Author Topic: Switch from Roth to Traditional 401k/IRA/TSP?  (Read 3841 times)

EngineerYogi

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Switch from Roth to Traditional 401k/IRA/TSP?
« on: January 19, 2016, 12:25:06 PM »
***Edit: link to google drive case study https://docs.google.com/spreadsheets/d/1K_2Tf221stuJSXGt3-8XmG0i-hIQH0W4dEwwrOW5lPo/edit?usp=sharing

Some case study leg work, still a work in progress:
Life Situation: Married filing jointly, no dependents, living in California in air force base housing, I am 26 years old and a resident of NM and husband is 30 years old and a resident of AZ

Gross Salary/Wages: My income is $91,624.00 as an engineer/analyst, husband's is $88,759.56 as an officer in the Air Force

Pre-tax deductions: HFSA-$2,500, Dental/Vision Insurance-$286.44, Military housing allowance-$23,976(we live on base so this is all handed over to housing, covers utilities and residence), Military "subsistence" allowance-$3043.56

Post-tax deductions: R401k-$5,497.44 , Short Term Disability-$96.21, Employee Life Insurance-$117.02, TSP contribution-$xxx, Medical dependent coverage-$xxx

Other Ordinary Income: company 401k contributions-$3664.96, Provide sources and any relevant details, the more the better

Qualified Dividends & Long Term Capital Gains: If these are significant for you

Rental Income, Actual Expenses, and Depreciation: 2015 Income $6,300, Actual Expenses $xxx, Depreciation $xxx

Adjusted Gross Income: This should equal the additions and subtractions above.

Taxes: Federal, state/local, and FICA.  These should be consistent with your AGI and Life Situation.  For non-U.S. posters, we’ll have to take your word for these.
weekly:

Fed Withholdng 222.74
Fed MED/EE 24.74
Fed OASDI/EE 105.77
CA OASDI/EE 15.34
NM Withholdng 76.10

Plus husband's: xxx


Current expenses: Provide breakdown and relevant details.  Aim to have “Miscellaneous” somewhere ~2.5%.  Much lower and you may be providing too much detail, much higher and you have an obvious problem of not understanding your spending.

For mortgage payments, separate the P&I (which stop when the mortgage is paid) from the T&I (and anything else) which continue as long as you own the property.--accomplished in spreadsheet (found a $300 escrow overage check that I overlooked in June while digging for this breakdown...this makes me sound unorganized and bad with money.)

Expected ER expenses: N/A 100% medical coverage through the air force

Assets:
2007 Toyota Corolla
Roth 401k
Roth IRA
TSP
Savings

Amount & description - include current asset allocation plan if you have one

Liabilities:
American Express Credit Card: Balance $1,999.82, this card is generally paid off each month but Christmas gifts and vacation/travel expenses carried over into this month-which was one of the eye opening reasons I ended up re-discovering MMM
Southwest Rewards Visa Credit Card: Balance $4,422.27, 0% interest until May 2016, Minimum Payment $44
Student Loan:  Original Loan Amount $5,500, Rate 3.15%(fixed/subsidized), 10-Year Term, Monthly Payment $54.51, Current Balance $4,933.13, Pay Off Date 10/2024
Personal Loan: Original Loan Amount $25,000, Rate 2.99%, 5-Year Term, Monthly Payment $449.59, Current Balance $13,011.59, Pay Off Date 06/2018
Truck Loan:  Original Loan Amount $35,206.35, Rate 1.90%, 5-Year Term, Monthly Payment $615.55, Current Balance $15,659.45, Pay Off Date 03/2018

Mortgage: Original Loan Amount $113,320, Rate 4.750%, 30-Year Term, Monthly Payment $754.85, Current Balance $104,755.27, Pay Off Date 7/2040

Hello Mustachians,

I am a brand new follower. I read some of MMM's articles a year or more ago and they stuck in the back of my mind but I took no action. I have some renewed interest in tackling debt and striving for FI and finally have my husband on board.

