Author Topic: Roth or Traditional 401k contributions?  (Read 3187 times)

ZiziPB

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Roth or Traditional 401k contributions?
« on: August 30, 2017, 09:27:37 AM »
What would you advise a single person who has just started a job fresh out of college?  The salary is 65K per year, so 25% tax bracket?  I am thinking traditional?

MDM

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Re: Roth or Traditional 401k contributions?
« Reply #1 on: August 30, 2017, 09:35:11 AM »
If you mean "just started" literally, this year's income will be much lower than $65K.  That might mean Roth would be better.

If the person could be eligible for the saver's credit this year (not being a full time student for 5 or more months is one of the criteria), then the marginal rate for a traditional contribution could be high enough to go that way.

See Investment Order and links therein, particularly https://www.bogleheads.org/wiki/Traditional_versus_Roth, for more.

dandarc

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Re: Roth or Traditional 401k contributions?
« Reply #2 on: August 30, 2017, 09:38:43 AM »
If I had it over again, I would have gone 100% traditional out of the gate, and I was making less than that.

That said, the basic calculus is marginal tax rate today vs. expected marginal tax rate later.  Keeping your expenses low helps lower expected tax rate later, since once you FIRE, you have much more control over your taxable income.  But some people are aiming to increase spending in retirement, so you have to think about this for yourself.

Another thing to keep in mind is this is a "good vs. better" decision and not a "good vs. bad".  Don't obsess over it to the point you delay getting the money invested - that's the only sure way to lose.

ZiziPB

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Re: Roth or Traditional 401k contributions?
« Reply #3 on: August 30, 2017, 09:49:58 AM »
I'm asking this question for my daughter, not myself.  She was a full time student until mid June.  And started the job mid-August.  Even though Roth may be a good option this year, I'm thinking that keeping it simple is better for her (still needs to learn about saving and investing, and not showing much interest in the topic currently).  A set it and forget it approach is probably easier at this point for her - so I think I'll tell her to go with traditional.

talltexan

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Re: Roth or Traditional 401k contributions?
« Reply #4 on: August 30, 2017, 11:20:42 AM »
when I started a job (in Sep), I didn't even elect a 401(k) provider until Jan 1 of the following year. A Roth is something you can set up with Vanguard this week. It depends on how quikcly you'd like her to take action.

ZiziPB

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Re: Roth or Traditional 401k contributions?
« Reply #5 on: August 30, 2017, 12:21:39 PM »
She has been told to go ahead and make her elections for the 401k - she can make either Roth or tax-deductible contributions.  I still need to review her investment options.

plog

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Re: Roth or Traditional 401k contributions?
« Reply #6 on: August 30, 2017, 01:43:49 PM »
This:
Quote
. ...still needs to learn about saving and investing, and not showing much interest in the topic currently...

doesn't exactly jive with this:

Quote
I'm asking this question for my daughter, not myself

I'd focus on getting her interested in her future and what a pile of cash can help her achieve (travel, lavish wedding, retirement, etc.).  If you come to her with the specifics of Roth vs. Traditional her eyes are definitely going to glaze over and she's going to do the minimum needed to get you to shut up about it.  Then in 18 months when she wants a new car she realizes she can take a loan against her 401k (which she then turns into a disbursement 6 months later when she leaves this job) and this is all for naught. 
« Last Edit: August 30, 2017, 01:47:04 PM by plog »

ZiziPB

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Re: Roth or Traditional 401k contributions?
« Reply #7 on: August 30, 2017, 03:01:27 PM »
This:
Quote
. ...still needs to learn about saving and investing, and not showing much interest in the topic currently...

doesn't exactly jive with this:

Quote
I'm asking this question for my daughter, not myself

I'd focus on getting her interested in her future and what a pile of cash can help her achieve (travel, lavish wedding, retirement, etc.).  If you come to her with the specifics of Roth vs. Traditional her eyes are definitely going to glaze over and she's going to do the minimum needed to get you to shut up about it.  Then in 18 months when she wants a new car she realizes she can take a loan against her 401k (which she then turns into a disbursement 6 months later when she leaves this job) and this is all for naught.
I'm trying, believe me!  Baby steps...  So far she's done a budget and she understands that 401k money is untouchable :-)

K60

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Re: Roth or Traditional 401k contributions?
« Reply #8 on: August 31, 2017, 06:44:11 AM »
The MadFientist recommends traditional, tax deferred, all the way:

http://nwww.madfientist.com/traditional-ira-vs-roth-ira/

jdotPT

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Re: Roth or Traditional 401k contributions?
« Reply #9 on: August 31, 2017, 07:47:43 AM »
I could write pages (or at least paragraphs) about why traditional is nearly always better. Your daughter certainly fits in the category of persons where a traditional would be better imo.

