Author Topic: Roth 401k or traditional 401k?  (Read 1529 times)

Jtrey17

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Roth 401k or traditional 401k?
« on: July 03, 2015, 09:31:09 AM »
Hello! I'm a long time reader, follower, admirer of all of you on this forum and am looking for your opinion on my retirement strategy. Which is better, the Roth 401k or traditional 401k option? My employer offers both. Currently I put in to the Roth (this was way before I started reading MMM). Is it better to pay the taxes now, or later? If more information is needed to answer the question please ask! I'm happy to supply it.

TN_Steve

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Re: Roth 401k or traditional 401k?
« Reply #1 on: July 03, 2015, 09:53:22 AM »
Here are some broad rules of thumb:

Many will say "Both," so as to get tax diversification.  I would agree with this if you think that your earnings/tax rate are likely to go up slowly.  Remember that any employer match will go into the traditional pot, regardless of your choice.  So even if you do Roth 100%, the match will serve as balance.

OTOH, if you are just starting out and expect steep increase trajectory from a current low marginal rate, Roth is more attractive (this is my kid's situation as a young engineer at company just out of start-up phase)

Or, if you make tons more money now than you expect to be paying tax on when you start tapping the retirement funds, a traditional 401k is likely a better idea.  (DW and me)

MDM

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Re: Roth 401k or traditional 401k?
« Reply #2 on: July 03, 2015, 02:53:54 PM »
Is it better to pay the taxes now, or later? If more information is needed to answer the question please ask! I'm happy to supply it.

As TN_Steve has already indicated, I'll ask: what marginal tax rate will you pay in retirement on money you invest today?  And, what marginal rate are you paying now?

You have to know the answers to those questions in order to know whether traditional or Roth is better.

Ok, you can't know the answer to the first part, but you might make some reasonable guesses.  Also note that your marginal rate in retirement may depend on your choice of traditional or Roth today: the more you have in Roth, the lower your taxable income (because Roth withdrawals are tax free); the more you have in traditional, the higher your taxable income (because traditional withdrawals are taxed).

So back to reasonable guesses.  One defensible rule of thumb is to use traditional if your federal marginal bracket is 25% or above, use Roth if that bracket is 10% or below, and flip a coin (or make a more detailed guess at your retirement situation) at 15%. 

This assumes no change in state tax - if you plan to retire in a state that will tax withdrawals much differently than you are being taxed in your current state, you should account for that.