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Many employers started offering roth 401k options, allowing us to invest post-tax dollars. I have a hard time deciding whether I should invest pre-tax, post-tax, or partly pre-tax and partly post-tax.

Here are some basics about roth and traditional contributions: http://www.fatwallet.com/blog/401k-vs-roth-401k-calming-the-conf... Clearly, roth is advantageous if you retire in a higher tax bracket than the one you are in currently. However, you also need some income or distributions from traditional accounts to fill the lower tax brackets in retirement. Another advantage of roth is the ability to invest more money as $17,500 post tax is more than $17,500 pre-tax. Finally, having some roth contributions lets you hedge against future tax increases.

Now my specific situation. This is my last year in the 25% tax bracket, and next year I will be in the 28% bracket. I am 30 years old and I don't expect to be in the 25% bracket again until possibly when I retire. NY state tax is an additional 6.85%. Shall I use the advantage of being in the 25% bracket and make at least some roth contributions, and then switch to traditional contributions next year once I am in the 28% bracket? Or shall I invest in a traditional account now? I realize this question doesn't have a "right" answer without knowing future tax rates, but I wanted to hear what others are doing.

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I did! But nothing you said covered your "special funds" argument after I pointed out that it doesn't preclude you from ... (more)

dshibb (Sep. 05, 2013 @ 8:40p) |

Technically speaking, aren't your IRA options between Roth IRA or Traditional IRA that is non-deductible, instead of Rot... (more)

gaffer (Sep. 06, 2013 @ 4:26p) |

Right, so functionally speaking, Roth or none.

dukerau (Sep. 08, 2013 @ 12:10a) |

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Your situation is murkier as you live in a state with a higher state income tax and its unclear whether you're currently maxing out your 401k contribution.

Thing about retirement is you get to choose where you live so if you goto Florida or Texas with no state income tax, that factors in favorably toward regular 401k vs. Roth. If you're currently hitting the 401k contribution limit that factors favorably towards Roth 401k vs. regular 401k.

Looks like you know what you are doing. It's too hard to foresee your tax situation in the future, so maybe half and half?

I am splitting my money between a traditional 401k, and a Roth IRA. Once the IRA is capped, I then allocate those funds to my 401k and try to reach the cap (along with trying to cap my HSA).

It mostly comes down to tax rate now vs. tax rate in retirement. Even with all the crazy deficits we currently have I doubt we will reach a point where the tax rates on retirees drawing from their 401ks is going to be higher than the current rate for workers making a good salary. Right now, ignoring a state itemized deduction, you have a tax rate of 34.85%. Your marginal tax in retirement would have to be higher than that to make a Roth beneficial. When you are retired you will probably earn less than you do now, maybe 80% of that figure, and will have the option to live in a state with no income tax if you choose. This tilts the balance more toward traditional. Some people would argue that they believe due to current budget deficits and whatnot the government will be forced to raise tax rates significantly in the future. While that may be possible, it is also possible they could mess with the tax free status of a Roth account, so just because the money is in there doesn't mean it's completely safe from tax.

I also like that traditional 401Ks give you flexibility. If you have a year or two where you have very low income, such as getting laid off, going back to school, or starting a business, then you have the option to do a Roth rollover at little to no tax cost. If everything was already in a Roth you never have that flexibility.

For me the biggest benefit to a Roth is that you can effectively contribute more money to the account. The IRA and 401K limits are the same whether you choose a traditional or a Roth. If you assume the tax rates will be the same in retirement as they are now (~35%) then a $17,500 contribution to a traditional IRA is the same as an $11,375 to a Roth. If you are in the position to contribute more than the traditional 401k limit then this starts to tilt the scales back to a Roth.

I think the USA has socialized medicine in its future and all the higher taxes that come with it. That combined with the huge deficits will make Roth IRA a hot deal.

The Roth is also more liquid in the event of an emergency it can be draw from without penalty.

I plan on putting money into a 401k in later years to draw from fill in the low tax bracket gaps.

Probably advantageous to pump up your Roth contributions this year and then switch to pre-tax next year.

The issue is that automatically assuming x% tax bracket at retirement is not a good idea in a vacuum. You actually have to put a rather large amount of assets into a 401k/tIRA or have a large pension in order for you to actually generate that tax bracket. Otherwise it's 0% at retirement. You don't want to be overpaying taxes all of your life by putting money into a Roth account just to have 0% tax brackets in retirement(because then you way overpaid your taxes over your life and it's tax inefficient).

Generally speaking you're typical responsible guy that puts about 15% of his salary into retirement accounts should have about 3 parts pre-tax to 1 part post-tax in his accounts. If that person makes it a habit of contributing less than that then they should be using more pre-tax accounts and less post-tax. If that person makes it a habit of contributing more than 15% than they should be contributing more to post-tax.


But the trick is to guess where you'll be at and then try to make your Roth contributions in lower tax brackets and pre-tax contributions in higher tax brackets while working so assuming you're not going to be way under funded come age 65, it's probably smart to contribute to the Roth now. If you can reasonably expect that you will go up another tax bracket soon afterward than I would continue to contribute to Roth until then. But once you get to that higher tax bracket it should be basically all pre-tax if you can help it.

See the balancing act you should try to do here? That is the correct way to play it.

awstick said:   For me the biggest benefit to a Roth is that you can effectively contribute more money to the account. The IRA and 401K limits are the same whether you choose a traditional or a Roth. If you assume the tax rates will be the same in retirement as they are now (~35%) then a $17,500 contribution to a traditional IRA is the same as an $11,375 to a Roth.That's correct, but remember that even after he maxes out his 401(k) for the year (regardless of whether it's a Traditional, a Roth or a combination of the two) he also has the option of making an additional contribution to a Roth IRA. In his tax bracket, he wouldn't even have to mess with a backdoor Roth IRA to do it. Unless he is in a position to max out his 401(k) and his Roth IRA, his ability to make effectively larger retirement contributions by using a Roth 401(k) is of largely academic difference.

brettdoyle said:   I think the USA has socialized medicine in its future and all the higher taxes that come with it. That combined with the huge deficits will make Roth IRA a hot deal.

