Switch to ROTH 401k?

[tryathlete2011]

Just received a letter that beginning next month, my company will offer a ROTH 401k option. I currently contribute $1468/month and company adds $275. I have an additional ~2800 each month that I invest in after tax mutual funds and I've already maxed my and my wife's Roth IRA for the year. Does it make sense for me to take the tax hit now and go with the ROTH 401k option, or keep doing what I'm doing and build a larger stash outside of retirement.

I'm 41 and plan to retire in 7-9 years. Thanks for any advise.

[DrF]

Stay the course. For most people, tax deductible is the way to go.

Here's the best writeup on the subject: http://www.madfientist.com/retire-even-earlier/

Then read this: http://www.madfientist.com/category/guinea-pig/

Then read this: http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/

[tryathlete2011]

Many thanks DrFunk.

[MustacheAndaHalf]

Depends on the tax bracket you'll have now vs retirement.  Most people go into a lower tax bracket, so pre-tax 401(k) allows them to wait for a lower tax bracket before paying tax.  But if you go that route, read about a "Roth conversion ladder" where you use retirement years to convert pre-tax into Roth over time.

[retiringearly]

I am late 40's, all of my 401k contributions have been pre-tax until last year. My company started offering a Roth 401k so I switched to it.  I like the idea of paying tax today and never paying tax on it again.

One variable that no one knows is what will tax rates be in the future.  My gut tells me they will be higher given the giant debts and unfunded pension/healthcare at the federal, state and local levels.

[DrF]

Meh...

Maybe, maybe not. Unless you are planning on pulling substantial amounts of cash from your retirement accounts every year there are ways to keep your tax bill very low or non-existent. I would agree that wealthier people will probably pay more taxes in the future, but not those with income (investment or otherwise) below ~$50,000 per year. With a paid off house and no car payments, that's plenty of money to live an extravagant lifestyle.

For example: http://www.gocurrycracker.com/never-pay-taxes-again/

edit for clarification: another link from bogleheads wiki (you pay 0% tax on long term capital gains and qualified dividends as long as you are below the 25% income tax bracket).
https://www.bogleheads.org/wiki/Capital_gains_distribution

[MDM]

See also https://www.bogleheads.org/wiki/Traditional_versus_Roth and https://www.bogleheads.org/wiki/Marginal_tax_rate.

For some perspective, check the amounts in a traditional account needed to reach current tax brackets, assuming a 4% withdrawal ratio.

E.g., for MFJ under 65, the top of the 15% bracket is $75,300.  Add $12,600 standard deduction and $8100 exemptions to get $96,000.  Divide by 4% to get $2,400,000.

Even with growth between now and retirement, that's a lot of room for traditional contributions.

Throw pensions, SS, and/or different tax brackets into the mix and things can change.

[csdreaming]

Keep in mind the employer contribution would still be tax deferred.

Only your contribution would grow tax free. You could also withdraw your contribution which makes a Roth a second savings account.

[MrMoogle]

I am late 40's, all of my 401k contributions have been pre-tax until last year. My company started offering a Roth 401k so I switched to it.  I like the idea of paying tax today and never paying tax on it again.

One variable that no one knows is what will tax rates be in the future.  My gut tells me they will be higher given the giant debts and unfunded pension/healthcare at the federal, state and local levels.

You're paying a marginal tax rate now vs an effective tax rate later.  It is very unlikely for the future effective tax to be more than today's marginal tax rate, especially since your income should drop during retirement. 

[retiringearly]

I am late 40's, all of my 401k contributions have been pre-tax until last year. My company started offering a Roth 401k so I switched to it.  I like the idea of paying tax today and never paying tax on it again.

One variable that no one knows is what will tax rates be in the future.  My gut tells me they will be higher given the giant debts and unfunded pension/healthcare at the federal, state and local levels.

