Employer is going to offer a Roth option, what to do next?

[Bonita]

My employer announced yesterday that, starting in January, they are going to be offering a Roth contribution option.

Right now I only contribute pre-tax money to my 401k, but I am really intrigued by having the option to contribute to a Roth since I haven't been able to previously!

I'm curious what I should think about regarding contributing to the Roth, and how I might split up my contributions between the Roth and 401k?  Any thoughts/advice is appreciated!
 

[gtkim]

A Roth 401K option?

I have that option but DH does not.  Our financial planner recommended that I do a 50/50 split.

[delawarejen]

I asked about this recently. I think the consensus (here and elsewhere) was that unless you're already contributing the IRS maximum that it doesn't make much sense - you'd be better off to increase your contributions rather than paying more tax.

Even for those who do max out (which is where I am), it may not be the best choice. I thought this article was pretty clear. thefinancebuff.com/case-against-roth-401k.html

[Deleted]

We both have the option and I split my contributions and DH doesn't. So 1/4 of our total contributions go to a Roth 401k type account (TSP for me). We do max our contributions though. There are advantages to Roth accts beyond pure tax consequences. No mandatory distributions and they can be passed to heirs. A lot will depend on your overall financial picture though.

[Bonita]

Oct 24, 2014 12:57:26 GMT -5 gtkim said:

A Roth 401K option?

I have that option but DH does not.  Our financial planner recommended that I do a 50/50 split.

Yes, I should have said Roth 401k contribution option as it's not an individual Roth.

That is good to know regarding the 50/50 split, here soon I will setup something with our financial planner too to make sure I go about it the best way...I'm just so thrilled I have the option now, that I figured I'd ask over here to get an idea of what others do

[Bonita]

Oct 24, 2014 13:04:40 GMT -5 delawarejen said:

I asked about this recently. I think the consensus (here and elsewhere) was that unless you're already contributing the IRS maximum that it doesn't make much sense - you'd be better off to increase your contributions rather than paying more tax.

Even for those who do max out (which is where I am), it may not be the best choice. I thought this article was pretty clear. thefinancebuff.com/case-against-roth-401k.html

Both my husband and I contribute the IRS maximum already which sounds like that may make a difference.  I'm off to read the article now...

[simpsongal]

Hmm, based on that article and our future plans, I think I'll stop contributing to my Roth 401K. TIA all!

[Mushe]

MH has the option to use a Roth 401k, and switched 100% of his contributions to that when his employer started offering it. Of course, we didn't adjust our tax withholdings that first year, and ended up owing a bunch! I am a government employee and have a mandatory (pre-tax) pension contribution that's just under 10% and contribute to a pre-tax 457 plan.  Because we each account for about 50% of the household income, I feel like we're just treading water or hedging our bets on our future tax liability.

We talked to a financial advisor who recommended that MH max the Roth 401k and that I max a back-door Roth prior to doing a 457, but the current tax liability bums me out too much to take that plunge right now.

[Mushe]

Okay, can I add a question here? I'm quoting from the article now: "Until you know you can generate from your Traditional 401(k) enough income to fill the lower brackets, it doesn’t make sense to contribute to a Roth 401(k). For people without a traditional defined benefit pension plan, it means the majority of the retirement savings should go to a Traditional 401(k), not Roth."

Since *I* have a traditional defined benefit pension plan, and one that I expect to pay out pretty handily, it sounds like MH steering his 401k contribtions into the Roth 401k makes sense.

[juliabug]

Oct 24, 2014 13:04:40 GMT -5 delawarejen said:

I asked about this recently. I think the consensus (here and elsewhere) was that unless you're already contributing the IRS maximum that it doesn't make much sense - you'd be better off to increase your contributions rather than paying more tax.

Even for those who do max out (which is where I am), it may not be the best choice. I thought this article was pretty clear. thefinancebuff.com/case-against-roth-401k.html

I think this article missed one of the biggest advantages of the Roth option. The growth is tax free. That is huge for young workers.

[Poppy]

Oct 24, 2014 14:57:14 GMT -5 juliabug said:

I think this article missed one of the biggest advantages of the Roth option. The growth is tax free. That is huge for young workers.

Do the math. If the tax rate now is the same as the tax rate at retirement, you end up with the same amount of money. Seriously. Make a spreadsheet to convince yourself.

[delawarejen]

Oct 24, 2014 14:26:26 GMT -5 Mushe said:

Okay, can I add a question here? I'm quoting from the article now: "Until you know you can generate from your Traditional 401(k) enough income to fill the lower brackets, it doesn’t make sense to contribute to a Roth 401(k). For people without a traditional defined benefit pension plan, it means the majority of the retirement savings should go to a Traditional 401(k), not Roth."

Since *I* have a traditional defined benefit pension plan, and one that I expect to pay out pretty handily, it sounds like MH steering his 401k contribtions into the Roth 401k makes sense.

I'm in the same position (although without a spouse). At this point I'm not going to switch over right now because I would find it difficult on my income to pay the additional taxes. Also, my employer hasn't provided the correct forms. (I'm in the middle of having to roll an old job's pension out of a different program at a different company without much notice due to changes in the plan. One account at a time is enough to deal with.)