My question: I have been contributing to a Roth 401k with the assumption I'd be in a higher tax bracket upon retirement, I was following the typical financial advice in that respect. My husband contributes to a Roth IRA as well as his TSP(he's in the Air Force) which I believe is also a Roth contribution. We've been contributing at a rate of 14.4% plus my employer contribution (4% flat, not a match) which averages us to 17.4% over the last 3 years (when I graduated and entered employment).

We get hit hard with taxes because we are dual income, no children and our mortgage(which is now an investment property because the air force moved us in 2014) is small enough that we have only ever qualified for the standard deduction.

We are also repaying the debts we managed to rack up over the first 9 years of marriage, last year was the first year we did not acquire any new debt and actually lived within our means. We were planning to get all credit cards paid off last year, but we ended up having to pay for my father-in-law's funeral out of pocket which was a big hit and we lost sight of our finance goals and then way over spent for Christmas and a vacation in December.

As soon as the debts are paid off and if we manage to sell the investment property (it's on the market but not looking good) we could easily be contributing 65% of income to retirement(59% if the property doesn't sell and sits without tenants).

So really to my question: Should I switch all of our retirement contributions from Roth to Traditional? Or should I wait and make sure my mustachian ways kick in first?

So far so good in January, I've cut our grocery and general spending down drastically and made some massive debt payments and it feels good. I forecasted our debt payments for the year and we could tackle all of them (credit cards, personal loan, student loan and an auto loan) by October as long as we keep our spending in check.

Any other questions? Suggestions? Thanks in advance!
« Last Edit: January 19, 2016, 09:45:35 PM by eat.train.yoga.love »

MDM

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #1 on: January 19, 2016, 02:00:43 PM »
I have been contributing to a Roth 401k with the assumption I'd be in a higher tax bracket upon retirement....
My husband contributes to a Roth IRA as well as his TSP(he's in the Air Force) which I believe is also a Roth contribution.
...
So really to my question: Should I switch all of our retirement contributions from Roth to Traditional? Or should I wait and make sure my mustachian ways kick in first?
Welcome to the forum!

How did you calculate/assume that you would be in a higher tax bracket upon retirement?  Not saying you won't, but all those Roth accounts will likely contribute exactly $0 to your taxable income when you withdraw.

Gone Fishing

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #2 on: January 19, 2016, 02:31:36 PM »
The tax links in my signature below may help you decide.

If you decide to change, you can go back and change (recharacterize) your 2015 contributions up until Oct 15th of this year.  The only catch is if you wait do it after you file, you will have to go back and file an amended return to get the difference.

Also, when deciding which debts to pay off first, consider that you can probably deduct your student loan interest without itemizing which effectively lowers the rate by the percentage as your federal tax bracket plus any state deduction you might get.

Probably wouldn't hurt to do a case study:

http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-'case-study'-topic/

The additional details make it much easier to give accurate advice!
 
« Last Edit: January 19, 2016, 02:35:09 PM by So Close »

EngineerYogi

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #3 on: January 19, 2016, 03:24:10 PM »
I have been contributing to a Roth 401k with the assumption I'd be in a higher tax bracket upon retirement....
My husband contributes to a Roth IRA as well as his TSP(he's in the Air Force) which I believe is also a Roth contribution.
...
So really to my question: Should I switch all of our retirement contributions from Roth to Traditional? Or should I wait and make sure my mustachian ways kick in first?
Welcome to the forum!

How did you calculate/assume that you would be in a higher tax bracket upon retirement?  Not saying you won't, but all those Roth accounts will likely contribute exactly $0 to your taxable income when you withdraw.

Uh... Suze Orman's suggestions? :P That was my previous financial dabbling, I read a book... So, now that I don't plan on working until I'm 65 and expecting to live on more than I do now, this changes thing significantly. I'm realizing I may be very near the highest possible bracket at this moment, hubby and I both have above average salaries especially combined and considering our age.

EngineerYogi

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #4 on: January 19, 2016, 03:27:42 PM »
The tax links in my signature below may help you decide.

