401(k) or Roth IRA


P

Paul

Currently I contribute the maximum to my company's 401(k) plan, about
$12,000. There is no match. This is about all we can save for
retirement. My question is should I continue to contribe the $12,000
to the 401(k) plan, or $9000 to the 401(k) plan and $3000 to a Roth
IRA, or 12,000 to the Roth. Any help is much appreciated.

Paul
 
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E

Elizabeth Richardson

Paul said:
Currently I contribute the maximum to my company's 401(k) plan, about
$12,000. There is no match. This is about all we can save for
retirement. My question is should I continue to contribe the $12,000
to the 401(k) plan, or $9000 to the 401(k) plan and $3000 to a Roth
IRA, or 12,000 to the Roth. Any help is much appreciated.
If you get no company match, and you are more than a decade away from
retirement, I would certainly opt to contribute the $3000 to the Roth (the
maximum allowed at this time). Yes you have to pay current taxes on this
contribution, but all of your growth/earnings will never be taxed. While
your 401k grows tax-deferred, all future distributions will be taxed as
regular income. Your thinking of the $9000/$3000 split seems the best mix.

Elizabeth Richardson
 
B

BMS

Before you opt for this strategy, what is your current tax rate? If you are
in the top bracket, tax deferral would be important, if you are in a lower
bracket the deferral isn't as important.
 
E

Elizabeth Richardson

BMS said:
Before you opt for this strategy, what is your current tax rate? If you are
in the top bracket, tax deferral would be important, if you are in a lower
bracket the deferral isn't as important.
Why would tax deferral, but then pay taxes on the original contribution plus
the earnings be better?

It seems to me that tax free would be important, especially if you are in a
high tax bracket. While you pay tax on the $3000, you invest the entire
$3000, so your contribution isn't diminished by the tax thereon. If you're
in a high tax bracket, it seems that you could pay as much as $1400 on this
money (I don't know anything about state tax rates since we don't have a
state income tax). All earnings are then tax free. If you have a long enough
time period, which is why I indicated at least a decade (the longer the
better), then you come out ahead with the Roth.

Elizabeth Richardson
 
B

BMS

The tax question is to be considered as part of the financial plan. Will the
contribution make a difference, as will time.

The problem with questions like this, is that they are done in the abstract
without looking at the overall picture.

Of course if you are cynical enough, do you believe that earnings will
always be tax free?
 
E

Elizabeth Richardson

BMS said:
Of course if you are cynical enough, do you believe that earnings will
always be tax free?
Yes. No elected representative would risk his re-election changing the rules
on existing Roth IRAs. However, it is entirely possible for the lawmakers to
disallow future contributions to such an account. All the more reason to be
fully funding now.

Elizabeth Richardson
 
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M

Michael T Wing CPA

Elizabeth Richardson said:
No elected representative would risk his re-election
changing the rules on existing Roth IRAs.
That's what they said years ago before Congress started taxing
Social Security.

MTW
 
B

BreadWithSpam

retirement. My question is should I continue to contribe the $12,000
to the 401(k) plan, or $9000 to the 401(k) plan and $3000 to a Roth
IRA, or 12,000 to the Roth. Any help is much appreciated.
Bear in mind that 401k contributions are pre-tax and
Roth IRA contributions are post-tax. If you lower your
401k contributions by $3000, you will not end up with
$3000 to stick into the Roth - you'll end up with
$3000 * ( 1 - <marginal tax rate>) -- probably something
more like $2250 or so. Your mileage may vary.

So, anyway, if you're going to reduce your 401k contributions
in order to max out a Roth, you'll have to reduce your 401k
contributions by _more_ -- substantially more -- than the
$3000 which maxes out the Roth.

I'd try awfully hard to max out both, though. If you have
to choose between them, it's a tough call, but I guess I
might lean towards maxing out the Roth first - easier to
pull your contributions back out, no mandatory distributions
at 70.5, etc.
 
R

Radley

I have a question about the 401K being taxed as income? In essence when one
retires they stop working. That would mean that they would make less income
as a retiree and be on a lower tax bracket thus paying less taxes in the
future rather than paying at the higher rate. Is there information I could
read about that explains this in more detail? I'm a visual learner and like
to see charts and spreadsheets. Am I seeing the wrong picture? I'm trying
to learn more about financial topics and there's so much, but too little
time! Thanks.

