Author Topic: canadian wondering about american 401k vs roth which and why?  (Read 7699 times)

strider3700

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canadian wondering about american 401k vs roth which and why?
« on: January 30, 2013, 01:45:26 AM »
On another thread Widerhaken wrote
Quote
The three main buckets are:

IRA/401k/403b/etc: Skip taxes today and pay taxes at retirement/withdrawal.
ROTH: Pay taxes today but no taxes at retirement/withdrawal.
Taxable: Pay taxes today and on all future earnings/withdrawals.

Obviously, there is a lot of nuance, tons of options for growing savings, and other issues with fees/age to take withdrawals/etc. Good luck! Learning about this subject will make you a superstar to your friends and family.

I'm curious for you american's,  which of those 3 buckets do you invest in and when?   
in Canada we have

RRSP - not taxed today, lowers your income saving you taxes but taxed at withdraw
TFSA - taxes now, no difference on income taxes but not taxed in the end including gains.
Taxable - tax now, tax later, tax if you think too much about it, tax, tax, tax...
so that sounds like RRSP matches your IRA/401k/403n/etc  option
and TFSA matches ROTH.

Conventional thinking here is RRSP to the limit to lower income taxes now and pay less taxes  in your withdraw years due to being in a lower bracket. TFSA is a new thing and only for after maxing the RRSP.    being younger(mid 30's)  then the average investor I'm thinking taxes long term could be brutal and I'd rather know that 25k in the TFSA is 25k I can spend  not guess what taxes will be like after the boomers do a number on the economy and pension plans.

RoseRelish

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #1 on: January 30, 2013, 06:58:12 AM »
Good to know that Canada has similar investment wrappers to the USA. I'm with you in that I prefer to max out the ROTH options. I think tax rates are going up, even with a lower income in retirement. I put money in my 401k to get the full employer match, so net/net I end up contributing similar amounts to the two buckets.

sherr

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #2 on: January 30, 2013, 07:33:03 AM »
Conventional thinking here is RRSP to the limit to lower income taxes now and pay less taxes  in your withdraw years due to being in a lower bracket. TFSA is a new thing and only for after maxing the RRSP.    being younger(mid 30's)  then the average investor I'm thinking taxes long term could be brutal and I'd rather know that 25k in the TFSA is 25k I can spend  not guess what taxes will be like after the boomers do a number on the economy and pension plans.

I am very much a "conventional thinking" guy. I wish it was more conventional thinking in the US. I max out the amount that I can put in the tax-later accounts before doing anything else.

I don't really doubt that tax rates in the US will go up in the future. However, I do seriously doubt that we will end up taxing the "low income" people much more. Our planed retirement spending, and that of most people on this forum, is much closer to the "low income" end of the spectrum than it is to the "high income" side, which is where the most additional taxes will be (IMHO).

But really what we're talking about here is predicting the future, which no one can do well. You are speculating that a future increase in taxes will make your tax-now investments more worthwhile. I think there is something to be said for acknowledging that we don't know the future, realizing that really it's possible for things to go either way, and sticking with the solution that makes the most mathematical sense given information that we have now.

RoseRelish

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #3 on: January 30, 2013, 08:27:45 AM »
But really what we're talking about here is predicting the future, which no one can do well. You are speculating that a future increase in taxes will make your tax-now investments more worthwhile.

I agree that we can't predict the future. That's why I'm trying to balance between the "pay taxes now" vs. "pay taxes later" buckets.

rugorak

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #4 on: January 30, 2013, 08:43:07 AM »
Usually the suggest way to do things in the US is as follows.

1. 401k/403b/etc to employer match
2. Roth IRA if available to max
3. 401k/403b/etc to max
4. Taxable/Other

Usually the reasoning is as follows. Always get your match if available. That is free money thereby increasing your income. Roth has a low limit so it won't hurt you much to pay taxes on that now (since you can't make too much to be eligible for a Roth anyway). So you might as well get it in and get withdraws tax free. Plus you can invest where and how you want instead of a subset of options that your employer choose for you. It still is wise to put money into the 401k since it lowers your tax bill now. And then whatever you have left into taxable. This assumes you are only saving for retirement. Obviously you will have to play with this formula if you have other savings goals (such as a home, etc). But it is the general guideline I have heard both the FIRE people and the regular old retire at 65 people use and seems to be a good blueprint to start from.

James

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #5 on: January 30, 2013, 09:09:49 AM »
A lot more people have access to the Roth 401k option now, which makes it a lot more flexible and complex.  It really comes down to tax rates, now and expected.  Best to just understand all the principles involved and make an informed decision for your own situation.

I agree with Widerhaken on two bucket approach, best to determine a balance between the two buckets based on your income now, expected income later, and your individual situation.  Then fill those buckets going forward to meet that goal, and empty them later to minimize total taxation.

strider3700

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #6 on: January 30, 2013, 09:38:23 AM »
I should probably point on that the TFSA is only 5 years old so  the max you can have in it as of this year is 25,500  and it's increasing by 5,500 per year now.   RRSP's can hold far more, I think my contribution room is something like 80,000 this year as I don't use mine.

I fully agree about predicting the future.   Canada's quite different then the US and I believe our lower middle class rates are already higher then the US rates. I expect higher across the board,  it just has to be done to correct for the debt and ongoing deficit.

