401k vs. Roth 401k

[srblanco7]

Read an article in the WSJ today that reviewed reasons for investing in 401k vs Roth 401k (e.g., tax rates, leaving money to heirs, etc.). The article presented a rule of thumb as follows:

The rule of thumb that he and his co-authors recommend: add 20 to your age and put that percentage of the money you are saving for retirement into a traditional 401(k), with the rest in a Roth.

I think this is the first time I've run across this rule of thumb. Interested in the groups thoughts on this.

[kork13]

That's a really strange ROT, and I don't think I agree with its utility ... Is the article available to share, or I assume behind WSJ's paywall? I'm curious what purpose it's meant to serve. Most people will be in a position where *either* one or the other makes the most sense. The 3 common scenarios are: (1) high income & want to reduce tax burden (traditional); (2) low income & want to take advantage of low tax rates (Roth); or (3) young & want to take advantage of decades in tax-free growth (Roth). Doing both seems indecisive & ineffective.

[Like2Plan]

I agree with Kork. I would think the rule of thumb would be related to tax brackets. If you are in a low tax bracket, the traditional 401K isn't giving you that much of a tax break. On the other hand, you could be young and have a high income and be paying loads of taxes.
Middle career it might be more challenging to figure out, but if you are in a high tax bracket maybe you won't be when you retire? When you contribute to a traditional 401k, the reduction in taxes comes off your highest tax rate(s). When you pull money out for retirement, you get exemptions and it is a graduated tax rate (i e 10 % on the first bracket, 12 % on the second bracket and so on) that you could be paying far less taxes on that money.
Also, some of the traditional 401k money may not be taxed at all due to high medical expenses in later life.

[srblanco7]

I agree with Kork. I would think the rule of thumb would be related to tax brackets. If you are in a low tax bracket, the traditional 401K isn't giving you that much of a tax break. On the other hand, you could be young and have a high income and be paying loads of taxes.
Middle career it might be more challenging to figure out, but if you are in a high tax bracket maybe you won't be when you retire? When you contribute to a traditional 401k, the reduction in taxes comes off your highest tax rate(s). When you pull money out for retirement, you get exemptions and it is a graduated tax rate (i e 10 % on the first bracket, 12 % on the second bracket and so on) that you could be paying far less taxes on that money.
Also, some of the traditional 401k money may not be taxed at all due to high medical expenses in later life.

Additional context from the article -

"David Brown, associate finance professor at the University of Arizona, said that once a person moves out of the 12% tax bracket, his research indicates it is best to start dividing savings between a Roth and a traditional account.

Advisers say putting a portion of 401(k) savings into a Roth can help workers hedge their bets if they aren’t sure what their future tax rates will be."

I think you captured it with the "middle career" person. Uncertainty regarding future tax brackets means it may make sense to hedge your bets. And having some in Roth may allow you to better manage retirement tax brackets or to avoid higher Medicare premiums.

[disneysteve]

There is some utility to having both pre-tax and tax-free money when you get to retirement, so if your entire portfolio is your 401k, having some of both isn't a bad idea. Personally, my 401k is less than 10% of our portfolio so it's not an issue for us.

[srblanco7]

There is some utility to having both pre-tax and tax-free money when you get to retirement, so if your entire portfolio is your 401k, having some of both isn't a bad idea. Personally, my 401k is less than 10% of our portfolio so it's not an issue for us.

Our Roth IRAs are a very low percentage of our investments @ approx. 6%. 401ks at 43% and brokerage at 51%. Plan would be to try to balance withdrawals between 401ks (up to 12% bracket) and brokerage distributions and withdrawals (cap gains and qualified distributions) to optimize tax efficiency.

Don't know if we'll touch our Roth accounts at all.

[riverwed070707]

I'm so intrigued that several of you have such a small % of your wealth in 401k and don't invest in real estate. Where is the rest? Taxable accounts?
My retirement is roughly 50/50 between real estate (counting equity only) and retirement accounts (mix of Roth and 401k).

Also thought that 401k to the match, max roth, additional to 401k was a pretty widely accepted RoT, which sort of naturally aligns with the low, middle and high tax brackets because most low and middle income earners aren't going to have enough left over to max both and no one should be leaving free money on the table if a match is available.

