Author Topic: Ratio of Roth IRA to 401k at Retirement  (Read 9998 times)

The Dutchman

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Ratio of Roth IRA to 401k at Retirement
« on: February 20, 2015, 06:50:45 AM »
There will be no correct answer to this but I wanted to see some opinions. 

When you retire what is the most optimum ratio of Post Tax (Roth IRA) to pre tax (401k or Traditional Roth)? 

My plan/projection is 40% Post Tax and 60% Pre Tax. 

Roots&Wings

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #1 on: February 20, 2015, 07:06:57 AM »

My plan/projection is 40% Post Tax and 60% Pre Tax.

Care to elaborate on how this plan was developed and will be optimal for your situation?  The underlying assumptions seem to be missing.

thedayisbrave

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #2 on: February 20, 2015, 07:17:48 AM »
Following.. I'm curious to know what is "optimum".. I personally have been front loading my Roth like crazy (including converting old 401Ks) due to my youth/earliness of my career.  But I have a feeling my traditional solo 401k will catch up eventually.

boarder42

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #3 on: February 20, 2015, 07:26:38 AM »
mine will end where ever it ends from maxing them both out. 

so 36k a year into 401k and 11k into roth settles out at

76% 401k and 34% roth give or take.  now if i add HSA and taxable into this mix the breakdown is different.  Taxable is probably 12k a year and growing and HSA is 6550 a year so my retirement breakdown will really be.

55% 401k
18.3% taxable (probably higher)
10% HSA
16.7% Roth

FarmerPete

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #4 on: February 20, 2015, 07:36:19 AM »
Ideal ratio is enough $$$ to support you for 5 years in roth/taxed accounts, and the rest in 401k/IRA accounts...unless you invested in roth accounts because your tax rate was really low when you were younger.

Cromacster

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #5 on: February 20, 2015, 07:39:18 AM »
I think this largely depends on what you expect/plan your tax situation to be in retirement.  You are also somewhat constrained by contribution limits depending on how you are contributing to these accounts.

I've never really looked at this ratio before, but if I stick to my current contribution plan I will be at.

Non-Tax advantaged - 34%
Roth IRA - 16%
401(k) - 50%

I max both my IRA and 401(k).  Depending on how the taxes fall for the year I may switch to a traditional every now and then.

The Dutchman

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #6 on: February 20, 2015, 07:46:12 AM »

My plan/projection is 40% Post Tax and 60% Pre Tax.

Care to elaborate on how this plan was developed and will be optimal for your situation?  The underlying assumptions seem to be missing.

I have about 95% Roth right now because of changing jobs and rolling over.  So I have a fair amount of catch up to do with my 401k.  I plan to get 100% of my employer match, max out my Roth each year, and then keep ratcheting up my 401k until it is maxed out.  So I will start Roth Heavy and get to more 401k as I can. 

I don't have all the answers which is why I am shooting for a more even split.  Everyone has theories of taxes going up and you will be screwed when you withdraw from your 401k or that your tax bracket goes down and  you wasted money when you put things into Roth early.  I don't claim to know either way which is why I am trying to play it safe either way and get it as close to 50/50 as possible. 

If I could max out my 401k and Roth like Boarder42 then I wouldn't have this questionand I would have way more 401k. 

Again not saying I have the answer just curious of opinions and plans. 

johnny847

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #7 on: February 20, 2015, 08:51:11 AM »

My plan/projection is 40% Post Tax and 60% Pre Tax.

Care to elaborate on how this plan was developed and will be optimal for your situation?  The underlying assumptions seem to be missing.
I think this is part of the problem in trying to plan this out, as the OP said himself in the first line of this thread. Any discussion on Roth vs Traditional will always need to make some assumption about future tax rates which nobody can reliably predict so long as the withdrawals occur far enough in the future.