If you decide to change, you can go back and change (recharacterize) your 2015 contributions up until Oct 15th of this year.  The only catch is if you wait do it after you file, you will have to go back and file an amended return to get the difference.

Also, when deciding which debts to pay off first, consider that you can probably deduct your student loan interest without itemizing which effectively lowers the rate by the percentage as your federal tax bracket plus any state deduction you might get.

Probably wouldn't hurt to do a case study:

http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-'case-study'-topic/

The additional details make it much easier to give accurate advice!

Ooo, I'll work on my case study! Thank you for the link. (my student loan interest was a whopping $171 last year, which a case study would have told you, so I'll get to it)

And you're saying I could change my contributions from Roth to Traditional for last year? How would that look from a tax perspective? Would I just be looking at a larger return which I could then invest on my own? (this is an exciting prospect, particularly if investing in traditional really is a better/smarter path forward)

Bicycle_B

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #5 on: January 19, 2016, 03:42:05 PM »
Here's a guess that So Close will answer newest questions "yes, good, yes" or some such, but more eloquently than I.

In case your question was intended to cover upcoming contributions, rather than considering an attempt to change prior contributions, the most common answer on these forums is usually that you are likely to come out ahead focusing your future contributions to retirement accounts into traditional accounts (401k, 457 plan, traditional IRA) instead of Roth because if you have a retirement period where you are living off modest investment income (roughly $37,000 or less per adult) you will have a chance to actually convert some or all of your retirement accounts to Roth without paying income tax.  This will reduce your tax rate compared to now, therefore you will save.  Bear in mind also that if your overall income is under the amount above, investment income usually ends up tax free; this will apply to stocks held in brokerage accounts as well as proper Roth withdrawals. 

Many discussions of the details of this can be found on this blog, including the forums.  Mad Fientist is another blogger whose specialty is detailing this very issue: how to minimize your tax payments under US law, specifically for early retirement. 

You're going to love this! 

EngineerYogi

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #6 on: January 19, 2016, 09:17:53 PM »
Here's a guess that So Close will answer newest questions "yes, good, yes" or some such, but more eloquently than I.

In case your question was intended to cover upcoming contributions, rather than considering an attempt to change prior contributions, the most common answer on these forums is usually that you are likely to come out ahead focusing your future contributions to retirement accounts into traditional accounts (401k, 457 plan, traditional IRA) instead of Roth because if you have a retirement period where you are living off modest investment income (roughly $37,000 or less per adult) you will have a chance to actually convert some or all of your retirement accounts to Roth without paying income tax.  This will reduce your tax rate compared to now, therefore you will save.  Bear in mind also that if your overall income is under the amount above, investment income usually ends up tax free; this will apply to stocks held in brokerage accounts as well as proper Roth withdrawals. 

Many discussions of the details of this can be found on this blog, including the forums.  Mad Fientist is another blogger whose specialty is detailing this very issue: how to minimize your tax payments under US law, specifically for early retirement. 

You're going to love this!

Thank you for the info! I believe you answered my initial question, probably more advantaged to go the Traditional IRA route if early retirement is for us. :)

EngineerYogi

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #7 on: January 19, 2016, 09:24:28 PM »
I started working out my case study, I added the link to the original post.
I have a couple of questions regarding that now: my husband is in the military and a portion of his income is tax free, he also spent some time this year in a combat zone so all of his income was tax free during that period. How should I reflect this in the spreadsheet?

Also, how do I determine depreciation for my house? The house was our primary residence until the military moved us far away so we started renting it out with a property manager, we had tenants for about half of last year. We also still pay the mortgage/taxes/insurance on it so I'm not sure how that all works out as far as "real costs" go.

I still need to add current investment accounts, we have been contributing entirely Roth.

There is not a place that works for credit card debt/payments? Should/can I tweak them to fit under loans? We do have 2 credit cards that are currently carrying balances, I get it, those have got to go, we can pay them off by early March if we cut back the outrageous spending we had from the past few months. January is looking much better. We are scaling back grocery spending, cutting out entertainment/restaurants/movies until those are paid off.

