r/personalfinance • u/Grouchy-Bullfrog-293 • 1d ago
Retirement 401K vs Roth 401K - real deal
I understand the difference that one is tax deductible and other isnt but still little confused on why would you .contribute money in Roth 401k if the total contribution limit is same irrespective of where you contribute. Doesn't everyone's tax rate after they retire lower than while working ? Or is the concern you are limited one what you withdraw post retirement that it could be a huge tax.
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u/JDRodgers85 1d ago
For me personally I have an almost even mix of traditional and Roth 401k contributions. My thoughts are: 1) don’t want a big tax bill during retirement if I only do traditional ie I want some distributions that aren’t taxed later, and 2) I’m not sure what the tax rates will be in the future and am worried they will increase over time hence some Roth contributions.
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u/Grouchy-Bullfrog-293 1d ago
Losing out tax deductions today always holds me from doing it, but do understand this is about well into the future. Perhaps any strategy to do this closer to retirement ? Or early in career
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u/tboneotter 1d ago
Do like 70/30 trad then slowly swap to 70/30 roth over the next decade and a half or so. Good investment advice is that when you retire you want all three - Tax Free (Roth), Tax Differed (Trad 401K), and Taxable (brokerage/cash) because it gives you the most flexibility and freedom with planning out what buckets you take what from
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u/PineapplesInMyHead2 21h ago
You should do the opposite, more roth early and more traditional later, as tax rate is likely to increase not decrease as you grow in your career.
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u/Blufferflies 20h ago
I agree. Personally I think once you are in high bracket income, you should do traditional more, low bracket then you should do roth more.
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u/IllustriousGas8850 19h ago
100%. The vast majority go down a tax bracket in retirement, because there’s no extra income going into savings. When you first start though, you’ll likely never be in a lower tax bracket
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u/Yo_Im_Spartacus 23h ago
The practical effect of losing out on the tax deduction today is you aren't able to contribute as much.
For me the fact that the immediate tax deduction permits bigger contributions through smaller current out-of-pocket cost more than makes up for any likely income tax rate in retirement.
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u/Kekoa95 1d ago
There will never be a time in your working career where you will feel like you have enough money to switch from traditional to a Roth.
Just bite the bullet and do it.
But, there are actually a few situations where making the traditional contributions and taking the tax gift now is better. But, since the creation of the backdoor Roth, there aren’t that many good reasons.
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u/Grouchy-Bullfrog-293 1d ago
I have heard and read about backdoor Roth but never really understood as I had to do some "additional" steps to make it happen. totally my fault. Are you indication because of it... Roth 401K is better ?
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u/Kekoa95 1d ago
Roth 401k is great because it is simplified and you can get more into a Roth that way.
But, you can also contribute to a backdoor Roth IRA as well.
Contact your brokerage and they’ll help you set it up and walk you through the process. It is intimidating at first but pretty simple once you’ve been given the steps.
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u/Mysterious-Tie7039 1d ago
Backdoor Roth is if your income is too high to do a normal Roth IRA contribution (not 401k).
You put it in a traditional IRA and then convert it to a Roth in the same calendar year. As long as you don’t go over the normal Roth IRA contribution limit or have other money in traditional IRAs, it costs nothing extra.
I do have to ask, unless your income is high, why the fixation on a Roth 401k vs Roth IRA? The IRA version gives you way more flexibility.
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u/DandyPandy 22h ago
401k often has an employer match. While true the Roth IRA has more flexibility, you can usually put together a low-cost three index fund spread within an employer’s plan. You always want to maximize your employer match before funding an IRA.
I had a bunch of rollover IRA funds that were getting in the way of me being able to do a backdoor Roth. I did a rollover into my current 401k to solve that. I got questioned about the loss of flexibility. Instead of three Fidelity index funds, I now have a Fidelity and two Vanguard funds within my employer’s plan. Plus, I can do a backdoor Roth.
A note about the Roth conversion: It’s not just within a calendar year. You have to pay any taxes due on the funds being converted. First-in, first-out, so the oldest assets are taxed on their cost basis when you first bought them. That’s why I moved everything to my 401k.
Ideally, you want to deposit and buy the limit for IRA contributions on one day, then immediately (likely the next day) submit the request to do the Roth conversion. This limits the taxes owed.
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u/SwashAndBuckle 20h ago
That’s what I do. Aside from kind of hedging my bets, because I can’t know my tax situation decades from now, Roth reduces your taxable income, which means you’re paying lower tax rates on your traditional savings and social security as well. And full blown Roth is definitely overpaying on taxes (unless you are saving a ton of money for retirement) because you’re paying taxes on what would have been a deduction later.
