Author Topic: Roth 401K vs. Traditional 401k  (Read 19247 times)

powersln

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Roth 401K vs. Traditional 401k
« on: June 20, 2012, 02:06:23 PM »
My employer offers both.    Currently I have equal amounts going into both.   Should I go 100% into the Roth?   I'm 25 now and looking to retire by 40.

JohnGalt

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Re: Roth 401K vs. Traditional 401k
« Reply #1 on: June 20, 2012, 02:08:46 PM »
I'm sure this has been covered repeatedly in the forums but... it mostly comes down to comparing your current marginal tax bracket to your expected bracket in retirement.  If your current bracket is higher, go with traditional, if the retirement bracket is higher, go with roth. 

The only other big side consideration is flexibility as roth contributions can be withdrawn anytime, without penalty. 

grantmeaname

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Re: Roth 401K vs. Traditional 401k
« Reply #2 on: June 21, 2012, 06:46:41 AM »
If you want to retire early and use your 401k money it needs to be in a Roth IRA when you want to use it.

If you want to move Roth 401k money into a Roth IRA, it has to sit for 5 years. If you want to move traditional 401k money, you have to let it sit for 5 years after you pay income tax on the entire amount being transferred. In other words, you'll be paying tax either way, so if you're after simplicity and early retirement you want a Roth 401k.

A more advanced technique is to use a traditional 401k now in addition to another vehicle (like directly contributing to a Roth IRA). When you leave employment, put the traditional 401k into a traditional IRA, then convert one year of expenses each year from traditional to Roth. For the first five years you're retired, you would need to cover your expenses with part-time work, money from any brokerage accounts you may have, or money directly contributed to the Roth IRA (as opposed to converted). On the plus side, you'd only be paying taxes at your effective retirement tax rate, so it would near the mathematical effectiveness of a traditional 401k but allow for early retirement.

Uncephalized

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Re: Roth 401K vs. Traditional 401k
« Reply #3 on: June 21, 2012, 09:10:57 AM »
With a Roth IRA that has employer matching, does the employer get to write off the match as an expense, and the employee doesn't have to pay taxes on it as well? Or does it count as taxable income for the employee?

EDIT: oh, Google is my friend... I see that the big advantage to the IRA structure is that the gains are tax free as well. Didn't realize that. Neat. Now I really see why you want to max that baby out!
« Last Edit: June 21, 2012, 09:26:02 AM by Uncephalized »

MrSaturday

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Re: Roth 401K vs. Traditional 401k
« Reply #4 on: June 21, 2012, 09:26:24 AM »
With a Roth IRA that has employer matching, does the employer get to write off the match as an expense, and the employee doesn't have to pay taxes on it as well? Or does it count as taxable income for the employee?

Matching contributions will go into a regular 401k that you'll owe tax on when you withdraw it.

velocistar237

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Re: Roth 401K vs. Traditional 401k
« Reply #5 on: June 21, 2012, 09:37:19 AM »
My employer offers both.    Currently I have equal amounts going into both.   Should I go 100% into the Roth?   I'm 25 now and looking to retire by 40.

Go 100% Traditional. When you're retired, the standard deduction will get applied, meaning the first few thousand dollars are taxed at 0%. Only do a Roth after you've maxed out your Traditional, or if you're in the 10% tax bracket.

sol

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Re: Roth 401K vs. Traditional 401k
« Reply #6 on: June 21, 2012, 09:41:19 AM »
My employer offers both.    Currently I have equal amounts going into both.   Should I go 100% into the Roth?   I'm 25 now and looking to retire by 40.

I'm a federal employee and we just recently got access to a Roth401k style plan.  The debate rages on the internet about which to choose, but for now almost everyone is staying with the traditional 401k style plan instead of the Roth401k.

The reason is that very few people make more money in retirement than they do while working and saving.  Even if you only save 10% of your income, you're living off of 90% and thus only need 90% of your pre-retirement income once you retire, which moves you into a lower tax bracket in retirement, and thus favors a traditional 401k over a Roth401k.

The one big exception, and the very reason the Roth401k plan was offered to federal employees, was that it's a fantastic deal for military personnel who don't pay taxes on their income up front.  They can put all of that money into the Roth401k and NEVER pay any tax on it.  The whole plan was basically a gift to the military types.  (The second group that benefits is people like federal judges who work veeeeery long careers anyway and thus sometimes retire into a higher tax bracket.)

