Author Topic: 401K Roth & Traditional Max Contributions for Tax Purposes  (Read 5449 times)

jwilliams0215

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401K Roth & Traditional Max Contributions for Tax Purposes
« on: April 21, 2014, 03:09:51 PM »
Through my employer, I have the ability to contribute to a 401K with both a Roth and/or a Traditional component. My goal is to maximize my tax savings currently and in the future.

I do understand (or perhaps believe) the max to be $17,500 in total and can contribute 100% to the Roth, 100% to the traditional, or anywhere in between. In contributing $17,500, I therefore can't contribute to a Roth IRA. Does this sound accurate?

On a personal basis, I live in Florida so don't pay any state income taxes. My income is $80K and have a year-end bonus that'll likely be between from $20K to $40K, but is not guaranteed. I currently try and contribute the $17.5K max, split evenly between the Roth/Traditional 401K. No other income generated and outside retirement accounts dividend income is minimal.

Further complicating the personal scenario. I'll be getting married this year and filing jointly. My SO has income of $47K, is contributing $9.4K to her traditional 401K and $3.6K to her Roth IRA.

Any general information or personal suggestions would be helpful!
 

Indio

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #1 on: April 21, 2014, 03:21:02 PM »
As your gf is doing, you can contribute to both the IRA and 401k simultaneously. The key is to make sure you don't go over the contribution limits for each plan. It is not a combined total of $17.5, that limit only applies to the 401K. Your combined max contributions can be $23K, if you're under 50 years old.

Cheddar Stacker

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #2 on: April 21, 2014, 03:39:41 PM »
401K contributions should not affect IRA contributions as indio mentioned.

Your are currently in the 25% tax bracket based on the data you provided. After you get married, you will still be solidly in the 25% tax bracket. That is too high, and you should very strongly consider all traditional 401K/IRA contributions whenever possible.

Read these to understand the reasons why paying 25% (in your situation) is just simply too high given all the strategies you can use to legally defer/avoid these taxes:
http://www.madfientist.com/retire-even-earlier/
http://www.gocurrycracker.com/never-pay-taxes-again/

aj_yooper

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #3 on: April 21, 2014, 03:54:59 PM »
+1 to Cheddar Stacker's recommendation.  You and your girlfriend need to max out your tax advantaged accounts or you will pay a ton of income taxes this year and in the future.  You have a good income and now is the time to protect it.

Indio

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #4 on: April 21, 2014, 04:13:19 PM »
That was a fascinating read and good analysis by madfientist. Thanks for positng it.

TomTX

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #5 on: April 21, 2014, 07:15:27 PM »
You should both be maxing (traditional) 401(k) contributions, and also traditional IRAs.

jwilliams0215

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #6 on: April 22, 2014, 06:41:05 AM »
Interesting, so the consensus plan is to utilize the traditional 401K (up to $17.5K each) and traditional IRA (up to $5.5K each) to get any income in the 25% tax bracket down. As long as I'm still in the 25% tax bracket, don't participate in the Roth?

Also I should utilize these tax deferred accounts for dividend based securities.

zurich78

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #7 on: April 22, 2014, 08:57:53 AM »
Interesting, so the consensus plan is to utilize the traditional 401K (up to $17.5K each) and traditional IRA (up to $5.5K each) to get any income in the 25% tax bracket down. As long as I'm still in the 25% tax bracket, don't participate in the Roth?

Also I should utilize these tax deferred accounts for dividend based securities.

Just a disclosure that I am not an expert but just wanted to weigh in on what I am doing.  But I would contribute to a traditional IRA last, if at all.  So if you have a match on the 401K then do that first, then Roth, then IRA.  If you don't have a match, I would do Roth first, then 401K, then IRA. 

Main reason is because a couple of years ago, I got a substantial raise and exceeded the maximum income requirement to contribute to a Roth.  So now I use the backdoor Roth method which still allows me to contribute to my Roth, but requires that I carry over no balance in my traditional IRA each year (unless I want to pay taxes on my Roth contribution).

Just curious on others' thoughts on this.  Since I exceed the income for direct Roth IRA contribution and have to do it backdoor (as long as the feds allow me to), I can't carry a balance in my IRA or I'm subject to pro rata.  So, in that event, I just have no IRA at all, I rolled it all in to my company 401K, and then I contribute the max to a Roth as well via backdoor. 

Cheddar Stacker

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #8 on: April 22, 2014, 11:36:27 AM »
Zurich78 mentioned an interesting wrinkle that can complicate things. When you start to make too much money (tough problem to have right?) you are phased out of deducting Traditional IRA's (TIRA) if you also have a 401K. Eventually you can also be phased out of direct Roth IRA contributions as well.

If you have a TIRA and you attempt a backdoor Roth contribution, you have to allocate a pro-rata portion of your Roth conversion to the existing TIRA, and a pro-rata portion to the new backdoor contribution. This means a portion of the conversion ends up being taxable and it sort of defeats the purpose of even making the contribution.