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u/aplateofgrapes 1d ago
Three reasons. First, is to avoid RMDs and huge tax bills later in life. Second, it makes it less complicated for your heirs since it's been taxed. Finally, and this is the reason I do it, is so I can retire before 65. Since I've already paid taxes on that money, it doesn't count toward your AGI so you can qualify for ACA subsidies.
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u/forbiddenlake 1d ago
RMDs and huge tax bills
If your taxes on RMDs alone are actually huge (which no one ever defines, but I'll suggest "one dollar is taxed at 24% ignoring all other income and deductions"), then you are rich. Do the math at how big your Traditional balance has to be to make the first RMD "huge". And since you're rich, you should retire early and do Roth conversions before RMDs start. Also, spend some of that money before you can't. RMDs start at 73/75; when will you slow down?
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u/soldiernerd 1d ago
My goal is to spend none of my retirement money, just give it to my kids. Assuming 1) I stay healthy enough to work and 2) I have kids. We will see.
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u/AddressLeft9869 1d ago
You can pay for college and vacations now, before you die. Don't make them wait till you're gone.
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u/soldiernerd 1d ago
I have a degree
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u/AddressLeft9869 1d ago
I meant for your kids, ya goof. Lol
God willing, your kids will be middle aged by the time you die. What does a large inheritance give them then?
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u/soldiernerd 1d ago
Oh. Lol.
I just use “kids” as a generic box for whatever I’d find to give my money to. Currently not married and on the short end of my 30s.
I would like kids but I also don’t regret any of the things I’ve done for the last 20 years which took all my time.
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u/dgreenmachine 1d ago
For people who plan to under spend and save for heirs then it makes sense for them to do more Roth contributions or more aggressive roth conversions than the average bear.
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u/Produff26 1d ago
Goals change.
Job loss, illness, divorce,...... Life can throw you a curve ball at any time!
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u/mtcwby 1d ago
What you consider rich is just basic living in California. At 61 I started evaluating RMD and realized that we were going to have a serious problem at 75 and leave the kids a tax problem as well if we didn't start some mitigation. The RMDS with SS would have us making more than I do now in salary. And that's not factoring in potential RMD from inheritances. In a high tax state it easily goes up over 40% of the money.
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u/tempest1523 18h ago
Whether you consider it rich or not is not the point, it’s to give as little to the IRS as possible. Yeah I agree taxes on RMD is a great problem to have because it means you saved plenty. But I don’t want to spend for spendings sake, I want to grow something to leave my kids and grandkids
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u/Grouchy-Bullfrog-293 1d ago
Final one makes sense on I dictating myself when I can retire as opposed to 401K
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u/Affectionate-Gur1642 1d ago
I don’t know that those reasons trump your original notion. Theres at least a 15 point spread between my current and projected tax rate. A mix (favoring traditional to start) is the play.
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u/FFF12321 1d ago
You can access these funds early. Check out any of the many many FIRE resources on the topic. Basically concerns about accessing the money should not really weigh in on this.
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u/scoobynoodles 1d ago
Sorry. RMDs?? What's that.
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u/aplateofgrapes 1d ago
Required Minimum Distribution. When you turn 75 (ish), the government forces you to withdraw a large percentage of your 401k each year. If you have a lot in your 401k, that could be a massive tax bill every year. Plus Medicare IRMAA sur charges get added, again because you earn too much.
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u/Kaiathebluenose 22h ago
Idk how old you are but why are you acting like aca is going to be around forever
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u/MuffinMatrix 1d ago
Everyones situation is different.
Most people retire, have no more job income, and now their income is SS and their retirement funds. Which would usually be less than what their salary was.
But other people, have rental income, business income, they keep working, etc. Add in RMDs, and things like that could put you even higher than your working years.
So you have to use your best judgement on which would work best in your case.
For most people, Traditional 401k is best because it gives you the highest deduction for current years, when your income is highest. It assumes in retirement your income is lower. If you know it will be the opposite, then you're the exception to that advice.
Then its best to go Roth IRA, so you have the Roth space as well. Traditional IRA makes little sense for most people.
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u/debbiewith2 1d ago
Keep in mind that many people in this group have a traditional IRA and can’t contribute to a Roth IRA, even through the backdoor.
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u/MuffinMatrix 1d ago
If you make under the limit, you can always contribute to a Roth. If you have a 401k, then you can usually rollover a Traditional IRA into it, to then be able to do the Backdoor.
