401K vs Roth401K

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JustChristine
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Joined: Wed Jul 21, 2010 11:01 pm

Post by JustChristine »

I've been reviewing my savings plan to make sure I'm making the most of my situation so I can ERE as ASAP :) My current job offers both a 401K and a Roth 401K. My initial idea was to contribute to the Roth 401K until that balance was equal to the balance of my rollover IRA (from previous jobs). Then I would change my contributions to be split between the regular and Roth 401ks. When I retired I would have roughly equal amounts in taxable and tax-free accounts so I would not take a big hit no matter which way tax rates went. I had never really thought too extensively about taxes in retirement so this seemed like a safe bet.
Of course, this was all before I discovered the concept of ERE and actively started planning for retirement. Now I'm wondering if this is my best way to go. Right now I'm solidly in the 25% tax bracket. When I retire, I would just barely be in the 15% bracket(in today's tax brackets). If the brackets stay relatively the same I'd be better in the regular 401k. Even when taxes go up, which they will have to eventually, I think the lower brackets wouldn't change too much. Most politicians seem to agree that taxing the 'poor' is not a great idea. So I would probably be better off going with the regular 401K....I think.
I'm not looking for advice one way or the other but rather a healthy discussion of the pros and cons. Thoughts?


Matthew
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Joined: Thu Jul 22, 2010 6:58 pm

Post by Matthew »

I think you just mentioned them all. Pay higher taxes now with the Roth 401k. Pay (hopefully) lower taxes later with a standard 401k because of the frugal (poor) income needed for living in retirement.
Con for both:
I am pretty sure that the rules could change for both of these accounts (although so far only the amount allowed each year).
Pro for both:
I am also pretty sure we will see our taxes go up and freedom's go down for all brackets. If ERE becomes too easy for too many people, there will be new legislation/taxes (72t elimination?) that makes things more difficult for people to retire early. So this might make the advantage for the standard 401k to be a wash with the Roth 401k long term.
Pro Roth 401k:
Low income earners
Pro 401k:
People far above high tax brackets who plan to live poor.
Pro split:
People JUST within higher tax bracket. Pay enough to standard to be in lower, put the rest in the Roth.


akratic
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Location: Boston, MA

Post by akratic »

A big plus for the Roth 401k that rarely gets mentioned is that if you're going to max out your contributions, you can actually save more and tax shelter more money with a Roth 401k than a normal 401k.
Suppose for example that you make $15k and put all of it in the 401k, and the money in there doubles, and you're taxed at 33% now and in the future.

- Traditional: $15k income -> $15k in 401k -> $30k in 401k -> $20k after taxes

- Roth 401k: $15k income -> $10k in Roth 401k -> $20k in Roth 401k -> $20k after taxes
So in that case where you put $15k in a 401k and $10k in a Roth 401k, things are equal. Guess what? $15k is about the max for the traditional 401k, but the max for the Roth 401k is much higher than $10k (in fact, brokenly, it's the same as for the traditional 401k).
A plus for the traditional 401k is that the only predictable thing about the government is its growth, so you might as well take your tax advantages while you can get them, rather than in the future when they are merely promised to us.


Robert Muir
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Joined: Thu Jul 22, 2010 10:15 pm

Post by Robert Muir »

"To Roth or not to Roth?" Aye, there's the question for the ages.
It's not just the initial deposit that we're concerned with. All future gains in the fund are also up for grabs. In the Roth account, future gains are exempt from income taxes whereas the gains in the non-Roth will be taxed at the full income tax rate at the time of withdrawal.
However, if you have full buy-in to Jacob's near ascetic lifestyle, then you'll have little to no income and thus pay little to no taxes regardless. Also, a Roth would have no protection against future sales or VAT taxes.
For me, I like having money in both tax-free and tax-deferred funds to provide maximum flexibility.


Kevin M
Posts: 211
Joined: Thu Jul 22, 2010 8:58 pm

Post by Kevin M »

If you have an employer match, you're somewhat hedged, since it ALWAYS goes to the regular 401(k) bucket.
I did a Roth last year, but switched back to regular for 2010 to get the tax deduction. I invest my funds outside the 401(k) in a Roth IRA, so I'm hedged there as well.
Also, if you live my the mantra: "Never pay a tax before you have to." you will go with the regular 401(k).


jacob
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Post by jacob »

Consider what the majority is currently doing because they will vote for politicians who will tax according to what those who lobby them will want.
For example, if everybody goes Roth now and future politicians want money from retirement money, they'll simply institute sales and VAT taxes. If that's unpopular, they can just borrow and monetize the debt.


Maus
Posts: 505
Joined: Thu Jul 22, 2010 10:43 pm

Post by Maus »

Currently in California, the Legislature is considering a plan that raises state income tax and lowers the sales tax. The theory, which is contested, is that the ability to deduct the higher income tax on one's federal return will result in a net decrease for the taxpayer while still yielding greater revenue for the state. Of course, how many EREistas are itemizing their deductions on schedule A? Personally, as an anti-consumer, I'd prefer a higher sales tax and a lower income tax. But as an investor, I want people to keep spending on high-dollar durable goods to maintain corporate profits. The retailers are very much in favor of the proposed plan now being debated.


Cashflow
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Joined: Mon Aug 09, 2010 2:06 am

Post by Cashflow »

My philosophy is to get as much money into a Roth account as soon as possible for two reasons.
The first reason is that I have no idea what the government will do about taxes. I can try to predict what might happen, but I've been around long enough to know such predictions are useless. Congress giveth and Congress taketh away, and the one vote I get isn't going to make any difference if the rest of the population votes differently.
The second reason is that I would rather put an after-tax acorn into a Roth account and have it grow into a tax-free oak tree (assuming tax law doesn't change). The alternative is to put a before-tax (or an after-tax) acorn into a Traditional account and have it grow into a before-tax oak tree (assuming tax law doesn't change).
I will change my philosophy if and when the tax law changes.


Q
Posts: 348
Joined: Thu Jul 22, 2010 8:58 pm

Post by Q »

I'm split with the new Cali tax proposal myself. Lower sales tax sounds great, but I would think a higher sales tax would work even better. California already collects a "fee" on any TV ($32 I think) and laptop sold in the state for "disposal" which I assume funds the e-waste programs in the state.
Higher income tax is great and all, but man, it means a painful climb while earning that ERE money. I currently itemize the sales tax, because I keep all my receipts and can prove it. I got audited last year to my disbelief (by CA)...
Anyways, look at SF - it charges a "healthcare tax" on restaurant tabs - people still eat out. I personally leave a lower tip because of it, since that employee is getting a benefit off that tax...tipping, in general tho, is a whole nother story ;)


KevinW
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Joined: Mon Aug 02, 2010 4:45 am

Post by KevinW »

Robert Muir's point is important. With the Roth you never pay income tax on the investment returns. This becomes a bigger factor as the holding time increases, so this is a bigger win for on-time retirees.
Another minor point is that the rules and paperwork for moving money in and out of a Roth are somewhat simpler.
Remember that if you can't make up your mind, you can always hedge your bets and go 50/50.


Matthew
Posts: 391
Joined: Thu Jul 22, 2010 6:58 pm

Post by Matthew »

We assume legislation will not be passed to tax the Roth...


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