Roth vs company match in 401K

[Annie7]

I was talking to my 22 YO son last night about Roth. He just started working last august after college. I was telling him to see if he could do a mega backdoor roth from his 401K to Roth IRA. He was very taken with the idea that the contributions and earnings will grow tax free in the Roth. He was not sure if he will get the company match (50% match upto 4% of contribution) if he did the Roth 401K or the after tax into the 401K.

He is now thinking of putting all his 401K contributions towards the after-tax portion and do a mega backdoor roth conversion even if it meant he missed out on the company match. He felt that giving up the company match to ensure that he gets tax free earnings over 30 years was a better bargain. 

I feel like he should contribute to traditional 401K for atleast 4% to get the match and any excess he can do either the Roth 401K or the after-tax and convert it to roth IRA. 

What do you feel about this? Which way should he go? 

[minnesotapaintlady]

Don't give up the match, that's 100% return on that money. 

Most companies don't have the ability to make in-service rollovers, so he may not even have the option of after-tax, but they might have a Roth 401K option.  I still personally think going all pre-tax and investing the tax savings in a Roth IRA is the best option for most, but that's just my opinion.  

[Rukh O'Rorke]

Mar 8, 2023 10:29:09 GMT -5 minnesotapaintlady said:

Don't give up the match, that's 100% return on that money. 

Most companies don't have the ability to make in-service rollovers, so he may not even have the option of after-tax, but they might have a Roth 401K option.  I still personally think going all pre-tax and investing the tax savings in a Roth IRA is the best option for most, but that's just my opinion.  

I looked into this at one time and the finding was that you can put your contribution into roth ira but the company match is still defered taxes....

am i corrrect, oracle of the ymam?

[Annie7]

Mar 8, 2023 10:29:09 GMT -5 minnesotapaintlady said:

Don't give up the match, that's 100% return on that money. 

Most companies don't have the ability to make in-service rollovers, so he may not even have the option of after-tax, but they might have a Roth 401K option.  I still personally think going all pre-tax and investing the tax savings in a Roth IRA is the best option for most, but that's just my opinion.  

MPL, 

I too feel like he shouldn't give up on the 100% return with the company match. However, he told me some math which I was too tired last night to follow    where it seemed to make it feel  like he'll come out ahead putting all the contributions to after-tax/Roth. I was unable to disprove his math.

I feel he'll go over the Roth limits with one raise. He's on the border right now. So, the option of investing the tax savings in Roth won't be possible. Only the backdoor will be possible for him.

In general, if you can afford to pay the taxes now and it's possible to do a backdoor conversion, is there a reason one shouldn't do all after-tax contributions? There is no RMD, all contributions and earnings are tax free. So, why not do this instead of traditional? What am I missing - other than that not every plan has the option to do this?

[minnesotapaintlady]

Mar 8, 2023 12:21:27 GMT -5 Annie7 said:

Mar 8, 2023 10:29:09 GMT -5 minnesotapaintlady said:

Don't give up the match, that's 100% return on that money. 

Most companies don't have the ability to make in-service rollovers, so he may not even have the option of after-tax, but they might have a Roth 401K option.  I still personally think going all pre-tax and investing the tax savings in a Roth IRA is the best option for most, but that's just my opinion.  

MPL, 

I too feel like he shouldn't give up on the 100% return with the company match. However, he told me some math which I was too tired last night to follow    where it seemed to make it feel  like he'll come out ahead putting all the contributions to after-tax/Roth. I was unable to disprove his math.

I feel he'll go over the Roth limits with one raise. He's on the border right now. So, the option of investing the tax savings in Roth won't be possible. Only the backdoor will be possible for him.

In general, if you can afford to pay the taxes now and it's possible to do a backdoor conversion, is there a reason one shouldn't do all after-tax contributions? There is no RMD, all contributions and earnings are tax free. So, why not do this instead of traditional? What am I missing - other than that not every plan has the option to do this?

Contributions are not tax-free.  You pay taxes going in, and that is money that can't be invested.

Mathematically if you invest the tax savings and are in the same tax bracket when you withdraw there is no difference, so it comes down to "will taxes be more or less when I retire?"  It's kind of a crap shoot because you don't really know what future laws will be...especially when you have like 40 years to go, but remember we also have a progressive tax system (at present, maybe that will change too!)  For single the first 13K of income is tax-free, then 10K at 10% and another 32K at 12%...  If he's near the Roth limit then he's in the 24% tax bracket.  He could be paying 24% now to fill brackets that are much lower in the future, especially if he's married  and all those income numbers are double for the lower brackets. 

