I understand your investment has done well. Now take that same 150k, plus the money you had to pay on taxes to convert it (perhaps 150k times 30% = 45k) and then that 860k would now be 1.1 million instead (actually more since money was pulled from it). So, you’d have 28% more money now as a base amount. If you pulled money out and your effective tax rate was less than 28% you’d be ahead right?
In our situation, we borrowed the money to convert it. I’d agree that 45K was about what the taxes were, very painful. Fortunately we borrowed at a very low interest rate. In retirement, our tax rate is not low. We get pensions, and last year we pulled a fair amount of money out of our 401Ks to purchase land. Paid taxes at the 35% rate. Our tax rate will likely never be low because of our pensions, and then add social security and eventually RMDs. Roth funds give us tremendous flexibility if we get weary of paying taxes. And I think tax rates will go up, not down.
But I’m not encouraging people to convert and pay the taxes if the taxes are punitive. What I’m encouraging people to do is invest in Roths right now if there is any way that they can. Backdoor Roth and mega backdoor Roth, find the money if you can.
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I really like the lightbulb going off in kid’s brain when trying to get across financial concepts. I will have the chance with DD2 in July when she is home for a wedding.
I got a free copy of The Epoch Times (Dec 27 2023 - Jan 2 2024) which had an article under ‘viewpoints’ - article on Charlie Munger (the Architect of Berkshire Hathaway) who died Nov 28, 2023 (33 days before turning 100). The article focused on several areas of ‘wisdom’ - live within your means; learn how to invest; keep it simple - and be patient; understand the importance of incentives; manage your character closely - and reject envy.
The ‘living within your means’ probably is one to really pass along early to children and grandchildren; many Americans find it difficult to practice. “Recent surveys show that roughly a third of U.S. households making more than $150,000 per year say they won’t be able to pay off their credit card balances this year. With the average interest rate of a credit card currently hovering at about 27.81 percent, credit card debt stands to be a major financial hurdle for countless families already struggling under price inflation.”
I thought some of you may be interested in what Warren Buffett had to say about Charlie Munger and Berkshire Hathaway printmgr file (berkshirehathaway.com)
I believe one advantage you have with Roth is you do not have to pay taxes on it once the money is moved into Roth, and that includes capital gains and investment income. There is no tax when you withdraw. Whereas 401k you would get taxed at your current rate when you do a withdraw, so in essence you would get taxed on any gains and income.
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So that was my discussion with my youngest son, actually my two youngest sons. They said they would not max out their 401k contributions if they went with a Roth 401k so they see maxing their traditional 401k with more money now with many more years of growth as better than less money now and lower taxes later. I’m a little conflicted because I get that there are no taxes on the gains with Roth, but you have control (with the exception of the RMD) of how much you want to actually take out when you retire. Is it better to put more in now…switch to Roth in your mid/late 30s, but of course that is when you are getting into the higher earning (although both are relatively high earners for their age). All that to ask, is it financially wiser to put more money in your 401k early for growth by deferring taxes until retirement or less money saved now for tax free retirement - or a sweet middle spot?
Something else to consider in the Roth vs traditional argument is what happens when one spouse dies. With traditional, the person still alive has to take RMD on the money from both spouses, which can push tax rate up significantly.
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In my opinion it is better to put money in the Roth at an earlier age when income is lower than at a later age when income is higher. It’s also advantageous to have that longer timeline of tax free growth. That’s what I’ll be preaching to my sons.
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When one spouse dies, and tax rates may get pushed up with RMD money from both spouses - honestly, can probably have that be a ‘wash’ with continuing living expenses for one versus expenses for two.
But taxes are a factor with decisions - pay upfront and have Roth IRA, or have more go into 401k and pay deferred taxes on all money coming out when it comes out. At this point, we are only converting a very small portion of 401k to Roth IRA annually. We plan to leave inheritance to DDs/Gkids (unless catastrophic health care needs or long debilitation), and however the funds need to be spent down in the 10 year period with associated tax payments, money should be there to do so.
We can’t control inflation, and that is the real kicker on having enough money in retirement. Here is from Warren Buffet - He has warned about the pernicious effects of inflation: “The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5 percent passbook account whether she pays 100 percent income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5 percent inflation.” — Buffett, Fortune (1977).
Another quote from WB, in his November 1999 Fortune article, he warned of investors’ unrealistic expectations: “Let me summarize what I’ve been saying about the stock market: I think it’s very hard to come up with a persuasive case that equities will over the next 17 years perform anything like—anything like—they’ve performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate—repeat, aggregate—would earn in a world of constant interest rates, 2% inflation, and those ever-hurtful frictional costs, it would be 6%!” — Buffett, Fortune (1999). Very interesting looking at Berkshire’s performance vs the S& P 500 (detailed on the last page of the 2024 annual letter to investors).
Some on this thread are actively managing their funds, while others are using index funds (or some combination). I also need to show DD how having the funds in good places and then have patience…
DH and I do need to meet with a tax advisor when we do some work on ‘estate planning’. We keep kicking that can down the road a bit…
It is nice to have the diversity of Roth funds. In retirement, you don’t always know what you’re going to need to pull out of IRA/401K funds, and if you have both, you can choose and manage your tax rate. A while ago when the market was down, I changed some funds around in our 401Ks. Kept the same balance of funds overall, but made sure the Roth was all the more aggressive index funds.
