Author Topic: Traditional vs Roth vs split 401k...in the gray area  (Read 91 times)

Sham

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Traditional vs Roth vs split 401k...in the gray area
« on: September 22, 2020, 05:32:45 AM »
Hello,

I just opened a Safe Harbor 401k for my small business and will be able to start investing in a 401k for the first time ever and have been doing some research into what is best for me Traditional vs Roth vs split for myself.  I had followed a link from a finance group on facebook about this topic that brought me to your blog from January 2015 about why Roth is bad.  It was a good read and not sure how you feel about it now since it has been 5 years and taxes have changed.  I have read some more of your stuff and find that you can really break complex things down to make it easier to understand, so thank you for that.

  My dilemma is I know the difference in Roth vs Traditional  (pretty much) and the general rules but I believe I am in the gray area.  It is my understanding that generally if you are young and you think you will be earning more later you should definitely do a Roth.  However I am 43 so not that young and pretty sure that I am near my max earnings (or won’t ever make enough to jump to the next tax bracket which for me is the 32% tax bracket).
I make around 225k (24% tax bracket) a year but probably live on around 100k a year (I’m a saver but unfortunately not an investor…yet).  I have about >100k in taxable account but no 401k or IRA’s. 

So it seems I should do the traditional, but the more I dig the more I realize we are at historic lows as far as taxes go (looking at tax brackets from years past adjusted for inflation) and I feel given the direction of the country they will most definitely be going up.  If I retire on perhaps 80k/year in 25 years (or sooner perhaps) if is very possible that 80k will be around 24-25% tax brackets (or higher?).  So its quite possible I will probably be in similar tax brackets in which case which would be better Roth or Traditonal?

The 401k I decided to go with (which by the way is entirely made of low costs vanguard index funds) had an article that said if you are in the 22% tax bracket you should be 25% traditional/75% roth and in the 24% tax bracket which is where I am you should allocate 50%trad/50%roth.  However they even made a statement that many high earners are doing Roth’s now because of where the tax brackets are at the moment.  I think I may do 50/50 split just to hedge my bets so to speak, or maybe 25% traditional/75%Roth.  Of course I plan to reinvest my tax savings from the traditional which is important.  I suppose I can do a Roth ladder with my traditional part of my 401k at some point.  I also plan on doing a backdoor roth IRA for myself and my wife (12k total, 6k each). 

But I wanted your thoughts of how do you feel now about your blog on why traditional 401ks are better given the difference in tax brackets from 2015 to 2020 and if you still feel that way now.  And, more importantly, for some one like me where I am in my forties at near peak earning years however in an environment with historically low tax brackets where would you allocate your ratio of traditional/roth 401k?
As I said I stumbled upon your site from a link and have been reading some forum posts and I know this is a FIRE blog but I feel a lot of the principals that you explain so well can be applied for many people not just in the FIRE community.  Thanks

gocurrycracker

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Re: Traditional vs Roth vs split 401k...in the gray area
« Reply #1 on: September 22, 2020, 09:28:35 PM »
A Roth isn't bad. It is just often confused as being better than it really is.

When you withdraw from a Traditional pre-tax 401k in 25 years, how will it be taxed?

Using 2020 numbers / adjusting for inflation / filing taxes as married filing jointly:
The first ~$24k is taxed at 0% (standard deduction)
The next ~$20k is taxed at 10%
The next ~$60k is taxed at 12%
https://www.gocurrycracker.com/federal-income-tax-brackets/

If you withdraw $80k, you'll have a marginal tax rate of 12% and pay about $6200 in total tax (effective tax rate of <8%.)
https://www.gocurrycracker.com/federal-income-tax-calculator/


By contrast, today you would save 24% for pre-tax Traditional 401k contributions.

24% is more than 8% or 12% -> 100% Traditional is the mathematically superior choice


>how do you feel now about your blog on why traditional 401ks are better given the difference in tax brackets from 2015 to 2020
The tax system is still structured the same - progressive marginal tax rates that start at 0%.

>looking at tax brackets ... I feel ... they will most definitely be going up. 
Would have to triple taxes on people who make <$80k/year to get to a 24% effective tax rate. Can't squeeze blood from a stone.


addendum:
If you are doing $12k in backdoor Roth and $19.5k Traditional 401k, you will already be at a 60/40 Traditional/Roth split
« Last Edit: September 23, 2020, 08:57:06 PM by gocurrycracker »