My company is offering a Roth 401(K) and we can choice to receive company matching in either our pre-tax 401(K) or the new Roth.
I am planning on retirement in 12-15 years and will our house paid off in 5 years. What other factors should I consider when choosing the pre-tax or Roth 401(K)? My company will also allow us to contribute to both plans.
I fear the US in going to hit big time in taxes in the future.
Another factor is whether you expect to have a higher income tax rate now or when you retire. That's a function of both what your income is like now vs. then and also your projection about income tax rates.
In general, someone that works for a long time and maintains a similar lifestyle in retirement is better off with a Roth because all the compound interest on their savings is never taxed, and the tax brackets are almost a wash. However if you are doing an ERE kind of thing where you earn much more than you expect to spend, and/or will only be saving for a few years, the traditional pre-tax 401k can be a better choice.
EDIT: Another factor is the state income tax rate where you're working vs. where you plan on retiring, if they differ. If you work in a high income tax state and retire in a zero income tax state, that makes the traditional even more appealing.
Last edited by KevinW on Fri Nov 30, 2012 9:14 am, edited 1 time in total.
Also keep in mind that you can covert virtually anything to a Roth IRA by doing rollovers from 401k -> IRA -> Roth IRA. You'll take the tax hit when you make the final jump to a Roth, but you get to decide when and where to take it, potentially generating some opportunities for optimization (e.g. doing the conversion in a state with no income taxes during your first year of ERE when you have no wages and therefore are in the lowest marginal tax bracket).
Human behavior is economic behavior. The particulars may vary, but competition for limited resources remains a constant.
- CEO Nwabudike Morgan
There was a post about Roth IRA's in the "other" discussions forum and somebody questioned the need for a ROTH if you expect your income to be below a certain $ (I think it was PointedStick and I think the amount was $75k but I could be wrong about both). The reason for this was because your capital gains tax rate would be zero any way.
I was contributing to both a Roth and traditional at work, splitting it 50/50 but because of the above along with another reason (my wife's 401k was discontinued), I quit contributing to the Roth. I do still intend to contribute the maximum amount to both mine and my wife's individual Roth IRA's each year. I do this because I'm applying the PP philosophy to taxes, i.e., nobody knows what's going to happen in the future so I'm trying to cover all bases.
MangoMan wrote:
What does the capital gains rate have to do with withdrawals from a Roth?
Under the current tax rates, if you're in the 10 or 15% federal tax bracket, your long-term capital gains tax rate is 0%. A married couple can be in this tax bracket by taking the standard deduction and still earning 80-something thousand dollars a year. Now your only capital gains taxes are imposed by your state. If you live in a state with no income or capital gains tax, then your total long-term capital gains tax rate is 0%! You have now nullified the advantages of a Roth IRA, which gives you the same thing but imposes a bunch of rules on withdrawals and contributions and ages and crap.
Roths are only advantageous for people/couples who live in states that impose income or capital gains taxes and whose income places them above the 15% bracket, but below the income limit.
Last edited by Pointedstick on Fri Nov 30, 2012 11:42 am, edited 1 time in total.
Human behavior is economic behavior. The particulars may vary, but competition for limited resources remains a constant.
- CEO Nwabudike Morgan
I still like Roth's... we're forgetting about state taxes, which rarely have exceptions for dividends or capital gains, and unless you're gain-harvesting every year, if you ever start approaching the 25% bracket, or tax rates set to change, you might have too much capital gain to get rid of.
If I can take my initial investment out anyway, I think the Roth IRA is a sweet deal compared to starting a taxable account. Especially when you consider that you can't just contribute more in future years, and it's not recognized for FAFSA purposes.
"Men did not make the earth. It is the value of the improvements only, and not the earth itself, that is individual property. Every proprietor owes to the community a ground rent for the land which he holds."
I like 'em as well. In fact, I'm maxing out two right now. Just pointing out that there are conditions where you can achieve a near-Roth environment outside of a Roth.
Man, the tax code. What a mess.
Human behavior is economic behavior. The particulars may vary, but competition for limited resources remains a constant.
- CEO Nwabudike Morgan
"So hold on to your wallet. Congress has many options when it comes to tapping this vast reservoir. It could eliminate the deduction altogether or just for top earners, further restrict the amount that is deductible (currently $17,500; for those over 50, $23,000), start taxing retirement savings growth, or take back the part that has grown tax-free.
In the throes of a retirement savings crisis, none of these options is appealing. But that last one is most troublesome. At stake is any savings that has accrued tax-free in a Roth IRA."
tonymonto wrote:
Before buying a Roth, read this...
"So hold on to your wallet. Congress has many options when it comes to tapping this vast reservoir. It could eliminate the deduction altogether or just for top earners, further restrict the amount that is deductible (currently $17,500; for those over 50, $23,000), start taxing retirement savings growth, or take back the part that has grown tax-free.
In the throes of a retirement savings crisis, none of these options is appealing. But that last one is most troublesome. At stake is any savings that has accrued tax-free in a Roth IRA."
and we can choice to receive company matching in either our pre-tax 401(K) or the new Roth.