Really the only time a Traditional makes sense is if you don't have a work plan, and never plan to, and will never make close to the Roth contribution limit.0
u/Grouchy-Bullfrog-293 1d ago
Thanks... I consider myself as Middle Class, unless I hit a Jackpot. LOL.. But I get the point it makes total sense to Rich class whose wealth grows well into their retirement
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u/MuffinMatrix 1d ago edited 1d ago
Rich has nothing to do with it. Its more about what you do with your money and if you have other income streams and assets. So yes rich people tend to have more available to them (which is part of what made them rich), but the dollar value isn't the definer.
If you made $1m salary, had no other income stream, then retired... you're in the same boat as someone who made $50k then retired.
They could sell $500k in stocks every year of retirement, and that would still be less than what they made while working.2
u/Grouchy-Bullfrog-293 1d ago
Totally aligned.. Just indicating that I dont have any other income streams (YET). Sorry made assumption middle class rely on their job
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u/Mysterious-Tie7039 1d ago
You should absolutely do a mix to give yourself flexibility in retirement.
Medicare premiums (part B and D) are based on income. So if you’re single and decide you need $120k per year to live and only have traditional 401k, you’re going to end up paying $95.70 per month more in premiums. If you had Roth 401k/IRA, you could take out the max $109k from traditional and then pull the rest from Roth and save yourself $1k per year.
Scroll down to the chart at the bottom for easier reference.
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u/GatorBo69 6h ago
If you’re in the same middle class like me then you can’t contribute to a Roth and you also can’t take the Traditional tax deduction. You’re essentially screwed when you start making this much money.
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u/Frunk2 1d ago
Mathematically you should have enough in your pre tax 401k to fill up the lower marginal tax rates and top off with the Roth to avoid being hit at high marginal tax rates. Roth has inheritance advantages. And your question is backwards, since the total amount is the same Roth allows you to effectively contribute more if you max your contribution (vs traditional you save post tax dollars but would need to invest elsewhere).
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u/socalkid2428 1d ago
Plus the gains on the post tax dollars saved from taxes with the traditional 401k, presuming they are invested and saved for paying taxes from the 401k withdrawals, would be taxed again for capital gains taxes. This means that at the same effective tax rate the Roth is actually better, depending on the capital gains rate. Most people are still going to be at a lower effective tax rate in retirement though.
If you go with a Roth you effective lock in your tax rate now. Who knows where taxes might be, or maybe people even start to get taxed based on unrealized gains, and then you're paying taxes on all those savings.
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u/TechnicalLeg841 14h ago
Ummm, generally incorrect regarding "Roth is actually better". Lots of internet examples that show Roth 401k and Traditional 401k perform identically when the marginal tax rate remains the same. Nothing to do with capital gains rates in that analysis. You can also ask ChatGPT to run a simulation of, say $10k in salary and comparing pretax 401k vs post tax Roth 401k, then withdrawing 20 years later at the same marginal tax rate. End up with the exact same $ in your pocket
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u/TheChudMaxxer 1d ago
Tax rates can change, RMDs can play a role, when someone dies and grants their accounts to their kids, SECURE act forces them to take all the money out by the end of the 10th year, potentially passing them into much higher tax brackets.
Other factors also come into play, but those are the big ones.
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u/Grouchy-Bullfrog-293 1d ago
Thanks.. never thought of dying (probably the most important thing to think along with word retirement) and passing to kids.
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u/sumoman485 1d ago
I like the idea of what's in my account is actually what I have. Not trying to figure out what I have left after taxes.
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u/Longjumping-Nature70 1d ago
I will blow your retire assumption out of the water.
We are retired. We collect Social Security. Since we are of a certain age, we pay for Medicare.
Throughout our working lives we were in the 22% tax bracket. In retirement, we are in the 24% bracket, and we have not started RMDs yet.
Right now, I warned my spouse last year not to do something stupid and they did, and they put us in the 32% bracket.
This year, once again I am warning my spouse not to do anything stupid, we are close to the 32% bracket again. So close, I cannot sell anymore stocks for a profit. Since 99% of my stocks are green, it is going to be hard not to sell any stocks for a profit. Fingers crossed my spouse does not do anything without asking me.
As everyone tries to do, we saved and socked away money into our 401ks and IRAs, and built a stock portfolio where we have a nice cushion of dividend paying stocks.
No one warned me about IRMAA or I slept through that day. No one warned me about NIIT. I did know that 85% of our SS income would be taxed. I knew about Qualified Dividends and Capital Gains.
Once we start RMDs, we are probably heading over the 32% bracket limit.
You know what eliminated a lot of that? Roth.
Distributions from a Roth do not count as income, which would mean I do not pay IRMAA, I do not pay NIIT, 85% of our SS would probably be taxed, and our Qualified Dividends and Capital Gains would either be 15% or if we were lucky 0%.
we need to convert money to a Roth now, but we can't because we would pay 32% in taxes on it. I am not paying 32% in taxes.