From boarder42's example, I don't think this is something some people need to plan though - people who max out a 401k/403b/457b and/or HSA at work and make too much to contribute to a Traditional IRA are going to be forced into a large traditional 401k and a small by comparison Roth IRA (unless of course they decide to contribute to a Roth 401k, which would be valid if they believe that there will be a large increase in taxes in the future).

For those that aren't in such a situation, I think contributing to traditional accounts makes more sense for those who want to FIRE, because they can use the Roth conversion pipeline. But again, this assumes that there isn't a big enough future tax increase that their marginal rate now is greater than or equal to their future marginal rate. I have no argument for or against this assumption because we really don't know.

VanityFIRED

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #8 on: February 20, 2015, 09:14:43 AM »
My opinion -obviously this depends on your goals and plan for how you will live in retirement.

If you can live comfortably in a low enough tax bracket, then the goal should be to have the majority of your savings in pre-tax accounts like a traditional IRA.  A roth IRA should have approximately 5 years worth of living expenses.

Every year you should be "re-filling" your roth IRA by rolling over 1 year worth of living expenses from your pre-tax (trad IRA) to your roth IRA.  The traditional IRA should never deplete itself if your withdrawal rate is less than the annual growth.

With this model assume you can live on $20k (in todays dollars) and assume a 3%/yr inflation.

So in my roth I would have: 20k + (20k*1.03^1) + (20k*1.03^2) + (20k*1.03^3) +(20k*1.03^4) = $106,200

My trad IRA would need to grow by (20k*1.03^5) = $23,185, so with a 3% inflation and 4% SWR, you'd need $331,200 to safely get that growth.

So my total (minimum) needed is $437,400, which would give me a ratio of ~ 75/25 (traditional/roth).  Of course I would probably like to have more than the minimums in each account just in case of the unexpected and I probably WILL have more in my traditional ira, so it'll probably be more like an 85/15 split.

And that's all assuming you don't have/need additional income like real estate or part-time work, etc.

Cromacster

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #9 on: February 20, 2015, 09:34:39 AM »
If you can live comfortably in a low enough tax bracket, then the goal should be to have the majority of your savings in pre-tax accounts like a traditional IRA.  A roth IRA should have approximately 5 years worth of living expenses.

Please note, if you rely solely on the Roth, you need 5 years worth in spending in *contributions* to bridge the gap.  For most people this means you will require other sources to bridge the 5 year gap until the roll over can kick in.

From your example it would take roughly 15-20 years of contributing to a Roth in order to be able to withdraw 20k/yr.

Gone Fishing

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #10 on: February 20, 2015, 09:41:01 AM »
I would not say that there is an "optimal" ratios as it depends heavily on your income, tax bracket, and age, but if I had it to do all over I would put as much as I could in tax deferred accounts (Traditional IRA, 401(k)) and anything left over in taxable accounts.  Then use the taxable accounts to fund my first 5 years of retirement while I set up my conversion ladder.

If my tax liability was negligible due to a low income/deductions or if I found myself in the gap where Traditional IRAs were not deductible, but I could still fund a ROTH I would only then fund the ROTH. 

If I found myself over the limit for ROTH contributions, I probably would not pursue a back door ROTH if I had other IRA balances due to the "blended funds" rules.   
« Last Edit: February 20, 2015, 09:50:04 AM by So Close »

skyrefuge

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #11 on: February 20, 2015, 10:19:10 AM »
It's seems like you're not completely clear on all the tax-sheltered savings options that exist. There are two different savings methods: pre-tax ("Traditional") and post-tax ("Roth"). And then there are two different savings locations: IRA and 401(k). The two sets can be combined to create four different account types. The one you seem to be unaware of is the Roth 401(k). Perhaps your 401(k) plan doesn't offer Roth contributions as an option, but it makes it confusing when you refer to simply a "401k" vs. a "Roth IRA", because people who have a Roth 401(k) don't know how to answer.

I have about 95% Roth right now because of changing jobs and rolling over.