[srblanco7]

I'm so intrigued that several of you have such a small % of your wealth in 401k and don't invest in real estate. Where is the rest? Taxable accounts?
My retirement is roughly 50/50 between real estate (counting equity only) and retirement accounts (mix of Roth and 401k).

Also thought that 401k to the match, max roth, additional to 401k was a pretty widely accepted RoT, which sort of naturally aligns with the low, middle and high tax brackets because most low and middle income earners aren't going to have enough left over to max both and no one should be leaving free money on the table if a match is available.

I think what you present is a fair rule of thumb. However, with more and more companies offering Roth 401k options (in addition to traditional), I'd suggest that those in lower tax brackets (for example, recent college grads) should put as much money in Roth 401ks (in lieu of traditional 401ks) and Roth IRAs as is feasible to take advantage of decades of tax free growth.

[disneysteve]

I'm so intrigued that several of you have such a small % of your wealth in 401k and don't invest in real estate. Where is the rest? Taxable accounts?

I've been saving for retirement for over 30 years. I've only had access to a 401k for the past 7, and I was only full time at that job for 4 of those years, so I just didn't have a huge opportunity to fund a 401k. I've got about 235K in there out of a $3.2 million portfolio so a little over 7%.

Where's the rest? Traditional IRAs, Roth IRAs, a small SEP IRA, an inherited traditional and Roth IRA, and the rest (about 55% of the total) is in taxable accounts.

I have absolutely zero interest in ever owning investment real estate.

[riverwed070707]

I've been saving for retirement for over 30 years. I've only had access to a 401k for the past 7, and I was only full time at that job for 4 of those years, so I just didn't have a huge opportunity to fund a 401k. I've got about 235K in there out of a $3.2 million portfolio so a little over 7%.

Where's the rest? Traditional IRAs, Roth IRAs, a small SEP IRA, an inherited traditional and Roth IRA, and the rest (about 55% of the total) is in taxable accounts.

I have absolutely zero interest in ever owning investment real estate.

I know how you feel about real estate, I was just thinking if it wasn't in 401ks, that meant A LOT was in taxable accounts. A mix other other tax advantaged accounts makes sense, although I'm still surprised about 50% taxable for some reason.

[disneysteve]

I know how you feel about real estate, I was just thinking if it wasn't in 401ks, that meant A LOT was in taxable accounts. A mix other other tax advantaged accounts makes sense, although I'm still surprised about 50% taxable for some reason.

IRA limits used to be even more pathetically low than they are now. It was $2,000/yr until 2002 when they finally indexed it for inflation, so for much of my career, we were extremely limited as to what we could stash in a tax advantaged account. That's of minimal value with a 6-figure income, but it was the best we could do. Everything else went into taxable accounts. It wasn't until I took my current job in 2016 that I finally had an employer-sponsored plan that let me put away more than pocket change. Still, we managed to build a nice nest egg (the inheritance helped too of course).

Now I'm taking RMDs from the inherited IRAs as required and very slowly drawing from the portfolio. We're on track to have about a 1.7% withdrawal rate this year. As long as I continue to work 4 or 8 hours per week, we should be able to keep the WR under 2% and give the portfolio some time to grow. YTD we're up over 180K despite pulling money out at a rate of about $1,000/wk so I think we're doing just fine.

[disneysteve]

I've complained for years that the IRA limit should match the 401k limit. Why can I put 26K in a 401k tax-deferred but only 6K in an IRA tax-deferred? If you make it so I can only do one or the other but not both, then they should both have the same contribution limit. It's not my fault that my employers didn't offer a 401k and I was stuck with an IRA.

[myrdale]

I fully disagree with the article.

The power of tax free growth outweighs any arguments of tax brackets I've seen.

[Petunia 100]

I fully disagree with the article.

The power of tax free growth outweighs any arguments of tax brackets I've seen.

Both traditional and Roth accounts offer tax free growth.

[kork13]

Both traditional and Roth accounts offer tax free growth.

Not quite, traditional accounts are tax-deferred .... on withdrawal, you'll pay taxes on the entire amount (contribution & growth), and at your standard income tax rate to boot (not the LTCG rate). Honestly, recognizing that is one of the reasons I don't like traditional accounts... At least in a taxable account your growth is taxed at a lower rate. And in a Roth, not taxed at all. So yeah, unless/until I'm well out of the 25% (22% currently) tax bracket from some fantastically high income, the tie always goes to the Roth in my book.