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How do I determine traditional 401 vs. ROTH 401?

I have 20 years plus before retirement and expect my tax rate to remain similar to what it is now.

Jan 12, 2016 by WILLIAM in  |  Flag
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Peter C. Karp Level 20

William,

Without knowing your specific tax situation it is difficult to identify one way or another as to the appropriateness of traditional 401(k) contributions or Roth 401(k) contributions. You also need to take into consideration your current cash flow. You need to speak with your CPA or tax consultant to determine the best option for you. The main differences between the two are: 1) Traditional 401(k) contributions are a pre-tax payroll deductions we tax-deferred growth and upon retirement, distributions are taxed as ordinary income at your then tax rate. This option allows you to reduce your current taxes and assumes a lower tax bracket at retirement;

2) Roth 401(k) contributions are after-tax payroll deductions with tax-deferred growth and upon retirement, the distributions are tax-free.

3) The Roth and pre-tax accounts are important to modulate in a well-defined financial plan. The benefit of having different contribution buckets allows you to choose how to take distributions in retirement given cash flow and to control taxes

You are welcome to contact my office to discuss your personal situation in great detail.

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Comment   |  Flag   |  Jan 19, 2016 from San Francisco, CA

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There's no absolute right or wrong here-couple of things: If your current cash flow situation is tight, then a traditional 401k with current tax deduction might be more advantageous. Alternatively, if you have excess cash, then the ability to fully fund a Roth may give you a greater after-tax result.

Re tax rates, impossible to predict what marginal rates will be but if you're saying that you dont expect to be in a different tax bracket, it's arguably more likely that marginal rates will go up than down, which would argue for a Roth. At the end of the day, splitting the difference and contributing to both might be the best solution.

Comment   |  Flag   |  Jan 12, 2016 from Manhattan, NY

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I agree with Robert that contributing to both could be a big benefit to you. In retirement, you might use the taxable part for your regular income and the Roth side for lump sum distributions (money for a cruise, car, etc). This way you can manage your tax liability with a little more certainty.

Comment   |  Flag   |  Jan 12, 2016 from Las Vegas, NV

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If you are in a very high tax bracket today, my projections always seem to favor the traditional - assuming that you use the tax deduction in order to invest more money. In other words, if the choice is investing $1 in traditional or 70 cents in the Roth, my math always seems to suggest that the traditional provides a better end result. But advisors will argue about this all day long. However, there is benefit to NOT having ALL of your money in retirement in pre tax funds which will be taxed when you withdraw them, so the splitting argument makes sense, if you are not already accumulting after tax money elsewhere.

Comment   |  Flag   |  Jan 12, 2016 from Bridgewater, NJ

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The tax rate will be the same today as it will be 20 years is extremely naive. The tax code changes almost on an annual basis, when considering phase in over previous tax acts. Pay your taxes today & look forward to a tax-free source of income. It will not matter what the tax rate is for this source of funds. You should however save more than you can in a Roth. Never let taxes keep you from making sound financial decisions

Comment   |  Flag   |  Jan 14, 2016 from San Antonio, TX

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The tax rate will be the same today as it will be 20 years is extremely naive. The tax code changes almost on an annual basis, when considering phase in over previous tax acts. Pay your taxes today & look forward to a tax-free source of income. It will not matter what the tax rate is for this source of funds. You should however save more than you can in a Roth. Never let taxes keep you from making sound financial decisions

Comment   |  Flag   |  Jan 14, 2016 from San Antonio, TX

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Tunc Tanin Level 10

I would split it favoring the ROTH, because if things change in 5 years and you get laid of, you can roll over your ROTH into a ROTH IRA and then 5 years after that you could access the principal tax free. It becomes a nice cushion that grows tax free and the principal is accessible without any tax consequences.

Comment   |  Flag   |  Feb 08, 2016 from Somerville, MA

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