Author Topic: Roth vs. Traditional 401K?  (Read 910 times)

Captain PlanIt

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Roth vs. Traditional 401K?
« on: January 29, 2021, 07:30:59 PM »
When I started investing for my retirement, the advice was so heavily in favor of Roth accounts that that's what I did, but I've begun to wonder if I should be contributing to a traditional 401k instead?

I got a new job this year and now make $80k/year. I max out a Roth IRA and contribute 8% of my income to the Roth 401k for a 3% match. My spending is at about $36k/year, so assuming that holds steady, I think my tax rate would be lower in retirement than it is now. So...does it make more sense to avoid the taxes now by contributing to a traditional IRA? Or is there another reason that the Roth is still a better choice?

seattlecyclone

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Re: Roth vs. Traditional 401K?
« Reply #1 on: January 29, 2021, 07:42:33 PM »
The correct thing to look at is your current marginal tax rate vs. what you think it will be during retirement. As a first approximation you might assume that your tax rate will be lower if your spending is half your current income, but it really does depend on many things, especially the ACA. If you plan to buy health insurance through the exchange you'll find that the premium subsidy phase-out acts as a 10-18% tax that sits on top of your standard tax bracket. Factor that, plus your personal estimate of how likely it is we'll still be using the ACA when you retire, into your guess of what your marginal rate will be during FIRE.

ender

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Re: Roth vs. Traditional 401K?
« Reply #2 on: January 29, 2021, 07:55:08 PM »
The correct thing to look at is your current marginal tax rate vs. what you think it will be during retirement. As a first approximation you might assume that your tax rate will be lower if your spending is half your current income, but it really does depend on many things, especially the ACA. If you plan to buy health insurance through the exchange you'll find that the premium subsidy phase-out acts as a 10-18% tax that sits on top of your standard tax bracket. Factor that, plus your personal estimate of how likely it is we'll still be using the ACA when you retire, into your guess of what your marginal rate will be during FIRE.

I'm glad you mentioned this, it seems like this really could mess with a Roth conversion pipeline efficiency.

seattlecyclone

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Re: Roth vs. Traditional 401K?
« Reply #3 on: January 29, 2021, 09:20:45 PM »
The correct thing to look at is your current marginal tax rate vs. what you think it will be during retirement. As a first approximation you might assume that your tax rate will be lower if your spending is half your current income, but it really does depend on many things, especially the ACA. If you plan to buy health insurance through the exchange you'll find that the premium subsidy phase-out acts as a 10-18% tax that sits on top of your standard tax bracket. Factor that, plus your personal estimate of how likely it is we'll still be using the ACA when you retire, into your guess of what your marginal rate will be during FIRE.

I'm glad you mentioned this, it seems like this really could mess with a Roth conversion pipeline efficiency.

Indeed! After my incomplete understanding of the rules led to my family being put on Medicaid, I decided we might as well try and ride this gravy train as long as it seemed like my family was getting decent care. We need to keep our MAGI below about $3k/month to do so. Go over by just a bit and we get punted to the marketplace plans. This would come with a cliff of about $1,000/year in premiums at the low end for the plan we might choose. This cost escalates pretty quickly from there according to the marginal rates shown in the blog post I linked earlier.

Not the end of the world if we do end up in that zone someday, but the combined rates are high enough to make it only slightly better to have chosen traditional over Roth, and that's with quite a high income during several of our DINK years.

Beach_Stache

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Re: Roth vs. Traditional 401K?
« Reply #4 on: January 30, 2021, 05:44:16 AM »
The correct thing to look at is your current marginal tax rate vs. what you think it will be during retirement.

+1.  I was in the lucky position where I've always maxed out my TSP/401k as well as my Roth IRA, as I got older I started a post-tax account as well.  Roth TSP has been around for a few years but I hadn't taken advantage until the last 2 years, as I was projecting what my regular TSP would be at retirement, and it's a lot, which could put me at a higher tax rate in retirement, so I'm hedging the bets more, DW doesn't have a Roth 401k, so she keeps maxing out 401k and I put most in my Roth TSP, then if we can contribute to Roth IRA (in phase out range) we do that as well so I can hedge my bets in retirement.  Roth we've paid so will never pay, but who knows, first 4 years in retirement tax rates may be huge and we want to take from Roth, then next 4 years they may lower and we want to take from 401k.  It's mostly about projections of what you will have and what you think the retirement rate will be at.  We won't see more than a normal cost of living in our salaries as we continue to work, so I can project pretty well.  I wish we had a Roth TSP/401k when I started work and was in the lower income range as I would have done that.  Try to project what  you'll be at at retirement, but if you want to retire early I would assume that traditional would be better so you can do rollovers to Roth when you're at low income tax bracket in FIRE.