Roth 401(k) vs. Traditional 401(k)

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Topic Author
sach1282
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Joined: Thu Nov 19, 2015 11:05 am

Roth 401(k) vs. Traditional 401(k)

Post by sach1282 »

Hey Bogleheads,

So my job offers both a traditional 401k and a Roth 401(k) option. I am unsure how to decide which to contribute to. I also have the option to split between them if I want to. There is up to a 4% match, which all goes into a pretax traditional pool. I've looked up info all over the place on this question, but it seems to come down to my expected future tax rate in retirement, and I have absolutely no idea how to even estimate what that might be. It occurred to me that people here might have a better idea. Here is (what I believe is) the pertinent info:
  • I am currently 35 years old but have no retirement savings - a personal disaster wiped everything out
  • I own my own house and have no debt though with about $20k in cash
  • I am making about 55k pretax
  • This is probably the lowest my income will ever be during my active career
  • I contributed the max of $6k to a Roth IRA this year
  • If I go with the traditional over the Roth I'll just increase my contribution amount by 22% (my current tax bracket)
  • I live in a high tax state and am not certain I will stay there forever
  • *EDIT: Single - no dependents
Last edited by sach1282 on Fri Jul 30, 2021 11:36 am, edited 1 time in total.
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Kenkat
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Re: Roth 401(k) vs. Traditional 401(k)

Post by Kenkat »

If you are in a relatively low tax bracket as compared with where anticipated future earnings will put you, I think using the Roth makes a lot of sense. The value of the tax deferral of the traditional 401k is less at your current earnings level.
Charon
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Re: Roth 401(k) vs. Traditional 401(k)

Post by Charon »

You are barely into the 22% tax bracket. Personally I'd contribute to traditional just enough to get out of the 22% bracket, then put the rest in Roth.
MrJedi
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Re: Roth 401(k) vs. Traditional 401(k)

Post by MrJedi »

If you don't think you'll have additional significant sources of income during retirement (pension, side business, etc.), I would say minimally enough pretax to get you out of 22% tax bracket. Then during retirement you have a decent chance at withdrawing at 0-15% tax instead.

If you can save beyond that amount, it gets a bit trickier without knowing how much you think you can stuff into your pretax between now and retirement, and the age you think you will retire.
02nz
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Re: Roth 401(k) vs. Traditional 401(k)

Post by 02nz »

Charon wrote: Fri Jul 30, 2021 10:58 am You are barely into the 22% tax bracket. Personally I'd contribute to traditional just enough to get out of the 22% bracket, then put the rest in Roth.
Right, less than $2K into the 22% bracket. However, in most cases the employee share of health insurance premiums comes out pre tax, and there may be other "above-the-line" deductions, so if the $55K is the gross salary, the OP may not be in the 22% bracket at all.

OP, if you expect significant income growth, it can make sense to lock in the 12% rate now with Roth 401k contributions, and switch later to traditional (at least for income that falls into the 22% and higher brackets).
bloom2708
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Re: Roth 401(k) vs. Traditional 401(k)

Post by bloom2708 »

You did your Roth IRA. That is good.

I'd do pre-tax as much as you can. You need to save more to get compounding to get going.

The "high tax state" tells me the additional deferral of tax will be worth it and it gets you out of the 22% bracket likely.
02nz
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Re: Roth 401(k) vs. Traditional 401(k)

Post by 02nz »

bloom2708 wrote: Fri Jul 30, 2021 11:16 am You did your Roth IRA. That is good.

I'd do pre-tax as much as you can. You need to save more to get compounding to get going.

The "high tax state" tells me the additional deferral of tax will be worth it and it gets you out of the 22% bracket likely.
It's a bit of a gamble. Traditional is lower risk. If OP goes with Roth, and has another financial wipe out / has to retire early or whatever, that will have been a costly mistake, as a tax-deferred balance could have been used to fill up the standard deduction every year. However, if things turn out better and OP has a significant number of years in the 22% and higher brackets, it will have been wise to lock in the 12% now. Basically, Roth is better when things turn out well, traditional is better when things turn out less well.
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retiredjg
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Re: Roth 401(k) vs. Traditional 401(k)

Post by retiredjg »

You speak as if you are single. If so, you may be at the top of the 12% tax bracket or bottom of the 22% bracket. It depends on your exact income (including sources other than your job) and how much/if you pay for employer sponsored health plan.

