Author Topic: Roth 401K vs Roth IRA vs 401K  (Read 4820 times)

monstermonster

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Roth 401K vs Roth IRA vs 401K
« on: May 07, 2015, 08:47:06 AM »
Oh  my. So this is a bit of a novice question, but I'm truly struggling with this issue and could use some advice from mustachians.

I can get a Roth 401K or a regular 401k with work (just triggered yesterday after a year.) There's no match but there's vanguard ETF options. The allocation options are pretty good and the expense ratios on the 401k's are similar to my IRA.

I'm 27 years old with ~$5000 in my Roth IRA. I'm looking to put away around $7000 a year (I make $39K). I was planning to simply max out my Roth IRA given my age, and put the rest in my regular 401K, but now I'm consider going all Roth 401 + IRA all the way.

I'm on the edge of the highest tax bracket of my life, and lowering my taxable income looks very advantageous to me with the traditional 401k

Other option: stop contributing to my IRA and put everything in the Roth 401k.

Can someone help me?

Edit: Clarity
« Last Edit: May 07, 2015, 11:45:03 AM by monstermonster »

seattlecyclone

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Re: Roth 401K vs Roth IRA vs 401K
« Reply #1 on: May 07, 2015, 09:07:39 AM »
You seem to contradict yourself when you say "lowering my taxable income looks very advantageous to me" and "I'm considering going all Roth 401(k) + IRA." Contributing to a Roth account does not lower your taxable income. You need to make traditional contributions to do that.

monstermonster

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Re: Roth 401K vs Roth IRA vs 401K
« Reply #2 on: May 07, 2015, 10:25:55 AM »
Sorry, I failed to finish that statement. What I meant to say was that "THOUGH lowering my taxable income looks advantageous to me, "

30French

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Re: Roth 401K vs Roth IRA vs 401K
« Reply #3 on: May 07, 2015, 10:39:54 AM »
If you want to stay out of the 25% bracket, you could contribute just enough to the 401 to put your income at the top of the 15% bracket, and put the rest in Roth.  DO you expect your income is going to increase in the coming decades?

skudjon

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Re: Roth 401K vs Roth IRA vs 401K
« Reply #4 on: May 07, 2015, 10:42:35 AM »
I recently came upon this post searching for a similar answer. After reading the Mad Fientist's article about building a Roth IRA conversion ladder http://www.madfientist.com/retire-even-earlier/ and then looking at vanguards rules for conversions https://investor.vanguard.com/401k-rollover/options I came up with this conclusion and please anyone correct me if I am mistaken. All this assumes FIRE before traditional retirement date and the building of the Roth conversion ladder

401k
1. contribute max to traditional 401k pre tax
2. once FI or RE convert traditional 401k to traditional IRA
3. Build the ladder and roll the traditional IRA to Roth IRA and take your distribution after 5 years.

IRA
1. If possible, contribute pre tax to dollars to IRA. (I haven't researched how to do this for a personal IRA yet. Anyone have insight?)
     a. If not possible go with the Roth 401k
2. Roll over traditional to roth IRA using the conversion ladder.

Side note: if you have an HSA, follow the mad fientist on that one as well. http://www.madfientist.com/ultimate-retirement-account/

This appears to me to be the most tax advantageous for you as it is what I plan for myself. We are tax bracket buddies. I miss anything? AS a newbie I'm sure there might be exceptions or I missed something entirely.

skudjon

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Re: Roth 401K vs Roth IRA vs 401K
« Reply #5 on: May 07, 2015, 11:04:06 AM »
Note about how to contribute to traditional IRA. Looks like you take a deduction and the amount also depends on whether or not you have a plan in place from your employer

http://budgeting.thenest.com/make-pretax-contributions-ira-24395.html

30French

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Re: Roth 401K vs Roth IRA vs 401K
« Reply #6 on: May 07, 2015, 03:48:20 PM »
A lot of these decisions are influenced by what your income will be between now and ER.  If you are going to have some high earning years at the end of your working life you may potentially be in a higher bracket in retirement than you are now.  You can't predict the future but you should do your best to come up with the most accurate estimations.

Druid

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Re: Roth 401K vs Roth IRA vs 401K
« Reply #7 on: May 07, 2015, 04:51:33 PM »
A lot of these decisions are influenced by what your income will be between now and ER.  If you are going to have some high earning years at the end of your working life you may potentially be in a higher bracket in retirement than you are now.  You can't predict the future but you should do your best to come up with the most accurate estimations.

I don't see the correlation between income made in later working years with income in retirement unless a pension is involved. It actually matters more what income bracket he plans to be in WHEN he makes the withdrawals. Income in working years helps people compare there current and retirement tax rates, but for most of the readers on this forum it's safe to assume a lower retirement income(assuming no pensions). Either way it matters more what the tax rate will be when the money is actually withdrawn. Financial advisors often recommend Roth to people who will be in higher income brackets when they are working, because they are not familiar with the concept of living on less in retirement.

I personally think that most MMM readers who are in high income brackets in their working careers will benefit from lowering the amount of their income in those high brackets now by choosing traditional with the expectation that they will be living a frugal retirement.  The real benefit is that they will have more than 25 percent principal to build wealth from. Comparing income brackets for people who plan to be in the lowest bracket during retirement anyway becomes less of a focus, since it is likely that the traditional will perform better than the Roth in most cases(people in the 15 percent bracket are the exception).

The Roth is actually preferable to young people who have effective tax rates that are less than 15 percent. The reason being that the starting principal will be less than 15 percent lower in a Roth, but the young investor will likely see 30 or more years of compounding that can be withdrawn tax free. As the investor ages the benefit of Roth dilutes regardless of tax bracket, since the tax free appreciation is the real benefit. Roth is also useful for rich people who plan to raise there income in retirement. We call these people the one percent.

An old MMM reader in the highest tax bracket is often better off with the tax break now, since he will likely not see that many years of compounding. Conventional financial wisdom does not always hold on this forum, because most people plan to be in the lowest possible tax bracket in retirement.  Traditional often wins since it can converted to Roth and be used to offset exemptions and standard deductions. The Op is the main exception to this rule. Young and still in the 15 percent bracket.
« Last Edit: May 07, 2015, 05:19:36 PM by Druid »

monstermonster

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Re: Roth 401K vs Roth IRA vs 401K
« Reply #8 on: May 10, 2015, 05:21:52 PM »
Druid,  Thanks for the incredibly thorough read. I really appreciate it. I'm convinced now on the Roth front, and I'm going to stick with my Roth IRA instead of the Roth 401K in case I consider pulling some $$ out for a down payment or emergency down the line (though hopefully I never do).

So I've decided to max out my Roth IRA and then stick 6% in a traditional 401K. Altogether this will give me a 20% retirement savings rate. If it's still not tight on my income (or after I'm done crash-saving for a down payment) I'll up the savings rate on the traditional 401k.