MDM

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Re: Roth or Traditional 401k contributions?
« Reply #10 on: August 31, 2017, 08:36:40 AM »
The MadFientist recommends traditional, tax deferred, all the way:
http://www.madfientist.com/traditional-ira-vs-roth-ira/
I could write pages (or at least paragraphs) about why traditional is nearly always better. Your daughter certainly fits in the category of persons where a traditional would be better imo.
For a single person making $65K/yr with no pension expected, traditional will likely be better due to saving at a 25% marginal rate (or higher).

For this year, OP's daughter will make ~$24K so Roth will likely be better due to saving at a 15% or 10% marginal rate.

dandarc

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Re: Roth or Traditional 401k contributions?
« Reply #11 on: August 31, 2017, 09:42:32 AM »
The MadFientist recommends traditional, tax deferred, all the way:
http://www.madfientist.com/traditional-ira-vs-roth-ira/
I could write pages (or at least paragraphs) about why traditional is nearly always better. Your daughter certainly fits in the category of persons where a traditional would be better imo.
For a single person making $65K/yr with no pension expected, traditional will likely be better due to saving at a 25% marginal rate (or higher).

For this year, OP's daughter will make ~$24K so Roth will likely be better due to saving at a 15% or 10% marginal rate.
Good point - so Roth this year, then Traditional next year.

You mentioned the saver's credit up-thread - thought I'd elaborate some.  If OP's daughter can get AGI down to 18,500, which if her gross is $24K for the year isn't too difficult, then she gets around $450 more  on the saver's credit.  Looks like it would be $600 (50% of $2K vs. 20% of $2K), but due to the standard deduction and exemption, the tax at that low of an AGI is only around $800-900, and this is a non-refundable credit.  $450 / $5500 adds about 8% to the "marginal tax rate" today.

So OP's daughter really should estimate 2017 income, run a few draft tax returns, see what the overall results are, and then decide what to do for this year, and going forward.  Luckily, estimate income should be pretty easy, and "run draft tax returns" could just mean "play around with MDM's case study spreadsheet", so you're talking just a few hours to get a very good idea of what each path entails.

ZiziPB

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Re: Roth or Traditional 401k contributions?
« Reply #12 on: August 31, 2017, 09:48:35 AM »
I don't think she will qualify for the saver's credit because she was a full time student until mid-June.  So just over the 5 months cut off.

dandarc

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Re: Roth or Traditional 401k contributions?
« Reply #13 on: August 31, 2017, 10:05:04 AM »
I don't think she will qualify for the saver's credit because she was a full time student until mid-June.  So just over the 5 months cut off.
Ah - so that's a non-factor.

Bracken_Joy

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Re: Roth or Traditional 401k contributions?
« Reply #14 on: August 31, 2017, 10:08:01 AM »
Guys. OP is asking about traditional or roth 401k. A lot of the answers are focusing on IRA. Important difference. My understanding is always, always a traditional 401k. Roth 401k has virtually none of the benefits of a roth IRA.

MDM

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Re: Roth or Traditional 401k contributions?
« Reply #15 on: August 31, 2017, 10:13:14 AM »
Roth 401k has virtually none of the benefits of a roth IRA.
Other than a Roth 401k having a Required Minimum distribution while a Roth IRA does not (and OP's daughter has ~50 years to deal with that), what do you see as a problem with a Roth 401k?
« Last Edit: August 31, 2017, 10:16:58 AM by MDM »

Bracken_Joy

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Re: Roth or Traditional 401k contributions?
« Reply #16 on: August 31, 2017, 10:20:52 AM »
Roth 401k has virtually none of the benefits of a roth IRA.
Other than a Roth 401k having a Required Minimum distribution while a Roth IRA does not (and OP's daughter has ~50 years to deal with that), what do you see as a problem with a Roth 401k?

