Roth 401k?

[LivingAlmostLarge]

My DH's company is offering a Roth 401k now and we are debating doing it. What are the pros and cons of it?

We don't qualify for a Roth IRA but back door it. So I'm not sure if this is the wisest move. Do we not take the tax break now or do we risk it?

I know rates are likely to go up. But at the same time I don't know when we'll retire or what bracket we'll be in. So many variables.

[disneysteve]

My DH's company is offering a Roth 401k now and we are debating doing it. What are the pros and cons of it?

We don't qualify for a Roth IRA but back door it. So I'm not sure if this is the wisest move. Do we not take the tax break now or do we risk it?

I know rates are likely to go up. But at the same time I don't know when we'll retire or what bracket we'll be in. So many variables.

I think you should always do the Roth before the traditional. I really can't think of any advantage to doing a traditional instead. I'd go for tax-free growth and tax-free withdrawals every time.

[feh]

But at the same time I don't know when we'll retire or what bracket we'll be in. So many variables.

Yup, the equation to determine which is better is not simple. You mention the 2 big variables above - tax rate now vs in retirement, and amount of time until retirement.

You must have some idea on the latter, don't you?

[jIM_Ohio]

My DH's company is offering a Roth 401k now and we are debating doing it. What are the pros and cons of it?

We don't qualify for a Roth IRA but back door it. So I'm not sure if this is the wisest move. Do we not take the tax break now or do we risk it?

I know rates are likely to go up. But at the same time I don't know when we'll retire or what bracket we'll be in. So many variables.

I contribute to both traditional 401k and Roth 401k.

I tweak percentages based on my AGI to try and stay in the 25% tax bracket (if I did not use traditional 401k, I would be in 28% tax bracket).

My advice- if you are in 15% tax bracket, all Roth, all the time
If you are in 25% tax bracket, try to get in 15% tax bracket (take as many deductions as you can)
If you are in 28% tax bracket, use traditional only until you are in lower tax bracket.

If your state has high taxes, I would use the traditional 401k more than listed above.

[LivingAlmostLarge]

DS tax rate now I guess is the question. Do I think we'll be in as high a bracket as we are now.

Feh, the way my DH acts I don't think he's retiring before 55 unless forced. So another 20 years. We are currently on pace based on back of the envelope I guess in another 10 years. But that also requires tax planning to retire at say 45. We need more taxable cash so perhaps we can allow our retirement accounts to grow. Plus I was thinking also rolling it over if we retire early up to the 15% tax bracket.

JimOH 28% bracket starts at $148k. We are over that with the 401k maximum deduction, personal exemptions, standard deduction. We might be close to under it our itemized deductions but off the cuff we are still over by $10k. So add back the $17.5k and we are solidly at 28%. Our state income tax is 6% so we are looking at 34% total.

Last year we didn't do roth and I don't think this year we will either but we did the non-dedectible and rolled it over.

[jIM_Ohio]

DS tax rate now I guess is the question. Do I think we'll be in as high a bracket as we are now.

Feh, the way my DH acts I don't think he's retiring before 55 unless forced. So another 20 years. We are currently on pace based on back of the envelope I guess in another 10 years. But that also requires tax planning to retire at say 45. We need more taxable cash so perhaps we can allow our retirement accounts to grow. Plus I was thinking also rolling it over if we retire early up to the 15% tax bracket.

JimOH 28% bracket starts at $148k. We are over that with the 401k maximum deduction, personal exemptions, standard deduction. We might be close to under it our itemized deductions but off the cuff we are still over by $10k. So add back the $17.5k and we are solidly at 28%. Our state income tax is 6% so we are looking at 34% total.

Last year we didn't do roth and I don't think this year we will either but we did the non-dedectible and rolled it over.

