Roth 401(k)

This is generally a better deal than a regular 401(k), right?

naturallight Wrote: ------------------------------------------------------- > This is generally a better deal than a regular > 401(k), right? if you think taxes will be higher when you retire then yes. I’d shoot for a mix, and plan to convert much of my traditional 401k to roth in 2010 with the roth conversion. I just wish most of Bush’s tax breaks are still around in 2010.

I would go for the Roth any day of the week.

Nice deal as long as you are eligible and don’t exceed the income limitations.

>> Nice deal as long as you are eligible and don’t exceed the income limitations. No income limitations. says: It is important to note however that Roth IRAs and Roth 401(k)s and Roth 403(b)s are not exactly the same. The big difference, and it’s an extremely important one, is that the new Roth 401(k) and Roth 403(b) plans are available to a much larger group of people. Roth IRA contributions are subject to adjusted gross income (AGI) limits. For instance, in 2007 they are only available to married couples filing jointly with an AGI of less than $166,000, single individuals with an AGI less than $109,000, and most married individuals filing separate returns with an AGI less than $20,000. These restrictive AGI limitations (which are indexed for future inflation) do not apply to the new Roth 401(k) or 403(b) plans, which means higher income individuals and couples can gain entry into the tax-free Roth environment.This change provides an unprecedented ability for employees to expand or in some cases begin to benefit from investments that will grow tax-free. The 2007 401(k) and 403(b) employee contribution limits are $15,500 (or $20,500 if you are 50 or older) per year. Here’s another link: Makes the interesting prediction that tax rates must rise to pay off deficit, so any plan (such as Roth) which allows you to pay tax now will save in the long run. But even without that belief in many (some planners say most) circumstances you can benefit (no pun intended!) with the new account.

had missed the 401k portion of topic and had assumed it was rolling a 401k into a Roth IRA

As I understand it, you will be able to funnel more dollars on a pre-tax basis into Roth 401k than regular 401k. The max contribution for both are the same, but Roth is after-tax dollars whereas regular 401k is pretax dollars. So if you are paying 30% tax, you can contribute a max of $15,500 pretax dollars into regular 401k, but you can contribute a max of $22,143 pretax into Roth 401k.

I am not a tax advisor, but I think that for a certain class of people the Roth 401(k) is fantastic. I think that if you fall under the AMT (as many people in high-tax areas like NYC do) you effectively end up paying tax on the contributions you were making to your traditional 401(k) because you can’t deduct those contributions from your income for AMT calculation purposes. And then when you take the money out down the road, you’ll be taxed again. So going Roth doesn’t much hurt your current taxes, but it helps you down the road. Let me stress that I am not a tax advisor, so everything I said could be baloney.

Roth = good, although there are usually contribution limits… often you can roll over stuff when you switch jobs, paying tax on it when you do so. Analysis of likely tax increases: I hadn’t factored this into the Roth calculation. It’s very true that taxes are likely to increase to cover lots of stuff that isn’t being paid for as we go, so not having Roths taxed ever again is a big benefit. Something to consider: Tax laws can change, and there will be pressure to do so later on. However, because taxes on Roth contributions have already been paid, it will be harder to argue that the withdrawals should be taxed. Roths are probably safer than most tax sheltered stuff in this case.

Your company has to offer this, right? I can’t enroll in a roth 401k at a normal brokerage, like with an ira, correct?

Luke77: you’re right, you can only contribute to a Roth 401(k) if your employer makes that option available to you.

My understanding was that the Roth was only better if you are taxed at a higher rate at retirement. Presumably your income and thus taxes will be lower at retirement, so that would make a regular 401k better. Am I missing something?

The advantages of Roth 401k over regular 401k are the same as Roth IRA vs. regular IRA. In regular IRA and 401k you investable base is bigger but then you get hit with taxes at the end, with Roth your base is smaller but you have full growth potential for your gains without worrying of being taxed on them. So if you are still young Roth is always attractive option since you have a long investment horizon and get the full benefit of compounding growth on your gains without worrying of being taxed. So even if at retirement your marginal tax rate is slightly lower then its currently is Roth may still be beneficial. In addition, Roth IRA has a nice perk of being isolated from estate tax, so you can pass it on to your children in terms of tax-free annuity or an account that can grow tax free for them. I am not sure if the same rule applies to Roth 401k. Another benefit, from overal portfolio management standpoint, is you should have a place in your portfolio imune to taxes, to take advantage of future investment strategies not viable in taxable world. Both Roth IRA and 401k accomplish that, but Roth 401k gives this option to people in higher income brackets above Roth IRA limits. So basically the question between 401k and Roth is not a simple matter of comparing your current marginal tax vs. your future tax. But you need to consider all pros and cons together. The calculation itself is not difficult. In my opinion, Roth should find a place in everyone’s portfolio, with appropriate balance, granted ofcourse you have available funds to contribute and that is not the money you have to live on today.

"… So even if at retirement your marginal tax rate is slightly lower then its currently is Roth may still be beneficial. " I do not see how. If you make the same investments, and the tax rates now are the same as in retirement, the Roth401k and regular401k should be equivalent. Starting with $100 growing at 8% yearly for 20 years at a tax rate of 25% will yield: For Roth: $100*0.75*1.08^20 = $350 For Regular: $100*1.08^20*0.75 = $350 If marginal tax is lower in retirement, regular401k is better. Of course this is purely from a tax perspective. Other points (estate rules, max eligibility dollars) may trump the tax question.

Agreed, on a pure tax basis, lower retirement tax rate favors regular 401k. But you also need to consider taxes over the entire investment horizon. It’s likely that at early stages of your career taxes will be lower, which makes it the best time to contribute to Roth. And, as I said the decision should be made taking all other factors into consideration.

OK, I see you point, if I were just starting out in my career, then Roth would make sense from a tax perspective.

Again the general FP consensus is Roth wins, or at least deserves some very careful consideration. It dominates in flexibility and estate planning considerations for example.