The Roth is also more liquid in the event of an emergency it can be draw from without penalty.

I plan on putting money into a 401k in later years to draw from fill in the low tax bracket gaps.

  
Bold: This is smart, but as I point out above make sure your cognizant of undershooting your retirement income.

Assuming current dollars: If you had an AGI of $150k in your 40s and then had only enough tIRA assets to spin off an AGI of $30k plus another $40k distributed from Roth tax free I can assure you that you made a mistake and overpaid your tax liability while working. But if you can front load your Roth contributions so that lets say age 22-32 is heavily Roth and then 33-65 is heavily tIRA and you end up with tIRA spinning off $100k in AGI while Roth could spin off $30k against a back drop of earning mid $100ks in AGI than you likely played it like a champ.

All I will say is that people tend to way overestimate what they'll be making in their 50s, so don't way undershoot and end up like the first example.

dshibb said:   The issue is that automatically assuming x% tax bracket at retirement is not a good idea in a vacuum. You actually have to put a rather large amount of assets into a 401k/tIRA or have a large pension in order for you to actually generate that tax bracket. Otherwise it's 0% at retirement. You don't want to be overpaying taxes all of your life by putting money into a Roth account just to have 0% tax brackets in retirement(because then you way overpaid your taxes over your life and it's tax inefficient).That's exactly right.

Generally speaking you're typical responsible guy that puts about 15% of his salary into retirement accounts should have about 3 parts pre-tax to 1 part post-tax in his accounts.I'm not sure that I am following, although I may not be reading it quite right. Did you mean to phrase this so generally without explaining how individual salaries and income prospects fit into this decision making process? If you are a medical resident currently making $45K, every penny of your retirement contributions should be in Roth accounts, as you are in a low tax bracket now, are virtually guaranteed to be in a much higher tax bracket post-residency and are unlikely to retire in a lower tax bracket.

On the other hand, if you've just won the lottery, every penny of your retirement contributions for the year should be in a traditional account (plus you should consider opening up a backdoor Roth IRA, as you won't be eligible for a deductible traditional IRA and a Roth IRA will almost always be far more advantageous than a taxable account).

dshibb said:   
brettdoyle said:   I think the USA has socialized medicine in its future and all the higher taxes that come with it. That combined with the huge deficits will make Roth IRA a hot deal.

The Roth is also more liquid in the event of an emergency it can be draw from without penalty.

I plan on putting money into a 401k in later years to draw from fill in the low tax bracket gaps.

  
Bold: This is smart, but as I point out above make sure your cognizant of undershooting your retirement income.

Assuming current dollars: If you had an AGI of $150k in your 40s and then had only enough tIRA assets to spin off an AGI of $30k plus another $40k distributed from Roth tax free I can assure you that you made a mistake and overpaid your tax liability while working. But if you can front load your Roth contributions so that lets say age 22-32 is heavily Roth and then 33-65 is heavily tIRA and you end up with tIRA spinning off $100k in AGI while Roth could spin off $30k against a back drop of earning mid $100ks in AGI than you likely played it like a champ.

All I will say is that people tend to way overestimate what they'll be making in their 50s, so don't way undershoot and end up like the first example.
Exactly. In general, the vast majority of the population out there would be FAR better off having 100% of their retirement money in traditional accounts with absolutely no Roth funds. That's because the vast majority of the population will find itself not having enough money at retirement (or at least far less money than they did during their working years), so making Roth contributions will generally cause them to unnecessarily overpay their taxes. Hence, the reason that my general advice is that when people are in doubt and it's a close call, they ought to be making a Traditional contribution rather than a Roth one (as long, of course, as they realize that the Traditional contribution is pretax and, therefore, needs to be bumped up by their tax bracket to be equivalent to a Roth contribution).

In general, people need to remember that being in a situation where in retrospect a Roth contribution would've been more advantageous than a Traditional one is a good problem to have, as it generally means that you've amassed a lot more in retirement funds than you had anticipated and is a situation that doesn't happen to most people out there.

The one obvious exception to the above rule has to do with people just starting out who can be reasonably expected to make way more money for the rest of their careers and to continue to diligently save towards retirement.


 

geo123 said:   
dshibb said:   The issue is that automatically assuming x% tax bracket at retirement is not a good idea in a vacuum. You actually have to put a rather large amount of assets into a 401k/tIRA or have a large pension in order for you to actually generate that tax bracket. Otherwise it's 0% at retirement. You don't want to be overpaying taxes all of your life by putting money into a Roth account just to have 0% tax brackets in retirement(because then you way overpaid your taxes over your life and it's tax inefficient).
That's exactly right.

Generally speaking you're typical responsible guy that puts about 15% of his salary into retirement accounts should have about 3 parts pre-tax to 1 part post-tax in his accounts.
I'm not sure that I am following, although I may not be reading it quite right. Did you mean to phrase this so generally without explaining how individual salaries and income prospects fit into this decision making process? If you are a medical resident currently making $45K, every penny of your retirement contributions should be in Roth accounts, as you are in a low tax bracket now, are virtually guaranteed to be in a much higher tax bracket post-residency and are unlikely to retire in a lower tax bracket.

On the other hand, if you've just won the lottery, every penny of your retirement contributions for the year should be in a traditional account (plus you should consider opening up a backdoor Roth IRA, as you won't be eligible for a deductible traditional IRA and a Roth IRA will almost always be far more advantageous than a taxable account).

