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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: runjmc on December 18, 2014, 10:10:07 AM

Title: Roth 401k and IRA vs Traditional?
Post by: runjmc on December 18, 2014, 10:10:07 AM
So, I've just started embracing Mustachianism and of course now I'm looking to get all of my retirement ducks in a row; the company I work for now pays ~ 57k/yr and offers a Roth 401k or traditional (2% company match), and I'm eligible to contribute to an IRA with my meager income. My question is this: should I opt for the Roth 401k or the Traditional, and should I be stacking my IRA dollars into a Roth or Traditional?

I've crunched the tax numbers, and I'll be paying about $5700 less in taxes by fully funding the Traditional tax-deferred plans, which is a cool $5700 that I can then also invest in a personal account. Needless to say, another $5700 to invest is VERY alluring, even though I know that I'll have to pay taxes to convert to Roth accounts later (because I plan on retiring well before 59.5) AND on the interest from my personal investment account.

On the other hand, fully funding the Roth counterparts eliminates that tax down the line and also has the added benefit of the already having matured to that sweet 5-year penalty free withdrawal of principal point, and the rollover of the 401k being trivial and tax free.

So, at the heart of this post is the question of whether or not that $5700 in tax savings in the taxable accounts is the better deal versus having a withdrawal ready, tax-free Roth system set up. Any advice here would be greatly appreciated!

How about splitting my contributions 50/50 between Roth and traditional?
Title: Re: Roth 401k and IRA vs Traditional?
Post by: dandarc on December 18, 2014, 10:30:41 AM
A lot of people draw the Roth / Traditional Line between the 15% and 25% bracket.  If you are REALLY committed to keeping your expenses down for the long-term, traditional can be a good play unless it takes you below the line where you'd pay income taxes.  Question - are you considering federal tax only?  And are you single?

It appears to me that you might be forgetting to subtract at least the standard deduction and personal exemption before starting this analysis because $5700 is awfully close to 25% of the 23K 'maxing out' 401K and IRA for 2014 means.  Any health insurance premiums too, and HSA or FSA contributions.
Title: Re: Roth 401k and IRA vs Traditional?
Post by: dandarc on December 18, 2014, 10:37:23 AM (

Is a good article on the traditional vs. roth discussion.
Title: Re: Roth 401k and IRA vs Traditional?
Post by: runjmc on December 18, 2014, 11:30:49 AM
I did account for my standard deduction, personal exemption and my health insurance and FSA contributions, student loan interest, and CA state income tax and SDI/SUI in that overall tax figure. The figures come out to $8600 in tax if I max out Traditional retirement accounts vs $14000 if I do Roth, so it's closer to $5400 in savings. I'm relatively new to thinking critically about my tax situation so there's something I may have missed.

A little more about my situation: I'm single at the moment, likely to be married in the next 4-5 years to a social worker who will probably be making 60-70k/year at the highest end of the spectrum. She's also interested in FI, but not necessarily in quitting her job (yet).

Thanks for that article! I had no idea there was such a nice little backdoor option for converting traditional to Roth essentially tax-free if you're able to do it in yearly chunks equal to your deductions and exemptions (if I'm reading that correctly). Is that something that would still work assuming I get married to someone who continues to work through my retirement/FI? Could I accomplish the same thing by going the married-filing-seperately route to avoid having the wife's income tacked onto my IRA conversions?
Title: Re: Roth 401k and IRA vs Traditional?
Post by: dandarc on December 18, 2014, 11:48:54 AM
California taxes explains that difference - I'm in Florida so no state income tax (it is as awesome as it sounds).

You're reading that exactly correctly - the standard (if there is such a thing) withdrawal plan involves:

1.  Tradtional IRA
2.  Roth IRA for conversions
3.  Taxable Account

If you've got enough in all of those accounts you can avoid paying any taxes when you FIRE if you keep expenses low enough.  Additional wages throw things off - you're not able to control your taxable income nearly as well.  So if you're married filing jointly (which when you're married is usually the way to go), your wife continuing to work would throw a wrench into that.  So factor that into your plan!  Luckily you've probably got a few years to figure this all out.