Frankly? I don't remember. I just remember being raked over the coals on the forum when I was looking into it for my own numbers, and the take away was "why would anyone do a roth 401k??". I would happily be wrong.

(I'm trying to find the blog post people kept linking to... I was thinking it was MadFIentist, but I can't find anything, so it must not be? I don't know, it's been a couple years).

dandarc

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Re: Roth or Traditional 401k contributions?
« Reply #17 on: August 31, 2017, 10:28:43 AM »
Roth 401k has virtually none of the benefits of a roth IRA.
Other than a Roth 401k having a Required Minimum distribution while a Roth IRA does not (and OP's daughter has ~50 years to deal with that), what do you see as a problem with a Roth 401k?

Frankly? I don't remember. I just remember being raked over the coals on the forum when I was looking into it for my own numbers, and the take away was "why would anyone do a roth 401k??". I would happily be wrong.

(I'm trying to find the blog post people kept linking to... I was thinking it was MadFIentist, but I can't find anything, so it must not be? I don't know, it's been a couple years).
The reason to do a Roth 401K is simple - you're paying low tax rates now, and you think you're likely to be paying higher tax rates on withdrawal.  Such as OP's daughter who only has a partial-year of earnings to factor.  For this year.

The higher your income is, the more you should lean traditional.  Such as next year for OP's daughter, when she'll likely have a full year of the higher salary.

Are you sure the prior thread was about a 401K and not a 457B?  Because Roth 457B has some rules that make "not sure why anyone would do this?" a truer statement.  Though even then - if you're not planning on withdrawing before 59.5, it is just a regular Roth vs. Traditional decision, and even if you are, you can roll over to a Roth IRA at some point and at least have tax and penalty free access to your contributions early.

Bracken_Joy

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Re: Roth or Traditional 401k contributions?
« Reply #18 on: August 31, 2017, 11:01:24 AM »
Roth 401k has virtually none of the benefits of a roth IRA.
Other than a Roth 401k having a Required Minimum distribution while a Roth IRA does not (and OP's daughter has ~50 years to deal with that), what do you see as a problem with a Roth 401k?

Frankly? I don't remember. I just remember being raked over the coals on the forum when I was looking into it for my own numbers, and the take away was "why would anyone do a roth 401k??". I would happily be wrong.

(I'm trying to find the blog post people kept linking to... I was thinking it was MadFIentist, but I can't find anything, so it must not be? I don't know, it's been a couple years).
The reason to do a Roth 401K is simple - you're paying low tax rates now, and you think you're likely to be paying higher tax rates on withdrawal.  Such as OP's daughter who only has a partial-year of earnings to factor.  For this year.

The higher your income is, the more you should lean traditional.  Such as next year for OP's daughter, when she'll likely have a full year of the higher salary.

Are you sure the prior thread was about a 401K and not a 457B?  Because Roth 457B has some rules that make "not sure why anyone would do this?" a truer statement.  Though even then - if you're not planning on withdrawing before 59.5, it is just a regular Roth vs. Traditional decision, and even if you are, you can roll over to a Roth IRA at some point and at least have tax and penalty free access to your contributions early.

It was definitely about a roth 401k, because I have a 401k through work, and wanted to know if I should do traditional or roth. I know I didn't start the thread, but it was basically a "oh, this is my situation too, what does everyone recommend?" type thing. And given my post count... I don't fancy trying to dig up the old post =\

dandarc

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Re: Roth or Traditional 401k contributions?
« Reply #19 on: August 31, 2017, 11:15:21 AM »
Was it month's or years ago?  Searching for Bracken_Joy and Roth IRA in google only gives me 9 posts, and none of those is it.  Taking away Roth gives hundreds of posts - too many to look through.

jdotPT

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Re: Roth or Traditional 401k contributions?
« Reply #20 on: August 31, 2017, 11:20:40 AM »
The MadFientist recommends traditional, tax deferred, all the way:
http://www.madfientist.com/traditional-ira-vs-roth-ira/
I could write pages (or at least paragraphs) about why traditional is nearly always better. Your daughter certainly fits in the category of persons where a traditional would be better imo.
For a single person making $65K/yr with no pension expected, traditional will likely be better due to saving at a 25% marginal rate (or higher).

