401k contributions: pre/post tax and roth.

[Badger]

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You will also want to consider what your tax situation will look like now vs. when you're 60. That may be difficult, or even impossible, to do, but right now straight out of college it's likely that you're in a lower tax bracket than you will be. This would be another pro to investing post tax dollars, as you'd pay more taxes on this money in a higher tax bracket. Who can say what the tax system will be in 2050 though.


[/ QUOTE ] This is where I am a little ignorant. If I am retired drawing money from my 401k/IRA isn't that money taxed at a lower rate because it is investment income as opposed to earned income (other than the actual contributions)?

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If it's a Roth IRA (and I'd assume Roth 401k, but don't quote me) everything you've amassed is completely tax free at age 59.5.

Qualified distributions from a traditional 401k after age 59.5 will be taxed at your ordinary income tax rate.

So picture a world where tax laws are the exact same 40 years from now and you want to retire. We'll talk tax deferred vs Roth. Not 401 vs IRA.

Scenario A- you're in the 28% tax bracket and you've saved just enough to live on. In 2007 dollars your distributions are less than they are now and therefore you're in a lower tax bracket. If you went the Roth route you paid higher taxes on this money because it was already taxed at 28% when it could now be taxed at 15%.

Scenario B- You've worked hard and saved millions and are ready to retire rich. Your distributions are now much more than your income in 2007 was (in 2007 dollars). If you went the Roth route, congratulations instead of paying the 35% tax bracket you saved all this money at the 28% tax bracket.

What scenario do you envision? Revisit this and plan accordingly in 5 years, and in 10, etc. etc. It sure can't hurt to have a mix of both since tax brackets could be different when you're retired. Also 401ks have stricter minimum distributions, so you could be forced to take money out when you don't want to to avoid penalties.

This is my understanding of things. I could be way off base here. Hopefully others will confirm or call me an idiot.

[Badger]

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This is where I am a little ignorant. If I am retired drawing money from my 401k/IRA isn't that money taxed at a lower rate because it is investment income as opposed to earned income (other than the actual contributions)?

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Also, you might be thinking Long Term Capital Gains, which are not tax advantaged. LTCGs are taxed at a lower rate than Short Term Cap. Gains. STCGs are taxed at your ordinary income tax rate. That doesn't apply here because these are taxed advantaged accounts. A Roth IRA is like a LTCG investment that you pay ZERO taxes on.

[Badger]

So after posting the hell out of this thread- what I'd do if I were you. (After you go thoroughly research Roth 401ks)

1. Get the max match on a Roth 401k
2. Max out a Roth IRA
3. Add some money to a traditional 401k
4. Retire rich

[mittman84]

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You will also want to consider what your tax situation will look like now vs. when you're 60. That may be difficult, or even impossible, to do, but right now straight out of college it's likely that you're in a lower tax bracket than you will be. This would be another pro to investing post tax dollars, as you'd pay more taxes on this money in a higher tax bracket. Who can say what the tax system will be in 2050 though.


[/ QUOTE ] This is where I am a little ignorant. If I am retired drawing money from my 401k/IRA isn't that money taxed at a lower rate because it is investment income as opposed to earned income (other than the actual contributions)?

[/ QUOTE ]
If it's a Roth IRA (and I'd assume Roth 401k, but don't quote me) everything you've amassed is completely tax free at age 59.5.

Qualified distributions from a traditional 401k after age 59.5 will be taxed at your ordinary income tax rate.

So picture a world where tax laws are the exact same 40 years from now and you want to retire. We'll talk tax deferred vs Roth. Not 401 vs IRA.

Scenario A- you're in the 28% tax bracket and you've saved just enough to live on. In 2007 dollars your distributions are less than they are now and therefore you're in a lower tax bracket. If you went the Roth route you paid higher taxes on this money because it was already taxed at 28% when it could now be taxed at 15%.

Scenario B- You've worked hard and saved millions and are ready to retire rich. Your distributions are now much more than your income in 2007 was (in 2007 dollars). If you went the Roth route, congratulations instead of paying the 35% tax bracket you saved all this money at the 28% tax bracket.

What scenario do you envision? Revisit this and plan accordingly in 5 years, and in 10, etc. etc. It sure can't hurt to have a mix of both since tax brackets could be different when you're retired. Also 401ks have stricter minimum distributions, so you could be forced to take money out when you don't want to to avoid penalties.

This is my understanding of things. I could be way off base here. Hopefully others will confirm or call me an idiot.

[/ QUOTE ]B, I plan on saving a good amount. I am also engaged, and my fiance makes decent money too (accountant working on CPA). Between the two of us saving 10% per year or more we should be in pretty good shape when retirement comes around.

[mittman84]

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So after posting the hell out of this thread- what I'd do if I were you. (After you go thoroughly research Roth 401ks)

1. Get the max match on a Roth 401k
2. Max out a Roth IRA
3. Add some money to a traditional 401k
4. Retire rich

[/ QUOTE ]Thanks for the input. Are there penalties for withdrawing from a Roth IRA before 59.5?

[TLC]

You will want to verify this with another source (like irs.gov)...

There are penalties for withdrawing <u>earnings</u> but not the <u>contributions</u>. So, if you contribute $100k over the next 20 years and it grows into $500k, you could take out $100k tax-free before reaching 59 1/2.

There is also provisions for withdrawals for the purpose of buying a first home, higher education costs, etc. that you can research.

[IdealFugacity]

I also have the opportunity to contribute to a Roth 401k instead of a regular 401k. I actually just set up my contributions to the 401k a few days ago without giving much thought to the Roth 401k, knowing that I am planning on maxing out my Roth IRA.

Edit, forgot this part: I am now thinking of switching to a Roth 401k. I guess this means I'll lose 28% of the money off the top, contribute 8% of the remainder and get a 4% match (total 12%). And never pay taxes after I retire, taking money out of my Roth 401k and Roth IRA.

What happens as I move up in salary and my current-tax bracket catches up to my future-tax bracket? Is it possible to switch my contributions to a 401k account while my Roth 401k continues existence?

What happens in the event that I have both a Roth 401k and a 401k (if possible, based on the question above), but for some reason change employers?

[TLC]

Yes, it is possible to have both a 401(k) and and Roth 401(k)...I do. It's up to your HR department how (and how often) you can switch your contribution designation. For example, they may require written notification 30 days prior to the end of a calendar quarter.

Just like a regular 401(k), when you change jobs, you have the option of rolling it into a self-directed IRA (a Roth IRA in this case) or into your new employer's plan(s). Personally, I never roll into my new employer's plan because the investment options are usually too limited vs. a self-directed IRA Rollover.

[IdealFugacity]

Next question: Why would you want a Roth 401k AND a regular 401k? Aren't they polar opposite ways of collecting the company match?

[Badger]

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Next question: Why would you want a Roth 401k AND a regular 401k? Aren't they polar opposite ways of collecting the company match?

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I think the main reason for doing so would be the uncertainty of your situation post retirement as well as the uncertainty in what tax environment will be at that time.