  
Yeah you have it right although you're response is just a rephrasing of what I wrote in the subsequent paragraph. Without getting into the specifics of each individual situation(because even still it will vary a lot) for your typical person if you put away 15% of your salary towards retirement plus the match you'll probably pull off an asset pool large enough to be able to safely distribute roughly your own working years income after taking into account social security. See the goal is to maintain roughly equal tax brackets throughout your life because paying a higher tax bracket one year and a lower tax bracket the following year is worse(in terms of tax efficiency) than paying some middle of the road tax bracket in both years.

So again it's a pretty rough rule of thumb there, but in general assuming you put away 15% + match away roughly speaking you'll have assets to spin off a close income to your working years. If at age 65 let's say you have $3 million pre-tax to $1 million post tax(3 parts pre-tax to 1 part post-tax) then your tax bracket in retirement should be close working and non working as you take your distributions. It's okay if it drops a tiny bit because you have to assign a value to stretch Roth in the likely event that you pass away with assets left over since stretch Roth is by far the most efficient tax vehicle to pass inheritance.

But as an add on to this there are numerous ways you can achieve 3 parts pre-tax to 1 part post-tax at retirement. You could contribute 3 to 1 all through life. You could contribute more pre-tax at first and then do more post tax down the road. You could also contribute more post tax up front and more pre-tax down the road. If you're just cognizant of what is going on you can hit a close income at retirement. Now obviously of those ways to prepare for it, front loading in the Roth while in a low tax bracket and back loading in the pre-tax accounts while in a high tax bracket is the more efficient way to do it which plays exactly into your examples of a resident soon to be doctor. Obviously it also plays into your lottery example(which is one of the ways someone can earn a lot more money while younger before making less while older assuming they elect lump sum) in which case they should massively increase pre-tax in that year. So yeah you get it.

Another risk with the Roth that no one seems to be considering or talking about is legislative changes. When you get the tax benefit from your traditional 401k or IRA contributions today that can't be taken back from you in the future. However as the Roth benefits are back-ended, there always remains a risk that DC will see that money as a piggy bank at some point in the future. I see this risk as small barring a large financial crisis, however since 2008 I see a large financial/government financial crisis as a distinct possibility. All politicians would have to do is underfund SS until it runs out, then look to the diligent savers to bail those out who never saved and were reliant on SS.

Something to consider. And while this would in effect be double taxation, it already happens with corporate dividends and would be possible, especially when the first wave retires that utilized/maxed out this Roth 401k/IRA is able to live very well off in retirement.

Can you imagine the popular press writing articles about someone with a seven figure Roth IRA and not paying taxes?  I can see the spendthrift plebs with their pitchforks already.

for the OP, I think traditional 401k is best in the 31.85% bracket. I mean for all you know, you'll retire in Florida with no state income tax whatsoever.

geo123 said:   In general, people need to remember that being in a situation where in retrospect a Roth contribution would've been more advantageous than a Traditional one is a good problem to have, as it generally means that you've amassed a lot more in retirement funds than you had anticipated and is a situation that doesn't happen to most people out there.

The one obvious exception to the above rule has to do with people just starting out who can be reasonably expected to make way more money for the rest of their careers and to continue to diligently save towards retirement.


 

  
While I agree with the spirit of everything you said the bold stuff I do disagree with given the exact way you wrote them. The issue isn't an income issue nor is it a 'luck of the draw' issue. It's a behavioral issue pure and simple. It's an issue of financial responsibility and it is scales completely on income so there isn't much if any advantage a higher income person has to a lower income person on this issue. The reason why it's scalable is because while a lower income person has less to put away they also have a much lower total asset pile they have to generate to replace their income during retirement. The higher income person has to generate a much higher asset pool to replace his income and honestly in a lot of cases even financially sophisticated high income people can have a higher likelihood of undershooting than their middle income friends because of the disparity in targets.

So it really comes down to the question of "What percentage of your income do you put away every year?" In a lot of ways that is all you need to know to roughly produce a good guess on what portion of assets should be traditional and what portion should be Roth. After that you then look at what their prospects are for higher income(or how parabolic is their income so to speak given their career track where doctors have much higher spreads between what they make as residents vs. practicing which is similar to small business owners which is similar to sales guys generally, but if you look at maybe a construction worker their income will probably only barely increase over inflation if that). If you have a reasonably high likelihood of a large rate of change in income than you should be front loading Roth and backloading tIRA/401k assuming you maintain a *financially responsible contribution rate*.

But the truth is that off these forums there is another half of the public that is financially irresponsible and those folks should only be contributing to 401k/tIRA because they aren't responsible enough to set enough away for retirement to even come close to replacing their income while working.

psychtobe said:   for the OP, I think traditional 401k is best in the 31.85% bracket. I mean for all you know, you'll retire in Florida with no state income tax whatsoever.
  
It doesn't really matter where he retires. At this stage it really only matters where he works.

1) If he is unwilling to load up more on Roth this year and more on traditional 401k next year when his MTR rises then he's committing to near 100% t401k/tIRA for rest of his working life(absent a temporary fall in income for conversion). Why? Because if at any point he says "Oops I should be contributing at least some to a Roth IRA" the fact that he didn't do it this year and is looking at doing it a higher tax bracket means that he made a mistake this year.
2) The only reason why someone would do entirely t401k is because they think they're going to have less income from their retirement accounts during retirement than they make while working. That is essentially them saying that they would rather live it up while working and have a drop in their standard of living while in retirement. The only way that makes sense in practice is if they have a low contribution rate.

