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Posted by dan on January 8, 2007, 5:00 am
I think the rule of thumb has always been, fund the 401k up to the
employer match, then stop and fund the Roth IRA, then go back to the
401k, right?
So now that "Roth 401k's" are appearing, how should that order change?
My employer now offers the Roth 401k, but in order to fund it over $500
i'd have to forgo some of my normally maxed 401k contributions. (My
Roth IRA would still get maxed either way)
I plan on being in a lesser tax bracket upon retirement.
Thoughts?
Dan
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Posted by joetaxpayer on January 8, 2007, 7:52 am
dan wrote:
> I think the rule of thumb has always been, fund the 401k up to the
> employer match, then stop and fund the Roth IRA, then go back to the
> 401k, right?
>
> So now that "Roth 401k's" are appearing, how should that order change?
> My employer now offers the Roth 401k, but in order to fund it over $500
> i'd have to forgo some of my normally maxed 401k contributions. (My
> Roth IRA would still get maxed either way)
>
> I plan on being in a lesser tax bracket upon retirement.
>
> Thoughts?
>
> Dan
See the posts titles "Roth 401(K)?" which was recent, Jan 4 latest post.
I maintain that the decision, Roth 401(k) vs standard 401(k) should be
based on the current vs future tax rate. If taxes are assumed the same,
there is no difference. (Except, of course, the Roth is a denser
account. i.e. The 401(k) limit is 15,000 for 06. $15,000 of pretax
money. If you earn enough to be in the 25% bracket, and choose the Roth,
it takes $20K of pretax money to net the $15,000. So a fully funded Roth
has 'more' money in it.) This may have been the point others were making
in the original thread.
JOE
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Posted by Mark Bole on January 10, 2007, 3:02 pm
joetaxpayer wrote:
>
> See the posts titles "Roth 401(K)?" which was recent, Jan 4 latest post.
Sorry didn't have time to follow up until now, so I'm doing it here
instead of the older thread.
> I maintain that the decision, Roth 401(k) vs standard 401(k) should be
> based on the current vs future tax rate. If taxes are assumed the same,
> there is no difference. (Except, of course, the Roth is a denser
> account. [...]This may have been the point others were making
> in the original thread.
I don't agree, here is a counter-example, where with a constant tax rate
the Roth comes out better.
Here is a two-year scenario: assume a constant combined fed/state tax
rate of 30% for all years. Assume all investments earn 5%, compounded
annually.
For a Roth, we put in $10K after tax and get the following after tax result.
Year Roth IRA
2006 10000
2007 10500
2008 11025
For a Traditional, we put in $10K pre-tax, and invest the $3K tax
savings in a side account (which is taxed every year, of course).
Year Trad IRA side account (after tax)
2006 10000 3000
2007 10500 3105
2008 11025 3213
-3307 tax
+3213 side account
Total 10931
Now, if you do this in a spreadsheet, and run it out for maybe another
ten years, the relative difference is even greater, hence the original
conclusion that I think we have been differing over, "the longer you
have the Roth, the more it shines". It looks to me like this is indeed
the case.
Now, it is true that it only takes a very small drop in tax rate in the
final year to push the traditional over the Roth, much smaller than my
gut feeling initial led me to guess.
-Mark Bole
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Posted by joetaxpayer on January 10, 2007, 6:55 pm
I Yield. I was only talking about Roth 401(k) vs Trad 401(k).
You have introduced a traditional IRA with a side account. Hmmm.....
Given the fact that a Roth 401(k) is 'denser', you may very well say
that in the big picture, I need to analyze a person who has $22,500 in
the 33% bracket. That person can put all the money, post-tax as $15K
into the Roth 401(k) or only put $15,000 into the Trad 401(k), and then
have a $5,000 post tax side account.
That introduced a level of complexity which I hadn't analyzed. Not
beyond me, just not my first project.
At the lower dollar values where there's no spillover to side accounts,
and no tax rate changes over time, Roth 401(k) vs Trad 401(k) are still
equal.
Mark Bole wrote:
> I don't agree, here is a counter-example, where with a constant tax rate
> the Roth comes out better.
>
> Here is a two-year scenario: assume a constant combined fed/state tax
> rate of 30% for all years. Assume all investments earn 5%, compounded
> annually.
>
> For a Roth, we put in $10K after tax and get the following after tax
> result.
>
> Year Roth IRA
> 2006 10000
> 2007 10500
> 2008 11025
>
> For a Traditional, we put in $10K pre-tax, and invest the $3K tax
> savings in a side account (which is taxed every year, of course).
>
> Year Trad IRA side account (after tax)
> 2006 10000 3000
> 2007 10500 3105
> 2008 11025 3213
> -3307 tax
> +3213 side account
> Total 10931
>
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Posted by Will Trice on January 10, 2007, 8:50 pm
Mark Bole wrote:
> Here is a two-year scenario: assume a constant combined fed/state tax
> rate of 30% for all years. Assume all investments earn 5%, compounded
> annually.
>
> For a Roth, we put in $10K after tax and get the following after tax
> result.
> For a Traditional, we put in $10K pre-tax, and invest the $3K tax
> savings in a side account (which is taxed every year, of course).
Try putting the $3K savings into the Traditional IRA account along with
the original $10K and see what happens. I know, I know, you can't put
$13K in a traditional IRA account all at once. But then, you can't put
$10K into a traditional IRA account all at once either. But $13K is
allowed (depending on the plan) in a traditional 401(k)...
-Will
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