Roth 401k

[Coastalinvestor]

Hey everyone,

I am a partner in my medical practice & I have my individual 401k with Vanguard.  I was advised by my friend who is a private wealth manager to open both a Roth 401k & traditional 401k with Vanguard and contribute the maximum employee contribution (18.5k) to the Roth side and maximum employer contribution (36k) to the traditional side.  My accountant agreed with this plan but I read some threads on bogleheads where people were generally against making contributions to the Roth side.  Just wanted to see if this was generally thought to be the best long-term strategy or if I should just contribution everything to the traditional side.  Thanks!

[jfoxcpacfp]

This is a personal decision and I would defer to the long-term tax projections you have worked on with your CPA. Most HIPs in top earning years are going to go with the pre-tax (traditional) 401k contribution simply for the tax deduction. However, if you have a low income year for some reason (spouse out on maternity leave and you take a couple of months off, in transition to another partnership, whatever), that might be a good time for the Roth-k. I don't see contributing to the Roth, just so you'll have some there in your high income years, just doesn't seem to make financial sense.

[Peds]

depends on taxes (like everything). are you in a state with taxes (CA, etc)?

are you doing a backdoor rIRA already?

for the majority, trad 401k is the correct move with roth conversions later like jfox said.

past a certain amount, then yes roth is also fine as you have amassed wealth.

the employer part is always trad so that you cant change.

[Coastalinvestor]

In South Carolina - state income tax is 7%.

Doing backdoor IRA already.

Interesting input - will have to review with my CPA - thanks everyone.

[cgossage]

Coastalinvestor wrote:

In South Carolina – state income tax is 7%.

Doing backdoor IRA already.

Interesting input – will have to review with my CPA – thanks everyone.

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7% is pretty high.  100% traditional looks pretty juicy at that tax rate.

[Dicast]

I think the decision should be based on what you believe your tax rate will be in retirement. Marginal rate now vs then. I have been thinking about this recently as my wife has a roth 403b option and we are currently putting over 100k back tax deferred each year. Not sure on the answer yet.

[spiritrider]

Coastalinvestor wrote:

I am a partner in my medical practice & I have my individual 401k with Vanguard.

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On a side note. For your protection, can you verify something?

Is the income you are using to justify the "adoption of"/"contributions to" a one-participant 401k from your partnership K-1 or self-employment income from a non-controlled group separate business? IRS regulations for employer retirement plans prohibit the former.

"For purposes of section 401, a sole proprietor is considered to be his own employer, and the partnership is considered to be the employer of each of the partners. Thus, an individual partner is not an employer who may establish a qualified plan with respect to his services to the partnership."

[jfoxcpacfp]

spiritrider wrote:

“For purposes of section 401, a sole proprietor is considered to be his own employer, and the partnership is considered to be the employer of each of the partners. Thus, an individual partner is not an employer who may establish a qualified plan with respect to his services to the partnership.”

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Good catch, totally blew by that.

[DMFA]

Coastalinvestor wrote:

I am a partner in my medical practice & I have my individual 401k with Vanguard.

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...so you have a separate 401(k) from your partnership than you do from your individual 401(k), right?

Employers can't make Roth contributions for their employees anyway, so if it were coming from one side, it would be your employee elective deferrals.

[litovskyassetmanagement]

spiritrider wrote:

Coastalinvestor wrote:

I am a partner in my medical practice & I have my individual 401k with Vanguard.

Click to expand…

On a side note. For your protection, can you verify something?

Is the income you are using to justify the “adoption of”/”contributions to” a one-participant 401k from your partnership K-1 or self-employment income from a non-controlled group separate business? IRS regulations for employer retirement plans prohibit the former.

“For purposes of section 401, a sole proprietor is considered to be his own employer, and the partnership is considered to be the employer of each of the partners. Thus, an individual partner is not an employer who may establish a qualified plan with respect to his services to the partnership.”