Don't forget also that stretch Roth is ***extremely valuable*** when that time comes and a way overfunded tIRA account in an example of someone that even contributed 20% of income through life is very penalizing especially when RMDs come out if they've been using excess tIRA assets as a safety cushion(something more suitable to Roth). Also don't forget that retirees tend to run lower on available deductions, exemptions, etc. 

dshibb said:   
Yeah you have it right although you're response is just a rephrasing of what I wrote in the subsequent paragraph.
Right, the way that it was phrased, you seemed to be saying conflicting things in those paragraphs, which is the reason that I wanted to clarify.

Without getting into the specifics of each individual situation(because even still it will vary a lot) for your typical person if you put away 15% of your salary towards retirement plus the match you'll probably pull off an asset pool large enough to be able to safely distribute roughly your own working years income after taking into account social security.When you say 15%, are you saying that it's the same number regardless of whether it's in Traditional, Roth or taxable accounts and regardless of the specifics associated with the structure of retirement plans? If so, while I appreciate that you are speaking in generalities, you are going to end up with absolutely enormous differences in retirement values. Remember, for instance, that high earners can max out their respective 401(k)'s/403(b)'s/TSP's with just a small fraction of their incomes. Also remember that some people are eligible for pensions and/or have employers making very large retirement contributions on their behalf regardless of whether those employees contribute anything to their retirement accounts.

In other words, while I certainly do appreciate the fact that you are speaking generically, I think that the 15% figure can be very confusing to a lot of people out there. For instance, a career federal employee who was covered under CSRS may've contributed very little or even nothing to his or her TSP but can still end up with more money than a person who was making the same money in the private sector and who dutifully contributed 15% of his salary to a 401(k).

Just to clarify, I fully agree with the substance of your post. I am just saying that the 15% figure is probably going to add more confusion than clarity.

LeveragedSpeculator said:   Can you imagine the popular press writing articles about someone with a seven figure Roth IRA and not paying taxes?  I can see the spendthrift plebs with their pitchforks already.
There are already stories like that out there. See this:How A Serial Entrepreneur Built A $95 Million Tax Free Roth IRA http://www.forbes.com/sites/deborahljacobs/2012/03/20/how-facebook-billionaires-dodge-mega-millions-in-taxes/ 
 

dshibb said:   
geo123 said:   In general, people need to remember that being in a situation where in retrospect a Roth contribution would've been more advantageous than a Traditional one is a good problem to have, as it generally means that you've amassed a lot more in retirement funds than you had anticipated and is a situation that doesn't happen to most people out there.

The one obvious exception to the above rule has to do with people just starting out who can be reasonably expected to make way more money for the rest of their careers and to continue to diligently save towards retirement.


 

  
While I agree with the spirit of everything you said the bold stuff I do disagree with given the exact way you wrote them. The issue isn't an income issue nor is it a 'luck of the draw' issue. It's a behavioral issue pure and simple. It's an issue of financial responsibility and it is scales completely on income so there isn't much if any advantage a higher income person has to a lower income person on this issue. The reason why it's scalable is because while a lower income person has less to put away they also have a much lower total asset pile they have to generate to replace their income during retirement. The higher income person has to generate a much higher asset pool to replace his income and honestly in a lot of cases even financially sophisticated high income people can have a higher likelihood of undershooting than their middle income friends because of the disparity in targets.

So it really comes down to the question of "What percentage of your income do you put away every year?" In a lot of ways that is all you need to know to roughly produce a good guess on what portion of assets should be traditional and what portion should be Roth. After that you then look at what their prospects are for higher income(or how parabolic is their income so to speak given their career track where doctors have much higher spreads between what they make as residents vs. practicing which is similar to small business owners which is similar to sales guys generally, but if you look at maybe a construction worker their income will probably only barely increase over inflation if that). If you have a reasonably high likelihood of a large rate of change in income than you should be front loading Roth and backloading tIRA/401k assuming you maintain a *financially responsible contribution rate*.

But the truth is that off these forums there is another half of the public that is financially irresponsible and those folks should only be contributing to 401k/tIRA because they aren't responsible enough to set enough away for retirement to even come close to replacing their income while working.

  
I agree with this, I would also add that at the OP's age he may not be married yet, and its possible that depending on how much his spouse makes getting married may push him into a lower tax bracket for a time making the Roth more favorable during that period.

Geo
1) I completely agree that it's going to produce a pretty decent degree of variability especially if you included a pension(but I would then argue said pension should be actuarially included in the percentage-I adjusted for typical match, but not pension). Not only that different investment performances over time will produce considerably different results as well. I get that.

2) I disagree that it adds more confusion than clarity. The current misinformation about the absolute superiority of Roth to Traditional adds more to confusion than clarity. The lack of anything resembling a realistic idea of how much Roth vs. Traditional a person should do adds more to confusion than clarity. Even an attempt at giving a way over generalized rule of thumb idea is at least a lot more useful than flying completely blind on this issue(as 99.9999% of even responsible financially astute people are now).


3) How else could a person handle it and be remotely understandable? I get the obvious limitations of trying to throw out some rule of thumb here, but you want to see confusion over clarity it would take me 50,000 words to try to cover even the generalities of all the exceptions, adjustments, etc. that could go into this topic particularly since there is like 60 variables(many small and a few large) that could go into estimating someone's exact retirement dollar figure at retirement while they're remotely young.

LeveragedSpeculator said:   Another risk with the Roth that no one seems to be considering or talking about is legislative changes. When you get the tax benefit from your traditional 401k or IRA contributions today that can't be taken back from you in the future. However as the Roth benefits are back-ended, there always remains a risk that DC will see that money as a piggy bank at some point in the future. I see this risk as small barring a large financial crisis, however since 2008 I see a large financial/government financial crisis as a distinct possibility. All politicians would have to do is underfund SS until it runs out, then look to the diligent savers to bail those out who never saved and were reliant on SS.