Vagabond76

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #8 on: January 19, 2016, 09:47:05 PM »
You can probably leave everything the way it is.

About 25% of your husband's take home pay is tax-free allowances.

Don't recharacterize Roth TSP or IRA contributions that were funded with tax-free combat pay. The contributions were tax-free going in and all distributions (contributions + earnings) will be tax-free coming out.

The mortgage and property taxes on the rental is 100% deductible along with depreciation. If your combined AGI is less than $100k, you can offset up to $25k in losses on the house against other I come.

I bet these benefits will combine to make your tax near zero.

MDM

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #9 on: January 19, 2016, 11:08:37 PM »
I started working out my case study, I added the link to the original post.
I have a couple of questions regarding that now: my husband is in the military and a portion of his income is tax free, he also spent some time this year in a combat zone so all of his income was tax free during that period. How should I reflect this in the spreadsheet?
Tax-free income should go in cell B50 - appears you found that. 

Don't include the same income in cell B2 or B3 that you have in B50.

If you pay state/local income tax you can enter a fixed percentage in cell H30.  If you want to get fancy, feel free to override the formula in G30 with your state's.

Do you pay both a mortgage and rent for your own home(s)?  If the mortgage is for the rental the monthly payment should be part of cell B31.

This is as good a place as any to mention: you'll have to decide if you want the spreadsheet to be a look back or a look forward....

Quote
Also, how do I determine depreciation for my house? The house was our primary residence until the military moved us far away so we started renting it out with a property manager, we had tenants for about half of last year. We also still pay the mortgage/taxes/insurance on it so I'm not sure how that all works out as far as "real costs" go.
Depreciation entered in the spreadsheet should be whatever the IRS allows - often 27.5 year straight line on the building (not land) value.

Quote
There is not a place that works for credit card debt/payments? Should/can I tweak them to fit under loans?
Yes, if you enter the balance, interest rate, and time over which you intend to pay off the debt the monthly payment will be calculated for you.  Spreadsheet uses the "original principal" and "original length" columns to calculate the monthly payments.  The "current principal" and "years remaining" go into the "time to FI" calculations.

You may want to change the filing status and number of exemptions from "single" and "1" to "MFJ" and "2" (cells G2 and G3).

Good work!

EngineerYogi

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #10 on: January 20, 2016, 01:52:25 PM »
You can probably leave everything the way it is.

About 25% of your husband's take home pay is tax-free allowances.

Don't recharacterize Roth TSP or IRA contributions that were funded with tax-free combat pay. The contributions were tax-free going in and all distributions (contributions + earnings) will be tax-free coming out.

The mortgage and property taxes on the rental is 100% deductible along with depreciation. If your combined AGI is less than $100k, you can offset up to $25k in losses on the house against other I come.

I bet these benefits will combine to make your tax near zero.

Good point on the tax free going into Roth. I don't think we'll be able to drop the AGI below $100k, it's at $150k for now, plus with needing to make the debt payments we won't be increasing retirement contributions yet.

EngineerYogi

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #11 on: January 20, 2016, 01:59:30 PM »
I started working out my case study, I added the link to the original post.
I have a couple of questions regarding that now: my husband is in the military and a portion of his income is tax free, he also spent some time this year in a combat zone so all of his income was tax free during that period. How should I reflect this in the spreadsheet?
Tax-free income should go in cell B50 - appears you found that. 

Don't include the same income in cell B2 or B3 that you have in B50.

If you pay state/local income tax you can enter a fixed percentage in cell H30.  If you want to get fancy, feel free to override the formula in G30 with your state's.

Do you pay both a mortgage and rent for your own home(s)?  If the mortgage is for the rental the monthly payment should be part of cell B31.

This is as good a place as any to mention: you'll have to decide if you want the spreadsheet to be a look back or a look forward....

Quote
Also, how do I determine depreciation for my house? The house was our primary residence until the military moved us far away so we started renting it out with a property manager, we had tenants for about half of last year. We also still pay the mortgage/taxes/insurance on it so I'm not sure how that all works out as far as "real costs" go.
Depreciation entered in the spreadsheet should be whatever the IRS allows - often 27.5 year straight line on the building (not land) value.

