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Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75825  
Subject: Roth 401k vs. Traditional 401k Date: 9/27/2012 8:32 PM
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I just started a new job this week, and have a choice between a traditional 401k or a Roth 401k. I only need to have a small amount withheld for the rest of this calendar year to max out, so I will have that amount put into a traditional 401k just because it is the easiest thing to do, and feels like that completes this year's contribution.

My question is how I decide between the Roth 401k and the traditional 401k going forward. I can even have some combination between the two, but it does feel like I should be able to choose one or the other.

I've looked around in the Fidelity site, and it seems like I might be better off staying the course, but I'd love more input from the folks here. I'm not sure what info I need to provide, but generally speaking, I expect to be in a lower tax bracket when we retire because we do not need as much income as we have now, and so will only need to take that amount out of our investments, which currently are both in tax-deferred and taxable accounts. We don't plan to purposely leave an inheritance for the kids, so I don't care about any leftover amount. And we do not qualify for a Roth IRA at our income level today.

Any advice or guidance? I think this is the best board for this question, but please redirect me if that is not the case.
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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70979 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/27/2012 11:03 PM
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Check this link;

http://www.bogleheads.org/wiki/Traditional_versus_Roth

But this comment;

...I expect to be in a lower tax bracket when we retire because ...

Pretty much makes the a deductable traditional 401k and easy choice.

If you tax rates do work out like you expect then you can do Roth conversion once you are retired and in a lower tax bracket.

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Author: gdett2 Big red star, 1000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70980 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 4:12 AM
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2gifts,

When choosing between trad vs Roth there are more things to look at besides current vs future anticipated income levels.

All funds in traditional IRAs and the "traditional" 401K/403B/SEP IRA/etc will be subject to Required Minimum Distributions, RMDs, in the year you reach 70 1/2. The first RMD is equal to the balance of all traditional accounts divided by 25.6. This is added to your taxable income. This will apply to a spouses account in the year they reach 70 1/2.

Failure to take RMDs out is penalized at 50% of the non-distributed portion of the RMD. If your RMD is supposed to be $20,000 but you only take $15,000 out, you will pay $2,500 in excise penalty.

Roth accounts, IRA and 401K, are exempt from RMDs.

If you have large amounts in these accounts, it can make a significant boost to your taxable income. In our case, it will nearly double our income and we do not need the IRA money for expenses.

RMD distributions are not eligible for Roth conversion. They need to be spent or saved in a taxable account.

Another factor about the future is the unknown. Will the tax rates be like they are today? Will they be higher?

If you do not have a traditional IRA in your name, you can make non-deductible contributions to it up to the standard limits for your age. Once the funds are booked into the IRA, do a Roth conversion of all the funds in the account. You are allowed to convert any amount to a Roth but are liable for any taxes due. Non-deductible contributions to a traditional IRA are not taxed on withdrawal. If the conversion is done the same or next day, you may have to pay tax on a couple cents earned in the money market account. Not a big deal. You will need to add an IRS Form 8606 to your taxes to track the non-deductible contribution and the conversion.

Do some planning on the accounts to see what the balances of your trad accounts might be. Calculate your first year RMD. On $1MM, the first RMD is $37,736 for most people.

The factors are in IRS Pub 590 at the IRS website.

Gene

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Author: TwoCybers Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70981 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 8:51 AM
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Tax rate differences (rate when IRA funds are earns and when IRA funds are withdrawn) are the key. We may have ideas, but no one really knows what the marginal tax rates will be 30 years out. That said, the Roth has as a primary basis no tax on its IRA funds. Congress can change that next week should they return to Washington. Such a change while very unlikely, possible.

Despite some of the political rhetoric, the actual portion of GDP the federal government takes in is low compared to history. (Keep in mind a 90% marginal rate applied to the last dollar earned with a zillion deductions can result in actual tax dollars being almost any percentage of total income.)