For most people on this site, the Roth401k isn't going to be very helpful in achieving an early retirement, because it just requires you to pay more taxes.  The primary benefit of the Roth IRA, on the other hand, is estate planning benefits and the ability to withdraw contributions before retirement age, making it a safe hedge for most of this audience.

Summary: 
Roth IRA:  good.  Max it to $5k/year
Roth 401k:  bad.  Probably better to stick your $17k in a traditional 401k.

MrSaturday

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Re: Roth 401K vs. Traditional 401k
« Reply #7 on: June 21, 2012, 10:52:09 AM »
A Roth 401k can also be good on a temporary basis for 20-somethings who start entry level jobs that will likely lead to much higher pay.

If I were young and in the 15% bracket I'd probably start with the Roth and switch contributions to standard when I got to the 25% bracket.

grantmeaname

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Re: Roth 401K vs. Traditional 401k
« Reply #8 on: June 21, 2012, 01:12:34 PM »
Only do a Roth after you've maxed out your Traditional
That's not how it works. You get up to $17,000 dollars of 401k and up to $5,000 dollars of IRA a year, and you can split that limit between Roth and traditional for each, but you can't put 17k in a traditional and then put more in a Roth.

velocistar237

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Re: Roth 401K vs. Traditional 401k
« Reply #9 on: June 21, 2012, 01:38:21 PM »
Only do a Roth after you've maxed out your Traditional
That's not how it works. You get up to $17,000 dollars of 401k and up to $5,000 dollars of IRA a year, and you can split that limit between Roth and traditional for each, but you can't put 17k in a traditional and then put more in a Roth.

The income requirements are different between a Traditional and Roth IRA, so you if you end up not being able to contribute to a Traditional IRA, then contribute the remaining amount to a Roth IRA.

$_gone_amok

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Re: Roth 401K vs. Traditional 401k
« Reply #10 on: June 22, 2012, 04:10:46 PM »
Only do a Roth after you've maxed out your Traditional
That's not how it works. You get up to $17,000 dollars of 401k and up to $5,000 dollars of IRA a year, and you can split that limit between Roth and traditional for each, but you can't put 17k in a traditional and then put more in a Roth.

The income requirements are different between a Traditional and Roth IRA, so you if you end up not being able to contribute to a Traditional IRA, then contribute the remaining amount to a Roth IRA.

It's the other way around. There is a income limit for contributing to Roth IRA, none for traditional IRA.

velocistar237

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Re: Roth 401K vs. Traditional 401k
« Reply #11 on: June 22, 2012, 05:38:41 PM »
...
The income requirements are different between a Traditional and Roth IRA, so you if you end up not being able to contribute to a Traditional IRA, then contribute the remaining amount to a Roth IRA.

It's the other way around. There is a income limit for contributing to Roth IRA, none for traditional IRA.

If you're single and do not participate in your employer's plan, then yes, what you say is true. If you participate in your employer's plan, like the OP does, then what I said is true.

As a married person filing jointly participating in my employer's plan, my 2012 contributions to a Traditional IRA are phased out for a Modified Adjusted Gross Income (MAGI) between $92K and $112K. If I did not participate in my employers plan, the phase out would be $173K to $183K. The Roth IRA has the second set of limits.

You can check online for the other cases.

skyrefuge

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Re: Roth 401K vs. Traditional 401k
« Reply #12 on: June 23, 2012, 10:42:57 AM »
If you're single and do not participate in your employer's plan, then yes, what you say is true. If you participate in your employer's plan, like the OP does, then what I said is true.

You're both right, but saying slightly different things.

Traditional IRAs have no income limits, even if you're covered by an employer's plan.  The income limit is on tax-deductible contributions.  You can still contribute to a Traditional IRA even if you make $1M, but your contributions won't be deductible.

Most people don't see a lot of benefit in making non-deductible contributions to a Traditional IRA (though earnings are still tax-deferred), so they don't even consider that as a possibility, but I'm pretty sure that's what $_gone_amok is talking about here.

velocistar237

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Re: Roth 401K vs. Traditional 401k
« Reply #13 on: June 23, 2012, 11:16:49 AM »
If you're single and do not participate in your employer's plan, then yes, what you say is true. If you participate in your employer's plan, like the OP does, then what I said is true.

