To preface, I am a CPA and I have spent a lot of time looking at retirement plan stuff from a tax perspective.
The choice between a traditional IRA or 401(k) and a Roth version of those is almost entirely whether you think you will be in a higher tax bracket when you take the money out. The math works out the same if you take the taxes out at the beginning or at the end when they’re the same rate. When you first start working, you’re probably going to be in a low tax bracket and won’t get much of an advantage of the deferral of the taxes, and you can always hope you’ll claw your way to the top and have lots of investment income in retirement such that you’ll be in a high tax bracket even before your IRA, plus you never know what Congress will do. But if you’re close to retirement, you are more likely to have the same tax brackets in effect in retirement as there are now, plus you should know about how much retirement income you have and should be able to calculate (with professional help if needed) what your tax situation is likely to look like, so it’s not as much of a guess as a calculation. Hire a fee-based (hourly rate) advisor to go over your situation if you haven’t already.
If you determine that you’ll be in a lower tax bracket in retirement, there still is a potential use for a Roth retirement account: pulling out money tax-free when you’re close to the top the tax bracket. If you really need money right now but it would be taxed at a higher rate than normal, it’s helpful to have a source of income you won’t pay taxes on. So consider setting aside a small portion of your 401(k) contributions if you don’t already have a large taxable investment account to draw on.
The other issue that doesn’t apply to your choice in this case because you’re just talking about a Roth 401(k) is that you can make a Roth IRA contribution if you already have a retirement plan at work and don’t earn tons of money. If you have a retirement plan at work and make a reasonable amount of money, you probably won’t be able to deduct a traditional IRA contribution, and while you’ll eventually get those funds not deducted back tax-free, the earnings on those nondeductible contributions to a traditional IRA are not tax-free like with a Roth, and you need to keep track of how much you contributed tax-free and how much you get to take tax-free each year, which is reason enough to avoid doing it in the first place if you don’t already have someone professionally do your taxes for other reasons.
I think such things would require a constitutional amendment, just like it did with income taxes. Not to say it won’t happen, but I’m fairly sure it’s the reason there isn’t a federal sales tax.
I have been following this thread for a few days now, and reminded of a thread that I had started. If I’m not mistaken, as a single man, I can only contribute up to $6,500 in 2018 of post-tax money to any and all of my IRAs, be they traditional, Roth, or any combination of the two. Correct me if I’m wrong. . .
Are there any hiccups if I can save some loose change and deposit more than $6,500? Will I pay tax on those extra bucks again?
Tripler
I have fifty-eight cents from the sofa cushions. What do do . . . what to do. . .
If you are under age 50, you may contribute up to $5500 to Roth and Traditional IRAs combined, if you are 50 and over, you may contribute up to $6500. If you are 70 1/2 or older, you may not contribute to a Traditional IRA, only a Roth IRA. However, your annual contribution may not exceed the amount of your “compensation income.” Compensation income is all of your taxable earned income (salary, tips, self-employment), plus taxable alimony, plus non-taxable combat pay.
If you over-contribute, there is a 6% additional annual tax on the amount of the over-contribution as long as the over-contribution remains in your IRA account. (This tax does not apply to 401(k) accounts.)
Which brings me to another point, the OP was about 401(k) accounts not IRA accounts. In many ways the two are very similar. But in a lot of details, they are not. Talking about both types of accounts in the same thread can cause more confusion to anyone who is already confused.
The maximum before-tax amount you can contribute in 2018 is $18,500 if you are under 50, or $24,500 if 50 or older. The maximum Roth 401(k) is the same. If you contribute to both, the sum of the contributions has to be under this number.
Few employers allow non-Roth after-tax contributions to 401(k) plans, so hardly anyone knows this is possible, but you can continue contributing to your 401(k) after-tax (if your employer allows) until the sum of all of your contributions plus all of your employer’s contributions reaches $55,000 ($61,000 if age 50 or over).
The $18,500/$24.600 limit is per-employee. The $55,000 limit is per-employer, so you can keep going if you have multiple jobs.
Some also have a belief that Congress will tax Roth IRA and Roth 401ks. My one time college roommate and current money guy bigwig is convinced that 5 years after Congress lifts the SS tax cap, that they will institute a tax on Roth withdraws since it can be viewed as a 'rich man’s" investment. I don’t think I concur with him, but it’s not an uncommon discussion.
It is partly semantics but some of the examples blur the point. If I’m having deductions from my paycheck to a 401k, that amount gets invested regardless of Roth or traditional. When my taxable income is determined for tax withholding and later for tax filing, my taxable income will be less with a traditional.
I contributed to a Roth 401k for a few years earlyish in my career. I think it made sense at the time, although I won’t find out for a few more decades.
Recently out of college with no dependents and working as a software developer, I had relatively low expenses and relatively high income, but I expected my future income to be higher. I wanted to save aggressively, and paying tax now effectively increased the contribution cap by my tax rate. I now have higher income, but also higher expenses. My tax rate is higher (well, it was before the recent federal changes. I haven’t figured it out yet for this year), so the deduction is worth more to me now.
It also protects me from future tax risk. I know what the taxes are now. I can guess that they’ll be lower when I’m 70, but who knows.
Having a mix of Roth and non-Roth retirement accounts likely lets me structure my future taxes better. I can withdraw whatever is tax-optimal from the non-Roth accounts, and if I want or need more money to meet my expenses, I can withdraw from the Roth.