My personal feeling is over all federal tax spending will increase over the next 30 years. Just one example - in the 50's and 60's the Feds spent on the Interstate system. Little has been spent on maintenance and it is getting old. Last year a bridge in Minneapolis fell. More of that will happen and Congress will decide to do something. I do not know if marginal rates will increase, deductions will decrease or new taxes will be added. But I do believe the portion of the GDP going to the government will increase. Therefore I am of the opinion putting some of your IRA funds into a Roth is a type of diversification worth consideration.

Gordon
Atlanta

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70982 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 10:15 AM
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Roth accounts, IRA and 401K, are exempt from RMDs.

Sorry, that'a not correct. Roth 401(k) accounts ARE subject to RMDs. From the IRS http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-re...

What types of retirement plans require minimum distributions?

The RMD rules apply to all employer sponsored retirement plans, including profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.

The RMD rules also apply to Roth 401(k) accounts. However, the RMD ules do not apply to Roth IRAs while the owner is alive.


Roth 401(k) accounts can be rolled over to a Roth IRA and shielded from RMDs. But as long as the account is a 401(k) account, whether it's a Roth 401(k) or a traditional 401(k), it is subject to RMDs.

AJ

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Author: StockGoddess Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70983 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 10:45 AM
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I'm with TwoCybers

Tax rates, despite what the Republicans are telling you, are at a 50-year LOW. With our yen for spending and our deficit there ain't no where for these rates to go but up.

I sleep better at night knowing that's not yet another unknown I must factor for when planning my retirement.

Roth. All the way.

SG

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Author: PSUEngineer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70984 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 11:07 AM
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Tax rates, despite what the Republicans are telling you, are at a 50-year LOW. With our yen for spending and our deficit there ain't no where for these rates to go but up.

2gifts is not eligible for a Roth IRA. That fact is a good indication of what tax bracket she is in. As current tax rates stand and with proper financial planning, it is very likely her tax rate in retirement will be lower, possibly quite a bit lower. Although tax rate may go up in the future, they would need to go up quite a bit before exceeding her current tax rate. Also she is closer to retirement than starting out in the employment world.

PSU

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70985 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 11:48 AM
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StockGoddess: "Tax rates, despite what the Republicans are telling you, are at a 50-year LOW. With our yen for spending and our deficit there ain't no where for these rates to go but up.

I sleep better at night knowing that's not yet another unknown I must factor for when planning my retirement.

Roth. All the way."


Do you lose any sleep thinking about FairTax or other national sales/consumption tax programs? It would clearly require taxes on money withdrawn from a Roth xyz and then spent on consumption.

Regards, JAFO

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Author: PSUEngineer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70986 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 11:59 AM
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Do you lose any sleep thinking about FairTax or other national sales/consumption tax programs? It would clearly require taxes on money withdrawn from a Roth xyz and then spent on consumption.

I don't lose sleep over the FairTax because I have a better chance of winning the lottery than it being implement. As for other sales/consumption tax programs, I do that has a better possibility.

PSU

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70987 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 12:37 PM
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Tax rates, despite what the Republicans are telling you, are at a 50-year LOW. With our yen for spending and our deficit there ain't no where for these rates to go but up.

I generally agree with this part.

I sleep better at night knowing that's not yet another unknown I must factor for when planning my retirement.

The problem here is that what matters for the Roth vs. traditional decision is your personal tax rate, not overall tax rates in general.

Some people have high incomes but got a very late start on retirement savings. For them, a traditional might make sense. They're in a high bracket now, but even if tax rates move up, they could easily be in a lower tax bracket in retirement.

Generally, I suggest a balanced approach. Get some retirement savings in traditional accounts, some in Roth accounts, and some in ordinary accounts (with no special retirement tax breaks). That let's you pick and choose what works best for you each year. If you only have one type of account when you get to retirement, you might get lucky and have picked the right one, but you might not. With a balanced approach, you might not make what is, in hindsight, the best choice, but you are also unlikely to have made the worst choice either.

Roth. All the way.

With some thought on the ideas above, I think you'll see that is just too simplistic for general advice. It's right for some, and very wrong for others.

