Roth 401k vs. traditional 401k

**Broken Arrow** · 07-01-2010, 11:04 AM

May I ask what your gross is? Are you single, married but file your taxes separately, or are you married and file your taxes jointly with your wife? Based on that, we can find out your marginal tax bracket for you.

Also, does your employer contribution apply equally to both 401(k)s? Strangely enough, not everyone does.

**Coronet** · 07-01-2010, 11:10 AM

My gross income is $61000/year. I am single and file as single.

My employer contributes dollar for dollar up to 4% of my income after the first 12 months of service. I believe it can be contributed to either 401k or Roth (or both) but cannot exceed 4% for both (if I'm reading correctly).

Additionally, I forgot to mention (I'll update my first post with this as well) my employer has a retirement plan contribution that begins upon hire. Each calendar quarter my employer will contribute 10% of my base compensation (so $6100 per year).

**Broken Arrow** · 07-01-2010, 12:07 PM

Ok, so you're in the 25% bracket. You could go either way, and it may be in your interest to split and contribute to both accounts, if your employer will allow it.

**jIM_Ohio** · 07-01-2010, 05:14 PM

Originally posted by Coronet View Post

My gross income is $61000/year. I am single and file as single.

My employer contributes dollar for dollar up to 4% of my income after the first 12 months of service. I believe it can be contributed to either 401k or Roth (or both) but cannot exceed 4% for both (if I'm reading correctly).

Additionally, I forgot to mention (I'll update my first post with this as well) my employer has a retirement plan contribution that begins upon hire. Each calendar quarter my employer will contribute 10% of my base compensation (so $6100 per year).

You want to look up tax tables and learn a little about taxes.
To me this is a tax question more than investing question.

If you are in 25% bracket now (I assume you are) and you are in 25% bracket in retirement, then it does not matter which one you choose. 75%+ of US tax payers are in the 15% tax bracket, and once you marry, if spouse makes about same amount you do (or less) your tax bracket will probably drop to 15% with some basic understanding of taxes.

Reference Room
is my tax reference site

2010 std deduction is $5700
2010 exemption for self is $3650

this means $5700+$3650 is reduced from gross pay and not taxed.
If 4% of 61k ($2440) goes to 401k, that is not taxed either.

Here is a crude estimate of your taxes with 4% going to 401k.

$61,000 gross minus ($5700+$3650+2440)=$49210
taxes paid on $49210 will be in 25% bracket
that math is
$4681.25+(49210-34000)*25%=$8480

this means your tax liability is about $8480. If you have other above the line deductions (like student loan interest) or other tax credits (like child tax credits), you will have a lower tax liability than this.

If you put more into 401k the sweet spot is about $15,000 more (which puts you over annual limit, but at same time would drop you to 15% tax bracket).

My advice would be this:
1) put it all in 401k pre-tax- take the 25% savings now.
2) if you ever find yourself in 15% tax bracket, then use the Roth (this is what I do)
There is more than one way to do #2. Because you have a Roth 401k, you have more choices than many.

My math looks like this
120k gross (married couple)
About $13k goes into 401k pre-tax
another $40k-$50k in deductions each year (HSA, child tax credits, interest on house)
4 exemptions
knocks the taxable income down to about 65k each year
Wife and I each max $5000 into a Roth IRA

We have done this for last 3 years. Now that I have a decent handle on the steady state nature of our taxes (kids are only 2, and HSAs for family is also new), we shifted a portion of my wife's 401k to a Roth 401k. Carefully staying in 15% tax bracket.

My logic is this:
1) My expenses are in 15% tax bracket (meaning as a married family, we only spend about 60k per year right now, so in retirement we could be in 15% bracket)
2) Saving 25% on 401k contributions is a significant bonus for us
3) even if taxes go up (when taxes go up?) they will go up on people earning more than me before they go up on me. The 25% tax bracket is punished severely (25% is 60% higher than 15% bracket below it- no other part of tax brackets are so unfair to make people in next bracket pay more).
4) 66-75% of US tax payers file in the 15% bracket or lower. There is no reason for me to be above average in this regard. 60k per year is a lot of money.

What would make this advice not apply to you:
1) If you know your income will shoot up faster than likelihood that you marry. If you see a 6 figure income because you are on a fast track, then Roth is a good move.
2) Do not "want" to be on fast track (it will cost you 25%), make sure you KNOW you are on fast track. When I was young I wanted to be there, and did well, but did not quite get what I thought was on the fast track.
3) You will marry someone making more money than you
4) when you have kids both spouses will continue to work and make good money (my wife and I both work, but 50k of deductions changes this comment in our favor).

Getting married and having kids will cut taxes paid considerably and push you into 15% bracket if you play cards right.

**MonkeyMama** · 07-01-2010, 05:27 PM

25% tax bracket is 50/50 territory.