Ideally you will have some of both.  But, again, just my opinion for optimization and covering all the bases.  Making that kind of money at 22 and maxing a Roth 401K is pretty damn good.  Also, if he doesn't already have a pre-tax IRA, a backdoor Roth IRA is a very simple process, so the income limit doesn't really mean anything.

[minnesotapaintlady]

Mar 8, 2023 12:15:45 GMT -5 Rukh O'Rorke said:

Mar 8, 2023 10:29:09 GMT -5 minnesotapaintlady said:

Don't give up the match, that's 100% return on that money. 

Most companies don't have the ability to make in-service rollovers, so he may not even have the option of after-tax, but they might have a Roth 401K option.  I still personally think going all pre-tax and investing the tax savings in a Roth IRA is the best option for most, but that's just my opinion.  

I looked into this at one time and the finding was that you can put your contribution into roth ira but the company match is still defered taxes....

am i corrrect, oracle of the ymam?

That was correct until this year.  Secure Act 2.0 allows for employers to put the match in a Roth.  Whether or not they choose to have that option is up to them.

[Rukh O'Rorke]

Mar 8, 2023 12:57:56 GMT -5 minnesotapaintlady said:

Mar 8, 2023 12:15:45 GMT -5 Rukh O'Rorke said:

I looked into this at one time and the finding was that you can put your contribution into roth ira but the company match is still defered taxes....

am i corrrect, oracle of the ymam?

That was correct until this year.  Secure Act 2.0 allows for employers to put the match in a Roth.  Whether or not they choose to have that option is up to them.

wild!!!

and you ARE the oracle!!!

Do you have to pay taxes on the employer match then?? In the year it is put into your account?

[minnesotapaintlady]

Mar 8, 2023 13:43:34 GMT -5 Rukh O'Rorke said:

Do you have to pay taxes on the employer match then?? In the year it is put into your account?

Yes, they are taxable to the employee at the time the contributions are made, so if your match is per paycheck it would be tacked on every pay period as income.

[Annie7]

Mar 8, 2023 12:56:12 GMT -5 minnesotapaintlady said:

Mar 8, 2023 12:21:27 GMT -5 Annie7 said:

Contributions are not tax-free.  You pay taxes going in, and that is money that can't be invested.

Mathematically if you invest the tax savings and are in the same tax bracket when you withdraw there is no difference, so it comes down to "will taxes be more or less when I retire?"  It's kind of a crap shoot because you don't really know what future laws will be...especially when you have like 40 years to go, but remember we also have a progressive tax system (at present, maybe that will change too!)  For single the first 13K of income is tax-free, then 10K at 10% and another 32K at 12%...  If he's near the Roth limit then he's in the 24% tax bracket.  He could be paying 24% now to fill brackets that are much lower in the future, especially if he's married  and all those income numbers are double for the lower brackets. 

Ideally you will have some of both.  But, again, just my opinion for optimization and covering all the bases.  Making that kind of money at 22 and maxing a Roth 401K is pretty damn good.  Also, if he doesn't already have a pre-tax IRA, a backdoor Roth IRA is a very simple process, so the income limit doesn't really mean anything.

MPL,

You are right - contributions are not tax free. My bad.

I'm asking questions to understand for myself and to guide my son. So please don't take it as challenging you. I just want to understand. Like Rukh said - you are the oracle of yman

When you say "You pay taxes going in, and that is money that can't be invested." - in my son's case, assuming he can't contribute to a Roth IRA directly, he would be investing the saved tax in taxable accounts - a brokerage account or something that is not a retirement account, correct? So he would be paying taxes on the earnings when he withdraws them. 

I assume he will be making more as he ages. Hopefully he'll continue fully maxing his 401K and HSA. In that case, I'm thinking he will have too much in tax deferred accounts and will have to convert during his retirement and before he needs to take RMDs (I'm assuming tax rules stay the same which is a big ASSumption). So, I would think he should contribute to Roth (whichever way - direct/backdoor 401K/IRA) now until his tax bracket now becomes pretty high and it makes sense to do pre-tax. What do you think?

[minnesotapaintlady]

Mar 8, 2023 14:09:55 GMT -5 Annie7 said:

Mar 8, 2023 12:56:12 GMT -5 minnesotapaintlady said:

Contributions are not tax-free.  You pay taxes going in, and that is money that can't be invested.

Mathematically if you invest the tax savings and are in the same tax bracket when you withdraw there is no difference, so it comes down to "will taxes be more or less when I retire?"  It's kind of a crap shoot because you don't really know what future laws will be...especially when you have like 40 years to go, but remember we also have a progressive tax system (at present, maybe that will change too!)  For single the first 13K of income is tax-free, then 10K at 10% and another 32K at 12%...  If he's near the Roth limit then he's in the 24% tax bracket.  He could be paying 24% now to fill brackets that are much lower in the future, especially if he's married  and all those income numbers are double for the lower brackets. 

