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Can Traditional 401K/IRA be better than Roth as resident? (Loophole?)

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  • Can Traditional 401K/IRA be better than Roth as resident? (Loophole?)

    Assumption:
    Its commonly said Roth is better as a resident, as itll be (likely) the only opportunity left to contribute to a Roth as this door will close as an attending (too high of salary to be eligible). Roth is better also due to the assumption taxes when your retire will be higher than today, so you save money.

    Question/Loophole:
    What's to stop a resident from maxing out Traditional 401k/IRA, taking the income tax deduction now (probably several thousand a year) and subsequently resulting in a lower AGI during repayment (therefore you pay less during residency and if you're doing REPAYE you're subsidized more with 'free money').

    Then, prior to getting a much higher attending salary (or after?), do a Roth conversion. You'll get tax bombed and pay 'the same' amount of money back, however, all of the money you saved (income taxes/lower AGI resulting in greater subsidy and lower monthly payments) was worth more due to progressing inflation.

    Discuss.

    EDIT for clarity and ease of potential readers who may not want to read whole thread (taken from comment on page 2):
    1)You'll get hit with a bit of a tax bomb following the conversion (so save accordingly for this event), but the $ in taxes owed following conversion at the end of your residency will be 'less' due to inflation making that money 'less valuable' than the money you saved in previous years on taxes (that money was worth more). ex: $10,000 in taxes 4 years ago was 'worth more' due to inflation than owing $10,000 in taxes today. Did that make sense? It is hard to word.

    2) Most people convert to a private loan after residency as the rates are now cheaper than when they were in residency on an IDR, such as REPAYE. You are correct, making that conversion after you become an attending would be very costly. However, if this conversion were made prior to becoming an attending, it would be a huge benefit based on my my OP / #1 I wrote above. Someone correct me if I am wrong but, in the final 6 months (may a bit earlier, maybe later, but lets stick with this), as long as you have an attending contract in hand, private companies will refinance at a lower rate.

    So you do 2 things during your final year of residency:
    1) During the first 6 months of your final year of residency convert your Traditional to Roth (after already receiving in previous years tax deductions, lower IDR monthly payments, and taking this money and saving / investing during those years. And also the money saved in prior years being more valuable than money in the future due to inflation). Then
    2) During the last 6 months of your residency, assuming you have a contract in hand for an attending position, sign on to have your loans converted to a private loan as being on an IDR will now be financially unfavorable relative to a low rate private loan.

    In the end, for simplicity, assume you have 3 residents, all maxing out their 401k and IRA after 4 years totaling to $102,000. Resident A did 100% Roth, Resident B 100% Traditional, and Resident C 100% traditional but converted to Roth prior to attending salary. By my OP and my rationale stated above, wouldn't resident C come out the farthest ahead?
    Last edited by asdfgghk; 06-27-2021, 12:26 PM.

  • #2
    The downside that immediately jumps out to me is any gains you have made in the tIRA will be taxed as income when you convert.

    You will likely need to do the conversion the calendar year before you graduate to avoid being taxed at a higher bracket. Will that bump negatively affect you loans that year (I am not familiar with loan repayment rules)?

    I would not do the conversion after becoming an attending as the income will be taxed at your marginal rate which will likely result in more taxes overall.

    Comment


    • #3
      Originally posted by asdfgghk View Post
      Assumption:
      Its commonly said Roth is better as a resident, as itll be (likely) the only opportunity left to contribute to a Roth as this door will close as an attending (too high of salary to be eligible). Roth is better also due to the assumption taxes when your retire will be higher than today, so you save money.

      Question/Loophole:
      What's to stop a resident from maxing out Traditional 401k/IRA, taking the income tax deduction now (probably several thousand a year) and subsequently resulting in a lower AGI during repayment (therefore you pay less during residency and if you're doing REPAYE you're subsidized more with 'free money').

      Then, prior to getting a much higher attending salary (or after?), do a Roth conversion. You'll get tax bombed and pay 'the same' amount of money back, however, all of the money you saved (income taxes/lower AGI resulting in greater subsidy and lower monthly payments) was worth more due to progressing inflation.