You're both right, but saying slightly different things.

Traditional IRAs have no income limits, even if you're covered by an employer's plan.  The income limit is on tax-deductible contributions.  You can still contribute to a Traditional IRA even if you make $1M, but your contributions won't be deductible.

Most people don't see a lot of benefit in making non-deductible contributions to a Traditional IRA (though earnings are still tax-deferred), so they don't even consider that as a possibility, but I'm pretty sure that's what $_gone_amok is talking about here.

Ah, I stand corrected.

It looks like some people make non-deductible contributions to a Traditional IRA and then immediately convert them into a Roth.

mtnrider

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Re: Roth 401K vs. Traditional 401k
« Reply #14 on: June 24, 2012, 03:19:47 PM »
My employer offers both.    Currently I have equal amounts going into both.   Should I go 100% into the Roth?   I'm 25 now and looking to retire by 40.

For many of us, this will be instructive:  http://thefinancebuff.com/case-against-roth-401k.html

However, you should be aware, as has been mentioned above, of the flexibility of the Roth. 

tannybrown

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Re: Roth 401K vs. Traditional 401k
« Reply #15 on: June 24, 2012, 03:27:59 PM »


Summary: 
Roth IRA:  good.  Max it to $5k/year
Roth 401k:  bad.  Probably better to stick your $17k in a traditional 401k.

Sol, my wife and I are currently in the 15% bracket so we're trying to "book" that tax rate now in a Roth 401k (and Roth IRAs) as we don't know what our tax rate will necessarily be in ER.  Would you still advise against that?

sol

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Re: Roth 401K vs. Traditional 401k
« Reply #16 on: July 04, 2012, 10:08:35 AM »
Sol, my wife and I are currently in the 15% bracket so we're trying to "book" that tax rate now in a Roth 401k (and Roth IRAs) as we don't know what our tax rate will necessarily be in ER.  Would you still advise against that?

If you're currently saving money while in the 15% bracket, meaning you live on less than you earn, and you intend to maintain the same standard of living in retirement, then the traditional 401k is still the better choice under virtually all scenarios. 

Hypothetically, a future President could dramatically jack up the tax rates on the lowest end of the income spectrum, but I think this is pretty unlikely and they'd have to get substantially higher to make the Roth401k the better deal.

If you're planning on living very modestly and working longer than necessary to support you current lifestyle, and so intend to retire into a higher tax bracket, then the Roth401k might be a better option.  If it were me, I'd still contribute to the traditional 401k until I got to the point where I could retire, and then I'd switch to the Roth401k once I was only working to increase my post-retirement income.

tannybrown

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Re: Roth 401K vs. Traditional 401k
« Reply #17 on: July 04, 2012, 10:20:51 AM »
That makes sense.  In turn, should we find a way to contribute to a Traditional IRA (pretax) rather than our Roth IRAs?

sol

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Re: Roth 401K vs. Traditional 401k
« Reply #18 on: July 04, 2012, 12:08:17 PM »
That makes sense.  In turn, should we find a way to contribute to a Traditional IRA (pretax) rather than our Roth IRAs?

I think most people here would suggest that you max the Roth, because it's only 5k and it provides some tax diversification benefit.

And since the Roth has the added benefit of penalty-free withdrawals of contributions at any time, it can double as an emergency fund.  I'm still contributing to mine.

BenDarDunDat

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Re: Roth 401K vs. Traditional 401k
« Reply #19 on: July 05, 2012, 11:26:34 AM »
If you want to retire early and use your 401k money it needs to be in a Roth IRA when you want to use it.

If you want to move Roth 401k money into a Roth IRA, it has to sit for 5 years. If you want to move traditional 401k money, you have to let it sit for 5 years after you pay income tax on the entire amount being transferred. In other words, you'll be paying tax either way, so if you're after simplicity and early retirement you want a Roth 401k.

Not entirely accurate. If you want to retire early, you can begin to take regular periodic distributions from your IRA with no penalty. No take backs or "oops, retirement is not for me." because the penalty is retroactive.

Roth is good for those who are in the bottom 15% bracket and for those in the top income bracket as a trust, and for those who plan to live it up in retirement. If you plan to be frugal in in the lower income brackets, traditional is the way to go.

grantmeaname

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Re: Roth 401K vs. Traditional 401k
« Reply #20 on: July 05, 2012, 12:00:17 PM »
The formulas used to calculate substantially equal periodic payments are so conservative that you need an incredible amount of principal to support even a mustachian lifestyle, which totally neuters them as an option in my opinion.