Hmm, so are you also not familiar with the Traditional IRA? The way I interpret this statement (in the context of your other statements) is that you had Traditional 401(k) money, and when you changed jobs, you rolled the Traditional 401(k) into a Traditional IRA, and then converted the Traditional IRA to a Roth IRA. Is that what happened? If so, hopefully you did those conversions when your income was low! Otherwise your desire for a 50/50 Roth/Traditional split might be costing you a bunch of money.

For the record, I'm in the camp who uses Roth space only when my Traditional space is maxed out. So I will end up with something like 85% of my tax-sheltered money in Traditional IRAs + 401(k)s, and 15% in Roth IRA at retirement. Ideally I'd have 100% in Traditional, since I have plenty of post-tax savings to cover 5 years of Roth pipeline priming, but the limits prevent that.

Eric

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #12 on: February 20, 2015, 10:43:18 AM »
At retirement, the optimal ratio is obviously 100:0 Roth:Not-Roth.  No taxes ever again!  Yeah!  However, that's not the optimal way to get to retirement the fastest.  That would be closer to the opposite.

Roots&Wings

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #13 on: February 20, 2015, 11:10:08 AM »
I would not say that there is an "optimal" ratios as it depends heavily on your income, tax bracket, and age, but if I had it to do all over I would put as much as I could in tax deferred accounts (Traditional IRA, 401(k)) and anything left over in taxable accounts.  Then use the taxable accounts to fund my first 5 years of retirement while I set up my conversion ladder.

If my tax liability was negligible due to a low income/deductions or if I found myself in the gap where Traditional IRAs were not deductible, but I could still fund a ROTH I would only then fund the ROTH. 

If I found myself over the limit for ROTH contributions, I probably would not pursue a back door ROTH if I had other IRA balances due to the "blended funds" rules.

Agree!  Likely there is a way to model this based on the relevant variables.   Maybe there is a formula and someone more knowledgeable will chime in :)

My dad retired semi-early (50's), and always wished he put more in Roth, because he can only convert so much per year from traditional to Roth before incurring a higher tax bracket, and will be facing huge RMD sums.

I'm also unsure if I will have 'too much' saved in traditional accounts to convert tax effectively and/or withdraw as income over my retirement time horizon, but have some time to figure this out.
« Last Edit: February 20, 2015, 11:11:57 AM by step-in-time »

Mississippi Mudstache

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #14 on: February 20, 2015, 01:25:59 PM »
At retirement, the optimal ratio is obviously 100:0 Roth:Not-Roth.  No taxes ever again!  Yeah!  However, that's not the optimal way to get to retirement the fastest.  That would be closer to the opposite.

Out of sheer curiosity, how does the EITC play into this? Since your traditional -> Roth conversions are counted as "earned income", is it possible that it would actually be advantageous to an early retiree (particularly one with dependents) to have traditional IRA accounts that can be rolled over each year, thus meeting the minimum earned income criteria to qualify for the maximum EITC? Or is there some requirement that would prevent this arrangement (i.e., Is a W-2 required to qualify)?

I've wondered this before, and I don't bring it up because I want to get into a discussion of the ethics involved (I do not), but I would be curious if anyone knows the answer to this question.

brooklynguy

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #15 on: February 20, 2015, 01:51:58 PM »
Out of sheer curiosity, how does the EITC play into this? Since your traditional -> Roth conversions are counted as "earned income", is it possible that it would actually be advantageous to an early retiree (particularly one with dependents) to have traditional IRA accounts that can be rolled over each year, thus meeting the minimum earned income criteria to qualify for the maximum EITC? Or is there some requirement that would prevent this arrangement (i.e., Is a W-2 required to qualify)?

Traditional to Roth conversions are not counted as "earned income" and therefore won't help you obtain the EITC.