For this year, OP's daughter will make ~$24K so Roth will likely be better due to saving at a 15% or 10% marginal rate.

I'm guilty of not reading the post closely. (at work) I see your point here and likely agree with you. FWIW- this is the article I like to show people. It gets into the weeds a bit, but the message and conclusion are solid and well illustrated I believe. Cheers! http://www.joetaxpayer.com/images/ThinkingAboutaRoth401%28k%29.pdf

MDM

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Re: Roth or Traditional 401k contributions?
« Reply #21 on: August 31, 2017, 11:28:29 AM »
FWIW- this is the article I like to show people. It gets into the weeds a bit, but the message and conclusion are solid and well illustrated I believe. Cheers! http://www.joetaxpayer.com/images/ThinkingAboutaRoth401%28k%29.pdf
That article is a good example of why having "Ph.D." after one's name does not guarantee what one says is correct.

The author makes a fundamental error when he says "A key point in any comparison of Roth and regular 401(k)s is distinguishing the taxpayer's marginal and effective tax rates."

Using an effective tax rate is not correct when it comes to the traditional vs. Roth choice.

See Traditional versus Roth - Bogleheads and Marginal Vs Effective Tax Rates And When To Use Each for some details.  More references and math available if needed. ;)

jdotPT

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Re: Roth or Traditional 401k contributions?
« Reply #22 on: August 31, 2017, 12:17:27 PM »
Thank you. I will review the links when I have more time. I'm a huge fan of the boglehead community. In fact, it indirectly led me to MMM.

Bracken_Joy

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Re: Roth or Traditional 401k contributions?
« Reply #23 on: August 31, 2017, 02:14:53 PM »
It was definitely about a roth 401k, because I have a 401k through work, and wanted to know if I should do traditional or roth. I know I didn't start the thread, but it was basically a "oh, this is my situation too, what does everyone recommend?" type thing. And given my post count... I don't fancy trying to dig up the old post =\

https://forum.mrmoneymustache.com/investor-alley/roth-401k-at-my-work/msg552918/#msg552918 ?  Though I don't see anything especially bad about ROTH 401k there.

Yeah I saw that one too, and I don't think that's it. Hmm. I wonder if I deleted it because I shared too many work details or something? It would have been end of 2015/beginning of 2016 I think, and I'm not seeing anything that fits in my post history.

dandarc

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Re: Roth or Traditional 401k contributions?
« Reply #24 on: August 31, 2017, 02:29:38 PM »
Bracken_Joy -

Differences I know of with Roth 401K vs. Roth IRA:

1.  Roth 401K - no income limits.  Roth IRA - has income limits which are easily circumvented via the Backdoor Roth technique.  So pretty much the same if you're organized.

2.  Roth 401K - up to 18K (24K if over 50) contributions.  Roth IRA - 5.5K (6.5K), although since you can do both at the same time this isn't really a difference of consequence.

3.  Roth 401K - early withdrawal is pro-rated between basis and earnings, so you're likely to get hit with penalties and some tax on earnings if you withdraw early.  There are some exceptions, of course. 
     Roth IRA - Early Withdrawal is subject to ordering rules.  These ordering rules are what allow us to say "withdraw contributions at any time, tax and penalty free".
     This is an advantage to the Roth IRA, although not a huge one, plus it is easily worked around most of the time - just roll the Roth 401K over to a Roth IRA, and the contributions follow.

4.  Roth 401K - subject to RMDs.  Roth IRA - no RMDs.  Again, the "fix" is to just roll the Roth 401K over to the Roth IRA.

5.  Roth 401K - investment choices are what your employer offers.  Roth IRA - choices are more or less unlimited.  This can go either way - if you have a good Roth 401K at a sufficiently large employer, odds are you can get lower-cost investments than you can find on your own.  A bad 401K may be a reason to favor a taxable account over the Roth 401K, whereas the tax-savings on the traditional 401K require the 401K to be even worse for that to be the situation.  But then you have to factor in that the 401K, Roth or Traditional isn't forever and you can't make up for missed years.  So the plan has to be pretty bad.  And this is a criticism of the specific 401K - not of Roth 401Ks as a whole.