Realize at 34% tax rate (Federal+State) that the withdraws in retirement could be half that, or less. For example in New York, my father tells me the exemption for retired people is much higher than those which work (something like a 40k exemption??) so the best advice is take deductions while you are eligible for them- save the 28% now, and resist chasing the shiny new object (the Roth 401k).

You don't know where you will retire (you may have 3-4 choices, but don't "know" the answer.
You don't know the state and local tax exemptions of those locations (yet) either.
You DO know you could save 34% taxes on the contribution
I would focus on what you do know and plan around the knowns, as retirement planning has significant unknowns to it.

[LivingAlmostLarge]

Okay Jim so do you propose the brackets aren't going up?

[jIM_Ohio]

Okay Jim so do you propose the brackets aren't going up?

Focus on what you know.

You KNOW you could save 28 federal + state income taxes on 401k contributions.

Even if tax rates go up (the 28% federal bracket and the state bracket), retirement tax profiles for people are much different.

The 6.2% flat SS tax goes away... the 1.65% flat medicare tax goes away...
standard deduction and personal exemptions allow first $400k of all 401k monies to be withdrawn tax free.

Take deductions now and try not to solve every problem which exists- taking the deductions allows you to add some money to a taxable account
then if you want you can do Roth conversions when income (and tax rates) drop in early years of retirement, that option is on the table.
If you convert to a Roth at 10% or 15% bracket when doing this, this planning just reduced your tax bill by more than half.

If you live off of a taxable account (and spend $80k per year from that account), do you realize the taxes on this money is zero or next to zero)? I would argue this is an even better than a Roth option for early retirement and financial independence.

[Zedon]

Focus on what you know.

You KNOW you could save 28 federal + state income taxes on 401k contributions.

Even if tax rates go up (the 28% federal bracket and the state bracket), retirement tax profiles for people are much different.

The 6.2% flat SS tax goes away... the 1.65% flat medicare tax goes away...
standard deduction and personal exemptions allow first $400k of all 401k monies to be withdrawn tax free.

Take deductions now and try not to solve every problem which exists- taking the deductions allows you to add some money to a taxable account
then if you want you can do Roth conversions when income (and tax rates) drop in early years of retirement, that option is on the table.
If you convert to a Roth at 10% or 15% bracket when doing this, this planning just reduced your tax bill by more than half.

If you live off of a taxable account (and spend $80k per year from that account), do you realize the taxes on this money is zero or next to zero)? I would argue this is an even better than a Roth option for early retirement and financial independence.

How is the first 400k tax free? please explain. Also how is 80k from a taxable account near zero tax? I've not heard of these scenarios.

In my case my income will be replaced by my pension so, the traditional witdrawals will be on top of my pension which will probably be well into the 25% bracket

[jIM_Ohio]

How is the first 400k tax free? please explain. Also how is 80k from a taxable account near zero tax? I've not heard of these scenarios.

In my case my income will be replaced by my pension so, the traditional witdrawals will be on top of my pension which will probably be well into the 25% bracket

The first $400k-$500k of pension income or Traditional IRA withdraws are tax free. This depends on filing status and IRS exemption amounts which change (increase) year over year.

You have control of this through 401k/ IRA, you do not have control of this for pension

The standard deduction for married filing jointly is $12,600, the personal exemptions is $4000 each. This is $20,600 per year the government gives you tax free.

Whether you work or are disabled or are retired, those numbers ($20,600) would be the same.

$20,600*25=$500k. This means if you take out 4% (1/.04=25X) of your 401k balance per year, or 4% of your IRA balance, none of it would be taxed. If you are single the numbers are lower than $500k, but still in favor of it's easy to take money out and not have it taxed at all.

If you add income from other sources (Roth IRA, taxable accounts), it is very easy to have a high income in retirement if you only take out the amount up to your standard deductions from taxable sources.

If you have money in a taxable account, you have already paid income taxes on this money. If you follow advice above (only take 4% out up to standard deduction from pre-tax accounts), then capital gains taxes are zero (using current tax law). You can then pull a Mitt Romney and not pay taxes on this either.

