I know this topic has been discussed a lot, but I'm unsure why nobody discusses state and city tax implications. I'm very new to this so please correct me if I'm wrong. From the way I see, choosing between a 401k and Roth 401k is determining whether you're paying a higher tax bracket now versus when you retire.
Suppose you live in NYC now and make $250k. You will fall in the 35% federal tax bracket, 7% NYC state tax bracket, and 4% NYC tax bracket. Altogether, your top income will be taxed 46%.
When you retire, what if you move somewhere that has low/no state and city taxes like Florida or Texas? Even if you make $5mm per year, you'd only be liable for the 37% federal tax bracket. I know there's the fear that tax brackets may increase, but do you really think they'd increase more than 9%.
I feel like most of us will retire in a place where we don't pay absurdly high state and city taxes. Doesn't it seem like an almost no-brainer (at least for NYC residents) to use a traditional 401k versus a Roth 401k, or am I missing something big?
There is an income limit to roth
Thats for a Roth IRA. I'm talking about a Roth 401k.
Even if the OP was talking about a Roth IRA instead of 401(k), you can do a backdoor contribution with higher income.
It boggles my mind how many high-income people do not know about this. I just had this conversation with our COO last week...he had no idea either.
Eliminates uncertainty
Bingo
401k allows you to lower your AGI which can be beneficial in some circumstances. My 2022 w2 income will be around ~170k I think, but due to maxing my 401k/HSA/Harvesting losses I will nudge my MAGI down to around 125k, which then allows me to max out my Roth IRA. This allows me to put away more tax-advantaged savings than I would be able to otherwise.
Also when you are starting out young and with a lower salary, a trad 401k allows you to take home more money due to the tax shield than if you were paying it now with a Roth.
The question of max roth now vs max trad (or vice versa) later will depend on your own personal situation, but I would say that when you are an analyst not saving much of your base, traditional makes more sense, especially if it lets you utilize a Roth IRA or other income limited vehicles. Later on, and especially if you intend to be a high earner past the age of 65, a roth option can make more sense so that you can "lock in" your tax rate now rather than later (income taxes are historically low at the moment, and there is a good chance they will [and frankly, should] go up for high earners down the line).
Contradicting yourself no?
You can do a backdoor Roth IRA contribution at any income level.
Roth IRA contributions can be withdrawn penalty free. I think Roth 401(k) withdrawals are a little less flexible, but still less punitive than a traditional 401(k).
If you anticipate bumpy income in the future, traditional contributions are nice because you can roll over to Roth if appropriate (say you start a business or go back to school).
You might expect tax rates to go up across the board.
Making both pre and post tax contributions is an option too.
1) Regular 401(k) comes out pre-tax on the federal level, aka before a place like NY/NYC can get their hands on your paycheck. Federal > State > City/County in the tax heirarchy (tangent: and speaking of county or city, ya'll are so fucked up with that there in the NE and it makes my head spin sometimes. NY is bad enough, but have you ever tried to deal with PA?! County income, then city income, then school district, SUI, finally property that in common sense jurisdictions aggregates everything else outside of SUI. Lord forbid you then have to deal with reciprocity too. Should do a simple rename of Steelers to Stealers as far as I'm concerned). Since Roth is post-tax, it's the contribution after whatever NY/NYC takes. Potentially less take-home pay now, but can be way more come retirement age depending on tax rates.
2) You're correct that due to how they're treated with #1 in mind, you delay any regular taxation on withdrawals from a regular 401(k) until you hit retirement age at 59 1/2. Then it's counted as normal income (sorry folks, no long-term carry loopholes this time). Pulling funds beforehand requires going through an additional federal tax hit on top of being counted as regular income or your firm's plan's loan rules if you go that route. The Roth on the other hand has effectively already been through income taxation, so that money you pull from it after 59 1/2 is income tax free. Still going to get whacked with the add'l fed penalty on withdrawls before retirement age of course.