I don't know, I guess I'm not seeing from any of that "Roth 401K is almost universally a bad move"  The main reason the people on this forum are likely to be better served by Traditional is the intersection of high tax rates today (we skew relatively high income) with lower tax rates on withdrawal (we also skew towards lower post-retirement spending and income than pre-retirement income).  But certainly there are exceptions - for example, if your taxable income is so low that you're in the 0% tax bracket, Roth is the obvious play, 401K or IRA as the case may be.  Or you have a remarkably low income year compared to a typical accumulation-phase year for you.


Another possible source of confusion - in a 401K, there is such a thing as after-tax contributions which are not the same thing as Roth contributions.  Until fairly recently, these went largely unused, because of the way they work if you leave them in the 401K and eventually withdraw from there.  You save no tax today - like a Roth 401K.  Growth is tax-deferred - like a Roth 401K.  But you pay ordinary income rates when you eventually withdraw - very much not like a Roth 401K - you pay no tax on qualified withdrawals from a Roth 401K.  But the IRS in a stunning move in 2014 or thereabouts, sent out a clarifying memo giving the OK for the MEGABackdoor Roth IRA technique (http://www.madfientist.com/after-tax-contributions/).  Now after-tax (Not Roth) contributions have a much more valid use-case, and there is therefore much more discussion around them.  I know I used to mentally equate after-tax with Roth, but in a 401K, and with knowledge of the MEGA backdoor Roth, that is an incomplete way of looking at things.
« Last Edit: August 31, 2017, 02:31:56 PM by dandarc »

jdotPT

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Re: Roth or Traditional 401k contributions?
« Reply #25 on: August 31, 2017, 02:50:06 PM »
Just speculating here, but I think the reason that a roth 401k would have a bad rep on here is because, for most people, there is a superior option, the traditional 401k. Whereas the Roth IRA has no competitor. If you qualify for a Roth IRA (or you want to do the backdoor), assuming you can afford to, use it.

MDM

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Re: Roth or Traditional 401k contributions?
« Reply #26 on: August 31, 2017, 03:32:34 PM »
...the Roth IRA has no competitor
...if one doesn't also qualify for a traditional IRA.  If one does, then it's the traditional vs. Roth decision all over again.

GizmoTX

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Re: Roth or Traditional 401k contributions?
« Reply #27 on: August 31, 2017, 04:45:44 PM »
Does her employer offer any kind of match for a t401k contribution? If so, she should be starting with that, & it reduces her FIT withholding.
Does her employer offer a HSA health plan? If so, if she can do a payroll deduction, her contribution would reduce her payroll taxes (social security & Medicare) as well as FIT.
If she still has enough money to contribute, fund a Roth IRA as much as possible up to the $5,500 max.
If she still has enough money to contribute (easier during the full year of employment in 2018), throw more at the t401k.

Our DS is in the same position as the OP's daughter: May graduate, new FT job, only it's paying $88K/yr (engineer position with MSEE). Because he has savings from previous summer internships, he's fully funding his t401k & HSA as payroll contributions, which means he gets to invest a sizable amount rather than pay it as tax withholding, even tho this year he'll be in the 15% bracket. He's also maxing his Roth IRA while he can. 

ZiziPB

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Re: Roth or Traditional 401k contributions?
« Reply #28 on: September 01, 2017, 04:52:16 AM »
No match from the employer and no HSA offered (I'm actually keeping her on my insurance through the end of the year so that I can max out the HSA at the family contribution level :-)  She has no other money, so she will not be doing a Roth IRA this year (if I'm feeling generous early next year, I may fund it for her as a gift but I haven't decided yet).  She lives in a very HCOL city so her disposable income is not that high.  And as I said, the kid still has a lot to learn about saving and investing, even though her dad and I tried teaching her since even before high school!

GizmoTX

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Re: Roth or Traditional 401k contributions?
« Reply #29 on: September 01, 2017, 10:28:19 AM »
Since she's already in the 15% bracket for 2017, she should fund a Roth as much as possible. Then she should contribute to the t401K in 2018 to lower her AGI.