In this case there are a few different approaches
  • -Put enough into traditional 401k to get into the 12% bracket and save the rest in Roth 401k

    -Not worry about the bracket and use all Roth 401k, knowing that you will contribute to traditional more as your income goes up

    -Use traditional 401k in an attempt to lower your income enough to get the saver's credit and/or the earned income credit on your taxes.

It is also possible you are single with a dependent - filing as head of household. In that case you are squarely in the 12% bracket. Using traditional 401k would have a higher likelihood of getting you into earned income credit territory and the saver's credit.

In your case, you will actually need to figure out what is best as it is not clear. What probably is clear is that 12% may be the lowest tax rate you will ever have, but of course that depends on the future which is hard to predict accurately.
Topic Author
sach1282
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Re: Roth 401(k) vs. Traditional 401(k)

Post by sach1282 »

02nz wrote: Fri Jul 30, 2021 11:13 am
Charon wrote: Fri Jul 30, 2021 10:58 am You are barely into the 22% tax bracket. Personally I'd contribute to traditional just enough to get out of the 22% bracket, then put the rest in Roth.
Right, less than $2K into the 22% bracket. However, in most cases the employee share of health insurance premiums comes out pre tax, and there may be other "above-the-line" deductions, so if the $55K is the gross salary, the OP may not be in the 22% bracket at all.

OP, if you expect significant income growth, it can make sense to lock in the 12% rate now with Roth 401k contributions, and switch later to traditional (at least for income that falls into the 22% and higher brackets).
Am I misreading the tax bracket info, doesn't 22% start at 40K? https://www.nerdwallet.com/article/taxe ... x-brackets It would be pretty difficult for me to contribute that much and still meet my other obligations right now.
02nz
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Re: Roth 401(k) vs. Traditional 401(k)

Post by 02nz »

sach1282 wrote: Fri Jul 30, 2021 11:34 am
02nz wrote: Fri Jul 30, 2021 11:13 am
Charon wrote: Fri Jul 30, 2021 10:58 am You are barely into the 22% tax bracket. Personally I'd contribute to traditional just enough to get out of the 22% bracket, then put the rest in Roth.
Right, less than $2K into the 22% bracket. However, in most cases the employee share of health insurance premiums comes out pre tax, and there may be other "above-the-line" deductions, so if the $55K is the gross salary, the OP may not be in the 22% bracket at all.

OP, if you expect significant income growth, it can make sense to lock in the 12% rate now with Roth 401k contributions, and switch later to traditional (at least for income that falls into the 22% and higher brackets).
Am I misreading the tax bracket info, doesn't 22% start at 40K? https://www.nerdwallet.com/article/taxe ... x-brackets It would be pretty difficult for me to contribute that much and still meet my other obligations right now.
You didn't account for the standard deduction, which acts like a 0% tax bracket, $12K and change for singles. Here's a handy website to help you visualize: https://engaging-data.com/tax-brackets/
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retiredjg
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Re: Roth 401(k) vs. Traditional 401(k)

Post by retiredjg »

sach1282 wrote: Fri Jul 30, 2021 11:34 am Am I misreading the tax bracket info, doesn't 22% start at 40K? https://www.nerdwallet.com/article/taxe ... x-brackets It would be pretty difficult for me to contribute that much and still meet my other obligations right now.
$40,526 in 2021 to be exact.

However that is not income. It is "taxable income" which is after all the deductions. You will find this "taxable income" number on line 15 of your 1040 form.
Topic Author
sach1282
Posts: 11
Joined: Thu Nov 19, 2015 11:05 am

Re: Roth 401(k) vs. Traditional 401(k)

Post by sach1282 »

retiredjg wrote: Fri Jul 30, 2021 11:33 am You speak as if you are single. If so, you may be at the top of the 12% tax bracket or bottom of the 22% bracket. It depends on your exact income (including sources other than your job) and how much/if you pay for employer sponsored health plan.

In this case there are a few different approaches
  • -Put enough into traditional 401k to get into the 12% bracket and save the rest in Roth 401k

    -Not worry about the bracket and use all Roth 401k, knowing that you will contribute to traditional more as your income goes up

    -Use traditional 401k in an attempt to lower your income enough to get the saver's credit and/or the earned income credit on your taxes.