      Discuss.
      The first bolded comment is not an accurate statement. In fact, I'm sure every single member of this board with significant income contributes to a Roth IRA (via backdoor) and/or has at least the option to contribute to a Roth 401k/403b today. It's important to distinguish CAN and MAY WANT TO.

      The second underlined comment is also not really accurate. The assumption isn't that taxes will be higher (i guess that could be, but I don't think people really argue that), but that you will be in a higher marginal tax bracket when you retire than you were as a resident. This is another really important point as many here (this group is a bunch of super savers) will potentially be in a higher (and sometimes significantly higher) tax bracket as a retiree vs. resident level because of RMDs.

      Then to your question - I guess the answer is maybe, but there are a ton of variables. How do you anticipate the conversion affecting your marginal bracket? How will that affect the next income verification, thus raising your payments significantly beyond what they would have been? I think I'd need to see someone model this out to convince me that it's worth the effort.

      Just to be clear in your scenario, it sounds like your goal here is to ultimately maximize the Repaye subsidy - this would suggest that you are not going for PSLF. If you are going for PSLF the subsidy is irrelevant, though payment level obviously is relevant. If not going for PSLF you should be checking your options for refinancing immediately as that's potentially a better route anyways in terms of the effective interest rate these days.

      Comment


      • #4
        Only if you're going for PSLF does this make any sense but I agree in this situation a resident should favor pretax over Roth to reduce payments - effectively an additional 10% tax break.

        Comment


        • #5
          Originally posted by wa2106 View Post
          Only if you're going for PSLF does this make any sense but I agree in this situation a resident should favor pretax over Roth to reduce payments - effectively an additional 10% tax break.
          I'd point you to the thread previously on here this week in which someone did the math for their situation and it's overwhelmingly in favor of roth - the reduction in payment level is not as big as some think it is when looking holistically at the big picture.

          Similarly, I did the math when we were in the situation and while that excel model is long gone due to that computer dying on me, the math using pretty normal assumptions was significantly in favor of doing ROTH while in residency and paying tax even if that meant paying more for student loans today.

          Comment


          • #6
            Originally posted by East coast View Post

            I'd point you to the thread previously on here this week in which someone did the math for their situation and it's overwhelmingly in favor of roth - the reduction in payment level is not as big as some think it is when looking holistically at the big picture.

            Similarly, I did the math when we were in the situation and while that excel model is long gone due to that computer dying on me, the math using pretty normal assumptions was significantly in favor of doing ROTH while in residency and paying tax even if that meant paying more for student loans today.
            As noted on the other thread, I don’t agree with this logic. What math and assumptions are you using to conclude that Roth is absolutely better during residency? I’d argue that pre-tax is still the way to go.

            Comment


            • #7
              I ran my numbers recently in MFS, PSLF, and Roth IRA contributions, to which I believe East coast was referring.

              Now, I'm sure there may be certain situations using certain assumptions where it could be better to go the traditional route...but in my particular case, which I feel is fairly typical for the whole PSLF/minimize loan payments/maximize future nest egg consideration...Roth slam dunk.

              Comment


              • #8
                Originally posted by ENT Doc View Post

                As noted on the other thread, I don’t agree with this logic. What math and assumptions are you using to conclude that Roth is absolutely better during residency? I’d argue that pre-tax is still the way to go.
                Yea, Im not sure that you were part of the thread I'm referring to. But the basic assumptions were resident tax bracket vs wealthy retiree (vast majority here are super savers - ppl going to be in the 24/32 % bracket) bracket. Another key assumption is that attendee career will all be traditional contributions. It's really a no brainer relative to lowering ones student loan payments when I built model.

                Some one feel free to show me the math that says otherwise.

                Comment


                • #9
                  Originally posted by East coast View Post

                  Yea, Im not sure that you were part of the thread I'm referring to. But the basic assumptions were resident tax bracket vs wealthy retiree (vast majority here are super savers - ppl going to be in the 24/32 % bracket) bracket. Another key assumption is that attendee career will all be traditional contributions. It's really a no brainer relative to lowering ones student loan payments when I built model.