--Peter

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Author: StockGoddess Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70988 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 1:53 PM
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2gifts is not eligible for a Roth IRA. That fact is a good indication of what tax bracket she is in


I am probably in that same "tax bracket" but there's a way around that. You put it into a standard IRA, then roll it into the ROTH. My Edward Jones person does it for me every year. I get no tax break for the standard IRA doing this, but I do get to ROTH invest. Here's a news article about it.

http://online.wsj.com/article/SB1000142405274870399490457564...

Also, if we were to have an awful stock year again and prices went way down, you could use that as an opportunity to move regular IRA into Roth IRA, pay taxes, and ride everything back up.

Ideas...

SG

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Author: reallyalldone Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70990 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 2:13 PM
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I am probably in that same "tax bracket" but there's a way around that. You put it into a standard IRA, then roll it into the ROTH. My Edward Jones person does it for me every year. I get no tax break for the standard IRA doing this, but I do get to ROTH invest.

While I wish this on no one, it turns out converting to Roths would have been a terrible idea for us/me because my husband's death changed all the calculations of tax brackets both before and after retirement. It didn't seem like a good idea to pay taxes at close the highest rate in the first place but now it would have been really dumb.

Yes, his death at 59 was premature but when you look at retirement, someone in a couple is going to be the first to go.

There are also different benefits tax & estate wise for regular old taxable investment accounts and it is worth examining them.

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Author: PSUEngineer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70991 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/28/2012 2:42 PM
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I am probably in that same "tax bracket" but there's a way around that. You put it into a standard IRA, then roll it into the ROTH. My Edward Jones person does it for me every year. I get no tax break for the standard IRA doing this, but I do get to ROTH invest. Here's a news article about it.

http://online.wsj.com/article/SB1000142405274870399490457564......

Also, if we were to have an awful stock year again and prices went way down, you could use that as an opportunity to move regular IRA into Roth IRA, pay taxes, and ride everything back up.


I'm well aware of the work around for putting money into the Roth IRA since I am also not eligible to make direct Roth IRA contributions. This method only works if you do not have any non-deductible traditional IRAs. Otherwise there are tax issues since you can't pick and choose to just rollover your non-deductible IRA contributions.

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Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70992 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/29/2012 8:21 AM
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Generally, I suggest a balanced approach. Get some retirement savings in traditional accounts, some in Roth accounts, and some in ordinary accounts (with no special retirement tax breaks). That let's you pick and choose what works best for you each year. If you only have one type of account when you get to retirement, you might get lucky and have picked the right one, but you might not. With a balanced approach, you might not make what is, in hindsight, the best choice, but you are also unlikely to have made the worst choice either.


I just did a quick look, and we have about 55% of our retirement savings currently in taxable accounts, 2% in Roth IRAs (we contributed any time I wasn't working and we were eligible, which wasn't much) and 43% in traditional IRAs and 401ks, so I think we do have a reasonably balanced approach.

We are within 5 years of retirement. I actually haven't checked yet, but if I get any sort of retirement benefits from the new company, it might make sense for me to work at least 5 years, and I would do that, but we are fairly close to that milestone.

Our retirement assets noted above are about 68% of the goal, so we are making good progress on getting to retirement.

I do have a written retirement budget based a lot on our current levels of spending as well as some projections of what we will be doing during retirement, and we will need about 70% of my current income, so that's a lot less than our current household income which also includes DH's income, hence I am fairly certain we will be in a lower tax bracket in retirement than we are now.

Based on what everyone has said, it does appear to me that the best way to go is to stick with the traditional 401k, and continue to also add savings to our taxable investments.

Thanks to all for the great discussion on this.

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Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70993 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/29/2012 8:24 AM
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I am probably in that same "tax bracket" but there's a way around that. You put it into a standard IRA, then roll it into the ROTH. My Edward Jones person does it for me every year. I get no tax break for the standard IRA doing this, but I do get to ROTH invest. Here's a news article about it.

But the big caveat is that this changes a lot when you have other traditional IRA money. We never did the conversion as it did not make sense for us given our particulars and how much money we have in other IRA vehicles.

Thanks for the suggestion, but we are in that exception area since we do have traditional IRAs already.