BenDarDunDat

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Re: Roth 401K vs. Traditional 401k
« Reply #21 on: July 05, 2012, 12:50:20 PM »
You are going to have to being receiving these very same distributions when you are 70.5 anyway except for a Roth IRA or taxable investments.

The actual rate of return is largely dependent on the type of investments you select. For example, from December 1999 to December 2009, the average annual compounded rate of return for the S&P 500 was -0.6%, including reinvestment of dividends. From January 1970 to December 2009, the average annual compounded rate of return for the S&P 500, including reinvestment of dividends, was approximately 10.1%

Read more: IRA Minimum Distribution Calculator http://www.bankrate.com/calculators/retirement/ira-minimum-distribution-calculator-tool.aspx#ixzz1zm6Exrpi


I plugged in a few #'s into the IRS tool and when you account for taxes, it's right in the ballpark.

grantmeaname

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Re: Roth 401K vs. Traditional 401k
« Reply #22 on: July 05, 2012, 02:06:02 PM »
SEPP withdrawals are limited by 120% of the Federal mid-term rate, not the performance of the account's investments like RMDs are. With the 120%AFR at 1.1%, you can see why that's a problem right now. You'd need a million bucks to get $2.2k a month (not adjusted for inflation, mind you, so it would quickly become inadequate) in SEPP if you retired this year at 35, and $750k for that amount if you retired at 50. Like I said, totally neutered.
« Last Edit: July 06, 2012, 05:17:24 AM by grantmeaname »

tannybrown

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Re: Roth 401K vs. Traditional 401k
« Reply #23 on: July 05, 2012, 02:19:37 PM »
SEPP payments don't adjust upwards over time to account for inflation?

sol

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Re: Roth 401K vs. Traditional 401k
« Reply #24 on: July 05, 2012, 08:53:56 PM »
SEPP payments don't adjust upwards over time to account for inflation?

They are adjusted upwards in time to adjust for both inflation and for life expectancy, which is exactly why they are so low when you are very young.

The payments aren't all that bad for a 50 year old retiree, but someone like Grant is probably looking at needing payments when he's like 30, and at that age they're disappointingly small.

grantmeaname

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Re: Roth 401K vs. Traditional 401k
« Reply #25 on: July 06, 2012, 05:33:30 AM »
Where are you seeing the payments adjusting for inflation? Of the three methods, I'm seeing two as totally fixed (amortization and annuitization) and therefore not changing, and one that is recalculated anew every year based on life expectancy tables (the life expectancy method). The life expectancy method would increase over time, I suppose, but it's only one of three methods, changes not with inflation but with actuarial tables, and notably has the lowest inital payout by far.

I've found this link, a summary of this internal revenue bulletin. Investopedia, the IRS FAQ, and the Bogleheads wiki support this.

sol

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Re: Roth 401K vs. Traditional 401k
« Reply #26 on: July 06, 2012, 08:33:35 AM »
Where are you seeing the payments adjusting for inflation?

Specifically tied to the inflation index?  No.  But the dollar amounts ramp up so dramatically as to easily outstrip inflation.

This is a quibble, though.  The net result is the same; as Grant pointed out, SEPP payments are hard to live on by themselves unless you have a huge stash.  I'm having a hard time envisioning a scenario where they're very helpful.

skyrefuge

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Re: Roth 401K vs. Traditional 401k
« Reply #27 on: July 06, 2012, 11:24:25 AM »
I'm having a hard time envisioning a scenario where they're very helpful.

They would be helpful if the Federal Mid-term Rate used as the basis for their calculation was 2 or 3 times higher than it currently is.  Which is exactly what it was for most of the last decade, up until rates collapsed in the last couple years.

Starting a SEPP plan any time between 2005 and 2007 would have resulted in a ~$27k/year payout on a $500,000k IRA (amortization method), which is well over a 4% withdrawal rate.  It seems that SEPPs only suck if started at this particular moment in time, which, while it seems might last forever, probably won't.

