The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: mistymoney on October 26, 2019, 07:20:44 AM
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I am making some progress - and I have my mini EF in place :).
I will be rejoining the 401k club very soon and had some questions about investment orders #1 and #4. I don't see a distinction on regular vs Roth 401k.
How does one decide? I think that I need the tax advantages of the regular, but would like to put a small portion into the Roth just to hedge my bets. As it all comes down to hypothesized future tax treatments - which we can only guesstimate and never really know until it is there. Like - if income tax were eliminated all together in favor of sales tax or similar. Unlikely - but just an extreme change that would upend current thoughts.
My salary is 128, and I will be starting at 6% to get the 3% company match. I was thinking 4% regular and 2% into Roth. But since the match goes regular - maybe 3/3 would be good?
Or should I just keep all in traditional and try to up the percentage as much as I can due to the tax benefits, and only consider Roth 401k when I am able to max the contributions?
TYIA for you inputs!
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I believe the investment order assumes regular 401k. The choice between Traditional and Roth is less about what the tax laws might be in the future (difficult to anticipate and unlike to change substantially) and more about the difference between your current income and expected retirement income. If you expect your income to be higher in retirement (inflation adjusted, probably) then Roth is better. For most Mustachians spending is way below income during working years so the required retirement income is also lower so Traditional is the better choice.
For you specifically your income is approximately equivalent to retiring with $3 million invested. If $3+ million is your FIRE target then going Roth is reasonable. My personal recommendation would be to stick with pre-tax (traditional) for your 401k and if you want to hedge also invest in a Roth IRA (you make too much to contribute to a Traditional IRA anyway).
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Even if you assume that your income and your income tax rate will be lower in retirement, I think it is a good idea to put money into a Roth. In fact, if you want to keep your MAGI low in early retirement, one way to do that is to draw from your Roth instead of a 401K or traditional IRA. Also, contribute to a Roth while you can. I waited too long and was only able to contribute to a Roth for a few years before my income became too high to contribute. I advised my daughter to contribute enough to her 401K to get the employer match and then contribute to a Roth.
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Even if you assume that your income and your income tax rate will be lower in retirement, I think it is a good idea to put money into a Roth.
With that assumption, why that conclusion? If you will pay a lower tax rate on withdrawals than you will save on contributions, you will have more spendable money using traditional.
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I don't see a distinction on regular vs Roth 401k. How does one decide?
See Traditional versus Roth - Bogleheads (https://www.bogleheads.org/wiki/Traditional_versus_Roth) for a deep drill.
In short, compare the 24% federal (plus whatever state&local) to your expected federal (plus whatever state&local) marginal rate when withdrawing. If you expect a lower marginal rate when withdrawing, use traditional now. E.g., if traditional withdrawals at 4%/yr are your only income, it takes more than $1.2 million in traditional assets to reach the 22% federal bracket, and more than $2.4 million to reach 24%.
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Even if you assume that your income and your income tax rate will be lower in retirement, I think it is a good idea to put money into a Roth. In fact, if you want to keep your MAGI low in early retirement, one way to do that is to draw from your Roth instead of a 401K or traditional IRA. Also, contribute to a Roth while you can. I waited too long and was only able to contribute to a Roth for a few years before my income became too high to contribute. I advised my daughter to contribute enough to her 401K to get the [full] employer match and then contribute to a Roth.
Pretend that you're Greystache's daughter, because her advice is golden.
Once you've filled the Roth bucket, you can either put more in the 401k for the tax savings, or in a taxable account to live on in the early years if you're planning to FIRE when you're still very young. At $128k/year, you should be maxing the first two options, with some left over for the taxable account.
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In your case, I would go 100% traditional to maximize your take-home pay. If you can only afford $7,560 per year in contributions on a $128,000 salary, I assume you're paying down some high interest rate debts. I was at that point a few years ago. When those are gone, you're maxing your 401k and still have extra cash left over, then you can think about paying that tax up front to give yourself flexibility in retirement.
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In your case, I would go 100% traditional to maximize your take-home pay. If you can only afford $7,560 per year in contributions on a $128,000 salary, I assume you're paying down some high interest rate debts. I was at that point a few years ago. When those are gone, you're maxing your 401k and still have extra cash left over, then you can think about paying that tax up front to give yourself flexibility in retirement.
And if that assumption isn't true, then it's time to enter a case study and get advice on how to cut costs and increase that savings rate! :)