However, traditional to Roth conversions can be useful for manufacturing income for other purposes, such as qualifying for ACA tax credits.

teen persuasion

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #16 on: February 20, 2015, 02:20:26 PM »
Out of sheer curiosity, how does the EITC play into this? Since your traditional -> Roth conversions are counted as "earned income", is it possible that it would actually be advantageous to an early retiree (particularly one with dependents) to have traditional IRA accounts that can be rolled over each year, thus meeting the minimum earned income criteria to qualify for the maximum EITC? Or is there some requirement that would prevent this arrangement (i.e., Is a W-2 required to qualify)?

Traditional to Roth conversions are not counted as "earned income" and therefore won't help you obtain the EITC.

However, traditional to Roth conversions can be useful for manufacturing income for other purposes, such as qualifying for ACA tax credits.
 

True.  If you have no earned income, no EITC.  If you have some earned income, traditional to Roth conversions will increase your AGI, possibly lowering or eliminating any EITC.

johnny847

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #17 on: February 20, 2015, 02:24:53 PM »
Out of sheer curiosity, how does the EITC play into this? Since your traditional -> Roth conversions are counted as "earned income", is it possible that it would actually be advantageous to an early retiree (particularly one with dependents) to have traditional IRA accounts that can be rolled over each year, thus meeting the minimum earned income criteria to qualify for the maximum EITC? Or is there some requirement that would prevent this arrangement (i.e., Is a W-2 required to qualify)?

Traditional to Roth conversions are not counted as "earned income" and therefore won't help you obtain the EITC.

However, traditional to Roth conversions can be useful for manufacturing income for other purposes, such as qualifying for ACA tax credits.
I couldn't help but laugh at this - I've been doing a decent amount of manufactured spending lately, but calling a Roth conversion manufactured income cracks me up. I mean it makes total sense....it's just amusing.

teen persuasion

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #18 on: February 20, 2015, 02:26:18 PM »
I would not say that there is an "optimal" ratios as it depends heavily on your income, tax bracket, and age, but if I had it to do all over I would put as much as I could in tax deferred accounts (Traditional IRA, 401(k)) and anything left over in taxable accounts.  Then use the taxable accounts to fund my first 5 years of retirement while I set up my conversion ladder.

If my tax liability was negligible due to a low income/deductions or if I found myself in the gap where Traditional IRAs were not deductible, but I could still fund a ROTH I would only then fund the ROTH. 

If I found myself over the limit for ROTH contributions, I probably would not pursue a back door ROTH if I had other IRA balances due to the "blended funds" rules.

Agree!  Likely there is a way to model this based on the relevant variables.   Maybe there is a formula and someone more knowledgeable will chime in :)

My dad retired semi-early (50's), and always wished he put more in Roth, because he can only convert so much per year from traditional to Roth before incurring a higher tax bracket, and will be facing huge RMD sums.

I'm also unsure if I will have 'too much' saved in traditional accounts to convert tax effectively and/or withdraw as income over my retirement time horizon, but have some time to figure this out.

This is what I am trying to figure out, the optimal max to have in traditional accounts.  Enough to convert to Roth, but not so much that runaway growth forces high RMDs and the taxes associated.

Of course, our situation also includes complications such as trying to maximise EITC and minimize EFC for the last few kids at home.  Optimizing one skews the others.

Roots&Wings

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #19 on: February 20, 2015, 03:24:19 PM »

This is what I am trying to figure out, the optimal max to have in traditional accounts.  Enough to convert to Roth, but not so much that runaway growth forces high RMDs and the taxes associated.



Yes, that is what I am trying to figure out too.  Granted, it's a first world 'problem' and not the end of the world if you eventually end up in the same or higher tax bracket in retirement than during working years and lose the tax sweet spot for optimally converting traditional to Roth, but it would be nice to optimize as much as possible. 

Personally hedging Roth in the meantime based on my circumstances (e.g. tax bracket, estimated working years until retirement, account balances in traditional vs Roth and taxable, conversion scenarios, and RMD projections). Just a few variables with relatively high uncertainty to consider given my time horizon (and probably others I'm missing since I don't know how best to model this).

