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Should I split my 401(k)/403(b) contributions between a traditional and Roth option?

I am currently receive income from two different sources and have the opportunity to participate in two different retirement plans. Certainly, the first goal is to attain maximum matching funds in each plan. After that I have the option of participating in either plan up to the yearly maximum of $17,500. I currently make between 500-600K and am in the highest federal tax bracket. I recognize I may or may not be in this same tax bracket when I retire. I also recognize that there may be changes in the tax code over time. One of my employers offers a Roth option. I am considering placing up to 50% of my retirement in this plan. I was also considering rolling a small traditional IRA (funded with pre-tax dollars) into a 401(k)/403(b) so that I could also contribute to a new traditional IRA with after-tax dollars and then roll it into a Roth each year. Does this make sense to diversify my retirement plans? Does anyone think that the government will tax Roth capitol gains in the future?

Feb 09, 2014 by tom from Birmingham, AL in  |  Flag
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3 votes

Hello Tom,

You are definitely asking the right questions. And it sounds like you are doing everything correct that is obvious. You are ensuring that you capture the maximum employer contribution at each job. And you are aware your maximum employee contribution to the plans combined is $17,500 (I am assuming you are under the age of 50. If you are 50 or older in 2014 you can contribute $23,000 by making $5,500 of catch up contributions).

Once you have determined how much you must contribute to each plan to take advantage of the employer match then you are asking where should the remaining employee contribution go; pretax plan or after tax ROTH plan. That’s a good question but to answer it you have to make a number of assumptions. Like you said you don’t know what your tax bracket will be when you retire and possibly withdraw funds from the plans. You also don’t know if the tax rules will change for ROTH 401ks (and ROTH IRAs). My best advice is to talk to your tax preparer as they know your situation better than we do. But in general I would maximize the contribution to the pretax account and only contribute what you have to contribute to capture the match in the ROTH account. The reason for this is, as you said, you are in the highest tax bracket today. As such, based on today’s tax brackets, the odds are you will be in a lower bracket during retirement. Or it could be that you do such a good job of saving that you leave your IRA to younger heirs who are in a lower tax bracket. There are other moving parts in this equation. The pretax account will require minimum distributions starting at your age 70-1/2 and the ROTH account will not. So if you knew with a high probability that you would not have to touch the balance of the retirement accounts and that they are for legacy purposes then the ROTH may be a better choice. In this case your ROTH account will grow tax free for your life, then that of your spouse should she survive you, then your heirs. Your heirs must make annual distributions from the ROTH but it will be over their life expectancy. I will admit that there has been so much talk of a 5 year distribution for heirs in the President’s budget that this decision is more uncertain then in the past. I have heard nothing of making ROTH account taxable although only time will tell.

Other factors in your decision of which plan to use is the quality and fees associated with each plan. If one has superior investments and lower fees then you must consider this when deciding which plan gets the extra pre-tax, or ROTH, contribution.

I could be wrong but I do not believe you can transfer a traditional IRA into a ROTH 401k, regardless of whether the IRA contribution is after-tax. However you can roll the IRA into a pretax 401k and, if the plan allows, convert into a ROTH 401k. However I believe you run the risk of the 1099-R that results from the conversion recording the conversion as 100% taxable. This depends on whether or not the employer can track the after tax and pretax amounts from the incoming IRA. I do know that during the rollover process you are allowed to break out the pretax IRA contribution from the after tax contribution and only roll over the pretax amount and leave the after tax amount in the IRA. I’m not in my office so I can’t research. Hopefully another advisor has the answer for you.

View all 5 Comments   |  Flag   |  Feb 09, 2014 from Woodbridge, VA
John A. Frisch CPA/PFS, CFP®, AIF®, PPC

Ok. That'll work and also makes sense. Just note that you can make $5.5k contributions in '13 and '14 ($11k combined).

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Flag |  Feb 09, 2014 near Woodbridge, VA

Thanks, I did not realize that the limit was now 11K. I'm trying to get as much in as early as possible. The 8th wonder of the world and all. Appreciate all the help!

Flag |  Feb 09, 2014 near Birmingham, AL

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3 votes

Great question! Simply, the ROTH or after tax contribution favors younger employeess or those that expect to be in a higher tax bracket at retirement. Unfortunately, 90% of us are in a higher tax bracket today becasue we're working and will be in a lower tax bracket at retirement because we havn't saved enough. If you're in the other 10% than ROTH makes sence otherwise, take the tax deduction today and run.

1 Comment   |  Flag   |  Feb 10, 2014 from Mission Viejo, CA

Also keep in mind the Roth is limited to $5500 a year excepting catch-up contributions. You probably want to put away a lot more than that. If you earn too much to qualify for a Roth, contributing to a 401k may reduce your taxable income enough to get in the gate. If not, you can do always to a backdoor conversion from Traditional IRA to Roth.

Flag |  Jun 03, 2014

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