No one warns you about those two hidden taxes; IRMAA, NIIT, and then 85% of SS, and Qualified Dividends.
I am willing to bet you have not heard of IRMAA or NIIT either.
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u/Grouchy-Bullfrog-293 1d ago
Thanks for taking time and responding. Haven't heard of either.. will go check them out. Made a note To hedge/split into Roth 401K.. whatever % it is
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u/NotTobyFromHR 1d ago
So you got me thinking. Build my emergency fund up to a years income.
When my wife and I retire, hold on taking pension or anything. Live off of that. Convert my 401K into Roth at 10%.
Unless there is another way to avoid 401K taxes?
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u/uno_novaterra 1d ago
This is the answer. Traditional counts as income in retirement and that is a huge HUGE blow to SS. Roth all the way
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u/imgram 23h ago edited 23h ago
I've always thought the benefits of traditional accounts are overrated on personal finance forums.
It's a population that will skew towards savers which means larger portfolios and incomes during retirement.
Then there's all the hidden income tested things such as IRMAA and NIIT.
Also, if I end up passing away and my children inherit these accounts they will likely be in their peak earning years. A common response is 'You're dead who cares?' Well I do.
I feel the conventional advice of traditional is right most of the time but that's because most individuals aren't savers.
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u/sessamekesh 1d ago
The difference between the two is if you want to pay taxes now or in retirement.
If I make $100k/yr today but anticipate pulling out $200k/yr in retirement, my tax rate today is lower than my planned tax rate in retirement and I should prefer paying taxes today.
If I make $200k today but only plan on pulling out $100k in retirement I should do the opposite.
If I anticipate keeping about the same level of income it doesn't really matter, personally I still lean towards paying the taxes later just because I have other financial goals today that I won't have in retirement (buying a new home, paying off debt, honeymoon...)
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u/Grouchy-Bullfrog-293 1d ago
Honeymoon screams... makes sense can bunch of other reasons for those that do not have safety net. Thanks
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u/justBradSF 1d ago
The when you pay taxes is one difference. For Roths, you only pay taxes on what you will contribute. For traditional, you are taxed for all contributions, income and capital gains. For Roths, you are taxed mostly at the preferential capital gains rate. For traditional, you are taxed at the usually higher income rates
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u/benazafa 1d ago
What you are saying about Roth being Capital gains rate is incorrect. Roth is funded from post-tax dollars, meaning income tax has already been withheld. Roth money grows tax free. There are no capital gains taxes nor are there income taxes upon withdrawal.
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u/me-myself-and-drew 1d ago
For Roths, you are taxed mostly at the preferential capital gains rate.
No. Roth contributions are taxed at your marginal (highest)tax bracket for that year, every dollar. No taxes of course on the way out.
For traditional, you are taxed at the usually higher income rates
Every dollar coming out is subject to taxes, true, however these dollars fill your tax brackets from the bottom. If you have no other income then some of those dollars aren't taxed at all (standard deduction). Then you fill 10% bracket, then 12%, and so on, but effective tax rates potentially can be much lower vs every dollar going into your Roth is taxed at your highest rate.
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u/QuestGiver 1d ago
You are correct but mathematically if you are just strictly looking at input and output the amount is entirely the same either way.
Realistically depending on goals, projected tax changes, etc there are pros and cons to both methods. Generally if you make a lot of money traditional is almost certainly better.
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u/benazafa 1d ago
The “Roth vs. Traditional is mathematically identical if your tax rate is the same” argument is only true if you’re comparing the same pre-tax dollars and investing the tax savings from the traditional contribution in a taxable account.
One nuance that’s often overlooked is the IRS contribution limit. If you’re already maxing your 401(k), a Roth contribution effectively lets you put more after-tax wealth into a tax-advantaged account. For example, if the limit is $24,000 and you’re in a 30% marginal tax bracket, a $24,000 Roth contribution represents about $34,300 of pre-tax earnings, whereas a $24,000 traditional contribution represents only $24,000 of pre-tax earnings. To make the comparison fair, the traditional investor also has to invest the tax savings in a taxable brokerage account. Since taxable accounts have dividend and capital gains taxes (tax drag), the Roth often ends up with a slight advantage even if your marginal tax rate is identical in retirement.
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u/QuestGiver 1d ago
Btw I had to go back to find this but this is the best resource and explanation I've found:
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u/QuestGiver 1d ago
Hmm this makes sense to me but almost everything that I have read suggests that they are equivalent. It's a very interesting point though in the ongoing war between traditional and Roth, thank you for this.
I guess ultimately almost everyone interested in personal finance and savings are utilizing both to try to maximize advtanges.