It is also possible you are single with a dependent - filing as head of household. In that case you are squarely in the 12% bracket. Using traditional 401k would have a higher likelihood of getting you into earned income credit territory and the saver's credit.

In your case, you will actually need to figure out what is best as it is not clear. What probably is clear is that 12% may be the lowest tax rate you will ever have, but of course that depends on the future which is hard to predict accurately.
Thanks, this was super helpful. Also thank you O2nz! I've come to a couple conclusions.

First, one thing I didn't include is that this year I started the job in April so, even though I have some rental income, I'll be comfortably within the 12% range for all of 2021. I also contribute about $1,500/year to my employer health plan. Thus, I decided that, at least for this year, I'm going to go exclusively Roth. Next year my income will go up to at least 64.5k gross, and I'll reevaluate then. Maybe I can lower myself enough to just hit the top of the 12%.
Last edited by sach1282 on Fri Jul 30, 2021 12:10 pm, edited 2 times in total.
02nz
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Re: Roth 401(k) vs. Traditional 401(k)

Post by 02nz »

^ Makes sense.
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FiveK
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Re: Roth 401(k) vs. Traditional 401(k)

Post by FiveK »

sach1282 wrote: Fri Jul 30, 2021 10:45 am ...it seems to come down to my expected future tax rate in retirement, and I have absolutely no idea how to even estimate what that might be.
  • I am currently 35 years old but have no retirement savings
Unless you expect a pension, without significant funds (at least $300K) in your traditional accounts an estimate of "0%" would be reasonable. See the table around cell Calculations!U5 in the personal finance toolbox. Given that, you wouldn't want to do all Roth for the rest of your career.
  • I am making about 55k pretax
  • This is probably the lowest my income will ever be during my active career
  • I live in a high tax state and am not certain I will stay there forever
  • *EDIT: Single - no dependents
With those considerations, it's probably a coin flip between traditional and Roth whether saving 12% (plus whatever state tax) now will be better or worse than the withdrawal tax rate after retirement. Much will depend on when and where you decide to retire.

Saving 22% federal now by using traditional until you drop into the 12% bracket, and Roth once you are there, given all the above, is a reasonable bet. But even that isn't a certainty, depending on how much Social Security you will receive and when you start those benefits. Your plan "Next year my income will go up to at least 64.5k gross, and I'll reevaluate then. Maybe I can lower myself enough to just hit the top of the 12%." looks good, especially the "reevaluate" portion if done annually - good luck!
wander
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Re: Roth 401(k) vs. Traditional 401(k)

Post by wander »

If Op will eventually move to a low or no income tax state, contributing to a Traditional 401k now will delay state tax portion and will pay nothing (or small %) in retirement when withdrawing the money.
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ruralavalon
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Re: Roth 401(k) vs. Traditional 401(k)

Post by ruralavalon »

sach1282 wrote: Fri Jul 30, 2021 10:45 am Hey Bogleheads,

So my job offers both a traditional 401k and a Roth 401(k) option. I am unsure how to decide which to contribute to. I also have the option to split between them if I want to. There is up to a 4% match, which all goes into a pretax traditional pool. I've looked up info all over the place on this question, but it seems to come down to my expected future tax rate in retirement, and I have absolutely no idea how to even estimate what that might be. It occurred to me that people here might have a better idea. Here is (what I believe is) the pertinent info:
  • I am currently 35 years old but have no retirement savings - a personal disaster wiped everything out
. . . . .
  • I am making about 55k pretax
  • This is probably the lowest my income will ever be during my active career
  • I contributed the max of $6k to a Roth IRA this year
  • If I go with the traditional over the Roth I'll just increase my contribution amount by 22% (my current tax bracket)
  • I live in a high tax state and am not certain I will stay there forever
  • *EDIT: Single - no dependents
. . . . .

Will you be eligible for both a significant pension and Social Security benefits? Will you have some other source of income in retiirement?

You currently have zero in traditional tax-deferred accounts?

What is your profession or occupation?

About how much (in dollars) do you believe that you may be able to contribute annually to investing (total, all accounts)?

Unless a significant pension is expected, my guess is that traditional 401k contributions will likely be better.
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