Contributing to Traditional vs. Roth 401 (k) in 2018

[joo2lo]

As a high income married couple, filing jointly, making about 360k/year, no house yet, more likely going to take the 24k standard tax deductionIn at the end of the 2018 tax year... In light of the new tax reform and new tax brackets most of our money will be in the much lower tax brackets. My estimates are that we will have an effective tax rate of around 17%. My question is should we continue to make contributions to our traditional 401(k) for the tax desuctions or should we make Roth 401(k) contributions and take advantage of the lower tax brackets our money will be taxed at? Any incite or advise is greatly appreciated. Thanks!

[cgossage]

You will want to look at your marginal tax rates and not your average.  Your marginal rate will be at 32% by my calculations.  At those rates I would still max your traditional 401k contributions and max out your Backdoor Roth contributions as well.

[joo2lo]

Got it. Thanks!

[jfoxcpacfp]

I recommend you talk to your CPA about running a tax projection for 2018 to help you make your decision. There is no one-size-fits-all answer.

I lean toward Roth contributions unless you will actually actually invest the money saved in a taxable account. Unfortunately, most people saving for retirement don’t do this and rely on math rather than human behavior. The result is that you are in worse shape at retirement than you would have been had you contributed to the Roth 401k.

If you’re not sure, and you’re not working with a CPA who can prepare a tax projection, just split 50:50 pre-tax:Roth.

[joo2lo]

We had gotten a one time financial plan from a CPA early 2017. We have been following that plan since and currently max out both our Traditional 401(k)'s, backdoor Roths, and put about $11k annually into a joint taxable account. I was just wondering if recommendations changing contributions to a Roth 401(k) instead of a Traditional 401(k) in light of the new tax reform would be advised.

[Peds]

Do you pay state tax?

Still though would cont trad.

[joo2lo]

Yes, we do pay state taxes. We live in California. I'm assuming considering this fact a Traditional 401(k) would be the way to go?

[Peds]

Yup. Hard to beat 9.3% return...

[joo2lo]

Thank you for the advice!

[GasFIRE]

It sounds like you are early in your career. I'm much closer to the end of my practice than the beginning so I can add some long-term perspective. Good job on maxing out your pre-tax traditional 401k's and the back door Roth, but does your practice also max out the employer contributions like matching contributions and profit-sharing (these are also pre-tax)? If it does, you will be pleasantly surprised at how fast it can grow. As your account accumulates, at some point in your career you may have "enough" (the blog post today on enough is a great read on this subject). Many financial sites have RMD calculators that project how much you'll have to take out in the future and I would do this calculation periodically throughout your career. If it reaches your magic "enough" RMD, I would consider switching to using the Roth over the traditional. More traditional will keep increasing your future RMD whereas the Roth accounts give you more flexiblity for your future since you control whether and when you use it, you're not required to do so. This is my holistic approach to retirement savings. I'll leave it to the accountants/CPAs to do the traditional vs Roth $$ projections.

[Tabaxus]

I struggle with this every year. I do invest the tax savings--at my marginal rate, I basically view the tax savings of the traditional 401(k) as funding my backdoor Roth IRA contribution plus some, as I'm teetering between the 32% and 35% marginal bracket on FIT, plus 4.9% for SIT (traditional 401(k) may push my marginal bracket down to 32%, but just barely).

Where I've started to struggle is the RMD question, the point that you have "more" money in a Roth 401(k), and the fact that I really do believe I'm likely to have higher taxes when I'm older--from a macro perspective, I just don't see how the country is going to avoid significantly increasing taxes on everyone.  I'm in my early 30s.  Plenty of time for that to happen.  Of course, the tax-free growth of Roths could be retroactively limited or cut off, too.

I have yet to pull the trigger and switch to Roth, but it's something I struggle with every year.  Basically too late for me to switch this year--I front-load my 401(k) contributions, and so I've already contributed $11k, though I guess I could do $7,500 into a Roth this year, if I wanted to split things up.  My CPA says I'm insane for even considering it.

[joo2lo]

Thank you so much for this incite. I admit after reading your reply it did help give me a broader perspective and got me thinking. On top of maxing our 401(k)s, the backdoors, and taxable account my employer will provide a defined contribution plan on my third year anniversary which I will be automatically contributing 100% to ($35500/yr pretax dollars) as well as a pension plan that I would be 100% vested in on my tenth year anniversary (also pretax dollars). I ran some estimates if I retired at age 60 and it seems like that a lot of my retirement income will be taxable and would easily push me into the higher tax brackets. Estimating the pension plan payouts alone would push me into the upper end today’s current 22% tax bracket! Considering this I am now contemplating to turn one of our traditional 401(k)s into a Roth 401(k) during my third year which would still allow for enough deductions to still land into the 24% marginal tax bracket. On top of that I looked into other options to reduce your tax bill in early retirement such as traditional 401(k) rollover and subsequently converting to Roth from ages 60-70 (before RMDs kick in) which I plan on doing.

[DMFA]

joo2lo wrote:

my employer will provide a defined contribution plan on my third year anniversary which I will be automatically contributing 100% to ($35500/yr pretax dollars) as well as a pension plan that I would be 100% vested in on my tenth year anniversary (also pretax dollars).

Click to expand...

Are you sure that's not a defined *benefit* plan?  401(k) and such are defined contribution plans.

[joo2lo]

Yes. Per my workplace's Schwab website: "The Keogh Plan and 401 (k) Plans are defined contribution retirement plans."