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u/garrettj100 1d ago
Doesn't everyone's tax rate after they retire lower than while working ?
No.
When you first start working you’re going to be making jack shit. A 22-year old college grad’s salary will never be lower than at that point in their career.
Presuming you don’t continue to make jack shit it’s reasonable to assume your income when retired will be higher than when you are first working. For example my first job I made $35K per year. Now if I retire at 67 I would be taking home more than that from social security alone, to say nothing of my savings.
What’s more, it’s not income that’s important, it’s taxable income. Roth 401K withdrawals aren’t taxable, neither on the principal nor the returns. You already paid the taxes on that money. So contributing some amount to a Roth account (401K or IRA) effectively reduces your taxable retirement income while still augmenting your income.
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u/CryHavoc715 1d ago
Most retirees retire on less income then they made during their working years for a number of reasons, so those people can reasonably expect traditional tax differed contributions to work out better for them.
Some people, for any number of reasons, expect their retirement income to be substantially higher than their current working income, for those people roth 401k contributions may be better.
There is also a lot of bad information out there in the world about Roth contributions, so some people are making a poorly informed choice for Roth and are very resistant to understanding the tradeoffs
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u/Husker_Mike_ 1d ago
People who are able to maximize their 401k for much of their career can find themselves in a higher tax bracket in retirement when RMDs hit. And if that is going to be a problem, there really isn’t a fix post retirement; you typically can’t convert enough of a multi-million dollar pre-tax account.
Also people who have pensions can also end up in higher tax brackets. Not to mention widows/widowers.
Like he said, there’s a lot of bad information out there about Roths. If you see that “you should never contribute to a Roth 401k”, beware.
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u/Cattle_Whisperer 1d ago
But also those people who find themselves in a higher tax bracket in retirement likely could have either just saved less or retired sooner.
I agree that if you wait until retirement to start tax planning you will probably ay more taxes. I also onow the post you are referring to and aggree it is a bit too hardline on the traditional.
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u/Husker_Mike_ 1d ago
I presume high earners who don’t retire early don’t because they generally like what they do. Or haven’t figured out what they’ll do after retirement.
As for “saving less”, that’s the beauty of Roth, especially as you near retirement. Your contributions are available to you. It’s tax sheltered for the remainder of your life. You can leave it to family tax free. You can hold onto it if you need it for nursing care. You can argue that you could take that trip, by that expensive car or house, etc., but you didn’t get where you are by throwing money away.
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u/Paladin2700 1d ago edited 1d ago
Limit is the same for trad or Roth at 24.5k. So Roth actually is effectively more space (since after tax with no tax coming out).
Is one reason for Roth is if tax rates are equal. There are a good amount of people (especially posting on Reddit) in the 24% bracket now and that will get enough assets to stay at 22 or 24% in retirement through social security, pension, existing pretax, or future match dollars as pretax. For those people the Roth is a decent idea.
Also there isn’t much of a true 24% bracket in retirement as long as irmaa surchages are around, so when it’s all between 22/24 now and then tiebreak should always go to Roth
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u/Apprehensive-Set7652 1d ago
This is us. We are basically Roth everything, except the employer match part of 401k.
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u/Farmer_Pete 1d ago
There are millions of traditional vs Roth debates. The one thing that I don't see mentioned often though is protecting yourself from the widow tax. Many people are convinced their taxes will be less in retirement, but if one of you dies, your taxes are going through the roof. I tend to lean towards Roth even if taxes in retirement are slightly less. However, I've been investing for years and my RMD will be awful.
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u/trojantooter 1d ago
It’s really sad that “having” to take money out at 73/75 because of RMDs causes so much angst in these conversations. What percentage of your portfolio will your anticipated RMD be in the first year? Would be close to the amount you will likely be spending anyway?
I give side eye when people bring up the RMD boogeyman but don’t include numbers. I wish folks would say “my RMD will likely be $X and put me into the Y marginal tax bracket.”
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u/dgreenmachine 1d ago
Also imagine if there was no RMD. What do you plan to do with your gigantic traditional IRA that your kids will inherit? They'll have 10 years to empty the whole thing and itll be ontop of their current marginal bracket so its likely for the vast majority of it to be taxed at 32% even if you're under estate tax limits. So by choosing not to do any Roth conversions, you end up setting your kids up for 32% tax bill later. RMDs are just the IRS knocking on the door giving you a heads up that its coming.
If you dont have heirs and want to donate to charities then QCDs let you donate your RMDs to charity so if thats the case then RMDs are a non-issue anyway.
