splitting Trad/Roth 401(k) to maximize tax-free accounts

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
User avatar
Topic Author
Raspberry-503
Posts: 954
Joined: Sat Oct 03, 2020 6:42 am

splitting Trad/Roth 401(k) to maximize tax-free accounts

Post by Raspberry-503 »

The tax-free portion of my portfolio (Roth and HSA) is less than 5% of my assets, so I would like to contribute to my Roth accounts even though it's anyone's guess whether I'll be in a lower bracket than 22% by retirement (in 10 years). But I also would like to stay in the 22% bracket by contributing to pretax accounts as needed. Also, In order to be able to contribute to a Roth IRA my AGI needs to be no more than $204,000

I made up some numbers below to make sure that I understand properly how I can use trad-401(k) to bring AGI into a range that helps me maximize my Roth contributions.

Let's assume I make $217k and for the sake of argument ignore the fact that some things like medical insurance premiums are pre-tax, assume the full $217K is taxable. So without contributing to pre-tax retirement accounts, I would be about $13K in the 24% tax bracket: (I'm using all 2022 tax numbers since this would be planning for next year) $217,000 - MFJ standard deduction of $25,900 = $191,100 which is greater than $178,150, the top of the 22% MFJ bracket for 2022

- base salary $217,000 taxable
- max out HSA 7300, leaving $209,700 taxable
- contribute $5650 to the traditional 401k, further reducing AGI so that after standard deduction, taxable income is $178,150, the top of the 22% bracket
- contribute another $51 to the traditional 401k, further reducing AGI to $203,999, now removing Roth IRA income limitation
- contribute $6000+$1000 catch up to Roth IRA, since AGI is below the limit of $204k
- contribute the rest of the 401k to Roth 401k ($26,500 with catchup - $5,701 above is $20,799) now that taxes are below 24%

Total savings: $40,800, the max that I can contribute to tax-advantaged accounts
Tax-free contribution for the year $7,300 HSA, and $20,799 Roth 401k and $7000 Roth IRA (about 70% of the overall savings)
Pre-tax contributions: $5650+$51 trad 401k (plus employer match no mentioned above)
any additional unspent income can be added to the taxable account.

Do I have the right idea? In practice things wouldn't be that clean, I sometimes get a bonus in the spring, my company does raises in July. But I could start 401k as Roth at the start of the year, and by August know when I need to switch to trad to get me in under the IRA income limit and overshoot by a little just to be safe.
tashnewbie
Posts: 4283
Joined: Thu Apr 23, 2020 12:44 pm

Re: splitting Trad/Roth 401(k) to maximize tax-free accounts

Post by tashnewbie »

Small comment: the max you can contribute to 401k in 2022 is $27k with catchup ($20.5k+$6.5k).
nolesrule
Posts: 2631
Joined: Thu Feb 26, 2015 9:59 am

Re: splitting Trad/Roth 401(k) to maximize tax-free accounts

Post by nolesrule »

What about spouse retirement accounts?
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: splitting Trad/Roth 401(k) to maximize tax-free accounts

Post by grabiner »

You have the right idea, but you might want to either leave some slack or else use a backdoor Roth contribution. If you happen to get a bonus, or receive a large distribution from your taxable account (one of Vanguard's ETFs is likely to do this), and wind up at $206,000 AGI rather than $204,000, your Roth contribution limit is $4800 rather than $6000, so if you already contributed $6000, you'll have to recharacterize $1200 of the contribution and then convert it back to Roth.

As long as you don't have a traditional IRA, you can use the backdoor Roth for essentially no cost, even if it turns out that your income would qualify you for a deductible contribution.
Wiki David Grabiner
Post Reply