Now that my father is deceased, my mom is paying a higher tax rate than ever, having to take his RMDs among with hers. They also have a substantial amount in a brokerage account, which I would say is rather stupid, since they had no Roths (but likely they didn’t have that option long when they were working). You should always put your money in a Roth before a brokerage account, never have to worry about what you trade, paying tax on dividends or selling things.
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My vote is for the Roth 401K now, even though your sons will not be able to contribute as many dollars to the Roth 401K as they would to the pre-tax 401K, although I understand that can be a hard sell.
Keep in mind that the current tax rates are scheduled to reset at the end of next year. That could change…but for now, it’s another vote in favor of funding the Roth 401K.
I could see switching to all pre-tax 401K once one hits a higher marginal tax level, which would then provide a mix of 401K and Roth monies.
Also, you commented about the Roth RMD…AFAIK, Roth accounts only have RMDs on inherited accounts. A person who inherited a Roth account pre-Secure Act has to take RMDs based on the Uniform Life table, but Roths inherited post-Secure Act must be emptied within ten years. RMDs are tax-free in both instances, but as of now, no RMDs on one’s own Roth.
Now, the trouble with any of this planning is that the government could change the rules.
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Ditto concern about the government changing the rules. Tax rates? Who knows. RMDs? Another question, who knows. Government confiscation of 401Ks? That’s a scary thought, but I can see why one would also prefer to have personal IRAs. Company confiscation of 401Ks, that’s another disturbing thought. My most likely scenario is the demise of Roths, so we always wanted to contribute while we could, mingled with much higher tax rates.
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But the longer timeline of tax free growth seems to push in favor of 401-k, so that the amount that would have been paid in taxes today will grow over the longer period rather than lost to the government.
I think of the Roth piece as building flexibility on withdrawals to manage the overall tax obligation in retirement.
But in terms of the early investor, I’ve always been of the impression (and advice) that the magic of time makes maxing 401-K contributions the first priority, then Roth, then IRA.
Am I wrong?
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You’re kind of mixing it up, since 401K and IRA can be Roth or non Roth. And not everyone has access to a Roth 401K, depends upon the company you work for.
I think the priority is making sure you contribute whatever your company match is first, to not lose that money, whether it is Roth 401K (if available) or non Roth. And certainly if you’re at a low tax rate and don’t need the tax break, the Roth is the best option.
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Not mixing it up. I just use ‘401-k’ as the general reference for pre-tax qualified retirement savings. 401-k Roth is, as you say, a plan feature. But people can have access to Roths outside of their company-sponsored plans.
Agree about the match. That’s a no brainer. Free money is free.
But in terms of the long-run investment return strategy, the rule of thumb as its always been presented to me is to invest the money you would otherwise pay to the government today, and shield as much of it as possible. Then do Roth (after tax), then do regular IRA.
But the Roth is interesting because it gives you a mix of taxable and tax-free withdrawal options in retirement so you can manage your taxes more precisely. But on the main goal is always to make “the number” as large as you can get it, and that would suggest investing tax dollars early so they can grow.
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Not all employers offer a Roth 401(k) option. Only recently this became more common to have a Roth option.
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Don’t forget, the tax brackets get cut in half as a single, i.e., marginal brackets increase at teh same retirement income. For example, the marginal rate of a retired couple MFJ at 24% tops out at $383k (retirement income). The year after a spouse dies, the surviving spouse with the same income is now at the 35% bracket.
The point is to factor this into yoru financial planning. RMD’s don’t stop, but the tax bracket can skyrocket.
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Ok, just to level set (because I’m getting confused):
Most companies offer a 401-k (or equivalent) retirement plan. These are qualified plans that are regulated by ERISA. I’m not talking about the supplemental plans for high earners. Just 401-k qualified. When I say “401-k”, I only mean to refer to the traditional pre-tax savings plans whereby you contribute up to an annual limit (with catch-up contributions after reaching a certain age), and where some (now many I think) employers match dollar for dollar with your contributions up to a specified %.
Some 401-k plans offer the ability to contribute after-tax money into a Roth that is administered under the same plan. That feature, if it’s there at all, varies by company.
Then there is the Roth IRA that you can open up at any brokerage firm or other custodial account sponsor. I think the plan Roths and the Roth IRAs work the same way. Are they different?
Am I missing anything?
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I don’t know if that rule of thumb is something that fits for everyone. If you have a fairly low tax rate and your company offers a Roth 401K (like Bunsen says, not available to everyone), why would you not utilize that option? If you’re only paying 10% tax rates or something like that, why not pay that and shelter for eternity?
And after that, sure, people could choose to invest in an IRA, but if you max out your Roth IRA, I’m not sure you can also do a non Roth IRA?
This makes it sound like the single surviving spouse will not have the tax bracket cut in half…it will actually…increase.
That I don’t know, but I think you’re right. I think if you max the Roth, you can’t also contribute to an IRA. Or maybe you can. Hopefully someone can answer that question.
I hear you about the benefits of a Roth. Totally get it. And I believe you can max Roth and max 401-k pre-tax. Those limits are separate (at least I hope so because I’ve been maxing them both for years … the Roth through IRA conversions). But if you’re young and choosing between incremental contributions to pre-tax and Roth, I would think it’s a pretty high hurdle to clear before you choose to direct pre-tax money to an after-tax account. That tax money instead of being paid to the government is instead working for you for all those years. Tax planning is what distorts that decision tree, but to me, the younger you are, the higher the premium you put on your most important variable of time and you get that money working now.
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