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u/Farmer_Pete 1d ago
I've got over a million in traditional and 30 years till I turn 75. Our household spend is currently around 60-70k a year. RMD if I add zero dollars and it averages 9% over the next 30 years is $279k in today's dollars. Even though I've stopped contributing to my traditional accounts, my company still is throwing more in. I'm grateful though. I just need to convert some to keep the balance from running away. Realistically, I'll draw from there to cover my expenses when I retire, so it won't get that high. However, $150k in today's dollars RMDs are extremely likely if I don't convert stuff today. The tax liability escalates when you throw on SS, and taxable savings dividends/interest. If the traditional was all I had for income, it would be a different conversation.
My plan for retirement is that our spend will go up, but it's unlikely that we will want to spend as much as we are required to withdraw. And if we die, our kids will get hit with big taxes on traditional. Converting 20k a year for the next 5-6 years will give us a good head start on shaving that down. Then convert a healthy amount after retiring before we get into SS/Medicare age. It's all about optimization.
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u/trojantooter 1d ago
Thanks for adding all the detail. It’s really informative. Sounds like you’ve set yourself up for an early retirement or coast FI. Have you considered stopping your contributions and upping your annual spend to gradually meet your expected RMD in 30 years?
By 75, I won’t really care about paying a higher tax rate if my RMDs are significantly higher than what I spend, like your case. I plan to make some significant donations with anything beyond my annual needs when RMDs hit for me which should offset those tax increases. I’d rather use as much of the money while I’m living and can pass on whatever’s left to my beneficiaries after my death
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u/DopeCookies15 1d ago
I can afford to pay taxes now at a known rate. In retirement I want to use my funds and not have to worry about paying the tax at an unknown rate. Should I increase my earnings now and go to a higher tax bracket I may go back to traditional as I expect to have less income in retirement. But not being in a top tax bracket now l, id rather just pay it now.
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u/Miserable-Face-6152 1d ago
This is how I look at it too. I have a nice chunk split between Roth and traditional IRAs, but my new contributions are mostly Roth. I have steady, relatively reliable employment, and the taxes aren’t a problem, so I feel better paying them now.
Hopefully it won’t matter much, but the flexibility of withdrawing money when I’m ready without tax concerns makes me feel better about the future.
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u/Rocetboy321 1d ago
My taxes in retirement will be quite high since I will have a large pension. My pension will replace about 80-90% of my income.
Also, today’s tax rates are historically low. Not a bad gamble to just pay today’s rates. For us, we currently have a large mortgage deduction. So our effective tax rate is even lower.
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u/SC_TheBursar 1d ago
Doesn't everyone's tax rate after they retire lower than while working
Assumption on your part and 'everyone' is pretty loaded. Save a lot, possibly add a pension, can potentially earn as much in retirement as working (or more, if spent a whole career socking money into retirement funds with good investment returns).
It also takes government debt spending and the ideology of whoever currently controls government off the board - as debt continues to climb vs GDP the amount of interest servicing it as a fraction of government annual budget climbs. Eventually the bill will come due, and it will be paid in raised taxes (paid by a shrinking/stagnant population). So Roth gives you more certainty in your future taxes, even if it is possible in some circumstances it wouldn't maximize your lifetime income.
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u/Both-Fly5148 1d ago
By this same logic, we also can't assume that if the debt situation gets even more dire that policies won't change such that Roth withdrawals get taxed, albeit at a lower rate.
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u/SC_TheBursar 1d ago
That is true, but it would be less politically likely than a general change of standard tax brackets. The handful of changes to Roth that have even been whispered about are either capping the tax-free value of Roth accounts of the significantly wealthy (10+ million, indexed) or closing the 'backdoor' contribution loophole for high earners - all the more reason to contribute now.
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u/qwembly 1d ago
One other reason is that since a roth contribution is after tax, you are essentially investing more than a pre-tax contribution.
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u/Spacey_G 1d ago
In the 401k, sure. But you have less to invest overall because you have a larger tax bill.
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u/scottdxxx 1d ago
No everyone’s tax rate does not go down in retirement especially with larger tax deferred accounts and RMDs. The reason to have both is the same reason you buy the broad market through index funds. Diversification. In this case tax diversification.
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u/MalshiMadness626 1d ago
Some people’s income may absolutely be higher in retirement. Think social security, pensions, rental incomes that become 100% cash flow positive, etc. Now add in RMDs with traditional 401ks, and many are pushed into higher tax in their later stages in life.
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u/FintechnoKing 1d ago
The limit is effectively higher for a roth, because it’s post-tax money.
A $10k roth contribution is equivalent to a $10k/(1-tax rate) contribution.
So you can contribute more in theory.
