Author Topic: Roth or Traditional 401k  (Read 3934 times)

DOPOLI

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Roth or Traditional 401k
« on: May 09, 2014, 09:13:16 AM »
Hello- I'm looking for suggestions or advice on whether to invest in a Roth or Traditional 401k.

I've recently considered the possibility of early retirement, and my wife and I are thinking we may be able to "retire" in around 5-6 years at age 42 or 43. I think we will have around 1.5M savings by then (assuming 7% annual return and 50% current savings rate (net income)). I think that will be enough, since our work-related and childcare expenses will go away when we are "retired". Assuming 4% annual withdrawal rate, that would be 60K annual income. To be safe, let's assume we use the full 60K per year.

Would you recommend putting our new retirement contributions in a Traditional 401k going forward in order to reduce taxes now?
If we do that, we won't have access to the traditional retirement accounts until we are 60-ish, without paying a penalty. Or, should we continue putting money into Roth accounts, so we can access the principal w/out penalty before age 60?

Here are our stats:
Both age 37.
Two kids (6 and 2).
Current Gross combined income: $250K
Wife works in public sector, so has access to two retirement accounts: 457 and 403b, in which we put max (17.5k each. 1 is Roth, 1 is Traditional). I work in private sector and put max in Roth 401k. We also put money in Roth IRA ($5.5k each- converting traditional/nondeductable to Roth).
Residence: Tx, so no state income taxes

Current savings:
Roth retirement accounts: $276K
Traditional retirement accounts: 180K
Non-retirement accounts: $130k

Debt:
Student loan: $35k at 2.1%, will be paid off/forgiven in 5.5 yrs. ($250/mo)
Mortgage: $230K remaining balance, 30 yr fixed at 3.4%. ($1000/ monthly payment). house worth ~330k. no plans to pay off early.

« Last Edit: May 09, 2014, 09:29:47 AM by FilopodG »

ZiziPB

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Re: Roth or Traditional 401k
« Reply #1 on: May 09, 2014, 09:18:23 AM »
I just read this earlier today.  Has some good calculations for different scenarios and break even points:

http://www.bloomberg.com/news/2014-05-08/one-of-the-best-retirement-deals-9-out-of-10-people-ignore.html

Frankies Girl

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Re: Roth or Traditional 401k
« Reply #2 on: May 09, 2014, 09:26:47 AM »
You can access 401k/403b/IRAs well before 59 without penalties or taxes in many cases... search for Roth Pipeline and SEPP for two ways of doing so. Has been discussed very, very, very often around these parts. ;)

http://www.madfientist.com/traditional-ira-vs-roth-ira/
^ good synopsis on the pipeline method


I'd also question how you're able to contribute to a Roth IRA since you make well over the income cutoffs to be eligible. You might want to check that, as you could be facing some difficulties with having to reclassify your contributions if so.

The traditional thinking around here is you max out all available work-related retirement accounts to get the reduction in income for taxable purposes and to take advantage of the tax deferred investing. Then you do a Roth if possible and then taxable investing.

I'm also not sure you can do both traditional and Roths - the maximum you can put in per working person is $5,500 so $11K total per year, and if you have both Roth and traditional I think that's between the both of them?

« Last Edit: May 09, 2014, 09:31:31 AM by Frankies Girl »

ZiziPB

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Re: Roth or Traditional 401k
« Reply #3 on: May 09, 2014, 09:44:06 AM »
Quote
I'd also question how you're able to contribute to a Roth IRA since you make well over the income cutoffs to be eligible. You might want to check that, as you could be facing some difficulties with having to reclassify your contributions if so.

Sounds like the OP is doing "backdoor Roth" which is not subject to any income limits.

beltim

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Re: Roth or Traditional 401k
« Reply #4 on: May 09, 2014, 11:51:28 AM »
You're a textbook case for the traditional retirement accounts being the better deal.  At 250k salary, you're in the 33% tax bracket.  When you retire with a 60k income, you'll be in the 15% tax bracket.  You're basically paying 18% for the privilege of being able to withdraw your contributions. 

But this is crazy, when you can withdraw about 3.8% of your 401k balance each year when you retire via 72(t) distributions (http://www.bankrate.com/calculators/retirement/72-t-distribution-calculator.aspx with data from http://www.irs.gov/pub/irs-drop/rr-14-13.pdf) without paying any penalties.  You should be putting all of your saving in traditional accounts, to save more than 18% more money!

DOPOLI

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Re: Roth or Traditional 401k
« Reply #5 on: May 09, 2014, 12:03:59 PM »
Thanks for the opinion. It kind of confirms what I was thinking.
We've only recently started making this much money. This lead me to think about the possibility of early retirement and to rethink our strategy of preferentially investing in Roth accounts.

beltim

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Re: Roth or Traditional 401k
« Reply #6 on: May 09, 2014, 12:09:11 PM »
Thanks for the opinion. It kind of confirms what I was thinking.
We've only recently started making this much money. This lead me to think about the possibility of early retirement and to rethink our strategy of preferentially investing in Roth accounts.

