Roth 401k vs. Regular 401k
Knowing there’s no tried-and-true answer to whether you should contribute to a Roth or regular 401k, was curious other’s thoughts on contributing to a regular over a Roth 401k. Working in PE with my spouse having a lower income our total household income is +/- $500k and our effective federal tax rate comes out to around 20-21%. We live in a state with no state income tax and have always contributed to a Roth 401k. Curious how others contribute to theirs.
If you can afford to max both options out, you can kinda put more money into a Roth than a traditional. Whatever you put into the traditional will always be lessened by (1-Taxes) which is less than 1 (Roth since contributions have already been tax effected)
Bloomberg ran an article this week titled “your 401K will be gone within a decade”. Unlikely they touching whatever’s already in a retirement account though. Probably only the contributions
https://www.bloomberg.com/opinion/articles/2024-02-20/retirement-if-you…
I’ve always followed the mentality of maxing out IRA contributions ($7k in 2024) and max out 401(k) contributions up to the company match. Both my IRA and 401(k) are Roth because no shot taxes will ever go down. They will just continue to rise, so may as well trigger a taxable event now when they are lower and I’m in a lower tax bracket
I’m Roth all the way. I’d like to think that at this rate of investing and career trajectory, I will for sure be in the highest bracket when retiring, pointing to Roth. Then if you look at historic tax brackets, we are at very low levels, unlikely to drop further and if anything shift up, pointing to Roth.
There’s probably something about knowing exactly how much money you have, too, that’s worth something.
I contribute 6% to regular to get my company match and then max out the remaining allotment in my Roth. Make sure you’re not missing out on your company match, if you have one, as that usually has to be through pre tax contributions.
EDIT: see discussion below
Thanks a lot for your reply. Can you give more color on how the traditional 401k could be more tax advantaged in retirement? My understanding was that Roth 401k distributions are non-taxable regardless of income in retirement. Company match is obviously traditional so you’d have to pay taxes in retirement on those withdraws.
The immediate tax benefit argument holds absolutely no water. If you invest $10 pre-tax today, and it grows to $20 (2x return), and then you pay taxes on the full amount (let's say 20%), you end up with $16. If you invest $10 of pre-tax dollars that get taxed, today that means you invest $8 post-tax. If it then doubles to $16 and you pay no additional taxes, you end up in the exact same place. Just saying "time value of money" doesn't make the argument valid.
The above poster who mentioned the fact that using Roth means you can actually be contributing "more dollars" in a tax-advantaged account is correct. There is a whole thread on this from a while back where I went into more detail (with a very helpful back and forth with another poster that teased out a lot of the key issues) - https://www.wallstreetoasis.com/forum/off-topic/traditional-vs-roth-401k
Edited to add: You should also confirm with your own company if you need to contribute Traditional to receive the match. Everywhere that I have worked, you still got the match if you did Roth, it just matched it as Traditional.
I stand corrected and have edited my post. Thank you.
Your link did not work, but I assume you are talking about the thread linked to below. Could you please explain how the Roth 401(k) gives you a larger investment exposure? Does your math in the thread below not assume that you are not investing the immediate tax benefit of a traditional 401(k) contribution? Could a traditional 401(k) contribution actually produce a higher overall return since I could take the immediate tax benefit and invest it in something whose returns are taxed at less than my marginal tax rate, such as real estate, a business, etc.?
EDIT: Could one also not make the argument that traditional 401(k) contributions allow you to invest your immediate tax benefit in higher ROI investments outside of my 401(k) thereby netting you a higher overall return than had you made Roth 401(k) contributions? Your "wash math" assumes that the growth rate is the same.
https://www.wallstreetoasis.com/forum/off-topic/traditional-vs-roth-401k
Good catch, I updated the link in my post as well.
The idea is that the Roth gives larger investment exposure to tax-advantaged accounts. In essence, this is because the limits for Roth and Traditional are the same $ amount, but the Roth is in after-tax dollars. So if you put the maximum amount of contribution into your 401k, in Traditional that means that you are putting in $23k of pre-tax dollars, but in Roth you are putting in $23k / (1-t) of pre-tax dollars (so around $38k if you are in a 40% tax bracket). Stated differently, your $23k of pre-tax dollars in the Traditional, once taxed on the back-end, only gave you post-tax exposure of $13.8k for investing ($23k * .6). You can most obviously see this by just comparing the ending balances. For Roth, if you 2x your $23k, you will end up with $46k and not pay any tax on it. For Traditional, if you 2x your $23k, you will end up with $46k, but then pay 40% tax and your final number is $27.6k. That is because in reality, you contributed fewer after-tax dollars to the account.
To your question about taking the traditional 401k tax benefit and investing it elsewhere, the answer is sort of. In the above example, you contribute $23k of pre-tax dollars to your 401k, vs. $38.3k of pre-tax dollars in your Roth. So assuming that you would have that last $15.3k, you'd have $9.2k of after-tax dollars to invest. Pretending you invest that $9.2k in something that also returns 2x (same as your 401k), you'll still be hit by another 20% of capital gains tax when you sell, so your $9.2k of gains will be taxed (let's say) 20%, which means that you'll end up with $27.6k in your Traditional 401k + $16.6k in your taxable account, totaling $44.2k. That's still less than the $46k you end up with in your Roth. That said, the question should not be whether you can invest in something that has a lower tax rate than your own marginal tax rate - you're going to pay your marginal tax rate on the $23k no matter what, it's just a question of when. The question is whether you can find something with a better return proposition than your 401k investment options, inclusive of the savings on not having to pay a capital gains tax.
Just to reiterate, the hidden assumption that people don't think about is that the capital gains tax in your 401k is 0% - everyone just focuses on the tax now vs. tax later question. But the 0% capital gains tax means that you really want to get as many apples-to-apples dollars into the account as possible (on a purely mathematical basis). Of course, as others have alluded to, if you think your tax rate will be different in retirement or if you have an outsized desire for near-term liquidity (whether for comfort or for other investments), then it can change the equation. Also, the above points only even apply if you are maxing out your 401k in the first place (which I assume most people in this forum are able to do if they want to).
Lastly, as of this year, the other nice benefit of the Roth 401k is that you don't have to take required minimum distributions, whereas for the Traditional 401k you are required to take distributions when you hit 72.
Are you going to have a low income point in the future? For example, if you are going to go to business school, it might be advantageous to do a traditional contribution now and roll over to a Roth plan in a lower income year. Generally though, if you're assuming your rate will be higher in the future (fair), and don't intend to do a Rollover, the Roth seems better.
Is there not an income limit to contribute to a Roth ? I thought it was like 150k.
That's for a Roth IRA, not a Roth 401k. Also, you can bypass the income limit on the Roth IRA by doing a backdoor Roth (you contribute after-tax to a Traditional IRA and then immediately roll it over into a Roth IRA, and land in the same place as a direct contribution to the Roth IRA).
If you do this, make sure you are fully understanding the pro rata rule. Otherwise, you might run into an unforeseen tax hit.
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