50/50 is the easy answer.

ROTH - you are betting on taxes rising. I think this is a good bet, for most young people in the 25% tax bracket. (The younger you are, the more compounding you will also get, tax free. I am not sure the contributions matter so much as the fact that your money can compound for decades, tax free).

OR

Traditional - Who cares about the future? You want the tax break NOW.

There is really no wrong answer.

I personally decide how much to put in based on how tight my finances are. ROTH is the logical best bet for the average young person. BUT, if I could put in a lot more into a Traditional with the tax break, I might do that. I didn't plan it this way, but am rather 50/50 at the moment. I still grapple with this decision, myself. Some days I rather just take the tax break now. Most of the time I think the ROTH is more logical.

**jpg7n16** · 07-01-2010, 09:06 PM

I've always liked the 50/50 solution because it virtually neutralizes the difference between a Roth and Traditional type. One saves the tax rate now but pays the tax rate later, one pays the tax rate now and saves the tax rate later. It's virtually a wash.

Except you do get some deductions later against traditional, so optimal might be like 60/40 or 65/25 or something, but 50/50 is just so easy to manage - and will really give you control over the amount of tax you will pay when you start withdrawals.

So I'm goin with BA and MM - split 50/50 if your plan allows you to.

But I'd almost say the amount you contribute is more important - I mean, who cares about tax savings if you haven't saved enough to live on, right?

So 1) take the match, 2) get out of any high interest debt (over 7%), then 3) get your retirement savings rate up high enough to get you where you want to go (likely 15-20%)

Good luck!

**jIM_Ohio** · 07-02-2010, 05:12 AM

Originally posted by jpg7n16 View Post

But I'd almost say the amount you contribute is more important - I mean, who cares about tax savings if you haven't saved enough to live on, right?

excellent advice
saving 8% is probably not going to get OP to where he needs to go, but is a good place to start.

**Broken Arrow** · 07-02-2010, 09:06 AM

Coronet, do you own a house? Do you own a business? Do you have kids you can claim? Do you know any tax exemptions or deductions that you may be eligible for?

Ideally, it would be great if you can push yourself down to the 15% tax bracket before you contribute to a Roth IRA, but you may make just a little too much to make it happen (which is a good problem to have). Consider:

The OP grosses $61,000 as a single.

The 15% tax bracket cut-off for 2010 single is $34,000.

That's a difference of $27,000 in the 25% territory.

The current maximum contribution into a 401(k) is $16,500.

Contributing the max to a traditional 401(k) would narrow the gap to $10,500.

Without knowing what can be itemized, the standard deduction for a single is $5,700.

The gap now stands at $4,800.

Perhaps he has a high deductible health insurance? If so, for a single person, the contribution limit to a HSA is $2,850.

Now the gap is down to $1950.

Hmm, maybe it IS possible. What else?

Well, the point is, if you can get yourself down to $34,000 MAGI, then it becomes tax-efficient to contribute another $5000 to a Roth IRA. Then, you'd be one lean, mean, tax-fighting, money-saving machine.

It also assumes that $29,000 gross is enough for you to live off of.

Otherwise, contributing to a little bit of both 401(k)s will suffice.

**Coronet** · 07-08-2010, 09:48 AM

Thanks all! I've decided to go with 100% into my 401k and once my employer starts matching once my first 12 months of employment are over I will split to 50/50 between the 401k and Roth 401k.

For additional information I am single, unmarried, but probably will be getting married to my boyfriend in a few years. He's currently still in school and we're not in any particular hurry to marry. He will probably make the same salary give or take 10k either way as me and our incomes will probably grow in tandem. In 10-15 years I expect to be making over 100k a year as will he, more than likely, assuming we're still together and nothing happens to our relationship. Even if I end up having kids I will probably continue to work.

Also I'm contributing 8% right now, but once my employer matches 4% I'm going to attempt to bump it up to 10% contribution. I'm fresh out of college and working on balancing my finances/getting a feel as to what my budget is.

**puck36** · 07-26-2010, 10:12 AM

Tell me if I'm wrong but I believe that the employer match must go into the traditional 401k because it is not taxed so it can't go into the Roth 401k.

**Broken Arrow** · 07-26-2010, 10:17 AM

Originally posted by puck36 View Post

Tell me if I'm wrong but I believe that the employer match must go into the traditional 401k because it is not taxed so it can't go into the Roth 401k.

From the IRS website.

Can an employer match an employee's designated Roth contributions? Must the employer allocate the matching contributions to a designated Roth account?

Yes, the employer can make matching contributions on designated Roth contributions. However, the employer can only allocate an employee�s designated Roth contributions to designated Roth accounts. The employer must allocate any contributions to match designated Roth contributions into a pre-tax account, just like matching contributions on traditional, pre-tax elective contributions.

In short, you are correct.

Roth 401k vs. traditional 401k