I would ask your tax expert the details here. They wouldn't know about 4% withdraws (that is an investment subject), but they would know the std deduction and personal exemption amounts and be able to validate that info.

[autoxer]

I know rates are likely to go up. But at the same time I don't know when we'll retire or what bracket we'll be in. So many variables.

Although your wages determine your tax bracket now, in retirement you can decide your tax bracket by how much you plan to spend every year. I'm beginning to realize that I can easily reduce my tax bracket in retirement without really sacrificing standard of living. If I pay off my mortgage and eliminate the portion of my budget directed towards retirement saving, I could easily drop down a tax bracket. I wouldn't need to 'realize' the same amount of income to support my current spending level.

Since the tax is progressive, you have to fill the 0% bracket first (deductions & exemptions), then the 10% bracket, then the 15% bracket... There's no point in paying 25% tax now, if I can defer the tax and use it to fill one of the lower brackets later. If you are on schedule with funding your traditional accounts, to the point where it can fill up all of the tax brackets below your current tax bracket in retirement at a safe withdrawal rate, then it might be time to consider a ROTH. I switched my 401k to a ROTH a few years ago and recently discovered that I might be under funding the traditional account, so it's back to a traditional for me. There is a lot of assumptions in that calculation about retirement date, spending, rates of return, inflation and safe withdrawal rate, but it's just a projection, so I can adjust my plan as the variables change.

[doingitallwrong]

The first $400k-$500k of pension income or Traditional IRA withdraws are tax free.

That's an interesting and fairly misleading way to state it. The more accurate statement would be that for a married couple filing jointly, the first $20,000 or so of taxable ordinary income is offset by deductions and exemptions. (The 2014 standard deduction for MFJ is $12,400 and the personal exemption is $3,950, so $20,300 for 2014. Probably the $20,600 will work for 2015. There's also an additional $1200 added to the standard deduction for each person age 65 and older. Of course itemized deductions might be higher.)

If you take out $400K from your traditional IRA in one year, it most certainly will not be tax free.

If you have money in a taxable account, you have already paid income taxes on this money. If you follow advice above (only take 4% out up to standard deduction from pre-tax accounts), then capital gains taxes are zero (using current tax law). You can then pull a Mitt Romney and not pay taxes on this either.

Yes, so long as any other income (including qualified dividends and capital gains) does not take your taxable income above the 15% tax bracket ($73,800 for MFJ for 2014).

[jIM_Ohio]

Yes, so long as any other income (including qualified dividends and capital gains) does not take your taxable income above the 15% tax bracket ($73,800 for MFJ for 2014).

To best of my knowledge, there is no way capital gains can increase taxable income. They are two separate line items on the 1040.

[autoxer]

To best of my knowledge, there is no way capital gains can increase taxable income. They are two separate line items on the 1040.

I've been trying to figure this out on the 1040. It looks like the qualified dividends are included in ordinary dividends on line 9a and line 13 is your capital gains. When you add up lines 7 - 21, you get your total income. They are still considered part of your taxable income (line 43) even though they may be taxed at a lower rate.

[doingitallwrong]

It looks like the qualified dividends are included in ordinary dividends on line 9a and line 13 is your capital gains. When you add up lines 7 - 21, you get your total income. They are still considered part of your taxable income (line 43) even though they may be taxed at a lower rate.

Exactly. Capital gains (and qualified dividends) are part of your adjusted gross income, from which is calculated your taxable income. They're taxed at a different rate, but are still considered as part of your taxable income. (For a very simplified example, if your AGI is $80,000 and includes $10,000 of capital gains, and your deduction and exemptions are $20,000 and you have no other credits etc., your taxable income is $60,000. You'll pay ordinary income tax on $50,000 of that and capital gains tax (which at that taxable income is 0% for MFJ) on the $10,000 capital gains.)