401k or roth 401k

[LivingAlmostLarge]

I'm having a discussion with a couple of coworkers/friends. Both say there is never a point to not using a Roth 401k. They said even at the 37% bracket they always tell people and have been to "seminars" saying the Roth 401k is always the way to.

Personally I don't suggest that and I don't do it either. We've always done the 401k and we have done after tax backdoor mega roth contributions. We also have maxed out the ESPP or any other opportunities.

Also we've been pretty highly compensenated so our bracket has always been 32% or higher until now. We recently went to the 24% bracket or thought we were until a bonus hit and now we're back at 37%.

Anyway DH had a 401k Roth option (no match on either) but I told him do the regular 401k for 2023 because I had suspicions the "bonus" would cause us to jump to the 37% bracket and it did. There is no backdoor after tax roth option so we're just stashing it in the taxable.

But the argument is that you need a roth because the earnings on $22,500 will grow a lot and it's better it be taxed otherwise even at 37%. Or at 32%.

My thought has always been, personally we live in the 22-24% bracket (at least we do) and paying 37% seems nuts. Plus to get to that sort of RMD you will need $15M in 401k. $7M RMD at 73 is only $280k which doesn't get you to the 37% bracket.

I'm not sure which is the correct way to think about it? Or are there other considerations? I've always said it's 1st world problems and if I bet wrong on our regular 401k and make $800k+ a year because my RMD on my 401k is so large then I'm happy to pay taxes. FWIW our 401k won't be large enough for $7M i'm guessing.

[kork13]

The way I see it, all Roth does make sense up to maybe the 24% bracket (or at least through all of 22%). Because like you said, you've got to have a huge balance in Traditional with massive RMDs to end up paying less taxes with Roth when you're in the higher brackets.

However, the big deal with Roth in my view is that Roth is more dense, as long as you're able to max out the contribution limits. You can effectively pack more into the Roth than you can with traditional. Adding $22,500 to traditional is only worth $17,550 once you consider taxes upon withdrawal (using 22% bracket). Whereas with $22,500 in Roth, I've effectively put away $27,450 of my income. On withdrawal, it's all there, not docked by taxes. But again, that dynamic is only to your benefit if you max it out. If you only go to half the limit in Roth, for example, you're not really adding more to your Roth account than you could otherwise do with Traditional.

Another argument that could be made about going Roth is to control your tax bracket now while you know what it is, vs. the unknown of what the future holds. We're already operating on reduced tax brackets than before (22% vs. 25%, for example) ... And at least personally, I don't see tax rates going anywhere but up from what it's at today. So if you have the same view, perhaps you'd prefer to pay taxes now at a known & tolerable tax rate, rather than having to worry about what the tax rates might look like in the future. Basically, Roth lets you choose your fate.

Finally, there could be value to all Roth if you're anticipating a taxable pension. The pension will eat up the "space" in your lower brackets, so as you do hit RMDs with traditional, you could get forced to pay higher taxes on those withdrawals. No RMDs is a huge benefit to Roth IMO.

[Like2Plan]

I found this calculator on the AARP web site:
https://www.aarp.org/work/retirement...=0AAAAAD5VhzXU 7gEqwwXIjjfkwPG2Ev17f&gclid=EAIaIQobChMI7P-j7duCgwMV0zWtBh1bdw-gEAAYASAAEgJGJ_D_BwE&gclsrc=aw.ds

It’s kind of cool because you can load in different assumptions. You can see how the RMDs go up each year. The percentage that must be withdrawn increases each year, but it also assumes there will be growth (you can change how much).

There are many more unknown variables that will affect the final taxation.
1. Will the federal tax rates remain the same (either higher or lower)?
2. Will state taxes remain the same (higher or lower)?
3. Will you be taxed at a single or married rate?
4. Will you have additional taxable income that will impact the taxation of the RMD income?

If tax schedules remain the same, most people will probably be in a lower tax bracket at retirement.
Plus, some tax deferred income may never be taxed (QCD’s and Medical expenses- if they are high enough for example).

But, yes, if you have “lots” of other taxable assets in retirement maybe there would be an advantage to Roth even at higher tax rates if you have no expectation of being in a lower bracket. (I just don’t know how much “lots” equals.)

