Author Topic: Roth vs Traditional Question for IRA & 401k/403b  (Read 5862 times)

fin123

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Roth vs Traditional Question for IRA & 401k/403b
« on: January 14, 2014, 08:50:23 AM »
Hi all,

Simple question regarding Roth vs Traditional elections.  My wife and I (24 & 26, respectively) combine to make ~135K, split basically even between us.  We contribute 10-12% of our income to our 401k/403b and max out our IRAs each year.  We both have the ability through work to elect a before or after-tax election for our 401k & 403b. 

I have a good feeling that in retirement we'll be in a lower tax bracket than we are currently as we won't be making our current level of income.  However, would it still be better to make Roth/Before tax elections for our 401k/403b & IRA accounts?  If anything, tax rates will probably rise, and while in 35 years the Gov could theoretically tax Roth accounts, I don't see them able to pass that legislation.  Or, should we hedge our bets and make Roth IRA contributions while going before-tax with one 401k and after-tax with the 403b?  That way, we can have more control over our income streams down the line due to ability to pull from before & after tax account.

In summary - 135K income, mid-20s, how should we make elections for IRAs and work retirement accounts?

Thanks in advance for any assistance!

NumberCruncher

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #1 on: January 14, 2014, 09:31:14 AM »
My husband and I have had similar questions in the past and are currently in the 28% tax bracket. One simple solution is to use the Roth IRA pipeline, in which case using tax-advantaged (traditional) accounts makes a ton of sense: http://www.mrmoneymustache.com/forum/ask-a-mustachian/help-me-understand-the-roth-conversion-pipeline-idea-and-its-benefits/

Even if we were to just withdraw funds and pay the 10%, our spending levels would put us squarely in the 15% tax bracket (which hasn't changed a ton in recent history: http://taxfoundation.org/article/us-federal-individual-income-tax-rates-history-1913-2013-nominal-and-inflation-adjusted-brackets ), meaning we'd still come out ahead with traditional accounts. Since we have very few other deductions (renting non-parents), it saves us quite a bit. We'd even do traditional IRAs if we could get the deduction. Since we can't, we do Roth.

I don't see them changing the rules much on the lower tax brackets, but even if I did...it's a lot of speculation.


the fixer

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #2 on: January 14, 2014, 10:16:02 AM »
I agree that you could speculate either way. I think raising the income tax rates on lower income earners is roughly as likely as putting a small tax on Roth withdrawals. Politicians and think tanks could put out all kinds of studies saying that despite the Roth IRA being intended for low-income taxpayers, the wealthiest receive most of the benefits. So having some in both accounts seems like a good idea.

I would put any money that would get taxed at 28% or more into tax-deferred accounts, then the rest could be split. The other variable worth considering is state income taxes if you think those will go down or up for you in retirement (including the case where you plan on moving to a different state).

FrugalSpendthrift

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #3 on: January 14, 2014, 01:05:27 PM »
I've been wrestling with this as well, but my crystal ball won't project that far.  I'm in my mid 30's, currently in the 25% tax bracket, but if business goes well, I could potentially be in a higher tax bracket in a couple years.  I've been using a Roth 401k for a number of years, and haven't really tracked it well until recently.  I just noticed that 56% of my portfolio across all of me and my wife's accounts is Roth money.  That shocked me into switching back to pre-tax contributions, but I can't decide if it was the right move.  If I was in a higher tax bracket, I would feel more strongly that the pre-tax investment was the way to go, but being in the middle, I'm not so sure.

frugally

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #4 on: January 14, 2014, 01:51:59 PM »

Cheddar Stacker

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #5 on: January 14, 2014, 02:43:47 PM »
I use these posts as my guideline. If you don't spend much money, and your tax rate is above 10%, traditional gives you a better tax benefit than Roth using these strategies.

http://www.madfientist.com/retire-even-earlier/
http://www.gocurrycracker.com/never-pay-taxes-again/

aj_yooper

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #6 on: January 15, 2014, 06:13:08 AM »
If you have an employer-basee HSA available, I would be using that too; they are the sweet spot for tax advantaged.  For me, generally, if you see yourselves retiring in the 10-15% bracket, tax advantaged is the way to go, assuming you are clearly above the 15% marginal rate already.  If you have more money left over to invest, taxable accounts, properly constructed, are also very beneficial.  The sites mentioned above are very good.

fin123

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #7 on: January 15, 2014, 12:49:52 PM »
OP here.  Thanks all for the responses.

For now, the Roth pipeline is a little too complex for me to delve into.

If you have an employer-basee HSA available, I would be using that too; they are the sweet spot for tax advantaged.  For me, generally, if you see yourselves retiring in the 10-15% bracket, tax advantaged is the way to go, assuming you are clearly above the 15% marginal rate already.  If you have more money left over to invest, taxable accounts, properly constructed, are also very beneficial.

I don't have access to an HSA.  But that would be ideal.

So having some in both accounts seems like a good idea.

I would put any money that would get taxed at 28% or more into tax-deferred accounts, then the rest could be split. The other variable worth considering is state income taxes if you think those will go down or up for you in retirement (including the case where you plan on moving to a different state).

I'm feeling that splitting would be a good tactic.  As retirement will be in decades, not sure where I'll end up then...

