Roth IRA Vs 401k

[Seajatt]

Hello,

It's been awhile since I've posted! I'm out of debt on the 1st of April (I had a very vengeful ex who had access to my credit and didn't like the fact that I left her). I'll be saving up for my van and the associated costs of a conversion over the next year, but I was also hoping for some feedback from those who have been there, done that.

I'm 34, I'm mentioning this as It'll play a part when it's time to cash-out.

Do you have experience using either as your retirement? How was it? If you could go back and re-plan your retirement, what would you do?

 

[B and C]

I went with a 401 for two reasons. My company made matching contributions and I figured the more that went in, the faster it would grow. Now that I am about to have to take mandatory withdrawals, I am considering rolling portions over to a Roth.

 

[Seajatt]

I went with a 401 for two reasons.  My company made matching contributions and I figured the more that went in, the faster it would grow.  Now that I am about to have to take mandatory withdrawals, I am considering rolling portions over to a Roth.

So your choice was a matter of your employer's contribution? And if I may, why portions over into a Roth?

As far as I understand the two, one is taxed on deposits when it comes to Roth, and one is taxed on disbursement when it comes to 401k, but not sure if I have that correctly, and if that's the only difference.

 

[mpruet]

I was doing both.  I had my 401K, but also had access to a ROTH-401K.  Also I had an external post-tax IRA.  

When I retired, the 401K was rolled into a traditional IRA and the ROTH-401K rolled into a ROTH-IRA.  Ever since then I’ve been doing partial conversions from my IRA into my ROTH.  I’ve got one more year before RMDs kick in so did another partial conversion this year.  If the current downturn continues into next January, I’ll probably do another partial conversion next year along with taking my first RMD.  

I’m in the process of rebalancing my private portfolio and will end up taking some losses.  This should significantly reduce my adjusted income for next tax season.

 

[mpruet]

As far as I understand the two, one is taxed on deposits when it comes to Roth, and one is taxed on disbursement when it comes to 401k, but not sure if I have that correctly, and if that's the only difference.

A ROTH is not subject to RMDs.  When you leave your job, your 401K should be directly rolled into a traditional IRA.  

Also, realize that a 401K/IRA is taxed on both what you put in as well as any growth upon disbursement.  Growth on the ROTH is tax free.

Actually since the investment market is currently in a pullback, right now is an excellent time to do some conversions from a traditional IRA into a ROTH.

 

[Tony's Dream]

As a federal employee we have thrift savings versus 401k. Each of the traditional and Roth have their advantages and disadvantages. As an active employee I contributed 5% into the traditional to receive the matching which basically doubled my deposits. The rest I deposited into my ROTH. We chose to take the tax hit now with the money placed into the Roth. Then if we need to pull money from our traditional fund, we will be at a lower tax bracket.

We learned to live on a fixed amount, so anytime I got a raise I would increase my deposits into my Roth account. Once you get used to living on a fixed amount, saving is really easy.

 

[mpruet]

We learned to live on a fixed amount, so anytime I got a raise I would increase my deposits into my Roth account.  Once you get used to living on a fixed amount, saving is really easy.

So true.

 

[tx2sturgis]

Also, realize that a 401K/IRA is taxed on both what you put in... 

Not until you reach the maximum, currently $19,500 per year. This amount will change, of course.

 

[MG1912]

First, congrats on being debt-free soon!  I sent my last check to Sallie Mae on November 1, 2010, and from that day forward, I would never owe another person anything ever again (except for a credit card balance that I pay in full each month).  That day was a personal milestone for me, just as your “day” will be for you (if you stay debt-free).

I am 40 and retired early.  Both my 401(k) and my Roth IRA played big roles in my personal finance plan because they are such powerful money-saving tools -- the 401(k) played the bigger role because the limits were much higher ($19,500 for a 401(k) and $6,000 for a Roth IRA this year, for example).  Some years, my income was too high to contribute to a Roth IRA, but when it was available to me, I always maxed it out.

I have not started withdrawing from my 401(k) or Roth IRA yet, as I am currently living on cash reserves.  When I need to, I’ll start withdrawing from the accounts, with special consideration for the fact that I am well below normal retirement age.  There are strategies I can employ to avoid the associated penalties and taxes, though.

To answer your questions…

Do you have experience using either as your retirement?  Yes.  I have used both since my first real job in 2006.  Both are still major components of my portfolio in retirement, second only to my taxable account.