Jamesqf

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #7 on: January 30, 2013, 11:57:55 AM »
For me, it's IRA up to the max (since I'm self-employed, I don't get 401k), then taxable.  I can't see a benefit to me in a Roth, since I spend very little, and will likely be in a low tax bracket when I might be taking money out of a Roth.

Undecided

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #8 on: January 30, 2013, 07:01:32 PM »
For me, it's IRA up to the max (since I'm self-employed, I don't get 401k), then taxable.

Google "solo 401(k)". I've been happy (as the "manager" of my wife's solo 401(k)) with both (at different times) Fidelity and Vanguard as trustees for her solo 401(k) account.

RaveOregon

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #9 on: February 01, 2013, 08:37:54 AM »
Quote
Usually the suggest way to do things in the US is as follows.

1. 401k/403b/etc to employer match
2. Roth IRA if available to max
3. 401k/403b/etc to max
4. Taxable/Other

I have seen this a lot. I am fairly new to this so maybe I am missing something, but if the goal is early retirement why put so much into conventional retirement  accounts?

iamlindoro

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #10 on: February 01, 2013, 09:37:05 AM »
Because they're tax advantaged, and because you can pipeline the 401k through an IRA to get at it early (and then use it traditionally when you hit eligibility) 

... and because if your employer offers match, it's free money!

Spork

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #11 on: February 01, 2013, 10:08:10 AM »
Usually the suggest way to do things in the US is as follows.

1. 401k/403b/etc to employer match
2. Roth IRA if available to max
3. 401k/403b/etc to max
4. Taxable/Other

Usually the reasoning is as follows. Always get your match if available. That is free money thereby increasing your income. Roth has a low limit so it won't hurt you much to pay taxes on that now (since you can't make too much to be eligible for a Roth anyway). So you might as well get it in and get withdraws tax free. Plus you can invest where and how you want instead of a subset of options that your employer choose for you. It still is wise to put money into the 401k since it lowers your tax bill now. And then whatever you have left into taxable. This assumes you are only saving for retirement. Obviously you will have to play with this formula if you have other savings goals (such as a home, etc). But it is the general guideline I have heard both the FIRE people and the regular old retire at 65 people use and seems to be a good blueprint to start from.

I'm curious on this order... Instead of your 1-2-3-4 order, I've assumed the 1-2-4-3 order.  My thoughts were to put more into regular "taxable" accounts to provide income from retirement to age 65.

Am I missing something obvious?

iamlindoro

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #12 on: February 01, 2013, 11:04:46 AM »
You can create a five year 401k-Roth IRA pipeline that funnels 401k money out after retirement but before 401k eligibility.  It allows you to get at the money in a tax advantaged way but still enjoy the matching, etc. of a 401k.

sherr

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #13 on: February 01, 2013, 11:12:03 AM »
Usually the suggest way to do things in the US is as follows.

1. 401k/403b/etc to employer match
2. Roth IRA if available to max
3. 401k/403b/etc to max
4. Taxable/Other

Usually the reasoning is as follows. Always get your match if available. That is free money thereby increasing your income. Roth has a low limit so it won't hurt you much to pay taxes on that now (since you can't make too much to be eligible for a Roth anyway). So you might as well get it in and get withdraws tax free. Plus you can invest where and how you want instead of a subset of options that your employer choose for you. It still is wise to put money into the 401k since it lowers your tax bill now. And then whatever you have left into taxable. This assumes you are only saving for retirement. Obviously you will have to play with this formula if you have other savings goals (such as a home, etc). But it is the general guideline I have heard both the FIRE people and the regular old retire at 65 people use and seems to be a good blueprint to start from.

I'm curious on this order... Instead of your 1-2-3-4 order, I've assumed the 1-2-4-3 order.  My thoughts were to put more into regular "taxable" accounts to provide income from retirement to age 65.

Am I missing something obvious?

Even ignoring the IRA-pipeline that other contributors have talked about, it can be cheaper to withdraw early from a 401k than to invest in an after-tax account. Let's say you're in a 25% tax bracket today, so every dollar you invest either goes straight to the bank (401k) or is taxed at 25% first (regular account). Now let's say you chose the 401k and that you're retired and withdrawing $30k per year (and married - the following is true either way, it just makes a difference in what your average tax rate will be).

Of that $30k:
The first $17.85k is taxed at 10%
The rest is taxed at 15%
Your average tax rate on the $30k is 12.025%. Add in a 10% early-withdrawal penalty, and your effective tax rate is 22.025%. Less than the 25% you would have paid if you just put it into a regular account.

This is not taking into account things like the standard deductible (which further tilt things in the favor of 401ks) and various other tricks you can use to avoid paying the penalty on the 401k money like SEPP. It's entirely conceivable that you can pay 10% or less in total taxes on money you take out of the 401k, even if it's early. Plus money in a regular account you pay taxes on up-front, so you have less to start with, and then you pay taxes again on any capital gains. So you're essentially paying even more than 25% on that initial money compared to if you had put it in a tax-advantaged account. All these things add up to make (IMHO) Traditional 401k and IRA accounts much much better than regular accounts, and significantly better than Roth accounts. Of course, a lot is dependent on how much you make now, how much you'll withdraw in retirement, and what the tax rates in the future will be. Your mileage may vary, and once size does not fit all.

Spork

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Re: canadian wondering about american 401k vs roth which and why?
« Reply #14 on: February 01, 2013, 12:29:00 PM »
Thank you.  (Especially for actually applying numbers to it.  My brain works best that way.)

I'll have to actually run some numbers here and see what falls out the other side.