true. Even if tax rates are the same, a Roth IRA has many other characteristics which make it more favorable (no RMDs, better for inheritance).

Agreed, but this is mostly a discussion of 401K vs. Roth 401K which come with the same basic rules, policies, and protections.

On a side note, it's worth noting that a 401K has better protections in place than an IRA when it comes to declaring bankruptcy.

agreed. Younger people pay lower tax rates (this appears to be a good example of this). When you have access to a Roth when younger, use it, as in 20 years you might make too much to have access to it

Very true. If they have a relatively high income now, it's completely possible, and even likely, that they will reach the maximum income level for Roth IRA contributions at some point.

Tax diversification is good. Realize tax diversification is a marathon, not a sprint, so it's OK to use 100% Roth one year if a person knows in 5 years they will use 100% traditional, as long as when person retires they have access to both accounts, a person is diversified.

Yes, the contribution rates of post-tax and pre-tax retirement accounts should be re-evaluated every year. Expecting a high income this year? Take advantage of the pre-tax accounts. Expecting a lower income this year (loss of job, birth of child, etc.)? Take advantage of the post-tax accounts.

There are definitely scenarios where you can be 100% pre-tax one year, then 100% post-tax the next year. It all comes down to your tax burden for a particular year.

Too much of this thread is "if this, then this", and I suggest making sure the current situation is the most efficient way, then dealing with only the next set of changes (job change/Roth 401k), if someone decides to stop working then solve that problem at that moment. Too many factors change from one solution to the other that the matrix of information and inputs from one decision to the other makes financial planning complex. Simplify, the OP needs to focus on making sure the exact current situation is understood.

As with most financial topics, there are many gray areas. I agree that the focus needs to be on making sure the exact current situation is fully understood and making an educated decision based on that understanding.

[thomasm]

FYI that post contains a lot of mis information, wrong information, or better technical terms are needed.

In addition- do both spouses work?
Do both have access to 401ks
what contribution is each spouse making to a retirement plan?
does either have access to an HSA?

I'm very sorry about this mistake. It was my fault.
Here is the data:
2014 AGI - 110k
2014 taxable - 90k
2015 AGI - 86k
2015 taxable - 51k


Answering your other questions. Yes they both work and each have their own 401k (only the wife has access to the Roth 401k option and she makes about 1/3 - 1/4 of the family income). The husband contributed 18k last year and the wife contributed 12k. They did contribute $1,500 to HSA.
They purchased a home January 2015 and had a child in 2015 also. Those might be part of the reason for the drop in 2014-2015 taxable income

[jIM_Ohio]

I'm very sorry about this mistake. It was my fault.
Here is the data:
2014 AGI - 110k
2014 taxable - 90k
2015 AGI - 86k
2015 taxable - 51k


Answering your other questions. Yes they both work and each have their own 401k (only the wife has access to the Roth 401k option and she makes about 1/3 - 1/4 of the family income). The husband contributed 18k last year and the wife contributed 12k. They did contribute $1,500 to HSA.
They purchased a home January 2015 and had a child in 2015 also. Those might be part of the reason for the drop in 2014-2015 taxable income

In 2015 their taxable income was in the 15% tax bracket
so they should MAX all Roth accounts available
I would also advise to max the HSA. I would even lower 401k contribution percentages to make sure more got put into a Roth... there is a sweet spot

for example if choice was 10% traditional 401k or 10% Roth 401k, choose Roth
find where 12% traditional=10% Roth for example (same take home pay) and focus on that

401k up to match for both
then max the HSA
then Roth 401k until it maxes
then Roth IRAs
then traditional 401k


I would spend time learning what was dropping their gross income by 1/3- know each tax break they were getting and focus short term planning on knowing if any of those go away. For example mortgage interest deduction going away, property taxes decreasing (if they move for example).

The tax planning now pays dividends down the line, as they are likely staying in 15% bracket for a long time, even with a clear 25% gross income wage earning.

This is a classic example of a person using gross income as what tax bracket they are in (early posts had it at 25%), when in reality they are paying 15% taxes because of the tax breaks (likely for 3 exemptions, plus mortgage interest plus property and state taxes).

Most middle class USA families should look at numbers here and see how much they can mirror this. The Roth and HSA in this case will be big winners.

[thomasm]

Thank you jIM_Ohio for all your help. Thank you for helping me to dig deeper and thank you for getting to the bottom of this situation. Your help has been greatly appreciated!!