Then this is the perfect time to rethink things.  Congrats on the raises, and let me know if you have any other questions - I'm happy to help. 

foobar

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Re: Roth or Traditional 401k
« Reply #7 on: May 09, 2014, 01:02:33 PM »
Just remember it is 60k in 2020 dollars. That is more like 50k in todays dollars.

But yeah do the traditional.  Dropping your MAGI from 250k to 200k is nice in that you also avoid the 3.8% tax on your qualified divs. And you are probably right at the AMT line also so reducing salary is also a plus When you retire, it might make sense to take a couple of years to roll over some big chunks into an ROTH.  Lets say you decided to do 200k/yr (probably not optimal). You would  only pay ~34k in taxes. That 17% is a heck of a lot lower than your current 28%+.  Only do a 100k? You are looking at more like 8%. And here is the final big thing. And here is the last big reason to do the traditional. Lets say you put 50k in a ROTH this year and have to pay 10k in taxes.   If the fund drops 50% guess what? You still pay those 10k in taxes. Your tax rate went from 20%(10k/50k) to 40%(10/25k).  Now lets say you do a ROTH conversion from your IRA and the same thing happens. You undo the conversion and pay zero taxes (or start another one and pay 20%).  Obviously an extreme example.



Hello- I'm looking for suggestions or advice on whether to invest in a Roth or Traditional 401k.

I've recently considered the possibility of early retirement, and my wife and I are thinking we may be able to "retire" in around 5-6 years at age 42 or 43. I think we will have around 1.5M savings by then (assuming 7% annual return and 50% current savings rate (net income)). I think that will be enough, since our work-related and childcare expenses will go away when we are "retired". Assuming 4% annual withdrawal rate, that would be 60K annual income. To be safe, let's assume we use the full 60K per year.

Would you recommend putting our new retirement contributions in a Traditional 401k going forward in order to reduce taxes now?
If we do that, we won't have access to the traditional retirement accounts until we are 60-ish, without paying a penalty. Or, should we continue putting money into Roth accounts, so we can access the principal w/out penalty before age 60?

Here are our stats:
Both age 37.
Two kids (6 and 2).
Current Gross combined income: $250K
Wife works in public sector, so has access to two retirement accounts: 457 and 403b, in which we put max (17.5k each. 1 is Roth, 1 is Traditional). I work in private sector and put max in Roth 401k. We also put money in Roth IRA ($5.5k each- converting traditional/nondeductable to Roth).
Residence: Tx, so no state income taxes

Current savings:
Roth retirement accounts: $276K
Traditional retirement accounts: 180K
Non-retirement accounts: $130k

Debt:
Student loan: $35k at 2.1%, will be paid off/forgiven in 5.5 yrs. ($250/mo)
Mortgage: $230K remaining balance, 30 yr fixed at 3.4%. ($1000/ monthly payment). house worth ~330k. no plans to pay off early.

FrugalSpendthrift

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Re: Roth or Traditional 401k
« Reply #8 on: May 09, 2014, 02:52:50 PM »
I just read this earlier today.  Has some good calculations for different scenarios and break even points:

http://www.bloomberg.com/news/2014-05-08/one-of-the-best-retirement-deals-9-out-of-10-people-ignore.html

I'm struggling to understand the math in that article.  Where does the 17% come from?  If that is the extra tax paid in the current year, then it isn't really a fair comparison, just two vastly different savings rates.

Quote from: Silly Bloomberg Article
An analysis by T. Rowe Price found that a 30-year-old saving in a Roth 401(k) would have 17 percent more spendable income in retirement even if his pre- and post-retirement tax rates were the same.

foobar

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Re: Roth or Traditional 401k
« Reply #9 on: May 09, 2014, 07:43:34 PM »
Sit down with a calculator and  run your numbers. If memory serves the TRowe price assumed you would either put 1k in a ROTH or a tIRA and the tax savings of the tIRA just disappeared. Otherwise it was cr*p

You can mess around with various calculators (http://www.calcxml.com/calculators/ret10?skn=#results I don't do the side account because I am not sure how they handle the taxes on it.). You have to make sure you but in a good tax rate.  10-15% is a good upper bound (seriously do the math on how much money you need to pay a 15% tax rate on your income if you don't have pension, SS or dividend income and ask yourself if you will be taking that out during retirement).  The other thing to think about is how long you have to either convert the money to a roth or spend it before age 70 (when RMDs and SS kicks in). The person that retires at 50 has 15 more years to spread out his withdrawals.

There are other things to think about (ACA subsidies is a big one) but the general though of if your making less money later in life, postpone taxes as long as possible.


I just read this earlier today.  Has some good calculations for different scenarios and break even points:

http://www.bloomberg.com/news/2014-05-08/one-of-the-best-retirement-deals-9-out-of-10-people-ignore.html

I'm struggling to understand the math in that article.  Where does the 17% come from?  If that is the extra tax paid in the current year, then it isn't really a fair comparison, just two vastly different savings rates.

Quote from: Silly Bloomberg Article
An analysis by T. Rowe Price found that a 30-year-old saving in a Roth 401(k) would have 17 percent more spendable income in retirement even if his pre- and post-retirement tax rates were the same.