Something to consider. And while this would in effect be double taxation, it already happens with corporate dividends and would be possible, especially when the first wave retires that utilized/maxed out this Roth 401k/IRA is able to live very well off in retirement.

Can you imagine the popular press writing articles about someone with a seven figure Roth IRA and not paying taxes?  I can see the spendthrift plebs with their pitchforks already.

  I've spent quite a bit of time considering this possibility. I do think the government will spend until it goes broke and will be in a desperate search of money.

I think the Roth IRAs are safe so far because they are not widely used. There would simply not be a lot of funds for politicians to get their hands on. Perhaps that will change in the future. The negative publicity would outweigh the benefit of the small amount of funds that could be taxed. Where as there is a lot more money to chase in 401k plans.

Politicians generally don't like to re-neg on a deals... I think a far more likely scenario is they try to confiscate wealth covertly and repay the national debt through inflation which would have a bigger impact on 401k as it will increase nominal returns and thus tax burdens. Most people won't protest this because they won't even realize it is happening.
 

dshibb said:   
2) The only reason why someone would do entirely t401k is because they think they're going to have less income from their retirement accounts during retirement than they make while working. That is essentially them saying that they would rather live it up while working and have a drop in their standard of living while in retirement. The only way that makes sense in practice is if they have a low contribution rate.
There are two separate issues here. An enormous if not an overwhelming percentage of high income earners have 100% of their retirement contributions in traditional accounts (other than backdoor Roth IRA's, if they choose to/are in a position to have those) and it typically has nothing to do with a low contribution rate.

If you are in something like the 39.6% federal income tax bracket, plus AMT (or are already making way more than the AMT threshold) plus state income tax, then it makes perfect sense for most of them to only have traditional retirement accounts. Even with huge retirement savings, they'll still need taxable income when they retire to fill all the lower tax brackets, which means that tax rates would have to rise dramatically for them to end up being better off with Roth accounts. This is not even to mention the fact that if they choose to retire early and/or move to a lower or no tax state, they'll come out way ahead with traditional accounts. This is also not to mention the fact that high income earners don't need to have a retirement stream anywhere near the income stream that they had during their working years to have the same standard of living.

brettdoyle said:   I've spent quite a bit of time considering this possibility. I do think the government will spend until it goes broke and will be in a desperate search of money.

I think the Roth IRAs are safe so far because they are not widely used. There would simply not be a lot of funds for politicians to get their hands on. Perhaps that will change in the future. The negative publicity would outweigh the benefit of the small amount of funds that could be taxed. Where as there is a lot more money to chase in 401k plans.

Politicians generally don't like to re-neg on a deals... I think a far more likely scenario is they try to confiscate wealth covertly and repay the national debt through inflation which would have a bigger impact on 401k as it will increase nominal returns and thus tax burdens.

  
If we're talking about a time horizon to retirement it wouldn't be the same ones who voted for it initially.  I'd bet there are only a handful of career politicians left that enacted the original 401k or IRA laws.  Remember politicians ultimately answer to voters, and there will be more dependent on SS/govt handouts than saved diligently their entire lives, that you can count on.

And right now Roth adoption is quite small, true.  However it wasn't until recently that I noticed employers were widely adopting Roth 401k plans with their benefit administrators.  I suspect use will rise over time.  But I don't think it will ever approach 401k use levels because 1) the public isn't good at math and doesn't understand how Roth vehicles work and its far easier to explain you save taxes today with traditional IRA & 401k and 2) no one is defaulted into Roth 401k elective deferrals yet many are now defaulted into 401k plans.

Your far more likely scenario is true and they've been trying to do that, but they don't have the direct means to induce inflation.  What they do have the direct means is to increase marginal tax rates in the case of a bind, and that's 401k withdrawals.  And if Roth adoption is small enough, while indeed a smaller pot of $, that's less voters to p1ss off.

That example above of the Roth IRA mega-millionaire entrepreneur (and I know of someone else who claims to have a 7 figure Roth via tech stock IPOs in the 90s and may have), means congress will likely look at this issue in the future, call it "abuse" and introduce limitations.  How far down the totem pole they go is anyone's guess.

This article from the Journal of Financial Planning helped me decide between pre and post tax accounts:

Thinking About a Roth 401(k) 

geo123 said:   
dshibb said:   
2) The only reason why someone would do entirely t401k is because they think they're going to have less income from their retirement accounts during retirement than they make while working. That is essentially them saying that they would rather live it up while working and have a drop in their standard of living while in retirement. The only way that makes sense in practice is if they have a low contribution rate.

There are two separate issues here. An enormous if not an overwhelming percentage of high income earners have 100% of their retirement contributions in traditional accounts (other than backdoor Roth IRA's, if they choose to/are in a position to have those) and it typically has nothing to do with a low contribution rate.

If you are in something like the 39.6% federal income tax bracket, plus AMT (or are already making way more than the AMT threshold) plus state income tax, then it makes perfect sense for most of them to only have traditional retirement accounts. Even with huge retirement savings, they'll still need taxable income when they retire to fill all the lower tax brackets, which means that tax rates would have to rise dramatically for them to end up being better off with Roth accounts. This is not even to mention the fact that if they choose to retire early and/or move to a lower or no tax state, they'll come out way ahead with traditional accounts. This is also not to mention the fact that high income earners don't need to have a retirement stream anywhere near the income stream that they had during their working years to have the same standard of living.

