Traditional 401k vs Roth 401k for new attendings

[ENT Doc]

mayberry wrote:

I give a talk to graduating fellows each year and wanted to discuss this as several of the fellows are joining my group in next couple years. Their fellowship does not have a 401k plan. The group allows access to the employee 401K/psp starting the second year of employment. No match but there is the option for roth. In general new docs to our group ramp up quickly within first 2 years to approximately 400K in income, but there is a step up in income which functions as a buy in to the group. I did traditional 401K but looking back I wonder if I should have done, and should recommend to the new guys, the roth 401K as there income increases over the 1st 3 years before they become partner at the end of their 3rd year of employment. The new guys are all married with children and non-employed or only partially employed spouses.

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The decision completely depends on their drawn down (tax rate during draw-down, current account balances, asset allocation, account diversification (taxable/Roth/401k), pension availability, etc).  Their current situation/benefit is known to them - $ contributed and marginal tax rate where they'll benefit from those contributions - but you haven't described that here.  What is their starting salary?  State?  It's impossible to give one-size fits all advice for this at all points in time.  However, IF they are starting out with zero to little in their 401k account the "correct" financial decision at that time is to fund the traditional 401k.  The only thing that matters is the marginal decision.  As you add dollars to the 401k this has a marginal effect across multiple future years and accounts in the future.  If you are starting at little to no balance then the initial draw-down (if assumed to be coming from the 401k) is not taxable (standard deduction assumed to still be in existence), so this is a clear win - don't pay tax on X% now, pay no tax in the future.  The decision becomes more complicated with each marginal contribution.  Others have posted here who have substantial pensions where contributing to a traditional 401k now made little sense because their tax bracket in the future was going to be catapulted higher by the pension benefit.  Same thing for when the 401k balance gets very high and required draw-down is already very high - the marginal contribution creates a marginal withdrawal at a high tax rate.  A Roth 401k is more optimal in those instances, but specifics of any given situation matter.

[mayberry]

I give a talk to graduating fellows each year and wanted to discuss this as several of the fellows are joining my group in next couple years. Their fellowship does not have a 401k plan. The group allows access to the employee 401K/psp starting the second year of employment. No match but there is the option for roth. In general new docs to our group ramp up quickly within first 2 years to approximately 400K in income, but there is a step up in income which functions as a buy in to the group. I did traditional 401K but looking back I wonder if I should have done, and should recommend to the new guys, the roth 401K as there income increases over the 1st 3 years before they become partner at the end of their 3rd year of employment. The new guys are all married with children and non-employed or only partially employed spouses.

[jhwkr542]

No, but use the irs online calculator. There's a place for you to add a previous job, which is what you need. For your residency or fellowship, that income had tax withheld thinking you were only making a resident's salary for the whole year so that tax was underpaid. You need to make up for lost time, or be prepared to own a pretty penny at tax time. You won't owe a penalty. Just be sure to have some cash handy when you file or try to adjust accordingly.

[Peds]

No.

[Wash]

jhwkr542 wrote:

@wash, it sounds like you’re confusing tax withholding on your paycheck to tax bill. Whatever% is withheld from your paycheck is essentially a guesstimate about what your tax liability will be. Whatever is withheld is not the same as your marginal tax rate. You’ll figure that when you get your w-2s. You can try to calculate it and get close, but I think that’s what you’re confusing. You average in your taxes by filling out your w-4 appropriately. The IRS has a calculator that may be worthwhile for you.

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Oh ok, I was confused about that.

I may have filled out my W-4 incorrectly then. Am I supposed to count my completed residency/fellowship and my current job as multiple jobs even though I did not hold them concurrently?

 

And the Betterment calculator mentioned above is recommending that I contribute to traditional 401k, so maybe I'll just stick with what I have set currently...

[Peds]

You're in Cali? Easy, traditional for everyone including this year.