                  Some one feel free to show me the math that says otherwise.
                  Resident has no savings. 27 years old. Married (or single) with taxable income at low end of 22% bracket, even after standard deduction.

                  Plan is to retire at 62, draw down from pretax and live off dividends for the remainder, Roth for any additional, converting up to top of 22% tax bracket. Assume die at 88. SS at 70.

                  The first dollar saved and its growth will be drawn out over time. These are the first dollars taken out in each year of retirement (or in worst case scenario all taken out in year 1 for maximum taxation). They come out at a marginal rate of 0% because of the standard deduction. $19.9k invested now grows to $212k over 35 years at 7%. Standard deduction at that time will be just under $49k. $212k gets metered out over multiple years, each year getting the benefit of the standard deduction.

                  So those initial dollars put in traditional 401k were at 22%. Let’s say they were at 12% for the heck of it. And those dollars get taken out at 0%. And you think this favors the Roth without question?

                  Comment


                  • #10
                    Originally posted by East coast View Post

                    I'd point you to the thread previously on here this week in which someone did the math for their situation and it's overwhelmingly in favor of roth - the reduction in payment level is not as big as some think it is when looking holistically at the big picture.

                    Similarly, I did the math when we were in the situation and while that excel model is long gone due to that computer dying on me, the math using pretty normal assumptions was significantly in favor of doing ROTH while in residency and paying tax even if that meant paying more for student loans today.
                    As far as I can tell, the calculations in that thread didn't take into account the taxes owed on the Roth contribution. Any comparison between Roth and traditional has to assume either lower ability to contribute to Roth (19,500*(1-marginal tax rate)) OR assume that tax savings from traditional (19,500*marginal tax rate) are invested in taxable account. Then for PSLF scenario, add in 10% payment savings to taxable account.

                    I ran quick numbers using first scenario and even gave benefit of doubt of resident at current tax level of 12% - more likely 22% so this is best case scenario for your argument. I also assumed that EVERY dollar of the pretax contributions would be taken out at 24% rate which again is very unlikely. In this ideal scenario Roth comes out ahead ($98,500 versus $94,500 post-tax dollars in 30 years assuming 6% ROR). In any other (more likely) scenario, pretax will win.

                    Comment


                    • #11
                      To compare the impact of Roth versus traditional contributions you need to consider the marginal rate.

                      It is incorrect to treat it as the first dollars out and claim they are 0% taxed. Unless you are living a very frugal retirement, your income will exceed your standard deduction. You need to consider marginal as we are just looking at Roth or traditional during residency (assume the rest of retirement portfolio will not change based on this decision). You are going to have the income from SS and other pre-tax retirement. If you have put the residency dollars into Roth, the standard deduction will still be used by your other income and take you up to whatever marginal tax rate your income dictates. If the money was placed in pre-tax it will result in a higher income and more taxation at your marginal rate.

                      You have to consider the entire financial situation at the time of retirement. Of course this is challenging as much can change between residency and retirement but one has to make a decision based on the information available.

                      Most physicians who are saving for retirement in residency will (hopefully) be maxing out all pre-tax accounts during their career as an attending. I don't think it is at all unreasonable to assume a marginal tax rate of 24% and for some people it may be even higher (and some may be lower).

                      So quick numbers. Going to use 8% return. Let's say resident A puts $10k in roth every year. Resident B put $12,800 in traditional (his marginal rate was 22% and he put his tax savings into the IRA). At the end of 5 years resident A has ~$78k and B has ~$100k. Now they both don't put anymore money in these account and retire in 20 years.

                      Resident A (roth) has ~$364k and B (traditional) has ~$466k. The $364k is free of taxes. The $466k will be income when withdrawn. If marginal rate at retirement is less than 22% B (traditional) is better. If marginal rate at retirement is higher A (roth) is better. Now if the residents were at 12% marginal in residency the numbers will tilt more towards roth.