Contributing your TIRA into your 401K fixes that problem as long as your plan allows that, but it will also likely increase the fees you pay on your investments. I believe that's a trade off that makes sense, since it opens up the tax deferral window again and provides a lot of long-term savings you otherwise wouldn't have. I think it's a smart fix Zurich78, so nice work.

Even with the wrinkle you've mentioned, I still believe the immediate tax savings of the TIRA and T401K are simply too valuable to pass up by doing a Roth contribution. This is not one size fits all as I've seen others point out scenarios where Roth's make a lot more sense (mainly super low income), but with a 25% rate I think it should be almost automatic.

NinetyFour

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #9 on: April 22, 2014, 01:09:22 PM »
Your combined max contributions can be $23K, if you're under 50 years old.

I think you mean over 50.

lackofstache

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #10 on: April 22, 2014, 01:18:36 PM »
17.5+5.5=23.

Over 50 there are allowances for extra...

Cheddar Stacker

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #11 on: April 22, 2014, 01:29:17 PM »
Your combined max contributions can be $23K, if you're under 50 years old.

I think you mean over 50.

I think indio was correct with under 50 since it's referencing 401k + ira. At over 50 its really 17,500 + 5,500 catch up plus 5,500 ira + 1,000?? Ira catch up. That makes the over 50 limits more like $30k.

NinetyFour

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #12 on: April 22, 2014, 01:43:04 PM »
Oh, I now see what Indio meant.

Thanks, Cheddar.

Apologies, Indio.

nawhite

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #13 on: April 22, 2014, 01:43:37 PM »
Interesting, so the consensus plan is to utilize the traditional 401K (up to $17.5K each) and traditional IRA (up to $5.5K each) to get any income in the 25% tax bracket down. As long as I'm still in the 25% tax bracket, don't participate in the Roth?

Also I should utilize these tax deferred accounts for dividend based securities.

I used to agree with this reasoning, but it turns out we are going to get bit because of healthcare subsidies in retirement. We are maxing out traditional IRAs and 401ks thinking we would do the Roth Conversion Ladder in retirement to eventually pay no or small taxes on out money. The problem is that in retirement we will likely be eligible for health insurance subsidies for our premiums.

Unfortunately the Roth Conversion would not increase our tax obligation, but will decrease the subsidy we are eligible for. This effectively works out to a 13% tax on the Roth conversion (for every additional dollar we convert, our subsidy decreases by $0.13).

This might not apply to you, just something to keep in mind. (http://renewablewealth.com/articles/think-for-yourself/)

HAULIN3

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #14 on: April 22, 2014, 02:57:24 PM »
Sooo.... If I'm over 50, and my 401k let's me do roth OR traditional, I could potentiallyl do say $11,500 toward ROTH, 11,500 toward traditional, and then go outside of my 401K and do a Roth ira for $6,500??? or is 6,500 the max, and then I could do $23,000 just toward the traditional 401K....   I'm just trying to get this stuff straight...  p.s. our adjusted gross is under the amount needed for a Roth...

AND, my husband and myself both being over 50 can do the same, correct??

Mazzinator

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #15 on: April 23, 2014, 05:00:47 PM »
Sooo.... If I'm over 50, and my 401k let's me do roth OR traditional, I could potentiallyl do say $11,500 toward ROTH, 11,500 toward traditional, and then go outside of my 401K and do a Roth ira for $6,500??? or is 6,500 the max, and then I could do $23,000 just toward the traditional 401K....   I'm just trying to get this stuff straight...  p.s. our adjusted gross is under the amount needed for a Roth...

AND, my husband and myself both being over 50 can do the same, correct??

I think it's this:
401k 17,500 + 5,500(catch up) per person over 50, could be Roth/traditional/combo (46,000 total for both of you)
IRA 5,500 + 1,000(catch up) per person over 50, could be Roth/traditional/combo (13,000 total for both of you)

http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Catch-Up-Contributions

HAULIN3

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Re: 401K Roth & Traditional Max Contributions for Tax Purposes
« Reply #16 on: April 24, 2014, 11:52:54 AM »
Sooo.... If I'm over 50, and my 401k let's me do roth OR traditional, I could potentiallyl do say $11,500 toward ROTH, 11,500 toward traditional, and then go outside of my 401K and do a Roth ira for $6,500??? or is 6,500 the max, and then I could do $23,000 just toward the traditional 401K....   I'm just trying to get this stuff straight...  p.s. our adjusted gross is under the amount needed for a Roth...

AND, my husband and myself both being over 50 can do the same, correct??

I think it's this:
401k 17,500 + 5,500(catch up) per person over 50, could be Roth/traditional/combo (46,000 total for both of you)
IRA 5,500 + 1,000(catch up) per person over 50, could be Roth/traditional/combo (13,000 total for both of you)

http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Catch-Up-Contributions

Thank you!! This is exactly what I needed!!