[jhwkr542]

@wash, it sounds like you're confusing tax withholding on your paycheck to tax bill. Whatever% is withheld from your paycheck is essentially a guesstimate about what your tax liability will be. Whatever is withheld is not the same as your marginal tax rate. You'll figure that when you get your w-2s. You can try to calculate it and get close, but I think that's what you're confusing. You average in your taxes by filling out your w-4 appropriately. The IRS has a calculator that may be worthwhile for you.

[welker]

If you can, why not max both?

[Wash]

I have a similar question and didn't want to make a brand new thread so I'm bumping this one...

I just transitioned from fellowship to first attending job. I understand the concept for this year being a good idea for a Roth 401k instead of a traditional 401k since the first half of the year I was making a fellow's salary at a lower tax bracket

However, now I am getting hit with that 33% tax for my attending paycheck. Logistically how do I "average in" the first half of the year to save on taxes since the contributions I would make now to a Roth 401k already have been taxed 33%? Is there something on the tax forms that will account for this? Sorry if it's a dumb question  :cry:

(didn't have a 401k while I was a fellow. Started my first 401k as an attending, it is currently a traditional 401k but I can switch over to making roth 401k contributions anytime if I want)

[StarTrekDoc]

One key benefit folk forget:  Roth IRA (and rolled 401k to IRA at retirement/leaving) are NOT SUBJECT TO RMDs and roll over on inheritance and RMDs for life of that beneficiary.    This is a key crucial issue on inheritance and something to think about if you're fortunate enough to be leaving retirement dollars to the next generation with superb planning.

 

[q-school]

when we started out as attending many many many years ago, we ran through the scenarios with multiple financial advisors.  they all recommended going in traditional.  that may or may not be somewhat related to the hope of them managing higher amounts of money, but they universally felt the tax drag was too much to sacrifice versus time and growth opportunities.

as the years passed, tax rates changed, including corporate gains.  incomes changed.  our jobs changed and state tax rates changed.

i think it is very very hard to accurately predict that far into the future.

fwiw, most of my senior partners who are good savers, still find themselves in fairly high tax brackets in retirement, so it may not be wholly accurate to assume you can tax plan around it unless you really do retire young.

good luck!

i think sometimes we lose sight of the forest for the trees.

imo, saving aggressively and working hard will go a lot farther than micromanaging investments and marginal tax arbitrage.  ymmv.

 

[RosieQ]

I agree with the above. Go with the tax deferred option. You can take a sabbatical year or two outside of California and do conversions in larger rollovers to help with tax arbitrage.

[jtse106]

Thanks for the suggestions everyone, will definitely look into the Betterment calendar.

One thing I forgot to mention is that I live/work in CA which has some of the highest taxes in the nation. I assume the suggestions posted above would still hold true?

Thanks!

[ajm184]

Betterment has a calculator that you can input the metrics you have for the traditional 401K/ROTH 401K choices.  Your annual income and corresponding tax rate make make a tax deferred 401K the likely choice based on math.

Assuming you work 25 to 30 years, continue to maximize tax deferred contributions etc., get decent returns, you'll likely have a tax deferred savings that will be multiples of the non-taxable accounts.  At retirement, you may still find yourself in the highest tax bracket anyway because your RMD's will then be taxable. I like the idea of trying to even out the tax-deferred versus non-taxable retirement savings, though in your case it does not make sense mathematically to eat a current 33% marginal tax rate unless future tax rates are going to be much higher, and there is no political/legislative indication of higher future rates in the US.

[jfoxcpacfp]

For this year, assuming 1/2 year at low income and a few months at high, I'd go with the Roth option and consider changing when you have a full year of attending income. Your g.f., otoh, is in the 28% bracket. I'd be tempted to go for the Roth and then change if and when you marry. Our projections for many dual-professional couples are showing RMDs of $500k and up and I'm not expecting that to be taxed at 15%, even 20 -30 years into the future, but it's just a guess and not exactly educated at that. A split between the two might be a wise decision. Or it might not be - we really don't know.

I happen to be a contrarian in this area and believe, where possible, to fill up as much tax-free space as you can afford. I will also recommend conversions during bears and market corrections and advise clients accordingly to be prepared to pay some taxes in those years if they want to take advantage of the opportunities.