You're paying a marginal tax rate now vs an effective tax rate later.  It is very unlikely for the future effective tax to be more than today's marginal tax rate, especially since your income should drop during retirement.

The single family homes I have as rentals will be fully depreciated in the not too distant future.  I will be taking significant income from them as a result.  That, combined with income from other non-tax sheltered investments & the possibility of higher tax rates in the future gives me pause.

[MDM]

You're paying a marginal tax rate now vs an effective tax rate later.

If only that were true, early retirement would be so much easier. :)

As it stands, one has to compare the marginal savings rate for traditional contributions now to the marginal tax rate on withdrawals for those contributions later.  As noted in Traditional versus Roth - Bogleheads,

A common misunderstanding about traditional accounts is "contributions are taken from the top while withdrawals come from the bottom": in other words, that one saves a marginal rate when contributing but pays only an average rate (starting at 0% for the first dollar withdrawn) when withdrawing. That is true in a limited sense - limited, that is, to the very first traditional contribution one makes. After that, subsequent contributions will be withdrawn on top of the withdrawals due to previous contributions. One must therefore calculate the marginal withdrawal tax rate due to those subsequent contributions.

[MrMoogle]

You're paying a marginal tax rate now vs an effective tax rate later.

If only that were true, early retirement would be so much easier. :)

As it stands, one has to compare the marginal savings rate for traditional contributions now to the marginal tax rate on withdrawals for those contributions later.  As noted in Traditional versus Roth - Bogleheads,

A common misunderstanding about traditional accounts is "contributions are taken from the top while withdrawals come from the bottom": in other words, that one saves a marginal rate when contributing but pays only an average rate (starting at 0% for the first dollar withdrawn) when withdrawing. That is true in a limited sense - limited, that is, to the very first traditional contribution one makes. After that, subsequent contributions will be withdrawn on top of the withdrawals due to previous contributions. One must therefore calculate the marginal withdrawal tax rate due to those subsequent contributions.

I really hadn't thought about it like that.  So, starting from no net worth, putting money into a traditional account will save you the marginal tax rate now, and you'd never pay income taxes on it (the marginal rate).  Then as your net worth increases you still save the marginal tax rate of today, but your marginal tax rate of the future increases. 

That makes it a much more complicated equation, you have to project out your savings from this year to the year you will retire, and your current net worth.  Then use your withdrawal rate to calculate the marginal taxes on the savings.

[MDM]

I really hadn't thought about it like that.  So, starting from no net worth, putting money into a traditional account will save you the marginal tax rate now, and you'd never pay income taxes on it (the marginal rate).  Then as your net worth increases you still save the marginal tax rate of today, but your marginal tax rate of the future increases. 

That makes it a much more complicated equation, you have to project out your savings from this year to the year you will retire, and your current net worth.  Then use your withdrawal rate to calculate the marginal taxes on the savings.

Yes, that's it.

Traditional will still be the best choice for most, but for those with a good pension Roth becomes preferable earlier than one might think.

[MrMoogle]

I really hadn't thought about it like that.  So, starting from no net worth, putting money into a traditional account will save you the marginal tax rate now, and you'd never pay income taxes on it (the marginal rate).  Then as your net worth increases you still save the marginal tax rate of today, but your marginal tax rate of the future increases. 

That makes it a much more complicated equation, you have to project out your savings from this year to the year you will retire, and your current net worth.  Then use your withdrawal rate to calculate the marginal taxes on the savings.

Yes, that's it.

Traditional will still be the best choice for most, but for those with a good pension Roth becomes preferable earlier than one might think.

With all the compounding of your first dollars, I'm not surprised that Roth could be better earlier.  As your income increases, it could even go Tradition -> Roth -> Traditional -> Roth.

Why did you tell me this?  Ignorance is bliss.

[MDM]

^Forewarned is forearmed?

[gggggg]

I just split it 50/50 trad vs roth. I don't know what I'll be doing when I retire, so half and half it is.