  
I think you're giving caveats that fit exactly with what I said. If you have a lower contribution rate because you don't think you'll be replacing your income than you would be right about this which is the exact rationale I gave. Presumably though if you were high income trying to even come close to matching your working income than you would be subject to the same taxation(with the only exception being moving from a high state income tax rate to a low one), but that is largely washed out by the value of some Roth holdings for stretch Roth(because in 99.99% of cases people don't manage to finish off every last dollar of their retirement assets the day they die and instead by just being on the safe side they end up passing away with substantial left over assets).

There is one other important piece that I've forgot to mention.

For a very smart person the first roughly $25k of Roth contributions shouldn't come at the expense of t401k or tIRA at all. Instead they should come at the expense of the vast majority of your taxable emergency fund. You would then hold your emergency fund assets in 401k/tIRA and then when emergency strikes you sell stable assets in 401k/tIRA and buy equities there. You sell equities in Roth IRA and withdraw funds from Roth IRA.

So the first thing to understand is that for the very financially astute Roth holdings are advantageous as a pass through vehicle for funding emergency needs so that you can place your emergency fund within a tax sheltered vehicle.

dshibb, you're talking about 15% + match. But the match rate will vary based on the employer. So that could be 15% or up to 21% or even more. DO you mean 15% including the match? Otherwise I'm not sure why the retirement savings goal should vary depending on how generous the employer match is.

dshibb said:   
Presumably though if you were high income trying to even come close to matching your working income than you would be subject to the same taxation(with the only exception being moving from a high state income tax rate to a low one)...
I agree that we seem to be on the same page. Having said that, people need to remember that even if their retirement income stream ends up putting them in the same exact tax bracket that they were in during their working years, they would be FAR better off with 100% of their retirement funds in Traditional accounts.

That's because if you are in a 28% tax bracket now, when you make your retirement contribution your money comes off the top, which means that with a Traditional retirement contribution you'd immediately save 28%. When you retire, even if you end up in the same exact 28% tax bracket, you'll still have a portion of your retirement stream taxed at 0%, 10%, 15%, 25% and 28%. Hence, the reason that you'd need to end up in a much higher tax bracket when you retire or have tax rates go up dramatically for the Traditional accounts to end up being less advantageous. Hence, also the reason that the higher your tax bracket is now, the less likely it is that a Roth contribution will make sense (other than a backdoor Roth IRA, which you'd only have after you've otherwise maxed out your other tax advantaged accounts).

weezyrob said:   This article from the Journal of Financial Planning helped me decide between pre and post tax accounts:

Thinking About a Roth 401(k)  

  
The analysis is good, but not entirely complete.

Say I currently contribute $20k a year towards retirement in constant(inflation adjusted dollars) for the rest of my life. If I all of sudden increase that to $20,001(which will subsequently grow by inflation since again we're talking about inflation adjusted dollars) is it appropriate to look at the extra $1 of contribution as having an average tax rate in retirement or an estimate of the marginal tax bracket at retirement(given my current contribution rate and a growth assumption)?

See? Switch what you're attempting to determine and you see that only looking at things from an average tax rate in retirement is a bit of a short cut not entirely encompassing of the truth. If you could actually handle the math involved you could in theory determine that the first $x of contribution rate annually will approximately produce the first retirement tax bracket, the next $y dollars of contribution rate annually will approximately produce the next retirement tax bracket, the next $z dollars of contribution rate annually will approximately produce the next retirement tax bracket...and so on.

If you could actually do the math(or just have a good general sense of what is going on) you should be able to plan better than what that article is saying. Make sense?

jerosen said:   dshibb, you're talking about 15% + match. But the match rate will vary based on the employer. So that could be 15% or up to 21% or even more. DO you mean 15% including the match? Otherwise I'm not sure why the retirement savings goal should vary depending on how generous the employer match is.
  
Again Jerosen this is always will be a very rough exercise(that is the best I could ever do for someone without looking at the exact situation). Let's just say roughly 18%-20% if you include the match.

As you approach closer to retirement you'll have a better sense of how far off you are. The math and your understanding of the situation you're in gets easier. But when you're 28 years old making $50k a year and reasonably expecting you'll be making $140k by the time you're 40 then all you have(given the size of the variables) is a guess at how much you want to front load your Roth contributions. If you're contribution rate is high and you intent to keep it that way then front load more Roth. If it's low then don't front load a lot of Roth since you'll probably be undershooting in your retirement years anyway.

The 15% is more of a guideline I'm using to just get a sense of how serious are you as a person while in a low income and early in age to being financially responsible towards your retirement and if you're much higher than that then you're probably the type that could overshoot your working income and then you would want to have started with more Roth contributions early in life.

Does that make sense? This is more art than science when your dealing with a 30 year old.

dshibb, OK gotcha. 18-20% including match makes sense. I thought that "15% + match" would mean that the actual savings goal would vary depending on how generous the match was which didn't really make sense.

dshibb said:   
psychtobe said:   for the OP, I think traditional 401k is best in the 31.85% bracket. I mean for all you know, you'll retire in Florida with no state income tax whatsoever.
  
It doesn't really matter where he retires. At this stage it really only matters where he works.

1) If he is unwilling to load up more on Roth this year and more on traditional 401k next year when his MTR rises then he's committing to near 100% t401k/tIRA for rest of his working life(absent a temporary fall in income for conversion). Why? Because if at any point he says "Oops I should be contributing at least some to a Roth IRA" the fact that he didn't do it this year and is looking at doing it a higher tax bracket means that he made a mistake this year.
2) The only reason why someone would do entirely t401k is because they think they're going to have less income from their retirement accounts during retirement than they make while working. That is essentially them saying that they would rather live it up while working and have a drop in their standard of living while in retirement. The only way that makes sense in practice is if they have a low contribution rate.