[LivingAlmostLarge]

1. The tax deferred growth is an argument people for the Roth make. But remember to get $22,5000 @ 37% = $29,925 pretax.
But in 2017 the top tax bracket was 39%. 2% more. Not a huge number. And the brackets are getting bigger.

$22,500 @ 8% for 40 years is $5.8M. That is an RMD is $218k. That's solidly in the 32% single but 24% bracket MFJ.

I think there are less than 14% of people iwth traditional pensions nowadays. Most do not have defined benefit plans. They do have defined contributions where a company puts say 10% in or matches, but even that is maybe.

Also Kork, you should be looking at traditional because the earlier you retire and the earlier you do rollover conversions if you retire say 55 and have 20 years to control conversions from 37% to say 24% or even 32%, you are saving on that tax break.

The chances of retiring early is only possible really with a pension (mostly military) because traditional government workers often need age like 55 or 62, and years of service. Then if you make enough to retire early chances are you have years to convert at the lower brackets. Or withdraw.

[kork13]

Also Kork, you should be looking at traditional because the earlier you retire and the earlier you do rollover conversions if you retire say 55 and have 20 years to control conversions from 37% to say 24% or even 32%, you are saving on that tax break.

The chances of retiring early is only possible really with a pension (mostly military) because traditional government workers often need age like 55 or 62, and years of service. Then if you make enough to retire early chances are you have years to convert at the lower brackets. Or withdraw.

Your point about Roth conversions is a good one, especially for high-income folks with plenty of room to work with in bringing >30% brackets down to 24%. However, there's less opportunity for that if you're working in the 22% or 24% brackets, because most "average" families operate with around $50k in annual expenses (often higher). So if you put money into traditional at the 22% bracket, you can only convert a small amount (say, $10k-$30k/yr) to Roth every year. If you're retired for 15-20yrs before RMDs hit, you can maybe manage to get up to about $1M converted to Roth at the lower bracket. But otherwise, it's fairly low-impact. Plus, how many folks have the financial management chops to execute that plan effectively? So having some traditional certainly doesn't hurt, but I still maintain that in most cases, focusing on Roth through at least the 22% bracket (maybe higher) remains the best go-to advice.

That said .... My perspective is almost certainly colored because my family is in exactly that exceptional case (military with pensions) -- the pensions for DW & I will keep us most of the way to the 22% bracket, and just $25k-$30k in additional income (like a part-time job, rental real estate, or some Roth conversions) will push us right back into the 22% bracket where we are today. So knowing that DW plans to work for another decade or more, I find that sticking with the "denser" Roth accounts is best for us.

[LivingAlmostLarge]

Your point about Roth conversions is a good one, especially for high-income folks with plenty of room to work with in bringing >30% brackets down to 24%. However, there's less opportunity for that if you're working in the 22% or 24% brackets, because most "average" families operate with around $50k in annual expenses (often higher). So if you put money into traditional at the 22% bracket, you can only convert a small amount (say, $10k-$30k/yr) to Roth every year. If you're retired for 15-20yrs before RMDs hit, you can maybe manage to get up to about $1M converted to Roth at the lower bracket. But otherwise, it's fairly low-impact. Plus, how many folks have the financial management chops to execute that plan effectively? So having some traditional certainly doesn't hurt, but I still maintain that in most cases, focusing on Roth through at least the 22% bracket (maybe higher) remains the best go-to advice.

That said .... My perspective is almost certainly colored because my family is in exactly that exceptional case (military with pensions) -- the pensions for DW & I will keep us most of the way to the 22% bracket, and just $25k-$30k in additional income (like a part-time job, rental real estate, or some Roth conversions) will push us right back into the 22% bracket where we are today. So knowing that DW plans to work for another decade or more, I find that sticking with the "denser" Roth accounts is best for us.

Absolutely. Anyone with a pension should be looking at Roths because their starting out base is much lower. But for most people if you look at the traditional 15% contribution to retirement does not replace 100% of income. So it's highly unlikely most couples wil be close to their pre-retirement income in retirement even if they retire early.

Most people will go down in bracket when they retire. I've seen very few people pulling in more money than when they were working, but I'd love to be surprised. Most who do make more like my aunt and uncle and mom, are retired with pensions which is paying out more than when they were working and having 401k, pension, health insurance all being paid out.