Jeremy

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #20 on: February 21, 2015, 01:28:50 AM »
I have a blog post coming on this, or more accurately, what is the best ratio of pre-tax/post-tax/taxable. I just need to spend a couple more days with Excel

We retired with 100% Traditional / 0% Roth which I think is the ideal ratio for somebody retiring extremely early

Our own example is explained here: http://www.gocurrycracker.com/gcc-vs-rmd/

Somebody with a more typical retirement date, a very large pension, or a large SS income may benefit from some Roth if they saved too much. Maybe. (Those 3 things all tend to go together though)

ender

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #21 on: February 21, 2015, 08:44:20 AM »
For someone planning ER the real question isn't so much whether tax rates change, but whether the following rules change:

  • Ability to convert traditional to roth by paying income taxes
  • Ability to withdraw roth contributions anytime and rollover contributions after 5 years

Assuming those stay the same, traditional is always preferrable for those seeking FIRE. Tax rates are largely irrelevant in the future, because ER seekers will have such low taxable income.

In my opinion it's incredibly unlikely that taxes on the amounts of income required for mustachian FIRE will increase much at all long term. Keep in mind that if you are FIRE and converting $50k* a year, your tax situation is currently the same as someone actively earning $50k/year and supporting a family of 4.

The liklihood that taxes on say $50k a year will increase enough that you will regret taking the huge pretax savings associated with deductible IRAs/401ks is incredibly small.

As long as the above rules exist FIRE'd people will have ridiculous opportunities to convert money to roth money for free. I don't think the first will, because the government collects all kinds of money from people who cash out 401k's when leaving companies.



*$50k is an example. But historical tax rates on the "lower income" folks have not changed much up/down for a long time. Look at inflation adjusted tax rates for FIRE'd levels of income. They are not dramatically different going back a looong time. If FIRE to you means $100k in taxable income/conversions yeah tax rates matter a lot. But most of us, after deduction/exemption(s) can convert a ton of money at rates very consistent with historical rates.

boarder42

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #22 on: February 21, 2015, 09:06:20 AM »
you do need a 5 year bridge though .. you cant be 100% trad.  you will need roth or taxable contributions to bridge the 5 year gap for the roth conversion pipeline to start delivering.

johnny847

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #23 on: February 21, 2015, 09:16:38 AM »
you do need a 5 year bridge though .. you cant be 100% trad.  you will need roth or taxable contributions to bridge the 5 year gap for the roth conversion pipeline to start delivering.
You could set up a SEPP for one of your IRAs. I'm fairly certain this is no "pro-rata" rule for SEPP withdrawals, so you'll want to set up a separate IRA for this. But the problem with this is once a SEPP gets started, it must continue for at least 5 years or until 59.5, whichever is later.

I only mention this because while it's not the greatest idea to plan on doing this because the SEPP has to continue for a long time for an early retiree, for people who have a significant portfolio, are practically 100% traditional, and want to FIRE, this may be a decent option compared to working more to saving in a taxable account.

For someone planning ER the real question isn't so much whether tax rates change, but whether the following rules change:

  • Ability to convert traditional to roth by paying income taxes
  • Ability to withdraw roth contributions anytime and rollover contributions after 5 years
I guess that's true. I can't imagine tax rates increasing dramatically for the low brackets that it becomes a significant factor for early retirees. That would not fly politically.

The Dutchman

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Re: Ratio of Roth IRA to 401k at Retirement
« Reply #24 on: February 25, 2015, 08:30:19 AM »
Some good information here.  Like I said before no clear answer but there are some great opinions. 

The one theme that I keep see coming up is that given the choice you should max out your traditional first.  That will provide tax deferred growth.  After that you should fund Roth.  If you want to really maximize you should have 5 years of spending in your Roth at retirement and utilize the "Roth Conversion Ladder". 

I know this is simplifying everyone's situation; but I was trying to summaries all the points without getting into a bunch of detail.