I've been at my first job for about a year. I've built up about $5000 in my workplace's 401(k) and I also fund a Roth IRA. I subscribe to the general notion that, for someone of my age and income, the Roth-style retirement fund will net me the most at retirement. Last month, my employer began offering a Roth 401(k) in addition to the traditional plan I've been using. I'm debating signing up for the Roth 401(k), but here are the questions that occur to me:

1) Is there any benefit (a sort of hedge-your-bets approach) in having half your retirement be in traditional and half in Roth? In other words, are there any drawbacks to having 100% of your retirement be in Roth form? The conventional wisdom (401(k) to the match, then Roth to the max, then 401(k) with what's left) doesn't address Roth 401(k)s.

2) Does it make sense to just 'strand' the $5000 that's already in the traditional 401(k)? Since you can't roll a traditional 401(k) over into a Roth, that money would just sit there and I'd start my Roth 401(k) over at $0. Or would I be better off maintaining the traditional 401(k) for as long as I stay with my current employer (the 'what's done is done' approach)?

Ultimately, I am fairly sure I would have gone with the Roth 401(k) had I the choice at the beginning. My question is, is it worth it to change to a Roth 401(k) at this stage?

Other information that may be helpful -- I'm not really close to a tax bracket boundary, and expect my student loans to be paid off in a few months (in other words, there's not much of a chance my traditional 401(k) contributions will bump me to a lower bracket in the near term).

Any opinions?

One possible drawback to a Roth would be if they decide to treat them like traditional IRAs (tax it all) or nondeductible IRAs (tax the profits) some time in the future.
One possible drawback to the traditional 401k is that, under current law, a sizeable 401k payout can cause your social security benefits to be as much as 85% taxable. (in other words, 85% of SS can be included in taxable income if your income is too high)

Lol at above post.

Earnings coming out untaxed is a huge advantage if the investments dont let you down. Dont forget that fact...(assuming of course they (IRS) leave Roth gains alone)

If your investments doubles every 10 years (find better investments) you would be saving the taxes on nearly 4x your initial investment by the time you retire...but I'm just a simpleton who subscribes that that mantra above (and if you have a roth 401k all the better for a young investor).

If you're very unsure about your future tax situation, splitting between Roth and regular 401ks is a way to diversify your tax liabilities. Not to say that's a great strategy -- if you're very unsure, you probably need to get some professional advise. However, if you are just starting out, you almost certainly will have higher taxes in the future. Personally, I'm just starting out and I'm predicting (for what it's worth) that taxes will probably rise in the future, in general. For now, my money is going to the Roth without a second thought.

I have a 80-20 split. Mostly because I think there's about an 80% chance that I will be in a higher tax bracket at the time I retire due to personal feelings on my future and an expectation that income taxes will rise.

If I am wrong, I bite the bullet and deal with the fact that my effective contributions were lower now, and benefit with the 20% I have in my traditional. If I am right, sweeeeeet. I just have the lost opportunity cost of putting the 20% in the traditional as opposed to Roth.

Again, I suggest everyone read the example in Geo's last post. It's a good one, and commonly misconstrued and misunderstood.

geo123 said:bNeta86 said:Lol at above post.

Earnings coming out untaxed is a huge advantage if the investments dont let you down. Dont forget that fact...(assuming of course they (IRS) leave Roth gains alone)

If your investments doubles every 10 years (find better investments) you would be saving the taxes on nearly 4x your initial investment by the time you retire...but I'm just a simpleton who subscribes that that mantra above (and if you have a roth 401k all the better for a young investor).Not again! Haven't we explained this quite throroughly in the past (just SEARCH this forum)?!

If in a particular year you can only allocate an amount towards your retirement savings equal to the contribution limit (in other words, you can either contribute the full $15K to 401K or $15K minus taxes to your Roth 401K; you can't afford to max out the roth and pay the taxes from some other pot of money), then the decision between Traditional vs. Roth, based on math alone (there are other considerations), is based purely on the tax bracket now vs. anticipated tax bracket at retirement.

If you require an easier example, if you have $100, your tax rate now and at retirement will remain the same at 20% and your retirement funds will triple over the course of your life, you have the following:

Traditional: $300 at retirement, minus 20% tax = $240
roth: $80 invested now ($100 - $20 tax) = $240 at retirement (no tax is owed then).

So, if your tax rate is the same now and at retirement, it makes no difference whether you choose a roth or a traditional account. Once again, if your tax rate is higher now than what you will have at retirement, you will come out ahead with a traditional account. If it's reverse, a roth is more advantageous.

Please keep in mind that your ability to make larger after-tax contributions does NOT automatically mean that a roth is a better alternative -- you still have to look at the math I explained above to determine this. For instance, even with a larger after tax contribution attributable to a roth, if you are in a 25% bracket at the time of the contribution but will be in a 10% bracket or lower at retirement (which can happen even with very large assets if they are invested in tax exempt vehicles), the larger assets in a roth account will often have come at an unreasonably high price of overpaying your taxes.