[juliabug]

Oct 24, 2014 15:05:43 GMT -5 Poppy said:

Oct 24, 2014 14:57:14 GMT -5 juliabug said:

I think this article missed one of the biggest advantages of the Roth option. The growth is tax free. That is huge for young workers.

Do the math. If the tax rate now is the same as the tax rate at retirement, you end up with the same amount of money. Seriously. Make a spreadsheet to convince yourself.

I'm not convinced by a spreadsheet. There are too many variables. Are you really convinced that you can predict the market, tax rates, inflation and social security for the next 40 years to get to retirement, much less the 30+ years so people will live after retirement? I'm not, that's why I am diversifying the tax status of my family's retirement accounts and doing both Roth and Traditional retirement plans.

[Poppy]

Let's say that you make 100k, and you want to take home 90k, so you have 10k to put toward retirement. Let's say the tax rate is 25% since that's a nice round number. You can either add $10k to your trad 401(k) or you can add $7,500 to your Roth and end up with the same take home this year. Agreed?

The math equation for taxes is:
Roth: ((1-T)*I)(1+R)^N
Trad: (1-T)*(I*(1+R)^N)
where T is the tax rate, I is the investment amount, R is the return, and N is the number of years. These are equivalent. @juno

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[Poppy]

Oct 24, 2014 15:18:10 GMT -5 juliabug said:

Oct 24, 2014 15:05:43 GMT -5 Poppy said:

Do the math. If the tax rate now is the same as the tax rate at retirement, you end up with the same amount of money. Seriously. Make a spreadsheet to convince yourself.

I'm not convinced by a spreadsheet. There are too many variables. Are you really convinced that you can predict the market, tax rates, inflation and social security for the next 40 years to get to retirement, much less the 30+ years so people will live after retirement? I'm not, that's why I am diversifying the tax status of my family's retirement accounts and doing both Roth and Traditional retirement plans.

LOL. OK. I was refuting your "BUT YOU IGNORE THE TIME FACTOR" point. I agree there are other reasons you would want to diversify, and the assumption I used to qualify my statement (assuming the same rate now as in retirement) obviously may not be true. But still. The compounding or the time or whatever is not the part that influences which type of account is better.

[juliabug]

Oct 24, 2014 15:24:26 GMT -5 Poppy said:

Let's say that you make 100k, and you want to take home 90k, so you have 10k to put toward retirement. Let's say the tax rate is 25% since that's a nice round number. You can either add $10k to your trad 401(k) or you can add $7,500 to your Roth and end up with the same take home this year. Agreed?

The math equation for taxes is:
Roth: ((1-T)*I)(1+R)^N
Trad: (1-T)*(I*(1+R)^N)
where T is the tax rate, I is the investment amount, R is the return, and N is the number of years. These are equivalent. @juno

View Attachment

I see what you did. With those assumptions, that makes sense. For me, I'm going the opposite direction. I'm putting $X into a retirement account, be it Roth or Traditional, and paying whatever tax I need to pay. The excess tax savings from a Traditional are going to hookers and blow, not extra retirement.

[Poppy]

Oct 24, 2014 15:32:41 GMT -5 @juno said:

Oct 24, 2014 15:24:26 GMT -5 Poppy said:

Let's say that you make 100k, and you want to take home 90k, so you have 10k to put toward retirement. Let's say the tax rate is 25% since that's a nice round number. You can either add $10k to your trad 401(k) or you can add $7,500 to your Roth and end up with the same take home this year. Agreed?

The math equation for taxes is:
Roth: ((1-T)*I)(1+R)^N
Trad: (1-T)*(I*(1+R)^N)
where T is the tax rate, I is the investment amount, R is the return, and N is the number of years. These are equivalent. @juno

I guess I'm looking more at it this way: I want to put $10K in my retirement fund this year, can I eat the cost of Roth taxes right now?  If I can afford to put $10K in the Roth, I end up pretty far ahead at the end, all else equal, because I'd be starting with $10K in my Roth, not $7.5K, and so on.  My standard of living in the mean time is cut down (in exchange for a higher standard of living in retirement).  Isn't that right?  I can see it both ways; which is why I'm not really committed to doing all of one or the other.

Well, but you are essentially contributing more to retirement if you do the math that way. So yes, you have more money in retirement but you have less money now. My point is that if you need a certain amount of money now, you end up with the same in retirement regardless of which account type you use (again assuming the tax rate now is the same as in retirement). Assuming that you aren't maxing your 401(k) to the 17,500 limit each year, you could just as easily up your contribution amount to your traditional and end up in the same position (less money now, more [THE SAME AMOUNT MORE] later).

[Poppy]

@juno and juliabug I think we're on the same page now. The blog post that delawarejen linked is a really good one, worth taking the time to really read and understand. I think it's counter-intuitive, but due to the marginal system, the traditional can be very advantageous.

He does have an accompanying post on how you can use the Roth to effectively tax shelter more money each year because you can essentially contribute more to your 401(k) (ie you take home less money now and you end up with more money later) IF you are maxing. thefinancebuff.com/roth-401k-for-people-who-contribute-max.html. He even has a spreadsheet that helps you figure out how much that's worth. But for people who do not max, the first post is very compelling.