Even then, SEPPs don't have to cover 100% of your expenses to be useful.  Even adding a little SEPP income on top of an income stream from a taxable account could be the difference between that keeps that taxable account from running out before you reach 59.5.
« Last Edit: July 06, 2012, 11:26:23 AM by skyrefuge »

MooreBonds

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Re: Roth 401K vs. Traditional 401k
« Reply #28 on: July 06, 2012, 07:20:01 PM »
When it comes to the age-old question of ROTH vs Traditional, I always suggest some of the same ideas that pertain to investing: diversification.

Neither you nor the country knows what the future tax rates will be. As such, it makes sense to diversify your accounts to take advantage of whatever the future holds - unless you like taking extreme chances and don't mind having 90% of your retirement accounts in one over the other.

And remember - the diversification will help not only with specific tax rates, but tax policies themselves: remember that Social Security used to be just (at most) 50% taxable, because you already paid income taxes on your half while you were working. The 50% of the SS check you received that was taxed was your employer's contribution that hadn't been subject to income tax.

However, the gov't changed that a number of years ago, such that now (depending on your income) up to 85% of your SS income is taxable. In essence, SS recipients are being double-taxed on up to 35% of their SS income. However, those currently collecting SS have seen a real increase in the value of their SS contributions, compared to what they're receiving now...it's those of us who are 40 and under who will be really screwed, as our SS contributions will likely not keep up with inflation when we finally receive them down the road, AND we will be double taxed on up to 35% of it (unless they increase that again!).

My verbose point?

Just because ROTH IRAs/401(k)s are tax-free now, don't assume it's guaranteed that they would be forever tax-free. The gov't could very well institute an 'income tax', or even an 'asset tax' on ROTHs in the future. If they could do it to the sacred cow of Social Security, they can do it to anything.


my wife and I are currently in the 15% bracket so we're trying to "book" that tax rate now in a Roth 401k (and Roth IRAs) as we don't know what our tax rate will necessarily be in ER.  Would you still advise against that?

If you're currently in the 15% tax bracket, don't overlook the SAVER'S CREDIT http://www.irs.gov/publications/p590/ch05.html! Worth up to $1,000 single/$2,000 married in tax CREDITS (not deductions!), in addition to deducting your 401k/IRA contributions.
« Last Edit: July 06, 2012, 07:22:17 PM by MooreBonds »

fiveoh

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Re: Roth 401K vs. Traditional 401k
« Reply #29 on: July 06, 2012, 07:46:06 PM »
When it comes to the age-old question of ROTH vs Traditional, I always suggest some of the same ideas that pertain to investing: diversification.

Neither you nor the country knows what the future tax rates will be. As such, it makes sense to diversify your accounts to take advantage of whatever the future holds - unless you like taking extreme chances and don't mind having 90% of your retirement accounts in one over the other.

And remember - the diversification will help not only with specific tax rates, but tax policies themselves: remember that Social Security used to be just (at most) 50% taxable, because you already paid income taxes on your half while you were working. The 50% of the SS check you received that was taxed was your employer's contribution that hadn't been subject to income tax.

However, the gov't changed that a number of years ago, such that now (depending on your income) up to 85% of your SS income is taxable. In essence, SS recipients are being double-taxed on up to 35% of their SS income. However, those currently collecting SS have seen a real increase in the value of their SS contributions, compared to what they're receiving now...it's those of us who are 40 and under who will be really screwed, as our SS contributions will likely not keep up with inflation when we finally receive them down the road, AND we will be double taxed on up to 35% of it (unless they increase that again!).

My verbose point?

Just because ROTH IRAs/401(k)s are tax-free now, don't assume it's guaranteed that they would be forever tax-free. The gov't could very well institute an 'income tax', or even an 'asset tax' on ROTHs in the future. If they could do it to the sacred cow of Social Security, they can do it to anything.


my wife and I are currently in the 15% bracket so we're trying to "book" that tax rate now in a Roth 401k (and Roth IRAs) as we don't know what our tax rate will necessarily be in ER.  Would you still advise against that?

If you're currently in the 15% tax bracket, don't overlook the SAVER'S CREDIT http://www.irs.gov/publications/p590/ch05.html! Worth up to $1,000 single/$2,000 married in tax CREDITS (not deductions!), in addition to deducting your 401k/IRA contributions.

I got excited when I saw this until I saw the income limits :

$56,500 if your filing status is married filing jointly,

$42,375 if your filing status is head of household, or

$28,250 if your filing status is single, married filing separately, or qualifying widow(er).

:(