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Posted by rg on January 2, 2007, 5:04 am
I have the opportunity to contribute to a Roth 401K starting this year
instead of (or blended with) a regular 401K. Should I?
Conventional wisdom would say that if I expect (and how can I tell?)
that my current tax rate is higher than my retirement tax rate then I
should NOT take the Roth 401K but that seems rather simplistic. Some
back-of-the-envelope calculations suggest that fully funding the Roth
401K compared with fully funding a regular 401K and investing the "tax
savings" in a taxable account would result in a win unless my retirement
tax rate was significantly (~30%) less than my current tax rate. Of
course, this is all (assuming I haven't made a fundamental error
somewhere) a function of the expected investment return (I used (an
optimistic?) 10%) - a lower return would reduce the Roth's advantage.
My current marginal tax rate is ~40% (including California's 9%) I'm 60
and plan to work for another 4-5 years; I've been fully funding my 401K
and IRA for the last 20 years or so and will also have a small pension
(~$1000/month) - which should allow me to retire, while not in the lap
of luxury, reasonably comfortably. I have no debts and own my own home.
I'm leaning towards the Roth to hedge my bets - comments.
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Posted by jIM on January 2, 2007, 9:23 am
rg wrote:
> I have the opportunity to contribute to a Roth 401K starting this year
> instead of (or blended with) a regular 401K. Should I?
>
>
> I'm leaning towards the Roth to hedge my bets - comments.
I find myself in a similar decision making situation. I chose to stick
with traditional 401k and Roth IRA.
for this discussion, I see 4 types of accounts:
Traditional IRA
Traditional 401k
Roth IRA
Roth 401k
two types of withdrawl rules (more or less): The traditional accounts
have one set of rules and the Roth accounts have another set of rules.
If you are not aware of the withdraw rules (and the differences), I
suggest asking.
In your situation I would look at "how much" will be in traditional
type of accounts at retirement age and what the RMD (required minimum
distrubution) would be. I would compare this amount to tax tables to
see if the RMD is in your same current tax bracket or higher than your
current tax bracket.
In my situation I believe my traditional 401k withdraws will still be
in my current tax bracket, so taking the tax break now is more
important than the other benefits later of the Roth 401k.
Two other questions- do you have any money in a Roth IRA at present
time? If you retire, do you plan to withdraw from 401k immediately or
do you have other assets you are going to draw down in taxable accounts
first?
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Posted by woessner@gmail.com on January 2, 2007, 10:32 am
> My current marginal tax rate is ~40% (including California's 9%)
That's high. In such a high tax bracket, the savings from the
traditional 401k is significant (.4 * 15k = 6k). I would count this as
a big pro for the traditional 401k.
> I'm 60 and plan to work for another 4-5 years;
Another potential pro for the traditional 401k. The Roth is at its
best when the money is allowed to sit and compound for a LONG time.
That being said, there's no reason you have to spend your Roth dollars
immediately upon retirement. If you have enough savings other than the
Roth, the Roth could happily sit and compound forever. I believe the
Roth is also superior for your heirs (I don't know the details of this;
someone correct me if I'm wrong).
> I've been fully funding my 401K
This is a pro for the Roth. If you're maxing out your 401k
contribution, the Roth option allows you to tax-advantage more money.
If you max out a traditional 401k, part of your contribution belongs to
the government in the form of taxes. Eventually, you'll have to give
that money back (hopefully you give back less because you're in a lower
tax bracket). With a Roth, all the money is yours.
> I have no debts and own my own home.
Another pro for the traditional 401k (but it's really the same pro as
your tax bracket). Your lack of mortgage interest raises your tax
bracket, making the traditional 401k more attractive.
> I'm leaning towards the Roth to hedge my bets - comments.
Excellent idea. People often discuss diversity among assets and asset
classes but sometimes ignore diversity among tax shelters. It sounds
like you have significant savings in your traditional 401k.
Contributing to a Roth at this point will give you more diversification
at the tax shelter level. This is important because there's no way to
predict what Congress will do to the tax code.
--Bill
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Posted by Will Trice on January 2, 2007, 6:43 pm
woessner@gmail.com wrote:
> The Roth is at its
> best when the money is allowed to sit and compound for a LONG time.
Why? It seems that time is immaterial to this decision, all else being
equal.
-Will
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Posted by joetaxpayer on January 2, 2007, 7:44 pm
> woessner@gmail.com wrote:
>
>> The Roth is at its
>> best when the money is allowed to sit and compound for a LONG time.
>
>
> Why? It seems that time is immaterial to this decision, all else being
> equal.
>
> -Will
And so I'd turn to the spreadsheet, only this one I can do on a napkin.
401(k) = G * (1.x)^Y * (1-t)
Roth = G * (1-t) * (1.x)^Y
Where Gross is the amount one has available to put in the account,
x is the rate of return (whatever you'd like),
Y= number of years
t is your marginal tax rate.
Doesn't matter when you pay the tax, if the rate is the same in and out,
there's no difference.
The presumption that favors the 401(k) is that more people will be in a
lower bracket at retirement than while working. Of course, this is a
generalization that applies to some percent of retirees. 60%? 80%? I
don't know, but when I hear of the paltry sums that people have saved
who are nearing retirement age, I believe the generalization is accurate.
The above napkin math assumes the same expenses in both accounts.
JOE
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