Radley
 
E

Elizabeth Richardson

Radley said:
I have a question about the 401K being taxed as income? In essence when one
retires they stop working. That would mean that they would make less income
as a retiree and be on a lower tax bracket thus paying less taxes in the
future rather than paying at the higher rate.
Someone else may be able to point you to a site that answers your specific
question. However, I'm not certain I agree with your basic premise. I don't
believe it is necessarily true that people in retirement have a smaller
income than when they were working. Some people save in earnest when they
are working so that they don't have a lesser standard of living when they
retire. In fact, I think some people actually plan to have a slightly higher
income in the early retirement years so that they can travel or have a
similar active lifestyle that may cost more than when they were working.

Elizabeth Richardson
 
R

Radley

I think I get it now after reading about retirement. My initial premise was
wrong and callow. I'm assuming now though that the goal of saving for
retirement would be to maintain or surpass the standard of living that a
person is currently at. The only retired people I know are still working
and therefore assumed that retirement income would be less. Thanks for the
info!

Radley
 
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T

Tad Borek

Radley said:
I have a question about the 401K being taxed as income? In essence when one
retires they stop working. That would mean that they would make less income
as a retiree and be on a lower tax bracket thus paying less taxes in the
future rather than paying at the higher rate.
Not everyone's tax bracket is lower during retirement. It depends how
much you end up with in your 401k & other retirement accounts, how much
other income you earn during retirement, how fast you draw down your
retirement accounts, and the total federal & state tax rates at the
time. In other words, most people have no idea! The last one (tax rates)
is especially a problem.

-Tad
 
Z

zak

Radley said:
I think I get it now after reading about retirement. My initial premise was
wrong and callow. I'm assuming now though that the goal of saving for
retirement would be to maintain or surpass the standard of living that a
person is currently at. The only retired people I know are still working
and therefore assumed that retirement income would be less. Thanks for the
info!
Even if you have the same income, it very much depends on where your
retirement funds are coming from. If you are living off your
retirement accounts, (i.e. no pension and prior to taking social
security), then your average tax rate will be much lower. The first
chunk you take out (up to your standard deduction) will be tax free.
The next chunk at 10% and so on. Your contributions, on the other
hand, will get you a deduction at your highest marginal rate (i.e.
25-35%).

The worst case scenario is a situation where you use the 401k as a
supplement to a pension and social security. Not only will your
withdrawal be taxed at a high rate, but the withdrawal may also cause
increased taxation of your social security benefits.
 
E

Elizabeth Richardson

zak said:
"Radley" <radleyramirez@hotmail.com> wrote in message
Even if you have the same income, it very much depends on where your
retirement funds are coming from. If you are living off your
retirement accounts, (i.e. no pension and prior to taking social
security), then your average tax rate will be much lower. The first
chunk you take out (up to your standard deduction) will be tax free.
The next chunk at 10% and so on. Your contributions, on the other
hand, will get you a deduction at your highest marginal rate (i.e.
25-35%).

The worst case scenario is a situation where you use the 401k as a
supplement to a pension and social security. Not only will your
withdrawal be taxed at a high rate, but the withdrawal may also cause
increased taxation of your social security benefits.

Why would tax rate of distributions from your 401k depend on the source of
your other income, if, in fact, you have any other income?

Elizabeth Richardson
 
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Z

zak

Elizabeth Richardson said:
Why would tax rate of distributions from your 401k depend on the source of
your other income, if, in fact, you have any other income?

I guess it doesn't, as long as the income shows up in your AGI for tax
purposes. The feature I was trying to highlight was the taxation of
social security benefits. The key difference being that below a
certain income threshold social security benefits are not taxed and
that taxation is phased in with increasing income (and that
401k/traditional IRA withdrawals are considered income for this
purpose but Roth withdrawals are not). Therefore, your marginal rate
can actually be higher than your top tax bracket, if your income
without retirement account withdrawals is in or slightly below the
range where social security benefit taxation phases in.

I recall a study I read a couple of years ago, where the researchers
looked at lifetime spending under different wage and retirement
conditions. IIRC, the study showed that under certain conditions
(which were likely to effect a large percentage of the population),
saving in a tax-deductible account was actually worse than a taxable
account (not even considering a Roth), largely due to the social
security effect.
 

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