Roth vs traditional 401k

[wildrice]

I've never had this option before, and I'm struggling to figure out which is better for me. I understand that a traditional 401k comes out before taxes and Roth is post tax. How do I decide which is a better choice for me?

We owed about $2500 this year in taxes, which as I type this out, may end up being MORE next year if nothing that I save for retirement will be pre-tax. That would mean our HHI will be higher. I'm putting away around $450 a check so that will add up. I would like to minimize our tax burden right now if it makes sense to do so, but don't want to regret that when we retire! Unfortunately we just take the standard deduction right now and I don't see any reason that will change anytime soon.

We have no idea really what our tax situation will look like in retirement, but ideally we'll have no debt (our current mortgage will be paid off) and we are talking about moving abroad, though with 2+ decades between now and then there is no way to know if that will really happen. We currently live in Maryland, which I think is a fairly crappy state to retire in because of taxes, but I don't know if we'll necessarily retire here even if we do stay in the states.

How did you/would you make the decision about which is best for your 401k?

ETA: I think we can afford our budget either way, but of course we'd have more ability to save more if we had more money in our paychecks! We also are trying to pay down over 100k in student loans for my H, so I don't know if it makes more sense to have more money available now or more money available later. 

2nd ETA: I am talking about me because I have this option, but I don't think my H does. He is saving in a traditional 401k so I guess his portion does reduce our taxable income.

[bee20]

There isn't a perfect answer, as you can tell, but my thought process was this:

1) At first, I put all my money to 401k Roth once it became available, maxing it out. Roth is pretty powerful tax-free growth, so it was pretty exciting.
2) Then, my company allowed mega-backdoor roth, so I switched to full pre-tax for my initial contribution and then converted my after-tax contributions to roth. You can only do this with some administrators so ask at work if after-tax contributions and in-service conversions are allowed. This option is probably being written out of the tax code soon though.

3)I just got a raise by changing companies. Unfortunately, they do not seem to allow mega-backdoor roth contributions, so I am re-evaluating. Something I have seen is to use Roth up to either of the big bracket jumps and then pre-tax after that(12%->22% at $40k for single filers is one big jump, and 24%->32% at 164k for single filers is the later one).

ETA: I would also consider the time you have left before retirement.  I'm expecting to retire in 5ish years, so my Roth won't have a ton of time to grow.  If I was 30 years from retirement I'd probably suck it up and pay the taxes now.

[RockNVoll]

It's pretty much impossible to really know which way might work out better. As such, we've opted to hedge our bets and have both Roth and traditional retirement funds, though we haven't contributed to our Roth option in recent years because of our high tax bracket.

What I like most about the Roth option and the reason we put some money there is the fact that there are no RMDs. That means we can keep our money in the Roth potentially for decades longer than in a traditional account and it'll keep growing tax-free. So we'll draw from the traditional accounts once we have to and reserve that Roth capital as long as possible. Not sure if that's a consideration for you, but thought I'd put it out there as a point for consideration.

Also worth noting that your plan probably allows you to split your contribution and put some in the Roth and some in the traditional if you prefer.

[tcu2003]

DH and I both have the Roth option and switched to have 100% of our contributions go in the Roth 401k accounts (from 100% in the traditional each) maybe 8 years ago. Our traditional 401ks each had a decent balance (DH’s more so than mine as he has 5 years on me and at that point the higher salary ☺️), and our company match was going to continue to go in the traditional one, so we wanted to utilize the Roth 401k for the later advantages. We’ve been maxing out for each of us for at least the last 5 years and so far are still sticking with the Roth options.

[wildrice]

Feb 28, 2022 23:36:26 GMT -5 RockNVoll said:

It's pretty much impossible to really know which way might work out better. As such, we've opted to hedge our bets and have both Roth and traditional retirement funds, though we haven't contributed to our Roth option in recent years because of our high tax bracket.

What I like most about the Roth option and the reason we put some money there is the fact that there are no RMDs. That means we can keep our money in the Roth potentially for decades longer than in a traditional account and it'll keep growing tax-free. So we'll draw from the traditional accounts once we have to and reserve that Roth capital as long as possible. Not sure if that's a consideration for you, but thought I'd put it out there as a point for consideration.

Also worth noting that your plan probably allows you to split your contribution and put some in the Roth and some in the traditional if you prefer.

This is a really good point - I can split them, so maybe I should just do that! Best of both worlds. 

I have no idea if we'd want to avoid having to withdraw funds or not, but it's always good to have more options. 

[flygirl]

I think I’d take a look at your taxes now-would the amount you’d be putting into a traditional help knock you into a lower tax bracket? Or for simplicity, look at how much you’d be putting in a traditional x your tax rate. For example if you’d put 15000 in your traditional 401 and your tax rate is 18% you’d save roughly $2700 in taxes because it reduces your taxable income-there are a few other things that effect this.

[wildrice]

Mar 1, 2022 10:41:28 GMT -5 flygirl said:

I think I’d take a look at your taxes now-would the amount you’d be putting into a traditional help knock you into a lower tax bracket? Or for simplicity, look at how much you’d be putting in a traditional x your tax rate. For example if you’d put 15000 in your traditional 401 and your tax rate is 18% you’d save roughly $2700 in taxes because it reduces your taxable income-there are a few other things that effect this.