Don't forget also that stretch Roth is ***extremely valuable*** when that time comes and a way overfunded tIRA account in an example of someone that even contributed 20% of income through life is very penalizing especially when RMDs come out if they've been using excess tIRA assets as a safety cushion(something more suitable to Roth). Also don't forget that retirees tend to run lower on available deductions, exemptions, etc. 

  I'm going to repeat most of what Geo has written in response so forgive me.
1. A single year's Roth contributions are pretty irrelevant over a lifetime. So I think it doesn't really matter what OP does this year. But mathematically it's hard to imagine him pulling his last dollar of retirement income from a traditional account in the 31%+ bracket, so traditional is better.
2. Most of us have lower income years at some point. Disability, layoffs, early retirement, stay at home parents, part-time work, etc., all lead to lower income years and better times to convert.
3. There are 7 states with no income tax and several of them are good places to retire (depending on your tastes, etc). This automatically tilts the playing field toward traditional.
4. echoing Geo again, high income earners save a lot of their gross salary, so they can essentially maintain their standard of living in retirement while paying less in taxes than they pay while working. Again this favors traditional.
5. Stretch Roth IRA is awesome, I'm just saying there are usually more propitious times to get one than while working in the nearly 32% bracket.

The classic example where a Roth IRA is better is a medical resident (unusually low income and tax bracket, unlikely to be that low again ever). For almost everyone else, Roths are oversold - they're a good source of revenue NOW for the government, and why would I want to pay taxes now on the back of a promise from our broke-ass government that I won't have to pay taxes later (wink, wink)?

Currently in the 33% bracket, gladly using my traditional 403b/401a. In order to even enter the 33% bracket my taxable income has to be greater than $233,000. Throw in a standard deduction and two exemptions and that's gross income of maybe $250,000? Take out a high earning couple's dual SS of $50,000 and that still requires $200,000 of income. At age 70 the RMD is only 1/27.4 so that would be more than $5,000,000 in traditional accounts, and very few people (even high earners) are going to run into that situation. I certainly don't think I will be.

geo123 said:   
dshibb said:   
Presumably though if you were high income trying to even come close to matching your working income than you would be subject to the same taxation(with the only exception being moving from a high state income tax rate to a low one)...

I agree that we seem to be on the same page. Having said that, people need to remember that even if their retirement income stream ends up putting them in the same exact tax bracket that they were in during their working years, they would be FAR better off with 100% of their retirement funds in Traditional accounts.

That's because if you are in a 28% tax bracket now, when you make your retirement contribution your money comes off the top, which means that with a Traditional retirement contribution you'd immediately save 28%. When you retire, even if you end up in the same exact 28% tax bracket, you'll still have a portion of your retirement stream taxed at 0%, 10%, 15%, 25% and 28%. Hence, the reason that you'd need to end up in a much higher tax bracket when you retire or have tax rates go up dramatically for the Traditional accounts to end up being less advantageous. Hence, also the reason that the higher your tax bracket is now, the less likely it is that a Roth contribution will make sense (other than a backdoor Roth IRA, which you'd only have after you've otherwise maxed out your other tax advantaged accounts).

  
As I mentioned above I get the issue of each dollar distributed out of the tIRA coming out at different tax brackets. That is why I said that the vast majority of your retirement assets on a tied income basis should be tIRA. The only exception that I make is that let's say we used a current retiree today and his prior income for the last lets say 20 years has averaged around $220k(married) and is in the higher echelon of the 28% tax bracket. He would be better off distributing $150k tIRA and $70k Roth. The first reason is that the excess $70k comes at a neutral tax bracket in retirement(28%), but quite likely if he frontloaded the Roth contributions while you that was likely contributed back when he was in maybe only the 25% or 15% tax bracket which means he yielded savings there. Then on top of that this guy's got one hell of a pile of assets at this stage of the game. He's not going to maintain a burn rate to get this thing to 0 at death. He's likely going to have maybe $1 or $2 million left at death which means that his stretch Roth is likely going to save him another several hundred grand to the family when he kicks the bucket.

Also there is the fungibility that Roth grants in bypassing taxable emergency funds(which wouldn't apply directly to mister millionaire up there, but would apply to a lower income person).

Also on top of that I'm not letting on that I'm also a bit of a conversion/contribution strategy wizard with a couple aces up my sleeve that have substantial value as well.

This is the original OP. Very nice discussion, thanks everyone. To give out some more details, I can afford to max out both the IRA and 401k. Also, I am a PhD which increases the chance I would enjoy / be able to work past 65.

I like what geo said about retiring with lots of income being a good problem. This essentially means that due to decreasing marginal utility, traditional accounts provide additional benefits. If one retires poor, the extra savings from traditional accounts will be more valuable than the extra income from a roth account for someone retiring rich.

I may use the roth 401k this year only, but in the long term I plan to max out a traditional 401k and a (backdoor) roth IRA.

wilythefox said:   This is the original OP. Very nice discussion, thanks everyone. To give out some more details, I can afford to max out both the IRA and 401k. Also, I am a PhD which increases the chance I would enjoy / be able to work past 65.

I like what geo said about retiring with lots of income being a good problem. This essentially means that due to decreasing marginal utility, traditional accounts provide additional benefits. If one retires poor, the extra savings from traditional accounts will be more valuable than the extra income from a roth account for someone retiring rich.

I may use the roth 401k this year only, but in the long term I plan to max out a traditional 401k and a (backdoor) roth IRA.

Personally, in your situation I do not think that one type of an account has a clear advantage versus the other, unless, of course, you expect to consistently find yourself in a much higher tax bracket (higher than 28%) for the rest of your career and expect to accumulate very significant retirement savings. If you do, I'd lean towards a Roth contribution now. Otherwise, for the reasons above I think that it'd be safer to make a Traditional contribution now.

