Roth vs After Tax 401k

[jyeh74]

My question involves personal finance in the State of: California


I’ve always heard that it is better to pay taxes now and let your 401k grow. Thus when you withdraw at retirement age, all the proceeds and growth will be tax free. That is why most people recommend participating in Roth 401k. However, for high earners, you will be paying high taxes now when contributing into the Roth 401k and when you retire, usually you will be at a lower tax bracket (since you have no income when you retire). So isn’t it technically better to contribute to the 401k as Pre-tax so you get a larger amount of contributions that grow over time. And when you withdraw from your 401k at retirement, you will get taxed at the lower tax bracket. Thus pretax 401k is better than Roth 401k?

[llworking]

My question involves personal finance in the State of: California


I’ve always heard that it is better to pay taxes now and let your 401k grow. Thus when you withdraw at retirement age, all the proceeds and growth will be tax free. That is why most people recommend participating in Roth 401k. However, for high earners, you will be paying high taxes now when contributing into the Roth 401k and when you retire, usually you will be at a lower tax bracket (since you have no income when you retire). So isn’t it technically better to contribute to the 401k as Pre-tax so you get a larger amount of contributions that grow over time. And when you withdraw from your 401k at retirement, you will get taxed at the lower tax bracket. Thus pretax 401k is better than Roth 401k?

I agree that for high earners a traditional 401K might make more sense than a Roth 401K. One way or another a person will be paying tax on the money. It is a question of predicting whether it is more advantageous to pay the tax now, or pay it after retirement.

[cbg]

I don't think there's one right answer that applies across the board.

[adjusterjack]

Do both. Tax deferred when your income is high. Upon retirement, convert portions to Roth (or cash) each year to minimize income taxes.

[jyeh74]

I estimate that an individual making $150-$400k a year will be taxed higher now, compared to an individual at retirement who isn’t working. There’s no way a retiree will be taxed higher than a working high earner. So now I’m thinking pretax is the way to go back Roth.
But Dave Ramsey picks Roth

https://www.daveramsey.com/blog/trad...k-vs-roth-401k

Do both. Tax deferred when your income is high. Upon retirement, convert portions to Roth (or cash) each year to minimize income taxes.

I’m not familiar with that. You’re saying contribute to 401k as pretax now, let it grow and when you withdraw at retirement, you convert the total 401k pretax amount to Roth and then withdraw? Didn’t think that they would allow you to convert pretax to a Roth without first taxing you.

[adjusterjack]

Yes, your conversion to Roth is taxable (without penalty after 59 1/2). The idea, though, is that your investment earnings that flows into the new Roth is non taxable after 5 years for each conversion.

It works well if you are able to leave your retirement savings alone.

The more you earn in a 401(k) or regular IRA, the more tax you pay on distributions over time.

If you are converting principal, you pay tax on just that amount. Earnings on the principal become non-taxable.

Here's an example from my own experience:

ROTH CONVERSION RECAP
2007 25,000 Earnings tax free after 2011
2008 60,000 Earnings tax free after 2012
2009 15,000 Earnings tax free after 2013
2010 15,000 Earnings tax free after 2014
2011 13,500 Earnings tax free after 2015
2012 17,000 Earnings tax free after 2016
2013 17,000 Earnings tax free after 2017
2014 17,012 Earnings tax free after 2018
188,512

I was collecting social security so a small amount of my social security was taxed but I paid an average of 1000 per year income taxes due to each year being in the lowest bracket. Figure about 8000. Maybe another 2000 or 3000 for 2008.

By 2019 my Roth was up to about 250,000 which, at that point included non-taxable earnings on my investments.

In 2019 I decided to downsize and bought a house for 238,000 cash from my Roth. Had that money been in a traditionsl 401(k) or IRA, and taken out all at once, I would have paid at least 1/4 of that money in income taxes (about 60,000).

My idea for making annual conversions was to hedge against the possibility of having to take out large amounts as I got older. In my case it was a house purchase. Somebody else might have an expensive medical emergency, or a new car, or something unimaginable that costs a lot of money. Anyway, it worked out well for me. Your mileage might vary.

[llworking]

I estimate that an individual making $150-$400k a year will be taxed higher now, compared to an individual at retirement who isn’t working. There’s no way a retiree will be taxed higher than a working high earner. So now I’m thinking pretax is the way to go back Roth.
But Dave Ramsey picks Roth

https://www.daveramsey.com/blog/trad...k-vs-roth-401k



I’m not familiar with that. You’re saying contribute to 401k as pretax now, let it grow and when you withdraw at retirement, you convert the total 401k pretax amount to Roth and then withdraw? Didn’t think that they would allow you to convert pretax to a Roth without first taxing you.

No...you are misunderstanding. You don't convert the total all at once. You convert an amount each year that minimizes the amount of tax you have to pay. Then if you have a year where you need a big chunk of money, you can take it out of the Roth tax free.