Good question, and no, it doesn't look like it. We're pretty solidly in the 22% bracket and probably will stay there for at least the next several years. It's good to keep in mind though - we probably will hit the next bracket someday and at that point it would likely make a lot of sense to switch away from Roths. Thanks!

[gt7301b]

Pretty much everything RockNVoll said.

We also both currently have pensions, so we will have income in retirement and I like being able to have flexibility in having both taxable and non-taxable income in retirement.

I have no idea what the future will look like so I just split the money between Roth and traditional. (Well I actually put a little more in the Roth because I have several years of contributions before I had a Roth option at work)

[ellipses84]

I know a lot of people who split it 50-50. It’s hard to predict the tax code and your income that far in the future, but most assume they’ll have a lower income when you need to take the tax hit. If you have debt or need more money in your budget now, I’d max out the 401k first.

[dragon's breath]

Mar 1, 2022 11:25:08 GMT -5 wildrice said:

Mar 1, 2022 10:41:28 GMT -5 flygirl said:

I think I’d take a look at your taxes now-would the amount you’d be putting into a traditional help knock you into a lower tax bracket? Or for simplicity, look at how much you’d be putting in a traditional x your tax rate. For example if you’d put 15000 in your traditional 401 and your tax rate is 18% you’d save roughly $2700 in taxes because it reduces your taxable income-there are a few other things that effect this.

Good question, and no, it doesn't look like it. We're pretty solidly in the 22% bracket and probably will stay there for at least the next several years. It's good to keep in mind though - we probably will hit the next bracket someday and at that point it would likely make a lot of sense to switch away from Roths. Thanks!

Pretty much agree that without some ability to see the future, it can be a bit of a crapshoot.

However, quoting and bolding this because the current tax brackets are set to expire after 2025, and will then revert to the pre-2018 brackets (though income levels within those brackets may be adjusted).  Depending on raises, etc, someone could be in the 22% tax bracket now, but be facing the 28% tax bracket later (or the 33% tax bracket with a few raises).

Just one more thing to add to all the other considerations.

ETA: This is if current breaks are not extended.

[puppyluv]

When I had access to both at a previous job, I contributed to both 50/50. I wish I had put more in the Roth because I don’t have access to it at those levels anymore, only through my IRA now.

[niq]

I don't think it's worth trying to forecast future tax rates. It's unlikely that future middle class income tax rates will go above current rich people income tax rates, for instance.

Generally speaking, if you think your taxable income now is higher than it will be in retirement (e.g. if you're midcareer in a household where both adults work professional class jobs), traditional is the better choice. If you think it's lower (e.g. if you just graduated college and have a part time job at a climbing gym while you figure out what you want to do with your life next), Roth is better.

But it really depends on your overall financial picture.

We make good money, and I get a good chunk of stock-based compensation which I feel like could disappear at any minute and certainly won't exist in retirement. That makes 100% traditional a pretty easy choice for us.

EDIT: It is a little easier to pull money out of a Roth. If that's something you think you might need some day, for education or a house down payment etc., then that's a good reason for a Roth. 

[wildrice]

Mar 2, 2022 13:54:31 GMT -5 niq said:

Generally speaking, if you think your taxable income now is higher than it will be in retirement (e.g. if you're midcareer in a household where both adults work professional class jobs), traditional is the better choice. If you think it's lower (e.g. if you just graduated college and have a part time job at a climbing gym while you figure out what you want to do with your life next), Roth is better.

Huh, that's a really good point. I wouldn't say we are high earners, but I do kind of doubt that we'll be pulling in this much per year in retirement. If for no other reason than, we shouldn't need it when we're not saving for retirement, paying off SLs, and paying off a mortgage. This is a dumb question, but when you're retired with a 401k, you basically choose how much income you get per year, right? So we would only really be having taxable income on what we need in order to live. Hmm. 

Although you never know what will happen that you need money for, I don't anticipate needing to withdraw at any point. We don't have kids and already own a house so unless we had some kind of medical or disabling issue (not impossible) we shouldn't ever run into needing to access a significant chunk of money.

[dragon's breath]

Mar 3, 2022 12:45:32 GMT -5 wildrice said:

Mar 2, 2022 13:54:31 GMT -5 niq said:

Generally speaking, if you think your taxable income now is higher than it will be in retirement (e.g. if you're midcareer in a household where both adults work professional class jobs), traditional is the better choice. If you think it's lower (e.g. if you just graduated college and have a part time job at a climbing gym while you figure out what you want to do with your life next), Roth is better.

Huh, that's a really good point. I wouldn't say we are high earners, but I do kind of doubt that we'll be pulling in this much per year in retirement. If for no other reason than, we shouldn't need it when we're not saving for retirement, paying off SLs, and paying off a mortgage. This is a dumb question, but when you're retired with a 401k, you basically choose how much income you get per year, right? So we would only really be having taxable income on what we need in order to live. Hmm. 

Although you never know what will happen that you need money for, I don't anticipate needing to withdraw at any point. We don't have kids and already own a house so unless we had some kind of medical or disabling issue (not impossible) we shouldn't ever run into needing to access a significant chunk of money.

To a point.  Traditional IRAs and 401ks are subject to RMDs, which require you to take out a percentage of your account, based on your age, starting in your early 70s (I think it was recently bumped to 72).  The more money you have in your account, and the older you get, the more you are forced to withdraw.  

[marie]

I agree that it is just a lot of guesswork. I have the option of both and I split my funding between the two 50/50.