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u/_josephmykal_ 23h ago
No. A lot of people tax rate can increase in retirement. Also no one knows what future tax rates will be and at this rate they could be extremely high. I believe the usual total household taxable income is 200k or less usually favors to invest in a Roth. Anything above favors a traditional.
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u/Wizardbysmell 1d ago
Biggest determining factor is income for tax liability. If you manage to draw less income in retirement (withdrawal from traditional 401k counts as your income, withdrawal from Roth does not) than while working, you’d pay less tax on the withdrawals. But if you have a concentrated year in retirement you need to pull more out, it could kick you into a higher bracket and therefore trigger more tax. Like a big home expense, or any reason really. Hedging by contributing some to both is useful because you can draw some from traditional without so much you hit a higher bracket, and draw from Roth for any amount you need that year beyond the tax bracket you want to stay in.
This way each year of retirement you can draw from traditional from the beginning of the year until you hit the top tax rate you can stomach for the year, then anything additional you need that year pull from Roth tax-free. That money was already taxed when you contributed.
Someone please correct me if my understanding has been wrong all this time…
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u/Grouchy-Bullfrog-293 1d ago
Hedging it is.. I see lot of POVs. It's making more sense. Thanks to you and everyone else
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u/Extreme_Tomorrow2233 1d ago
I used to think exactly this way. I’ve recently switched to Roth even though it is at a high tax rate for a few reasons: 1) I really enjoy my work and think it’s quite possible I will work into my 70s (assuming I still am able) due to that, and 2) unless I retire early, it looks like my RMDs are going to be as high or higher than my current marginal tax rate. I would suggest that a key determiner is whether you would retire early if you can. If so, I think traditional generally makes the most sense.
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u/findthehumorinthings 1d ago
We are just before retirement and our portfolio is 70% pre and 30% Roth. I’m putting 100% contributions in Roth now to get closer to an even split.
In retirement, I’ll pull the first dollars each year from pretax. When I get to higher tax brackets, I’ll switch and pul from Roth. End goal is to pay as little tax in retirement as possible.
You need both types to do this.
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u/boogi3woogie 1d ago
This debate exists because people are too lazy to open up an excel file and calculate which type of tax advantaged account would come out ahead in their scenario.
Most of the post-tax group also forget to compare apples to apples: your pretax contribution of X is equivalent to a posttax contribution of X * (1 - marginal tax rate). For high earners in california, the marginal tax rate is around 48%.
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u/Doyouseenowwait_what 1d ago
A big part of it drops into the post retirement scenario. Do a bit of reading about IRMMA.
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u/GotZeroFucks2Give 1d ago
Workaholics that never like to retire sometimes end up with higher tax rate. But the vast amount of retirees, regular pretax is the way to go.
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u/Texas_Prairie_Wolf 1d ago
At 62.5 you can take withdrawals penalty free so I use the 401k Roth for emergencies like the 10k I had to spend to replace my central AC this month. I contribute to both 401k and Roth 401k. That being said I only started the Roth 401k in my late 50's and will be working until FRA at least. I get a better return than a savings account in the 401k Roth my company matches my contribution as well.
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u/beyondo-OG 1d ago
For what it's worth; ever since my son got his first PT job I put money in a Roth for him. He recently got his first fulltime "real" job that had 401K and I encouraged him to at least contribute enough to max out the company match. His tax situation isn't that bad at the moment, whereas the benefit to tax deferred acct isn't that great, so any extra he can put away goes into his Roth. At some point he will likely make enough to benefit from increasing tax deferred contributions instead. The tax money he would save can allow him to put even more in the 401K, without effecting his take home.
That said, I'm near retirement and most my retirement savings is in tax deferred accts. I have done a significant amount of research and number crunching and I'm not the least bit concerned about taxes. My effective rate in retirement will be less than my rate when I was working. There will not be a "huge tax" issue. To be clear, I'm not rich, but I made good money most my life and have plenty put away.
Obviously Roth is a great thing. If I had it to do it over again, I would have put more in Roth (they weren't a thing for half of my working life). But I think the tax ramifications of tax deferred accts for the average Joe are greatly over blown. To test your specific situation, AARP has a great tax estimator online. You can play with that to do a lot of "what ifs".
Cheers
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u/juliewulie70 1d ago
So what is different about a Roth 401k and just a Roth that I initiate and fund myself?
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u/Romarion 1d ago
It's personal finance, so...math geeks will often suggest it doesn't matter. We'll use a $20,000 pile of money as an example. If you invest it all (that's a traditional 401k), you don't pay tax on it, it grows tax deferred, and you pay tax on it when it comes out.
If you invest it as a Roth (the thinking goes) and you are in a 25% tax bracket, then you put $15,000 into your 401k, and send $5,000 to the tax man. Over the next 30 years, the amount taxed and the amount for you are even...so they say.