Another reason that many people (even those who can afford to max out the roth) are often better off contributing to traditional accounts is because it gives them the ability to convert that account to a roth in a year where they are temporarily in a lower tax bracket. Most people experience those lower tax bracket years in their lives -- people go back to school, get married to non-working spouses, have kids, lose jobs, take sabbaticals, decide to work part-time, etc... Converting all or a portion of a traditional account to a roth in such a lower tax bracket environment can save quite a bit of money.

Once again, please take the time to understand the differences between Roth and Traditional accounts and then run the numbers for your specific situation.

P.S.
Aren't you a financial advisor who charges 1% for your advice?

One other thing to consider is that if you are near the AMT limit. with the deduction now, you may not hit AMT, but if you go with ROTH and have more taxable income you may hit the AMT mark

KnickFanRA said:If you think there is a 50-50 chance that you end up in a higher (or lower) tax bracket in retirement, and you take your suggestion and use the information that you have to make a Roth or Traditional selection, aren't you essentially flipping a coin for maximum profit or maximum disadvantage?If you are truly neutral -- you think your rate has exactly as much chance of going down as up -- then splitting 50/50 is fine (but so is any other split). If you think it's 51/49, go with the 51.

If you are very risk averse, then don't be averse to making one bad call, be averse to not having enough money. The Roth option is less risky than the traditional (you pay today's known rates rather than tomorrow's unknown rates). So if you're very risk averse, that should push you a little toward the Roth, that's all.How would this be different than the decision between an investment which will either return 10 or -5 and one which returns 5 or -2.5?With two investments, diversification makes sense if they're not (completely) correlated -- a combined portfolio can have lower risk than any of its individual holdings. Ignoring that possibility -- if those 2 investments will be either both up or both down -- there's no general reason to split between them 50/50. The more you hold of the first, the higher your expected return and the higher your risk. You should figure out how much risk you can stand, and then buy just enough of the first one to give you exactly that risk level.

asdf9876 said:Why? Because tax brackets are marginal.

Let's say I'm in the 25% tax bracket now and when I retire I'm in the 28% tax bracket. By your logic I should be 100% Roth and 0% Traditional.

However, even in retirement, the $x amount is tax free, the next $Y amount is 15%, etc.

Therefore if I can "avoid" 25% taxes on a piece of my "top line" income and then in retirement I pull $X+$Y per year from my traditional account and then pull the rest from my Roth account I will be better off.I'm not following your point. If you're in the 25% bracket today, and you'll be in the 28% bracket in retirement, and you don't care about the other differences (like no required lifetime distributions from a Roth IRA), then the marginal dollar belongs in the Roth IRA. It really is that simple.

If money you've already contributed one way or the other affects your guess of your future tax rates, you need to take that into account, but no more than any other information about future tax rates.

LH2004 said:asdf9876 said:Why? Because tax brackets are marginal.

Let's say I'm in the 25% tax bracket now and when I retire I'm in the 28% tax bracket. By your logic I should be 100% Roth and 0% Traditional.

However, even in retirement, the $x amount is tax free, the next $Y amount is 15%, etc.

Therefore if I can "avoid" 25% taxes on a piece of my "top line" income and then in retirement I pull $X+$Y per year from my traditional account and then pull the rest from my Roth account I will be better off.I'm not following your point. If you're in the 25% bracket today, and you'll be in the 28% bracket in retirement, and you don't care about the other differences (like no required lifetime distributions from a Roth IRA), then the marginal dollar belongs in the Roth IRA. It really is that simple.

If money you've already contributed one way or the other affects your guess of your future tax rates, you need to take that into account, but no more than any other information about future tax rates.

You're right, what I meant was what tax bracket you would be in if your Roth was taxable. Otherwise you end up with 100% tax free income in retirement and you throw away all the low tax brackets.

I'm just saying let's say you'll want more money per year in retirement (i.e. income). But if you plan on putting it 100% in Roth then you have no taxable income so then you are in the 0% tax bracket. Then because you're going to be in the 0% tax bracket and you are currently in the 25% tax bracket by your logic you shouldn't hedge or go 50-50 so then you should put 100% in traditional. But then because it will be 100% taxable you're now in the 28% tax bracket so by your logic you don't hedge so you now put 100% in Roth.......


So my point is regardless of what "income" you want in retirement it is not easy to predict your tax bracket. I don't see doing an 80-20 split as a diversifying compromise. In fact it could be "optimum" because you have to get the lower tax bracket in come from *somewhere*.


A lot of people like the idea of splitting between Roth and traditional accounts. I do not.

Would you care to explain where my 0%, 15%, 25% tax bracket income is supposed to come from if I do not "split" between Roth and traditional?

LH2004 said:A lot of people like the idea of splitting between Roth and traditional accounts. I do not. Diversification is a good thing -- when you have no information about which investment is better. Everybody has SOME information about whether their tax rate will go up or down, even if they don't have a very definite opinion, and should use the information they have.

This is not true. You are forgetting that the tax system is always changing. Sure you can make concrete arguments about which investment vehicle is better based on today’s tax structure. However, you have no guarantee that when you retire that the tax structure will have gone unchanged. People that split between different vehicles are hedging themselves against changes in the income tax structure. Very rarely is it a good idea to have all your eggs in one basket.