Author Topic: Traditional vs Roth 401k?  (Read 2147 times)

minnie76

  • 5 O'Clock Shadow
  • *
  • Posts: 11
Traditional vs Roth 401k?
« on: February 15, 2016, 08:05:15 AM »
Hello!

My husband just started a new job and now has the option of funding either a traditional or Roth 401k  (or a combination of the two) with a 6% match. We pay a lot in taxes right now (no dependents, $45k mortgage @3.25% interest so no deductions to speak of) so I'm leaning towards the traditional to lower our taxable income but I just want to make sure that logic makes sense.  I'm worried I might not be taking into account a huge benefit of the Roth 401k that might sway this decision so any advice or other viewpoints would be greatly appreciated!

General info:
Both of us are 27 years old
His income: $90k+ up to 7k bonus (company offers 6% 401k match)
My income: $81k+ 4k bonus (company offers 9% 401k match)
Plan to put $18k each in our 401k's and max each of our Roth IRA's this year

Questions:
Are there hidden benefits to the Roth 401k that need to be considered?

Would some kind of hybrid approach between the Roth and Traditional make sense?

Does funding a Roth 401k affect the ability to max out the Roth IRA?

What would you do?

capitalninja

  • Stubble
  • **
  • Posts: 102
  • Know what the other guy is making on the deal...
    • Entrepreneur, Investor, Life Advice
Re: Traditional vs Roth 401k?
« Reply #1 on: February 15, 2016, 08:37:10 AM »
Suppose that depends on whether you expect your tax rate to be higher or lower during retirement. If I were able to, I would do both the ROTH IRA and ROTH 401k. The idea of paying taxes now and never again as the money grows is too good to pass up. To your point you lose the current income tax deduction but if you think about it, all you're really doing is deferring paying the taxes until you retire.  Who knows what the tax code will look like at that point.

Considering that you're maxing out your retirement accounts, neither decision would fall into the "dumb" category. At 27, also consider starting your after tax investing in a traditional brokerage account (assuming you haven't already).

Great work. You have a good "problem". :-)

MDM

  • Walrus Stache
  • *******
  • Posts: 9087
Re: Traditional vs Roth 401k?
« Reply #2 on: February 15, 2016, 12:47:21 PM »
At those incomes - unless you expect them to become much higher in a few years - traditional all the way.

Re: "Does funding a Roth 401k affect the ability to max out the Roth IRA?"  - No.

In the lists below, thinking "first your 457 (if you have one), then your 401k and/or 403b" wherever "401k" appears is likely correct -   
   unless your 457 fund options are significantly worse than those in the 401k/403b.
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).   
   
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).  See also
   https://www.bogleheads.org/forum/viewtopic.php?f=2&t=182081,
   http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-overwhelming-student-loan-debt-how-would-you-get-started/msg868845/#msg868845
   and other posts in that thread about exceptions to the rule.
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?"   
   
Priorities above apply when income is primarily through W-2 earnings.  For those running their own businesses (e.g., rental property owner, small business owner, etc.),   
   putting money into that business might come somewhere before, in parallel with, or after step 5.

minnie76

  • 5 O'Clock Shadow
  • *
  • Posts: 11
Re: Traditional vs Roth 401k?
« Reply #3 on: February 15, 2016, 01:23:58 PM »
Thanks for the feedback.  I think going the traditional route makes the most sense to defer taxes  until later when our income should be lower. 


Scandium

  • Handlebar Stache
  • *****
  • Posts: 2198
  • Location: EastCoast
Re: Traditional vs Roth 401k?
« Reply #4 on: February 17, 2016, 07:38:26 AM »
Thanks for the feedback.  I think going the traditional route makes the most sense to defer taxes  until later when our income should be lower.

Yeah since you're here I assume you won't spend $180k/year in retirement.. Traditional all the way! Couldn't disagree more with capitalninja. Saving ~$10k in taxes now between the two of you is a good deal. In retirement you'll spend less and you can control your own income/taxes.