Roth 401k

[Anonymous]

Should I do a Roth 401k through my employer if our HHI is on the higher side? (its about 220k) and we are young - 34.

My gut says yes because then the entire balance is tax free to me, and I think that is a bigger gain than the contributions being tax free, but wondering if any financially savvy people can weigh in?

[Anonymous]

It's very hard to know. Depends on your tax rate now, and your tax rate in 40 years and some other factors.

Strictly speaking, if you were going to contribute $15k, and your tax rate is 33% now and in the future, then it doesn't matter if you contribute pay $5k in tax now, and let the $10k grow, vs. if you put the $10k and the $5k in the 401k, and then withdraw it and pay the $5k plus its earnings to the govt as tax (you can think of the $5k being in its own account to cover taxes).

The stickier questions are: 1) are you paying a higher rate now than you will later-- generally people expect income tax rates to go up, but you may find yourself in a a lower tax bracket in retirement any way?
and
2) can you (under the plan and your finances) pay $15k into the Roth 401k, which is effectively comparable to putting 20k into a regular 401k (because paying the tax on it now isn't counting against your contribution limits for retirement, even though effectively that's what it is).

A Roth IRA is more flexible than a regular IRA (for example it does not have minimum distributions and fewer penalties), but I don't know if the same is true for Roth 401ks.

Personally, I think the best advice is to have some money in both pre-tax and after-tax retirement accounts, because there's no way to know how the law will change. Maybe Congress will pass a surtax on Roth accounts, maybe tax rates will go up. Maybe they won't. Just like you want to be diversified in different asset clases, I would try to be diversified for different tax situations.

[Anonymous]

OP back - thanks for your comments. I will contribute $17,500 either way - not sure if this changes anyone's analysis or opinion.

[Anonymous]

It's practically ALWAYS going to be a better deal to do the ROTH, especially for higher earners who have access to a Roth 401k.

The Roth allows you to put more money away ($17k after taxes is more money than $17k before taxes).

And, even if your tax rate is the highest bracket now and you expect it to be lower in the future, you'll be paying that percentage on a higher number, later. To just pick really easy numbers, 35% of $26k (about what you'd you'd be putting, pre-tax, in a Roth to meet the $17k max) is about $9k in taxes. Let's say you earn a healthy 8% annually on that investment. In 30 years, your $17k will be almost $190k. But taxes have already been paid, you'll be making your withdrawals tax-free.

If the money were in a regular 401k, you'd be paying a lot more than $9k in taxes. Even at a very low tax rate of 20%, you'll be paying almost $40k in taxes on your earnings! Future dollars aren't worth as much, sure, but that's a pretty big difference. And your rate will probably be higher than 20% when you start withdrawals.

[Anonymous]

Well if you start with 26k, then you can either pay 9k in taxes and put 17k in the Roth, or you can put 17k in the 401k, and then put the 9k in a Vanguard etf/index fund. Doing the analysis as if it's 17k for a Roth, or 17k for an traditional 401k is going to favor the Roth but it's not really accurate.

[Anonymous]

Another thing to consider is if you pay all these taxes now, as a high income earner, to get your money squared away in a Roth, that just increases the chances you'll be in a lower tax bracket when you retire (since Roth withdrawals won't count as taxable income).