It seems like the feelings of most that Traditional would be the way to go.  I still feel like paying taxes now and being tax-free in the future is a little safer.  The way the country is moving, rates (especially on capital gains) aren't going anywhere but up...


aj_yooper

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #8 on: January 15, 2014, 12:58:48 PM »
If you do a Roth, you are effectively putting more money than in a traditional.

fin123

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #9 on: January 15, 2014, 01:00:17 PM »
If you do a Roth, you are effectively putting more money than in a traditional.

Taking into account future gains and no taxes - is that what you mean?

aj_yooper

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #10 on: January 15, 2014, 01:14:00 PM »
Sorry for being unclear.  I mean:  in a Roth, because the tax is paid, when you put in $5,500 it is there, plus gains.  If you put the same in a traditional IRA, the money is (deposit plus gains) times tax rate at disbursement.  So effectively, you get more out of the Roth in retirement, but it's not magic as you paid the taxes.   This could be helpful to some.

I think it is usually better to do a traditional tax deferred, if the marginal tax rate is over 25%, if you plan to retire in the 10-15% marginal bracket.  You transport the money from a tax scenario which is higher to a lower tax scenario.  That is also why taxable accounts are beneficial, especially if you go from 25% or greater tax rate to the 10-15% tax since the long term capital gains is 0% in the lower 2 brackets.

TheDude

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #11 on: January 15, 2014, 03:56:15 PM »
I started putting money back in my roth instead of traditional for a couple of reasons.

1. we max our 401k, simple ira, hsa and soon possibly a 457. That's a lot of tax deferred. I want to mix it up a little.

2. In addition to the the above accounts my wife will have a pension. This will more than likely completely cover living expenses plus.

2. The Roth is not required to take mandatory distributions at 70. All of the deferred account do.

frugally

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #12 on: January 15, 2014, 06:15:20 PM »
I use these posts as my guideline. If you don't spend much money, and your tax rate is above 10%, traditional gives you a better tax benefit than Roth using these strategies.

http://www.madfientist.com/retire-even-earlier/
http://www.gocurrycracker.com/never-pay-taxes-again/

I think madfientiest has a good point here; I've never seen this article.  The potential problem, I see, is that I think most of us who are likely to FIRE also will have our staches grow over time due to our nature, and may be in the 15% tax bracket and beyond.  It's a human nature thing, though, and a good problem to have overall if that does end up being the case.

kpd905

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #13 on: January 16, 2014, 04:52:02 AM »
I've been wrestling with this as well, but my crystal ball won't project that far.  I'm in my mid 30's, currently in the 25% tax bracket, but if business goes well, I could potentially be in a higher tax bracket in a couple years.  I've been using a Roth 401k for a number of years, and haven't really tracked it well until recently.  I just noticed that 56% of my portfolio across all of me and my wife's accounts is Roth money.  That shocked me into switching back to pre-tax contributions, but I can't decide if it was the right move.  If I was in a higher tax bracket, I would feel more strongly that the pre-tax investment was the way to go, but being in the middle, I'm not so sure.

25% is still high to go with Roth.  If you go traditional, you immediately save 25% on those contributions.  To pay 25% effective federal tax on 401k withdrawals, you'd have to withdraw $240,000 per year.

Cheddar Stacker

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #14 on: January 16, 2014, 08:55:40 AM »
I use these posts as my guideline. If you don't spend much money, and your tax rate is above 10%, traditional gives you a better tax benefit than Roth using these strategies.

http://www.madfientist.com/retire-even-earlier/
http://www.gocurrycracker.com/never-pay-taxes-again/

I think madfientiest has a good point here; I've never seen this article.  The potential problem, I see, is that I think most of us who are likely to FIRE also will have our staches grow over time due to our nature, and may be in the 15% tax bracket and beyond.  It's a human nature thing, though, and a good problem to have overall if that does end up being the case.

It's certainly possible to end up in the 15% tax bracket, but I've commented on this before in the forum and ran my own scenario in complex tax software. I can generate around $96K in income through IRA > Roth conversions and LT-Cap Gains/Qualified Dividends, and pay almost no federal income taxes. That's a lot of income that you can shelter while continuing to grow your stache. If you can manage it properly, it's possible to never pay taxes on a lot of your conversions which means you've never paid federal income taxes on those earnings. Here's a link to that post:

http://www.mrmoneymustache.com/forum/ask-a-mustachian/4-withdraw/msg187544/#msg187544

bryaday

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Re: Roth vs Traditional Question for IRA & 401k/403b
« Reply #15 on: January 16, 2014, 10:41:29 AM »
I started putting money back in my roth instead of traditional for a couple of reasons.

1. we max our 401k, simple ira, hsa and soon possibly a 457. That's a lot of tax deferred. I want to mix it up a little.

2. In addition to the the above accounts my wife will have a pension. This will more than likely completely cover living expenses plus.

2. The Roth is not required to take mandatory distributions at 70. All of the deferred account do.


This is my main point.  We don't know what taxes will be upon retirement of this couple and you do not mandated to withdrawl out of Roth accounts at age 70.

There is no Tax.  My recommendation is always do some kind of 50/50 split because we don't know we will be in a lower tax bracket but we can assume we will be.