Ideally you will have some of both.  But, again, just my opinion for optimization and covering all the bases.  Making that kind of money at 22 and maxing a Roth 401K is pretty damn good.  Also, if he doesn't already have a pre-tax IRA, a backdoor Roth IRA is a very simple process, so the income limit doesn't really mean anything.

MPL,

You are right - contributions are not tax free. My bad.

I'm asking questions to understand for myself and to guide my son. So please don't take it as challenging you. I just want to understand. Like Rukh said - you are the oracle of yman

When you say "You pay taxes going in, and that is money that can't be invested." - in my son's case, assuming he can't contribute to a Roth IRA directly, he would be investing the saved tax in taxable accounts - a brokerage account or something that is not a retirement account, correct? So he would be paying taxes on the earnings when he withdraws them. 

I assume he will be making more as he ages. Hopefully he'll continue fully maxing his 401K and HSA. In that case, I'm thinking he will have too much in tax deferred accounts and will have to convert during his retirement and before he needs to take RMDs (I'm assuming tax rules stay the same which is a big ASSumption). So, I would think he should contribute to Roth (whichever way - direct/backdoor 401K/IRA) now until his tax bracket now becomes pretty high and it makes sense to do pre-tax. What do you think?

I don't take it as challenging me.  I do the exact same thing to other people.   

My point was it's just money he's losing that he could either invest or use now.  He's gambling that his marginal rate will be higher in the future.  24% is a pretty high bracket.  Assuming all stays the same and he gets married only taxable income over 190K in retirement would be taxed at that rate.  The Roth is a guaranteed no tax on withdrawals in retirement, but he might be kicking himself if he paid twice as much tax 40 years earlier.  Or maybe taxes will be through the roof and he'll be patting himself on the back  Or we go to a national sales tax and they eliminate income taxes altogether!  So much could change.  Do some of both!

Also, just because he can't directly contribute to a Roth IRA, know that a backdoor Roth is VERY EASY to do (as long as you don't have an existing IRA with pre-tax money).  You just contribute to a regular traditional IRA (everyone is eligible regardless of income) and then immediately convert it to Roth before it produces any earnings (not a big deal if it does, you just pay the tax on those earnings, but if you convert the same day that won't happen)  It's a simple process that anyone can do.  With Vanguard, it's literally a button right on your traditional IRA account.  If he's still eligible now, but on the verge, I would just contribute via backdoor to start.  That way if he crosses the income limit mid-year he's already covered.

[haapai]

May I ask whether your son contributed to a traditional 401(k) in 2022?  Knowing the answer to that question may help us guage his financial sophistication and current mind-set. 

[Annie7]

Mar 8, 2023 14:37:43 GMT -5 haapai said:

May I ask whether your son contributed to a traditional 401(k) in 2022?  Knowing the answer to that question may help us guage his financial sophistication and current mind-set. 

Yes, he did contribute - I'm not sure if he maxed it out last year since he started in Aug. He has contributed to the traditional 401K this year until now with the aim to max out by EOY. He is also on target to max out his HSA this year. Again, not sure about last year.

[Annie7]

Mar 8, 2023 14:37:11 GMT -5 minnesotapaintlady said:

Mar 8, 2023 14:09:55 GMT -5 Annie7 said:

I don't take it as challenging me.  I do the exact same thing to other people.   

My point was it's just money he's losing that he could either invest or use now.  He's gambling that his marginal rate will be higher in the future.  24% is a pretty high bracket.  Assuming all stays the same and he gets married only taxable income over 190K in retirement would be taxed at that rate.  The Roth is a guaranteed no tax on withdrawals in retirement, but he might be kicking himself if he paid twice as much tax 40 years earlier.  Or maybe taxes will be through the roof and he'll be patting himself on the back  Or we go to a national sales tax and they eliminate income taxes altogether!  So much could change.  Do some of both!

Also, just because he can't directly contribute to a Roth IRA, know that a backdoor Roth is VERY EASY to do (as long as you don't have an existing IRA with pre-tax money).  You just contribute to a regular traditional IRA (everyone is eligible regardless of income) and then immediately convert it to Roth before it produces any earnings (not a big deal if it does, you just pay the tax on those earnings, but if you convert the same day that won't happen)  It's a simple process that anyone can do.  With Vanguard, it's literally a button right on your traditional IRA account.  If he's still eligible now, but on the verge, I would just contribute via backdoor to start.  That way if he crosses the income limit mid-year he's already covered.