Click to expand...

What OP probably means is that this is a self-directed brokerage account, hopefully titled correctly in the name of the plan (if it is not, it is open for creditor claims, and not titling SDBAs correctly is actually quite common).  Many docs treat those as solo 401k plans where anything goes.  Far from it.  Plan sponsor is 100% on the hook for any investments/fees in such accounts, so if docs buy bitcoin, the plan sponsor can be liable for penalties in case of an audit.  There often admin mistakes made by the docs because they are the ones handling everything in the account, yet another strike against the plan sponsor.

Same goes for having huge fees in such accounts.  The doc can then sue the plan sponsor for allowing this to happen (if their 'adviser' who is not a fiduciary sold them a variable annuity, for example, as plan sponsor has to oversee SDBAs).  But unfortunately, that's just how many of these plans are run.  Outside (anything goes) SDBAs, and nobody is overseeing those, while rank and file are often either stuck with a crappy fund menu, or just as bad, also have to open SDBAs (there goes the 404c compliance). Fiduciary/compliance nightmare all the way around.

Even if there are only docs in the practice, still a pretty bad idea because some docs treat SDBAs as their own personal accounts and can sometimes pull money out of those to invest in all kinds of stuff (a recent forum example: someone just pulled their money from their SDBA and invested in some crazy asset using a self-directed IRA, of all things). Ideally, SDBAs should be opened from within the plan, as they would at least be limited in terms of investments that can be purchased, though abuses can still happen, such as frequent trading that IRS/DOL still frowns upon.

[spiritrider]

Kon, what you are describing is unlikely in this case because of the terminology used. There are smaller plans that allow each participant to open investment only accounts at the custodian of their choice. Typically this is either at TD Ameritrade, Fidelity, etc..., but not Vanguard because they no longer offer such accounts.

Vanguard stopped offering such accounts several years ago. Vanguard limited such plans to a single pooled account for all participants from that plan wanting to use Vanguard as a custodian. The TPA had to provide the record keeping for that pooled account. To best of my knowledge there is currently no way to open Vanguard individual traditional 401k and Roth 401k accounts as described by the OP except under their Individual 401k plan.

We will just have wait for the OP to clarify.

 

[Coastalinvestor]

Thanks, everyone.  For clarification we are a group of 3 physicians and we all have our own S-corporations (pass-through entities).

The account that I am referencing is an individual 401k/solo 401k.

I emailed my accountant yesterday and this is what he said:

"If tax rates are the same when you retire as they currently are, then you are correct that you would save more tax on the amount you are contributing by doing 100% into the traditional now, and taking the deduction while you are at the highest tax rate.

However, with the roth growing tax free, all your earnings over the years will be tax free when you retire.  With a traditional, all the earnings would be taxed at your ordinary rate when you take them out.  I anticipate the tax savings on your roth earnings to outweigh the tax rate cut you would get if you went 100% traditional."

 

What do you think about his advice?

[litovskyassetmanagement]

spiritrider wrote:

Kon, what you are describing is unlikely in this case because of the terminology used. There are smaller plans that allow each participant to open investment only accounts at the custodian of their choice. Typically this is either at TD Ameritrade, Fidelity, etc…, but not Vanguard because they no longer offer such accounts.

Vanguard stopped offering such accounts several years ago. Vanguard limited such plans to a single pooled account for all participants from that plan wanting to use Vanguard as a custodian. The TPA had to provide the record keeping for that pooled account. To best of my knowledge there is currently no way to open Vanguard individual traditional 401k and Roth 401k accounts as described by the OP except under their Individual 401k plan.

We will just have wait for the OP to clarify.

 

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Yes, OP's description makes it clear, this can be classified as a solo 401k, but if it is, and if it uses a solo 401k plan doc, that would be a bad idea.  I'd rather have a custom plan doc, and a TPA.  If they actually have an I401k at Vanguard, that has tons of limitations I would rather avoid (such as incoming rollovers, Roth conversions, etc), and also using only investment shares of Vanguard funds.  This is at least 10 bps in cost, and I would rather hire a good TPA going forward than pay this in a rapidly growing plan.