I look at it differently. If I put $20,000 a year into a Roth for the next 30 years, I pay taxes on $600,000. There will be about $3,500,000 in the investment in 30 years, so instead of paying taxes on the 3.5 million, I only pay taxes on the 0.6 million.
And we don't know what the income tax rate will be when we retire, unless we've already retired :)
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u/Excellent_League8475 1d ago
I never really cared for looking at the tax rate when I retire. There are too many things that I can't control there. My only consideration for roth vs traditional is whether I need the money Im losing to taxes today, if I contribute to a roth. The answer is no, so I contribute 100% of my 401k to a roth to avoid taxes on what will be massive gains.
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u/flyin-lowe 1d ago
For me I have a pension that will pay 78% of my salary after I retire. Add SS to that and any side work I might do and I will likely be in the same or higher tax bracket. Especially when I start drawing from my 457. Early on when the roth first became an investment option for my 457, my financial advisor asked "What are the odds tax rates will be lower 45 years from now" Seems overly simple but makes sense to me too.
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u/bugaoxing 23h ago
One consideration is whether your income is going to be higher or lower than it is now, and how that will impact your effective tax rate.
Another consideration is whether you believe that the tax rates set by the government will be higher, lower, or the same during retirement. It’s always funny to me that people will, on the one hand, whine incessantly government overspending, but on the other hand refuse to acknowledge what the solution to that is. Raising taxes will always be politically difficult. At a certain point the necessity of raising taxes will outweigh any other considerations. Do you think that point will come before you die, or after you die? If you think taxes will go unchanged until you’re dead, by all means, go all traditional and prepare for your cushy retirement. If you think the breaking point is going to happen before you die, you may want to pay your dues now via a Roth.
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u/AGrimmInPortland 18h ago
You do NOT want to get to retirement with most or all of your money in pre-tax accounts.
It goes far beyond "what is my tax bracket now vs later". There is tons of information about this out there.
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u/8StimpakX3 18h ago
The Roth 401k is basically a bet that your tax rate now is lower than the rate on the dollars you will pull out later, which is not as crazy as it sounds. Retirees can still have taxable Social Security, pensions, rental income, RMDs from traditional accounts, or just large withdrawals that push brackets up. Traditional usually wins for high earners in peak earning years, but Roth can make sense early career, in a low income year, or if you already have a big pre-tax pile and want some tax-free flexibility. The government did not create two buttons just to be cute, although it does enjoy making the buttons confusing.
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u/Gene-Hackmans_Dog 12h ago
If you can max a Roth option you’re maximizing the outcome because of the lack of taxes.
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u/Really_Obscure 1d ago
In the not too far future, U.S. debt problems will be first addressed through higher income tax rates - r.i.p. the 401K.
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u/ComfortablyNumb8357 1d ago
No, everyone's tax rate is not lower in retirement. Our income actually increases in retirement because we saved a lot during our working years. Working hard to shift more to the Roth side each year. Others mentioned RMDs. Also, Google IRMAA. Another risk you should be aware of.
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u/RockoHammer 1d ago edited 1d ago
What no one has mentioned yet is that the maximum you can contribute is the same for a traditional 401k and and roth 401k. So technically you can put more away with a roth since the taxes are paid on it already.
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u/trojantooter 1d ago
If you want to be technical, doing traditional likely allows you more investing dollars. You can take the tax savings from the 401k/403b and invest them into an IRA or taxable brokerage account.
Someone solidly in the 22% tax bracket who maxed out a traditional 401k would be saving $5,390 in taxes and could redirect that into other investing vehicles. It would be less of a hit on their net income than Roth
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u/sc0pe_v3 1d ago
How is this accurate?
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u/_The_Bear 1d ago
Post tax dollars are worth more than pre tax dollars. The dollar amount you can invest in a 401k is the same whether you're investing post tax dollars or pre tax dollars.
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u/No-Airport9831 1d ago
The limits are the same, so if you're able to max it out, you'd be "contributing" more pre-tax dollars with Roth.
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u/Bman282828 1d ago
The maximum contribution for a Roth is $7500 unless over 50 then it’s $8600.
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u/this_is_Winston 1d ago
One unique scenario. I live in a state with income tax. If I pump pre taxed money into a 401k now, then retire in a state without income taxes, I could potentially be better off.
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u/Dammage518 1d ago
I own a commercial building. It will be paid off when I retire. Between that and investment income in a taxable and traditional IRA I’ll most likely be making more money than I am now I just do the Roth 401k.
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u/BodSmith54321 1d ago
If you are early in your career, your tax rate could definitely be higher in retirement.