                      Comment


                      • #12
                        Originally posted by Gamma Knives View Post
                        To compare the impact of Roth versus traditional contributions you need to consider the marginal rate.

                        It is incorrect to treat it as the first dollars out and claim they are 0% taxed. Unless you are living a very frugal retirement, your income will exceed your standard deduction. You need to consider marginal as we are just looking at Roth or traditional during residency (assume the rest of retirement portfolio will not change based on this decision). You are going to have the income from SS and other pre-tax retirement. If you have put the residency dollars into Roth, the standard deduction will still be used by your other income and take you up to whatever marginal tax rate your income dictates. If the money was placed in pre-tax it will result in a higher income and more taxation at your marginal rate.

                        You have to consider the entire financial situation at the time of retirement. Of course this is challenging as much can change between residency and retirement but one has to make a decision based on the information available.

                        Most physicians who are saving for retirement in residency will (hopefully) be maxing out all pre-tax accounts during their career as an attending. I don't think it is at all unreasonable to assume a marginal tax rate of 24% and for some people it may be even higher (and some may be lower).

                        So quick numbers. Going to use 8% return. Let's say resident A puts $10k in roth every year. Resident B put $12,800 in traditional (his marginal rate was 22% and he put his tax savings into the IRA). At the end of 5 years resident A has ~$78k and B has ~$100k. Now they both don't put anymore money in these account and retire in 20 years.

                        Resident A (roth) has ~$364k and B (traditional) has ~$466k. The $364k is free of taxes. The $466k will be income when withdrawn. If marginal rate at retirement is less than 22% B (traditional) is better. If marginal rate at retirement is higher A (roth) is better. Now if the residents were at 12% marginal in residency the numbers will tilt more towards roth.
                        I don’t agree with how you are looking at it. Question to highlight what I’m talking about. Attending is 60 and has a high 401k balance. Is there any scenario where you think doing a Roth 401k is better, assuming no tax law changes?

                        Comment


                        • #13
                          Please help me understand what in particular you don't agree with. It is math.

                          So a scenario building off the previous numbers: attending is 60 and single with $8million in tax deferred money (contributed $150k profit sharing and cash balance plan every year) and has his resident either traditional or roth 401k. He takes roughly $300k from his attending tax deferred 401k. His marginal rate is 35%. So the $364k roth is worth more than $466k traditional as $466k * (1 - .35) = $302k. (see prior post for the $364k vs $466k).

                          To simplify if marginal tax rate in retirement is greater than marginal tax rate as resident than it is better to do roth as a resident (from income tax point of view ignoring questions of loan repayment or other programs).

                          Comment


                          • #14
                            Originally posted by Gamma Knives View Post
                            Please help me understand what in particular you don't agree with. It is math.

                            So a scenario building off the previous numbers: attending is 60 and single with $8million in tax deferred money (contributed $150k profit sharing and cash balance plan every year) and has his resident either traditional or roth 401k. He takes roughly $300k from his attending tax deferred 401k. His marginal rate is 35%. So the $364k roth is worth more than $466k traditional as $466k * (1 - .35) = $302k. (see prior post for the $364k vs $466k).

                            To simplify if marginal tax rate in retirement is greater than marginal tax rate as resident than it is better to do roth as a resident (from income tax point of view ignoring questions of loan repayment or other programs).
                            You aren’t looking at the marginal effects correctly. Look at my question above. Is there a scenario whereby you’d recommend an attending with a high 401k balance to switch to Roth contributions. If so, why?

                            Comment


                            • #15
                              I'm sorry but you are clearly looking at marginal rates incorrectly. The discussion was resident contribution to roth versus traditional IRA not converting a traditional to roth as an attending (edit: or switching to roth contributions as an attending). These are not equivalent to a resident roth contribution as tax rate will be different.

                              I've provided details answers and your response has simply been you're wrong. I am trying to help you understand (or see what I'm missing) but your response is not helpful.
                              Last edited by Gamma Knives; 06-05-2021, 09:51 AM.

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