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Author: JLC Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70994 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 9/29/2012 2:25 PM
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Here is my take. I put a little in each. Won't get the best tax break now or in the future but you won't get the worst either. Plus, gives you a little more flexibility from where to withdraw.

JLC

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Author: MurrayS Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70997 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 10/1/2012 11:05 PM
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Here's something I learned when looking into converting traditional IRAs to Roths several years ago:

When you divert money or convert from a traditional 401k or IRA, the income is tacked on top of your existing income and taxed at your highest marginal rate. In my case, that's above 30%.

When I retire, of course my traditional 401k & IRA withdrawals will be tacked on top of my income, but guess what? I won't have any income besides 401k or IRA withdrawals!

This means that we will pay ZERO tax on the first $19,500 of withdrawals each year due to the current standard exemptions and deductions.

The next $17,400 will be taxed at 10%. The next $53,300 will be taxed at 15%.

Putting it another way, my wife and I could withdraw $90,200 (we should be able to live on that ;) and pay under $10k in taxes for an effective tax rate of under 11%.

You might notice I didn't take into account SS. Let's say we make $30k in SS income and we withdraw another $60k to get to $90k. For the sake of argument, let's assume all the taxes are paid after the SS income. In other words, we pay $10k of taxes on $60k of IRA withdrawals. That would STILL be under a 17% effective tax rate which is way under 30%.

Bottom line, it made little to no sense for us to convert a traditional IRA to a Roth. Of course, if you're in a lower marginal tax bracket (15% or below) or you will have a substantial income in retirement, a Roth will make more sense. It's also a great idea to have a Roth to have more tax flexibility and avoid RMDs.

But, people seem to forget our tiered tax system and the difference between marginal and effective tax rates when considering traditional and Roth IRAs.

-murray

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Author: gdett2 Big red star, 1000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70998 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 10/2/2012 1:27 AM
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MurrayS,

When you divert money or convert from a traditional 401k or IRA, the income is tacked on top of your existing income and taxed at your highest marginal rate. In my case, that's above 30%

[SNIP]
Bottom line, it made little to no sense for us to convert a traditional IRA to a Roth. Of course, if you're in a lower marginal tax bracket (15% or below) or you will have a substantial income in retirement, a Roth will make more sense. It's also a great idea to have a Roth to have more tax flexibility and avoid RMDs.

Two very good points. That is why it is vitally important to look at the situation on an individual basis.

In my case, I started doing the conversions after I retired. I plan the amount based upon how much room I have to the next hop. If I go over or under a little, I can live with it. The biggest thing for our situation was nearly doubling our income when I turn 70. This gives me 15 years to nibble off some of the trad IRA funds at a low impact.

Gene

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Author: MurrayS Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70999 of 75825
Subject: Re: Roth 401k vs. Traditional 401k Date: 10/2/2012 11:28 PM
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Also, if we were to have an awful stock year again and prices went way down, you could use that as an opportunity to move regular IRA into Roth IRA, pay taxes, and ride everything back up.

Ideas...


I don't think it's a bad idea, but I also think that people get too caught up in the <u>amount</u> of tax they pay vs. the <u>percentage</u> of tax they pay. If your tax rate in retirement is the same as when you make the conversion, the money in your pocket is the same.

For example, if you have $100 in a traditional IRA and convert it while you're in the 25% tax bracket, you will pay $25 in taxes leaving you with $75. Assuming your investment triples, you will have $225

OTOH, if you leave it in the traditional IRA and the investment triples, you will have $300. Pay your 25% tax at withdrawal and you're left with the same $225.

Now, if you don't have much income in retirement, it's highly likely that you will pay a lower average rate on the withdrawal. If, as I pointed out in my previous post, you could withdraw the money in the 15% bracket, you would only pay $45, clearly more than the $25 you paid to convert to a Roth, but you're left with $255 instead of $225.

Certainly, it's better to do the conversion at a lower stock price than a higher one since it's less likely to push you into a higher bracket, but, in the end, my advice is still the same: If you will pay more than 25% in taxes and you don't expect to have much income in retirement, leave it in the traditional IRA.

-murray

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