How was it?  Well, the answer to that question depends entirely on the market, but seeing as I have been investing seriously in both accounts since 2008 -- and we were in a gigantic, sustained bull market this whole time -- it has been phenomenal… until just recently, of course, but that will turn around, too, in time.    You get a huge tax break by using these tax-advantaged vehicles.  There is zero disadvantage to using them, so why not use them?  Every year I worked after grad school, I maxed out both 401(k) and Roth IRA contributions, as long as I had access to those accounts.  Both played a huge role in my Investment Policy Statement (IPS), along with a taxable account.

If you could go back and re-plan your retirement, what would you do?  Make more money, save more money, and start earlier!  If I had started saving and investing with purpose, starting with my first job as a busboy at the age of 15?  I’d be twice as wealthy, probably.  If I could go back and re-plan starting at age 34?  I’d try to make more money (take higher-paying assignments) and sock more money away into the taxable account after maxing out my Roth IRA and/or 401(k).

If you are interested in a deeper understanding of Roth and other IRA’s, 401(k)’s, or any aspect of retirement planning, personal finance, managing debt, etc., I recommend downloading a free pamphlet called “If You Can” by Bill Bernstein and reading it through completely.  Then, if you can (ba-da-bump), purchase the seven or so books (they can be purchased cheap and used or even borrowed from a library) in the reading list and go through the reading exercises.  And if you read all that, you will understand every important aspect of personal finance better than 99% of professional financial advisors.

P.S. -- As I suspected, others were also not clear on whether you were asking about a Roth IRA vs. a 401(k) or a Roth 401(k) vs. a traditional 401(k).  Those are very different questions, but in either case, there are excellent, professionally-produced information products online that can answer either of those questions with more accuracy and clarity than I can.

 

[mpruet]

Not until you reach the maximum, currently $19,500 per year. This amount will change, of course.

You didn’t quote my full sentence.  The 401K and traditional IRA is most definitely taxed UPON DISPERSEMENT.  They are not taxed during funding.

 

[tx2sturgis]

You didn’t quote my full sentence.  The 401K and traditional IRA is most definitely taxed UPON DISPERSEMENT.  They are not taxed during funding.

Yes, distributions from those are taxed as regular income. But the part that I was addressing was your statement that contributions to a 401k are taxed....and they are, AFTER the current max of $19,500 per year...but contributions under that amount are not taxed.

Either way, the answer is, that both a standard IRA and a Roth IRA are taxed...either upon contributions (Roth) or upon distributions (standard)...and maybe both, depending on which one we are referring to.

 

[mpruet]

I didn’t say that money was taxed when the 401K or IRA was being funded.  I said that the money you put into those account and the growth was taxed upon disbursements (i.e. money being paid to you from that retirement fund.). There is no growth as the money is funding the account, only potentially when the money is extracted via disbursements from the account. 

You’ll then get a 1099-R indication that you took a distribution from a retirement account which will have to be included as income on your taxes. 

Also, you can set up a non-deferred taxable traditional IRA.  Folks who have large of an income do that frequently because you can’t fund a ROTH-IRA when you have a high salary.  You can set up the non-deferred IRA, fund that and pay the tax, and then do a backdoor conversion into the ROTH.  Once that is done, the growth becomes tax-exempt.

 

[barleyguy]

I'm definitely in the Roth (or even taxable brokerage account) camp.

- Taxable income after retirement can cause Social Security to be taxed
- Taxable income after retirement can increase Medicare premiums
- Tax rates will probably go up. The current tax rates have an automatic sunset date where they will go back up to previous levels. I doubt they will be cut to this rate again anytime soon.
- Investments in taxable accounts are taxed as "long term capital gains" if they are held long enough, not as ordinary income. This is a much lower rate than ordinary income, and is actually zero below a certain amount.
- Growth of Roth investments isn't taxed on the back end at all.
- Tax deferred accounts such as a 401K or IRA have Minimum Distributions, which can cause you to pay a large amount of taxes in your 80s.
- Heirs that inherit a tax deferred account have to pay taxes on that money, and only have about 10 years to do so. That can leave a tax bomb for your kids.

Another thing to consider is Roth CONVERSIONS, where you put money in a 401K or IRA first, and then convert it to a Roth. Because of the high standard deduction right now, you can generally convert that amount to a Roth each year without increasing your actual taxes much if at all.