3) Associate 1 - $125k is decently below the MAGI Roth limit for 2022. (WAY less than the traditional 401(k) limits too for those curious). Maxing out a traditional 401(k) at $23k is a good way to help maneuver your MAGI to then take advantage of additioanl Roth rules (unless you're over 50 and can make catch-up contributions regardless.)
4) Also max out that HSA while you're at it if you can. The quiet part they don't say out loud is that after a threshold you can invest those funds at your own discretion and effectively create another tax shelter retirement account. Because that money too can be drawn out and won't send you into Dante's Inferno for not doing so for strictly healthcare or your perscriptions. I won't go into any specific scenario, but the law was written with loopholes that may just make a person think of the prhase "legal avoidance versus illegal evasion". And I mean that in more scenarios than one here. Wish more people knew the meaning of avoidance vs evasion, but that's a different topic. As standard internet disclaimer these days, I am not giving legal advice and I do not advocate anyone breaking the law. I will say however, since we're talking about taxes, look up transfer pricing sometime if you don't know it. Fun and interesting topic...
5) Hidden bonus level of the game: 409 DCP/457 plans and the mess of being marked as HCE and having to deal with all those rules. Oh boy that's a fun one!
6) I left off ESOP/ESPP because thankfully those are pretty straight forward. Unlike said HCE issues, or safe harbor for that matter, definitely take advantage of them if have the ability to. Even if you wait it out for the LTC rate, being able to buy at $40/sh while it's already trading at $55/sh and selling a decade later at 5x ain't bad if you ask me. Hopefully the taxes won't suck too much, but that should be a good windfall.
7) Since everyone seems to be on the IB/PE/RE type train here, I won't even go near the 1256 revenue topic.
Edit: Forgot the whole idea of 529 plans and yet another tax advantaged plan you can take advantage of. Only mess there is 529's are state specific, so you're at the mercy of whatever firm the state chooses. Want a Vanguard plan, but your state goes with Hartford? Tough titties.
You can use any states 529 you want. Utah uses Vanguard.What's this 457 you speak of?
Good point on the 529 and thanks for catching me out. I should've been more specific that 529's are set up for each specific state, but yes you can in fact enroll in Indiana's though you live in Oregon. It's kind of boilerplate, but this is a fair explanation of 457. I bet WolfofWSO already knows, but if anyone wanted to know what a 409(a) is.
Honestly I just contribute to both and think of it as diversifying my tax risk. I lean more towards roth 401k because I generally prefer it and hope to have a lot of income in retirement (but who knows).
You can do a ton of analysis on current vs. expected retirement income / tax brackets, which state you live/work in now vs. where you think you'll retire, political climate now vs. your retirement years, etc etc etc but the truth is there is no way to predict any of this... so I just contribute to both and don't worry too much about it. It's just another form of diversification in my mind.
I go 100% Roth 401K because taxes are at a historical low and no doubt they're gonna go up in the future, and I'm also 99% sure I'm going to be pretty damn rich in the future
What’s the guidance on max contribution here?
I previously read that if you were to invest in both 401k and Roth 401k, the combined of the two cannot be greater than the 22k or now $23k threshold for the tax year? Is that everyone’s understanding?
combined 401k contribution limit was $20,500 this year and will be $22,500 next year. It's higher if you're over 50. These limits do NOT include employer match, just the employee contribution, so you can go over the limit with an employer match (There is a limit to total employee + employer contribution around $60k but idk how it would even be possible to reach that unless you're making over 7 figures or have a very generous match %).
Roth 401(k) because taxes are low right now and it removed uncertainty. It just provides you so much more flexibility from a wealth planning perspective it’s almost a no-brainer. You will have no RMD torpedo and heirs will not have to worry about 10-year RMD rule if you’re setting up an inheritance
Ya'll already know what disclaimer I'm about to throw out, so I'll spare you. Those changes didn't remove uncertainty, just postponed it (hopefully perpetually) at best. But yes, not having to deal with the RMD (Required Minimum Distribution for those unaware) torpedo is also super beneficial. Again, not jinxing it, just saying so long as that doesn't change either.
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