Yet another traditional v. roth question - 401(k) and IRA

[andy85]

New to the forum and the idea of early retirement....and I am liking the forum very much so far!

Salary: $42k
I currently have about $23k in a roth 401(k)...company matches 70% up to 6% of my income.
Not contributing more because I am in the process of trying to stack some cash for a small down payment on a house, renovation and furnishing costs, and use the remaining funds to open an IRA and hopefully have a couple of grand left to start a small cash emergency fund.

I've always been told that roth is the way to go, but have since learned this is not a hard and fast rule.

Onto my question:
So, how should I break up my contributions? roth v. traditional 401k and a roth v. traditional IRA? From what i have been gathering on this forum it sounds like i should be doing traditional since my income is so low. Should i stop the roth 401k contributions and switch it to a traditional? And when the time comes to open an IRA, traditional again? I plan on maxing out the IRA once it is opened but will not come close to maxing the 401(k)...making what i make and being single it will just be impossible. I cant say i'm seeking an extreme early retirement like some on here (at least not yet), but i would like to shave several years off my retirement date for sure.

I appreciate any insight.

[Gone Fishing]

Welcome!

Of the $42k, how much are you able to save annually?

[MDM]

With $42K gross, the $6200 deduction and $3950 exemption puts you in the 15% (plus whatever state tax) marginal tax bracket.

If you think you will be in a much lower bracket after retirement, do traditional.

If you think you will be in a much higher bracket after retirement, do Roth.

If you aren't sure, just put as much as you can into either.

One consideration based on your specific situation: if you need to save to buy a house, you can withdraw your Roth contributions at any time.  Personally I'd wait on a house until I had enough taxable money accumulated after maximizing tax-advantaged savings (either traditional or Roth) every year, but YMMV.

Good luck!

[andy85]

Welcome!

Of the $42k, how much are you able to save annually?

not including my 401k contributions i've saved about $10k in cash so far this year. I plan on buying a house in the spring or summer after a few more months of saving, a bonus at work, and a tax refund, which will put me around $16k or so.

after i buy a house my savings will probably dip to maybe 700/month (hopefully)...until i can learn the ways of the MMM community's knack for reducing spending. :) $42k gross doesnt leave me a ton to work with after my monthly expenses really, which is why i plan on getting a roommate, so i can have some meat on the bone at the end of the month.

I'm 29, so I am getting a late start...but better late than never i suppose. On a good note, the only debt i currently have is about $8900 and 3 years left on a car loan ($269/month at 3.34%). but no credit card debt (payed off a large amount, hence the late start) and no school loans to deal with.

[rmendpara]

With $42K gross, the $6200 deduction and $3950 exemption puts you in the 15% (plus whatever state tax) marginal tax bracket.

If you think you will be in a much lower bracket after retirement, do traditional.

If you think you will be in a much higher bracket after retirement, do Roth.

If you aren't sure, just put as much as you can into either.

One consideration based on your specific situation: if you need to save to buy a house, you can withdraw your Roth contributions at any time.  Personally I'd wait on a house until I had enough taxable money accumulated after maximizing tax-advantaged savings (either traditional or Roth) every year, but YMMV.

Good luck!

I mostly agree with this.

Only thing I would add is for you to think about if you expect your annual earnings to increase significantly over the next decade, I might consider putting more toward a Roth IRA/401k today since the benefit of contributing post-tax will go down as your income goes up.

Otherwise, it's hard to go wrong either way.

It's infinitely more important that you save something in those accounts, and do it consistently.

"From what i have been gathering on this forum it sounds like i should be doing traditional since my income is so low. "

Exact opposite. You should contribute to Roth because your income is so low. MDM summarized it well. At a 15% marginal bracket, you are probably paying +/-10% effective tax rate (total taxes / total income). Your effective rate will increase rapidly once you reach the 25% marginal bracket. This assumes, of course, that you expect your future earnings to increase substantially.

[andy85]

With $42K gross, the $6200 deduction and $3950 exemption puts you in the 15% (plus whatever state tax) marginal tax bracket.

If you think you will be in a much lower bracket after retirement, do traditional.

If you think you will be in a much higher bracket after retirement, do Roth.

If you aren't sure, just put as much as you can into either.

One consideration based on your specific situation: if you need to save to buy a house, you can withdraw your Roth contributions at any time.  Personally I'd wait on a house until I had enough taxable money accumulated after maximizing tax-advantaged savings (either traditional or Roth) every year, but YMMV.

Good luck!

I mostly agree with this.

Only thing I would add is for you to think about if you expect your annual earnings to increase significantly over the next decade, I might consider putting more toward a Roth IRA/401k today since the benefit of contributing post-tax will go down as your income goes up.

Otherwise, it's hard to go wrong either way.

It's infinitely more important that you save something in those accounts, and do it consistently.

"From what i have been gathering on this forum it sounds like i should be doing traditional since my income is so low. "

Exact opposite. You should contribute to Roth because your income is so low. MDM summarized it well. At a 15% marginal bracket, you are probably paying +/-10% effective tax rate (total taxes / total income). Your effective rate will increase rapidly once you reach the 25% marginal bracket. This assumes, of course, that you expect your future earnings to increase substantially.

thanks for the clarification...makes sense.
and yes, i do expect my future earnings to increase...quite a bit hopefully. I just finished my MBA in the summer and the workforce at my company is exceptionally old...so i expect to move up over the next several years...hopefully i can come close to doubling my current salary.

[rmendpara]

With $42K gross, the $6200 deduction and $3950 exemption puts you in the 15% (plus whatever state tax) marginal tax bracket.

If you think you will be in a much lower bracket after retirement, do traditional.

If you think you will be in a much higher bracket after retirement, do Roth.

If you aren't sure, just put as much as you can into either.

One consideration based on your specific situation: if you need to save to buy a house, you can withdraw your Roth contributions at any time.  Personally I'd wait on a house until I had enough taxable money accumulated after maximizing tax-advantaged savings (either traditional or Roth) every year, but YMMV.

Good luck!

I mostly agree with this.

Only thing I would add is for you to think about if you expect your annual earnings to increase significantly over the next decade, I might consider putting more toward a Roth IRA/401k today since the benefit of contributing post-tax will go down as your income goes up.

Otherwise, it's hard to go wrong either way.

It's infinitely more important that you save something in those accounts, and do it consistently.

"From what i have been gathering on this forum it sounds like i should be doing traditional since my income is so low. "

Exact opposite. You should contribute to Roth because your income is so low. MDM summarized it well. At a 15% marginal bracket, you are probably paying +/-10% effective tax rate (total taxes / total income). Your effective rate will increase rapidly once you reach the 25% marginal bracket. This assumes, of course, that you expect your future earnings to increase substantially.

thanks for the clarification...makes sense.
and yes, i do expect my future earnings to increase...quite a bit hopefully. I just finished my MBA in the summer and the workforce at my company is exceptionally old...so i expect to move up over the next several years...hopefully i can come close to doubling my current salary.

Given your degree and assertion, I think that plan makes sense.

Regardless, it's important to have some eggs in all baskets. None of us is qualified to bet on which way tax/retirement/investment policy will go in the next 30 years, so it's best to hedge your bets between 3 buckets:
- pre tax (e.g. trad IRA/401k)
- post tax (e.g. roth IRA/401k)
- taxable

You can decide the split however you wish, as the most important factor is how much rather than in which bucket.