Some do (mine included). And if you are really lucky, they may allow you to do an in-service non-hardship withdrawal of the after-tax money which you can then transfer to a Roth IRA, which basically allows you to exceed the $5500 limit in Roth contributions. Sometimes called the “Mega Backdoor Roth”.
The fact that all of this hoop-jumping is still in place is insane, but here we are.
My kids both have Roth IRAs (not the same as a 401K, I know) because right now their tax rates are crazy low - and will never be lower.
We contribute a combinatoin to our 401(k) - mostly non-Roth, some Roth. I’d prefer to tilt more to the Roth side but for various reasons, our current cash flow needs mean we need to save some tax money now.
The OP should probably not convert regular IRA funds to Roth, given age - there’s less time for that money to grow tax-free, and you’re probably in an income bracket that the taxes on conversion would be insane.
Of interest: employer retirement plans are better protected from bankruptcy and lawsuits than IRAs are. So if you’re deciding whether to put more in your employer’s account putting it into an IRA, that’s a consideratoin.
Ah yes, this was something I forgot to mention, and should explicate further.
There is a limit on the dollar amount you can contribute to any retirement account. But if you’re contributing after-tax dollars and won’t be taxed on those earnings (as in a Roth), compared to contributing to a traditional plan you’re effectively contributing more. That is, since you’re not paying tax on the money when you take it out, while the nominal amount of the money in the retirement plan is the same, you’ll have more of it after taxes. This means that you effectively get to add to your retirement contributions the tax that you pay on the after-tax earnings that you contribute. It does mean you have to have more money to be able to put that amount away, but the issue here is running into the cap of how much you can contribute. If you’re going to otherwise put the money you save in taxes by deferring the compensation into a taxable investment account, there’s no reason to not put it into a Roth plan instead if you can.
Gotta correct one thing: With a Roth (IRA or 401(k) ), earnings are never taxed.
BUT - you can contribute after-tax earnings to regular IRAs / 401(k)s… and if you do THAT, the earnings are taxed when you take them out.
Compare: you put 2,000 aside in a Roth, another 2,000 aside in a traditional IRA using pretax money, and 2,000 aside in a traditional IRA using post-tax money.
20 years from now, each has grown to 10,000 dollars.
You cash it all in. You’ve got 30,000 dollars in your pocket.
Your taxable income is 18,000:
Zero from the Roth
8,000 from the traditional IRA using post-tax money (10,000 - the 2,000 you’ve already paid tax on)
10,000 from the traditional IRA where your contribution was pretax.
I was a college prof and we have this thing called TIAA. You put some money into it pre-tax, matched up to a certain point in many cases by the college. The traditional thing to do when you retire is convert it into an annuity for use as your pension payment. But you have other options. Note with the annuity you don’t have to worry about RMD. (Which I am not happy about the way that works.)
I tried checking to see what the max. limit on contributions/year are but got lost in the forest of 401(zzzzz)s. But it had to have been fairly high. Certainly much higher than the IRA limits.
We were so good at putting stuff into tax-deferred savings that our marginal rate now isn’t all that great. Esp. when you figure the penalty of tax on SS. But I keep telling myself: “That’s just the marginal rate. That’s just the marginal rate.”
The stuff we put in would have been taxed at the marginal rate. Most of the stuff we take out is taxed at below marginal rate.
Some people argue the income tax is still unconstitutional despite the 16th amendment. You can make a little more plausible argument that a VAT (likely IMO the US will eventually have one like almost every other comparable country, plus the income tax) is unconstitutional but only a little more plausible. And a VAT could be crudely ‘progressived’ with a rebate to outright low income payers but still wouldn’t hit very well off people any harder than just OK-off people.
The other quite plausible shift in taxation though is to a progressive consumption tax via the existing income tax. That would work by allowing unlimited deductions for net money saved. IOW all savings would get the tax treatment of Traditional IRA/401k upfront as well as the investment income (if and only if it was rolled back into the account). Then income after this deduction, the person’s consumption (whatever is earned but not saved is consumed), could be taxed at quite high marginal rates for upper income people with less criticism that it was a disincentive to capital formation since savings is exempted. But retired people drawing on a Traditional IRA/401k aren’t saving unless quite well off. In fact the leading political argument against a progressive consumption tax is that well off retired people vote disproportionately to almost any other group. Otherwise there are things for both left and right to like about it, and economists pretty much across the board agree it would be more efficient. But somehow a huge unfunded liability of US entitlements has to be paid for, and cutting our way to that is not IMO very plausible, maybe reining in the benefits for already quite well off people, but higher taxes seem inevitable sooner or later.
The basic US fiscal outlook tells you taxes are more likely eventually to be higher than lower compared to now but predicting the details is impossible. The Roth does in general tend to protect you against a higher tax environment in the future, unless the tax free nature of the Roth is also repealed on a ‘means tested’ basis which isn’t inconceivable either.
I am with TIAA too. I love the flexibility in my former employer’s plan (TIAA stuff plus very low fee Vanguard funds).
I have two types of TIAA accounts, a 401(a) and a 403(b). The contribution limits are the same as 401(k) - $55k per year from employee + employer match - for each so $110k total. The limit for just employee money is $18.5k. Over 50 and you can tack on $6k per account.
You can make a little more plausible argument that a VAT (likely IMO the US will eventually have one like almost every other comparable country, plus the income tax) is unconstitutional but only a little more plausible. And a VAT could be crudely ‘progressived’ with a rebate to outright low income payers but still wouldn’t hit very well off people any harder than just OK-off people.