Quote
There is not a place that works for credit card debt/payments? Should/can I tweak them to fit under loans?
Yes, if you enter the balance, interest rate, and time over which you intend to pay off the debt the monthly payment will be calculated for you.  Spreadsheet uses the "original principal" and "original length" columns to calculate the monthly payments.  The "current principal" and "years remaining" go into the "time to FI" calculations.

You may want to change the filing status and number of exemptions from "single" and "1" to "MFJ" and "2" (cells G2 and G3).

Good work!

Thanks for the help, I got my excel sheet fixed up, need to add it to the google doc. Now I have lots of things to consider looking at this more complete picture of our situation.

I'm considering switching my future contributions to traditional 401k(double checked, Roth401k contributions cannot be re-characterized), but keeping my husband's contributions set for his Roth TSP which will capture the tax-free income into a tax free account regardless of when his income may be tax free throughout the year.

More work can be done once all the debt is out of the way, I did my own forecasting on that and we should be debt free (with the exception of the mortgage) by October and that will free up $4,000 per month to invest!

EngineerYogi

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #12 on: January 20, 2016, 02:10:40 PM »
And one more, I found this advice from MDM in a couple of places while doing more reading:
"WHAT   
0. Establish an emergency fund to your satisfaction   
1. Contribute to 401k up to any company match   
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.   
3. Max HSA   
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level   
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)   
6. Fund mega backdoor Roth if applicable   
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.   
8. Invest in a taxable account with any extra.   
   
WHY   
0. Give yourself at least enough buffer to avoid worries about bouncing checks   
1. Company match rates are likely the highest percent return you can get on your money   
2. When the guaranteed return is this high, take it.   
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.   
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between (or see   
   http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/
   if you want even more details on that topic.)
5. See #4 for choice of traditional or Roth for 401k   
6. Applicability depends on the rules for the specific 401k   
7. Again, take the risk-free return if high enough   
8. Because earnings, even if taxed, are beneficial   
   
The emergency fund is your "no risk" money.  You might consider one of these online banks: http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001   
     
If your 401k options are poor (i.e., high fund fees) you can check http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/ for some thoughts on "how high is too high?"   "

My loan debt (aside from the two credit cards which will be paid off by March) are all under 5%, 3.15, 2.99 and 1.9 the last two have payoff dates approx. 2 years from now. Should I stay the course and be investing instead?

MDM

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #13 on: January 20, 2016, 03:21:13 PM »
And one more, I found this advice from MDM in a couple of places while doing more reading:
...
My loan debt (aside from the two credit cards which will be paid off by March) are all under 5%, 3.15, 2.99 and 1.9 the last two have payoff dates approx. 2 years from now. Should I stay the course and be investing instead?
I would vote for investing based on my perception of the probability the market will outperform those rates.  Of course, that is not guaranteed - over some time periods the market will do worse.

An updated (i.e., incorporating any good ideas that come up here, in bogleheads, etc.) version of those rules of thumb is kept in the case study spreadsheet: tab 'Investment Order'.

EngineerYogi

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Re: Switch from Roth to Traditional 401k/IRA/TSP?
« Reply #14 on: January 20, 2016, 04:03:07 PM »
And one more, I found this advice from MDM in a couple of places while doing more reading:
...
My loan debt (aside from the two credit cards which will be paid off by March) are all under 5%, 3.15, 2.99 and 1.9 the last two have payoff dates approx. 2 years from now. Should I stay the course and be investing instead?
I would vote for investing based on my perception of the probability the market will outperform those rates.  Of course, that is not guaranteed - over some time periods the market will do worse.

An updated (i.e., incorporating any good ideas that come up here, in bogleheads, etc.) version of those rules of thumb is kept in the case study spreadsheet: tab 'Investment Order'.

Guess I should have kept reading! :D I still have some(lots) reading to do, and must pay off credit cards in the mean time. I'll be back for more advice in the near future I'm sure! You guys rock, Thanks again!