Question about 401k vs Roth IRA
by carofe » Thu Mar 20, 2014 8:32 pm
Hi,
My company matches 33% up to 18% of contribution ( I know, it sounds weird but it is real)
I would like to contribute 12% total to my retirement but putting everything into the 401k is not what I would like to do since I expect higher taxes when I retire.
If I put all in 401k, it would be only 9% contribution (+3% matching = 12%) pretax.
but if I decide to put something in a Roth IRA I can do something like:
6% pretax contribution (+2% matching = 8%)
4% post tax contribution to Roth IRA (to meet the 12%)
It is a total of 10% out of my salary.
Definitely I would be saving 1% if I put everything in my 401k but I would be paying higher taxes in the future.
Is it worth having the Roth IRA in this case? What would you recommend?
Thanks for you help
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Re: Question about 401k vs Roth IRA
by kerplunk » Thu Mar 20, 2014 9:28 pm
Definitely contribute the 18% to your 401(k) if you can. It's free money.
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Re: Question about 401k vs Roth IRA
by joe8d » Thu Mar 20, 2014 9:36 pm
kerplunk wrote:Definitely contribute the 18% to your 401(k) if you can. It's free money.
!8% contribution (TD) + 6% Company match. The company match will pay for taxes upon withdrawal up to the 25% Bracket. You will get a tax break on your 18% + no tax on any future gains on your portion up to the 25% bracket upon withdrawal
All the Best, | Joe
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Re: Question about 401k vs Roth IRA
by Johm221122 » Thu Mar 20, 2014 9:40 pm
I had a dollar per dollar match years ago and said to myself I don't want to put all my money in 401, now I look back and think I'm a big dummy 
John
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Re: Question about 401k vs Roth IRA
by retiredjg » Thu Mar 20, 2014 10:53 pm
carofe wrote:...but putting everything into the 401k is not what I would like to do since I expect higher taxes when I retire.
This would be unusual. Are you willing to share why you think this?
You may be confusing wealth with high tax rate. They do not necessarily go together.
Either way, I would not pass up any free money - get your entire match.
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Re: Question about 401k vs Roth IRA
by carofe » Thu Mar 20, 2014 11:33 pm
Thank you all for your advice! I'm expecting higher taxes because I expect to be in the 25% bracket soon and also because of the way the US government is going...
Regards
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Re: Question about 401k vs Roth IRA
by rkhusky » Fri Mar 21, 2014 8:11 am
If you are in the 15% tax bracket now and you have horrible choices in your 401K (active funds with ER of 1-2%), it might make sense to forgo some of the free money.
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Re: Question about 401k vs Roth IRA
by jimb_fromATL » Fri Mar 21, 2014 9:34 am
carofe wrote:Thank you all for your advice! I'm expecting higher taxes because I expect to be in the 25% bracket soon and also because of the way the US government is going...
Regards
You may be overlooking that in addition to getting the free extra pay for contributing the first 18%, another of the tax advantages for maxing the 401(k) is that you get to defer taxes on dividends, too. In an after-tax account, you'll have to pay taxes on the dividends every year. Thus you have less to invest for the next year. So your equivalent rate of return each year is less.
Chances are that the long-term capital gains tax rate will be less on your earnings in the after-tax account, but the earnings from the money you didn't pay in taxes in the deferred account will probably more than offset it. There's certainly no way that you can beat the free money of the company match.
It also sounds like you're falling into the trap that even a lot of book and website writers, speakers, and talk show hosts fall into, in thinking that your marginal or top tax bracket is the percentage that you pay on all of your income. Actually, we have standard deductions, personal exemptions, and graduated steps in lower tax brackets that all go up with inflation. You pay no tax on anything until you exceed the deduction and exemption(s), and then pay a lower percentage on all of your income now (or withdrawals in retirement) in the lower brackets.
In Georgia where I live, and presumably some other states, you'd get to defer paying state income tax and invest that money to earn compound interest for your entire life in the 401(k) and pay little or no state income tax on your retirement withdrawals. The same would apply if you can defer tax in the state where you work but move to GA or some other state where you wouldn't pay income tax after retirement.
Also bear in mind that you don't pay FICA tax on retirement income like pensions, social security, and withdrawals from retirement plans. Depending on your total retirement income you may pay no tax on social security, or pay tax on some percentage of it. But you'll never pay tax on more than on 85% of SS ... as the laws now stand.
So ...you usually won't have to withdraw nearly as much at retirement to have the same amount left to spend. That may reduce your top (marginal) bracket and your average tax percentage.
A good rule of thumb is to contribute up to the maximum company match, then --if your income allows it-- invested money in a Roth IRA too. Since a Roth IRA is not subject to the Required Minimum Withdrawals, you may may be able to balance withdrawals from the tax-deferred/taxable accounts and the Roth in retirement to keep your top bracket lower if you're near a step to the next higher marginal rate.
Here's an example to illustrate the difference between marginal bracket and the actual percentage of taxes you pay:
Note that you'd actually be increasing your income (hopefully) and retirement contributions over the years. So this is effectively in terms of today's dollars:
For 2014 a married couple with total income of $120,000 contributing 14.58% ($17,500) to 401(k)s and taking the standard deduction of $12,400 and personal exemptions of $7900 for 2 has an AGI of $102,500 and a taxable income of $82,200. They'd pay $12,263 federal income tax. They would have $8,400 of ther income taxes in their top bracket of 25%, but their federal income tax before any credits is only 10.22% of their wages.
Notice that the average of all the income tax is way less than their top bracket. That means there could be very substantial percentage increases in all of the brackets across the board before you'd pay nearly as much tax on your retirement income as you get to defer in your highest brackets while you're working.
jimb
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Re: Question about 401k vs Roth IRA
by retiredjg » Fri Mar 21, 2014 10:00 am
You are probably mistaken in your concern that you will pay higher taxes in the distant future. Very few people do, for a couple of reasons.
First, your "income" will probably drop when you retire and not all of your income will necessarily be taxable. Second, as already mentioned, in our tax system you have some income that is not taxed, some is taxed at 10%, some at 15%, some at 25%, etc. So even if you end up in something like the 25% tax bracket in retirement, not all of the money is taxed at that rate.
I'm not sure what "33% up to 18% of contribution" means, but if you are not getting all the match that is available, you are not only throwing away the free money, you are throwing away the income from the free money. That could be a lot.
Roth IRA is a great and wonderful thing and I suggest it highly....after you contribute enough to get all the match from your employer.
A good potential choice for you, while in the 15% bracket, would be to use Roth 401k if you have that available. Once you hit the 25% bracket, I'd switch back to traditional 401k. Or you might be in a position to use traditional enough to pull you into the 15% bracket, then use Roth for the rest.
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