Roth 401k or Traditional 401k

[Dr.Jeckyl]

My job started offering a Roth 401k option a few years ago. I have not used the Roth 401k yet but wondering if I should. My company puts about $5,000 in the traditional through a match and profit sharing per year. My wife and I are both maxing our Roth IRAs. I plan on retiring before 59.5 and would need access to the money. Would I be better off using the traditional and doing a Roth IRA conversion ladder?

Am I missing something?

Thoughts?

[mre]

For investment order, read this thread first:

https://forum.mrmoneymustache.com/investor-alley/investment-order/


There are ways to access money in non-ROTH accounts before traditional retirement age.  Look up ROTH conversion ladder which is a ROTH conversion method and Substantially Equal Periodic Payments which is not.

[dandarc]

The 59.5 thing is a minor inconvenience - well known ways to get around that are detailed here: https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Roth vs. Traditional is simple - do you think your marginal tax rate will be higher in retirement than it is today, or lower?  If you think it will be higher in retirement than it is now, Roth is the best bet.  If you think it will be lower, then generally traditional is the way to go. 

I'd say that standard advice for most members of this forum would be to go traditional - most here are spending far less than they earn, so are expecting retirement income and therefore tax rate to be lower in retirement than it is today.  Obviously, you should make your decision based on your specific situation and plans for the future.

I see MRE has already posted the investment order thread - that has a lot of good general advice.

[zolotiyeruki]

How much before 59.5 are you planning to retire?  You can withdraw Roth contributions (but not earnings) without penalty before then.  Also, if you set up a SEPP on an IRA, you can gain some access to those funds penalty-free as well.

[Eric]

In general, unless you plan to spend more in retirement than youmake right now, traditional will come out ahead.  Defer those taxes until you have no job.

[Beach_Stache]

Agree on deferring taxes with a traditional.  It does depend on how early before 59.5 you want to retire, if you will have a pension or not, and ultimately what your tax rate will be at.  If you retire early enough and have no pension you can do the Roth conversion ladder and pay very little in taxes each year compared to your current salary. 

I max my TSP and have for years, and plan on retiring early, but not super early (around 58 maybe) b/c I enjoy my job, but now I'm running into the good problem of potentially having too much in my TSP in 2 decades, so have been contemplating going to the Roth TSP as my normal TSP may have enough in 20 years to push me in a higher tax bracket when I start taking distributions.  If I were going to retire at 50 or younger though I would go traditional all the way, as you have so many years at lower tax rates where you can slowly convert.

[Dr.Jeckyl]

For investment order, read this thread first:

https://forum.mrmoneymustache.com/investor-alley/investment-order/


There are ways to access money in non-ROTH accounts before traditional retirement age.  Look up ROTH conversion ladder which is a ROTH conversion method and Substantially Equal Periodic Payments which is not.

WHAT           
0. Establish an emergency fund to your satisfaction           
1. Contribute to your 401k up to any company match           
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.           
3. Max HSA             
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level           
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)           
6. Fund a mega backdoor Roth if applicable.         
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.           
8. Invest in a taxable account with any extra.           

Looks like I'm currently working on 5.

This definitely made me think. I'm thinking salary when I should probably be thinking spending. Currently, I'm saving almost 40% of my take home pay in investment accounts. Which means that I only need 60% of my take home pay to live. Which as I get even older will probably be even less once the wife can draw her pension and even later when we could draw SS. So my taxable income would be higher now versus when I hit FIRE. Which seems to really point towards the traditional 401k being the better option. Less taxes now and lower tax bracket later.

[Dr.Jeckyl]

The 59.5 thing is a minor inconvenience - well known ways to get around that are detailed here: https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Roth vs. Traditional is simple - do you think your marginal tax rate will be higher in retirement than it is today, or lower?  If you think it will be higher in retirement than it is now, Roth is the best bet.  If you think it will be lower, then generally traditional is the way to go. 

I'd say that standard advice for most members of this forum would be to go traditional - most here are spending far less than they earn, so are expecting retirement income and therefore tax rate to be lower in retirement than it is today.  Obviously, you should make your decision based on your specific situation and plans for the future.

I see MRE has already posted the investment order thread - that has a lot of good general advice.

Good call. The issue was my thinking. "Most are spending far less than they earn" I was thinking that the amount I'd need in retirement is the same as what I earn now. But I'm living off about 60% of my income. I'm sure my travel expenses will go up but other expenses such as commuting, kid, etc... will go down.

[Dr.Jeckyl]

How much before 59.5 are you planning to retire?  You can withdraw Roth contributions (but not earnings) without penalty before then.  Also, if you set up a SEPP on an IRA, you can gain some access to those funds penalty-free as well.

I'm thinking I'll be able to hit FIRE in my early to mid fifties that's on my current trend but if I dig deeper I may be able to get there sooner and need the money well before my fifties. Then again I'm 40 now so ten years isn't that far away. I've looked into the SEPP and have thought that if I keep maxing my Roth IRA I may be able to pull some of that money in the beginning without touching the 401k.

[Dr.Jeckyl]

In general, unless you plan to spend more in retirement than youmake right now, traditional will come out ahead.  Defer those taxes until you have no job.

I'm a bit of an overthinker. This opens my eyes. If I spent more than I currently make I'd be spending almost double what I am now. Even sprinkling in some travel and other fun FIRE activities it would be unlikely I could do that.

[Dr.Jeckyl]

Agree on deferring taxes with a traditional.  It does depend on how early before 59.5 you want to retire, if you will have a pension or not, and ultimately what your tax rate will be at.  If you retire early enough and have no pension you can do the Roth conversion ladder and pay very little in taxes each year compared to your current salary. 

I max my TSP and have for years, and plan on retiring early, but not super early (around 58 maybe) b/c I enjoy my job, but now I'm running into the good problem of potentially having too much in my TSP in 2 decades, so have been contemplating going to the Roth TSP as my normal TSP may have enough in 20 years to push me in a higher tax bracket when I start taking distributions.  If I were going to retire at 50 or younger though I would go traditional all the way, as you have so many years at lower tax rates where you can slowly convert.

No pension for me but my wife has a pension. I've actually left pension and SS out of all my calculations for FIRE. Partly because my DW has been hesitant about talking to anyone to find out the info. However, recently she spoke with someone and YAY me for not calculating the pension because we are now in a pretty good spot adding it in. If we can wait until she is 55 then she'll be maxed on her pension but that will mean that we probably just start drawing less out of the retirement accounts at that point.

[MDM]

No pension for me but my wife has a pension. I've actually left pension and SS out of all my calculations for FIRE.

Might be worth estimating your retirement marginal rates in various scenarios, including
- one retires but not the other
- both retired but not taking wife's pension yet (this could make sense only if the pension payments will be larger if the pension start is deferred)
- retired with pension
- retired with pension and SS
- retired with pension and SS and RMDs.

See the investment order post for one approach to estimating those marginal rates.  Once you have those, the traditional vs. Roth contribution and subsequent t->R conversion strategies may be clearer.