Having said that, I think that in your case it's possible to make a reasonable case for either one.
 

psychtobe,

I get your argument and it's certainly one way to look at it.

The entirety of my view for having at least some portion of Roth holdings is the following:
1) I tend to believe that among responsible individuals the opportunities for great conversions due to sabbaticals, being laid off, etc. tend to be pretty few and far between. I would typically estimate that the average career successful person will have maybe 1 or 2 in their lifetime. Events like disability are things you insure against, but don't plan around actually occurring.
2) While we may not see 31%(which operates under the assumption of him moving--which actually a majority of retirees don't because of grand kids), there is a reasonable chance of 28% which means that the physical tax bracket differential is low enough where other factors play a much larger impact.
3) Roth holdings have substantial tax fungibility uses throughout life. The emergency fund issue I brought up above is also a factor.
4) Most people don't go through all of retirement with a linear spend or burn rate. Actually several years of retirement will likely produce substantial large distributions against smaller distributions other years. Small quantities of Roth holdings do provide the ability to cushion and smooth out distributions during that period.
5) Then there is stretch Roth
6) Roth is a superior vehicle to hold reserves in than a tIRA during your retirement.
7) And this is all before talking about at least hedging your bets a little bit against the prospect of higher tax rates in the future. While I don't like to plan around congress, putting all my eggs in the basket of tax rates being the same or down in retirement doesn't exactly seem smart either given the frequency by which marginal tax brackets change in the US.
8) In the OPs case we do know that this years Roth contribution will be better than one after next year. If we operate under any assumption of some Roth holdings mixed with majority tIRA holdings is ideal than this does seem to me this would be one of those ideal times to do it(especially considering that even falls in income in the future due to life events will likely make even decent sized conversions subject to similar tax rates because he's likely to stay in the current state he lives in while working).


All that said how it exactly will play out I have no idea. There is a lack of detail so far that could allow us to increase our accuracy on a suggestion, but it seems to me that I would rather take my chances on a few years of overpaying tax rates from 31% vs. 28% or 25% vs. overshooting with small Roth holdings(for all of the above reasons) and trying to force even more of it all together at a time when his tax bracket is even higher. That's just my opinion(hence why I used the word "probably" in my first comment). How it actually plays out nobody could specifically say.

Very similar boat here OP. As a person who is teaching finance stuff and used to be in investment banking, I won't bother with Roth because:

1. a bird in hand is worth more than 2 in bush;
2. in case decades later I'm in higher than current brackets during retirement, I will simply do more charity to write things off. Heck, I can even incorporate a 501(c) or use numerous other tools at my disposable to avoid taxes when I'm old and grey, and live very comfortably.

wilythefox, working beyond 65 is one of those variables that I mentioned that can have a sizable impact.

And it's impact is to increase the proportion of Roth desired to the degree that you work beyond age 65(holding everything else equal) because you're shrinking the number of years between your true retirement date and your life expectancy. Less years means higher safe withdrawal rate at different stages of retirement. Higher safe withdrawal rate means higher income taken off of assets. Higher income means more reported income. More reported income means higher tax brackets. Higher tax brackets means the more you want to hold a portion in Roth to mitigate with.

Now this is just one compensating factor of many(some might go the other direction), but I just wanted to point out that if you plan on going longer than 65 then this is a compensating factor for more Roth not less.

dshibb said:   1) I tend to believe that among responsible individuals the opportunities for great conversions due to sabbaticals, being laid off, etc. tend to be pretty few and far between. I would typically estimate that the average career successful person will have maybe 1 or 2 in their lifetime. Events like disability are things you insure against, but don't plan around actually occurring.
Depends on the occupation, career path, etc... Highly successful CEO's, for instance, frequently have multiple periods where they are in between jobs (whether by choice or not). A ton of highly successful enterpreneurs have countless periods of $0 income. Quite a few employers offer sabbaticals to certain types of employees (it's fairly common in academia; it's less common but also isn't unusual in a number of industries).

It also depends on the reason that you are in a relatively high tax bracket. For instance, a couple of married professionals making $140K/year each is in the 33% tax bracket. If the wife (or the husband -- I don't mean to be sexist here) ends up taking some time off to care for the kids, the couple's tax bracket drops to 25%. This happens all the time and represents a great conversion opportunity.
And this is all before talking about at least hedging your bets a little bit against the prospect of higher tax rates in the future. While I don't like to plan around congress, putting all my eggs in the basket of tax rates being the same or down in retirement doesn't exactly seem smart either given the frequency by which marginal tax brackets change in the US.
Once again, the tax rates do not need to be the same in order for you to be far better off with 100% of your money in traditional accounts. You still need taxable income to fill lower tax brackets, so in situations where your only sources of income will be Social Security and your retirement savings, tax rates would have to rise dramatically (not just a few percentage points) for you to come out ahead with a Roth (unless you made those Roth contributions while you were in an ultra low tax bracket or you somehow accumulated retirement savings that are causing your income to be much higher than it was while you were working, which would be quite unusual).

Skipping 25 Messages...
gaffer said:   dukerau said:   I'm in the 25% bracket in a relatively high state tax state, and I do 100% pretax into 401k, and then max out Roth IRA. So I'm hedging some, and since my options of IRA are Roth or none (no Traditional since I have a 401k through employer), it's an easy choice there.
  
Technically speaking, aren't your IRA options between Roth IRA or Traditional IRA that is non-deductible, instead of Roth or None at all? Even if you have a 401k through employer?
Of course for the Traditional IRA that is non-deductible, the next step is to do the backdoor ROTH conversion, because you wouldn't want to hold funds on a non-deductible traditional IRA for too long anyway.


Right, so functionally speaking, Roth or none.



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