Tax defer, inflation and Roths.

[momo]

Hi all.

Since it is tax filing season I wanted to ask the MMM community how they invest and plan for their retirement involving taxes. Recently multiple accountants have been informing me if I want to capture the most money now, it is in my best interest to participate in a tax deferred retirement account (traditional 401k). Their logic is it is better to capture the money now when inflation is lower. Do you agree with this?

Also the accountants feel if you want to use a Roth 401k or Roth IRA, you are leaving your fate in the hands of Congress. Yes it currently is structured so taxes should not be added on the capital gains. However, the argument can be made the government can create new tax laws allowing somekind of future taxes. Perhaps it won't be 90% taxed but how about 30%? Suppose the newer Roth accounts are subject to these newer taxes and the older ones might be grandfathered in, but even then it is no guarantee the government won't try to tap into the growing pool of Roth assets, right?

Essentially the accountants believe you if are are making retirement plans 30+ years into the future you are assuming a "fiscally responsible" government. The reality is we don't know how what the tax rates will be in one year from now, let alone 30 years from now. We also do not know how high inflation will rise, but we do know every year the value of a dollar depreciates.

Thoughts? Ideas? Please discuss. Thanks.

[jrhampt]

I base my decision to invest in a 401k solely on the basis of my current tax bracket (28%).  I could invest in a Roth 401k through work but choose not to because I want to lower my taxable income (I can no longer contribute to a Roth IRA).  I am not particularly paranoid about the government deciding to tax Roths in the future.

[NYD3030]

This is why I split my 401k contribution between the Roth and regular accounts.   I find arguments persuasive both ways, and since nobody knows what tomorrow's tax rates will be i don't let all my money ride on one or the other.

[brewer12345]

I have always taken the traditional 401k choice, believing that the bird in  the hand was more attractive than the Roth in the bush.  But I think it depends on your tax bracket.  For most of my working career I have had a federal and state/local marginal rate in excess of 30%.  I might feel differently it it had been 15%.

In my case it is looking like I made the right choice.  When I bail from the day job some time next year I will probably have at least a few years with a really low tax bracket and I willl start doing roth conversions.  My goal is ultimately to have my IRA assets half roth and half traditional so that I ave the ability to fully manipulate taxable income in any given year.

[GreenGuava]

My current employer offers both traditional and Roth options in the 401(k);  I choose to go with traditional for all of the 401(k).  I go with a Roth IRA because I cannot deduct a contribution to a traditional (I also cannot do a backdoor Roth - this is a concern some, but not all, years), and I'd rather have some tax-advantaged money than none.

My feeling is this:  I'm in a high bracket now (28% federal and I live in California for another 9.3%).  While I do think some taxes will go up in the future, I don't think there will be much - if any - effect on the brackets I'll choose to live in during retirement, especially in those years of it when I may be drawing upon the IRA.  In short, I don't think either party will make a meaningful raise on taxes on the lowest income earners - and that includes those withdrawing from an IRA.  Besides, an increase on those brackets would affect just about every elderly person - and there's a demographic that votes in far greater proportion to their demographic numbers than most (if not all) others.

[anotherAlias]

I've read the arguments about Roth vs tax deferred accounts.  There are so many variables with future wages, future taxes, inflation, etc, that I've decided to just hedge my bets.  I'm working on having my investments split fairly evenly between 401k/Ira, Roth 401k/Roth Ira, and my taxable accounts.

[arebelspy]

Roth max is 5k. If you are only saving 5k, you'll never ER anyways, so the question is moot. If you are planning to ER then it's not an either/or choice - you should be able to max the Roth AND contribute to a 401k.

The Roth is great for an early retiree for being able to access the principal early without penalty (or taxes, of course).

[GreenGuava]

Roth max is 5k.

Actually, the IRA contribution maximum - Roth and traditional, combined - for 2013 is $5500.  You can split that any way you choose.  If your earned income (dividends and the like don't count) is under $5500 for the year, it's capped at that instead.

The rest of your point stands - if you're only saving $5500, you won't ER so it's a moot point.

[arebelspy]

Right, thanks for the correction.

So max the Roth at 5.5k as well as doing the 401k bit (and quite possibly even some taxable).  Win-win.

[skyrefuge]

If you are planning to ER then it's not an either/or choice - you should be able to max the Roth AND contribute to a 401k.

Well, the OP is debating between a Traditional 401k and a Roth 401k, not a Roth IRA. Limits to the Roth 401k are the same as the Traditional 401k. But yeah, whet the heck, max the Roth IRA too, and then that makes the decision easier to do a Traditional 401k, as a hedge against the unknowable future government tax policy.

The upshot in my mind is that if future government tax policy is the only thing that would make one option mathematically better than the other, then pick one with the flip of a coin and don't worry about it, since it's a waste of time and energy to worry about stuff you can't control or predict.

I'm not sure I understand the relationship inflation has to this decision though...

[sherr]

First of all inflation does not play into the Roth vs Traditional vs taxable debate at all in any way. You shouldn't take advice from people who think it does.

Personally I disagree with the "it's a flip of a coin, make a random choice" advice. You should do the best thing you can with the information that is currently available. To do otherwise implies that you know things about the future, which clearly no one here does.

In my opinion that means that if you're in the 25% or higher tax bracket, put the most you can in Traditional (deductible) accounts. If you are in a 15% or lower bracket (or can't contribute any more to a deductible Traditional account) put everything you can in a Roth account. Once you've maxed out all the Traditional or Roth options you can start contributing to a taxable account.

[arebelspy]

If you are planning to ER then it's not an either/or choice - you should be able to max the Roth AND contribute to a 401k.

Well, the OP is debating between a Traditional 401k and a Roth 401k, not a Roth IRA.

What makes you think that?  Nowhere in their message do I see Roth 401k mentioned, but I do see Roth IRA mentioned.

Agree with you and sherr that inflation is irrelevant to the difference between the two types of accounts -- either way the money will grow based on your investments.

[skyrefuge]

What makes you think that?  Nowhere in their message do I see Roth 401k mentioned, but I do see Roth IRA mentioned.

Look three words before the phrase "Roth IRA". :-) But yeah, the OP doesn't specifically say that the Roth 401k is an available option being weighed, so my statement was too strong as well; I guess I just saw the post as weighing the pros/cons of Traditional-vs.-Roth in general, regardless of whether it's in IRA or 401k form.

And sherr, I don't know if you were referring to my "flip a coin" advice, but I suggested that only if there was no other factors to clearly tip the balance; my point was not to let worry about the uncontrollable future freeze you from any action. In reality, I figure in most cases the knowable factors obviate the need for a coin flip.

[momo]

Thank you everyone for sharing your thoughts.

To clarify I was referring to traditional 401k and Roth401ks. Currently weighing future options available through employer; we have both, however I am now pausing to consider adding more to the traditional tax deferred 401k portion.