You are correct that Vanguard stopped offering a small business investment-only accounts as part of their retirement plan offering.  However, Vanguard still has VRIP accounts which are trust accounts for pretty much anything.  So many practices use these as SDBAs, because that's exactly what they are. It just wasn't clear from OP's post.  I rarely see partnerships using solo 401k plans, but I often see practices with a full 401k plan using SDBAs opened at Vanguard.  So my comment related to that (which is unfortunately not only done, but done very often).

Yes, Vanguard SDBAs typically are all mixed assets, and TPAs have to track those. However, I've seen a plan that has two pooled accounts, one is for profit sharing, another is for deferrals, and I believe it is possible to have multiple SDBAs and split them in different ways.  I'm not sure what the rules are on separating various types of contributions, but it might be possible to separate Roth from tax-deferred, just like it is possible to separate profit sharing, especially if you only have several pooled accounts (believe it or not, this was a large plan too). Such older pooled plans don't allow Roth or mix it in with the tax-deferred.  But if Vanguard does it, I'm sure there are probably pooled plans that do this as well. I've seen participant-directed plans with individual SDBAs pool profit sharing for example.  There are some interesting arrangements out there, so you never know.

[jfoxcpacfp]

Coastalinvestor wrote:

Thanks, everyone.  For clarification we are a group of 3 physicians and we all have our own S-corporations (pass-through entities).

The account that I am referencing is an individual 401k/solo 401k.

I emailed my accountant yesterday and this is what he said:

“If tax rates are the same when you retire as they currently are, then you are correct that you would save more tax on the amount you are contributing by doing 100% into the traditional now, and taking the deduction while you are at the highest tax rate.

However, with the roth growing tax free, all your earnings over the years will be tax free when you retire.  With a traditional, all the earnings would be taxed at your ordinary rate when you take them out.  I anticipate the tax savings on your roth earnings to outweigh the tax rate cut you would get if you went 100% traditional.”

What do you think about his advice?

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I am in the minority here (I think) in that I agree with him. I believe doctors are going to have far more in their 401k/403b/TIRAs than they anticipate and the RMDs are going to be high (based upon our current client plans). Of course, this assumes law remains the same, which is the best we have at this time.

[litovskyassetmanagement]

jfoxcpacfp wrote:

Coastalinvestor wrote:

Thanks, everyone.  For clarification we are a group of 3 physicians and we all have our own S-corporations (pass-through entities).

The account that I am referencing is an individual 401k/solo 401k.

I emailed my accountant yesterday and this is what he said:

“If tax rates are the same when you retire as they currently are, then you are correct that you would save more tax on the amount you are contributing by doing 100% into the traditional now, and taking the deduction while you are at the highest tax rate.

However, with the roth growing tax free, all your earnings over the years will be tax free when you retire.  With a traditional, all the earnings would be taxed at your ordinary rate when you take them out.  I anticipate the tax savings on your roth earnings to outweigh the tax rate cut you would get if you went 100% traditional.”

What do you think about his advice?

Click to expand…

I am in the minority here (I think) in that I agree with him. I believe doctors are going to have far more in their 401k/403b/TIRAs than they anticipate and the RMDs are going to be high (based upon our current client plans). Of course, this assumes law remains the same, which is the best we have at this time.

Click to expand...

I'm afraid you are probably in the majority, because that's what I think as well.  Aside from backdoor Roth, I prefer to do the conversions prior to age 70 and 1/2, especially if the doc wants to retire relatively early (giving them more time to convert their tax-deferred assets to Roth).  Partial conversion might be warranted as a hedge if the account value is substantial (the longer one lives the more benefit from prepaying taxes will be realized).