So for all the reasons above, I think it's a better idea to not defer the taxes. Just pay them on the front end, into either a Roth or just a regular brokerage account.

 

[tx2sturgis]

From post #5:

Also, realize that a 401K/IRA is taxed on both what you put in as well as any growth upon disbursement. 

From post #12:

I didn’t say that money was taxed when the 401K or IRA was being funded. 

Hmmm....well which is it?

Actually, and repeating myself, a 401k is not taxed until your contributions equal or exceed $19,500 for the year, then it IS taxed. 

And the OP has the information now so I'm done.

 

[MG1912]

I'm definitely in the Roth (or even taxable brokerage account) camp.  ...

So for all the reasons above, I think it's a better idea to not defer the taxes. Just pay them on the front end, into either a Roth or just a regular brokerage account.

I think you might be forgetting that you already paid taxes on the funds in your taxable account, i.e. you bought shares for a taxable brokerage account from money in your bank account, i.e. money for which you have already paid marginal tax rates.  THEN the funds are taxed again, a second time, in the form of capital gains.
 
On top of that, there is employer matching.  Most organizations, private or public, match employee 401(k) contributions up to certain percentage.  For me, while I was working, it was 5%.  That is free money that you essentially turn down if you are not participating in a workplace 401(k) plan.
 
And on top of all that, if you put enough money into your 401(k) (the max is $19,500), you could bump yourself down to a lower tax bracket and further lower your overall tax bill.
 
You speculated in your post that tax rates will go up in the future.  Do you know how much income you will have in the future, i.e. when you are retired?  Maybe you do, but the vast majority of people don't know what they'll have for income decades from now... and most who guess probably get it wrong.  We do know, however, that we can get a significant tax savings now with a 401(k) plan.
 
I can't think of anyone (really) who would be better served by opening a taxable brokerage account rather than participating in their 401(k) at work.  Investing your money in a 401(k) plan -- provided you have reasonable, low-cost options in said plan -- is vastly preferable to investing in a taxable account for the vast majority of people.
 
 

Hmmm....well which is it?

Actually, and repeating myself, a 401k is not taxed until your contributions equal or exceed $19,500 for the year, then it IS taxed. 

And the OP has the information now so I'm done.

mpruet's post was perfectly clear to me.  It appears that you misread his post, and based on your follow up post (quoted here), it appears that the concept is not clear:  the money you contribute to your 401(k) plan at work is not taxed upon funding, but rather is taxed upon disbursement/withdrawal.  All that means is that you will pay marginal tax rates on the entire amount of money in your 401(k) plan -- both the contributions you have paid AND the earnings -- when and as you withdraw it in retirement.
 
You are disagreeing with a point that mpruet isn't even making...

 

[mpruet]

Hmmm....well which is it?

Actually, and repeating myself, a 401k is not taxed until your contributions equal or exceed $19,500 for the year, then it IS taxed. 

And the OP has the information now so I'm done.

Perhaps it would help you understand if you read the following... 
https://budgeting.thenest.com/taxes-due-401k-disbursements-26954.html

 

[mpruet]

I'm definitely in the Roth (or even taxable brokerage account) camp.

I would only do that after I had fully funded my retirement accounts.  The main advantage of the brokerage account is that it’s usually easier to get access to those funds for large purchases.

 

[MG1912]

I would only do that after I had fully funded my retirement accounts.  The main advantage of the brokerage account is that it’s usually easier to get access to those funds for large purchases.

I think this is good advice and is basically what I did: first max out tax-advantaged accounts (401(k) and Roth IRA), and then contribute to taxable accounts only after the tax-advantaged accounts are maxed out.

And regarding brokerage accounts, one could go even farther and argue that anyone who is buying equities in order to make a bunch of short-term money for a large purchase like a van needs a serious education in personal finance.

 

[mpruet]

And regarding brokerage accounts, one could go even farther and argue that anyone who is buying equities in order to make a bunch of short-term money for a large purchase like a van needs a serious education in personal finance.

True.  Any investing needs to be thought in long terms, not short terms.

 

[nature lover]

I never have any questions or trouble handling my retirement accounts. Because I don't have any. At 50 I was just getting serious about preparing for retirement when my brain tumor decided on an early retirement. "Never put off till tomorrow..." So I live on Social Security and it is not very social or very secure.