I agree with the bolded. I too would want him to do both and have diversification just because we don't know what the future brings.

I think he has enough (even living in Manhattan with his GF) to not need the tax savings now. He's pretty good and has been saving on top of maxing out the available options.

He has his accounts at fidelity but I'm sure it's the same process there too to do the back door. He doesn't have any IRAs yet, so this would be a good way to get some into Roth.

Thank you MPL. You are a help as always

[haapai]

Mar 8, 2023 15:40:45 GMT -5 Annie7 said:

Mar 8, 2023 14:37:43 GMT -5 haapai said:

May I ask whether your son contributed to a traditional 401(k) in 2022?  Knowing the answer to that question may help us guage his financial sophistication and current mind-set. 

Yes, he did contribute - I'm not sure if he maxed it out last year since he started in Aug. He has contributed to the traditional 401K this year until now with the aim to max out by EOY. He is also on target to max out his HSA this year. Again, not sure about last year.

Ouch!  With only four months of "real job" income in 2022, he almost certainly would have been better off skipping the match entirely and plowing as much as possible into Roth vehicles.  Think about what his AGI probably was and what tax bracket he landed up in. 

He may be over-compensating, belatedly switching to the strategy that would have worked better in 2022 without actually sitting down and figuring out his mAGI and marginal tax rates will be in 2023. 

[haapai]

He shouldn't kick himself too hard for missing an opportunity that was only open for four months.  Almost everyone misses that partial income year tax gambit.  Also, he avoided some substantial NY state and  NYC income taxes that he might not have to pay unless he retires in the city.  (Yes, I had to google the state and city taxes.  Oh, wow!) 

[minnesotapaintlady]

This article explains my feelings on this better.  It's a little dated...like the RMD age is now 75 for most people...but the meat of it is still valid.

www.gocurrycracker.com/roth-sucks/?fbclid=IwAR0p9E39N64VxYBBIwXZQfdpTajKIO-pA_0ZttWywfFgkGQxzAg5SbmSWXs

..

[teen persuasion]

Bogleheads has a very detailed explanation of the traditional vs Roth decision: bogleheads wiki

Unless he's expecting a large pension (which can fill the lowest brackets) AND expecting to work until RMD age (just increased to 75) so that he has no years to do any Roth conversions, he should at least contribute to his traditional 401k to reduce his high marginal rate right now (24% + NYS + NYC).

If he has any interest in retiring early, then he has lower income (read, lower tax) years to convert traditional balances to Roth before SS and RMDs kick in.

His first order of business is to request a Summary Plan Description to see whether his plan has the requisite parts to do a mega backdoor Roth, or if it is a moot point. Contribute to the max to traditional 401k, any match will go to traditional (at least until they work out the details on matching going to Roth), and fill up the rest of any space with after tax contributions->mega backdoor Roth (if possible). Then contribute to a non-deductible tIRA and convert it to Roth IRA for a backdoor Roth IRA (as long as he has no previous tIRA to trigger pro-rata rules). Max HSA. Any additional savings go into a taxable account.

[Annie7]

Mar 8, 2023 20:29:34 GMT -5 minnesotapaintlady said:

This article explains my feelings on this better.  It's a little dated...like the RMD age is now 75 for most people...but the meat of it is still valid.

www.gocurrycracker.com/roth-sucks/?fbclid=IwAR0p9E39N64VxYBBIwXZQfdpTajKIO-pA_0ZttWywfFgkGQxzAg5SbmSWXs

..

MPL,

Is the article assuming that the amount in the Roth is NOT invested? I don't think it's taking into account the accumulation of earnings which can be withdrawn tax free. 

[Annie7]

Mar 8, 2023 23:13:10 GMT -5 teen persuasion said:

Bogleheads has a very detailed explanation of the traditional vs Roth decision: bogleheads wiki

Unless he's expecting a large pension (which can fill the lowest brackets) AND expecting to work until RMD age (just increased to 75) so that he has no years to do any Roth conversions, he should at least contribute to his traditional 401k to reduce his high marginal rate right now (24% + NYS + NYC).

If he has any interest in retiring early, then he has lower income (read, lower tax) years to convert traditional balances to Roth before SS and RMDs kick in.

His first order of business is to request a Summary Plan Description to see whether his plan has the requisite parts to do a mega backdoor Roth, or if it is a moot point. Contribute to the max to traditional 401k, any match will go to traditional (at least until they work out the details on matching going to Roth), and fill up the rest of any space with after tax contributions->mega backdoor Roth (if possible). Then contribute to a non-deductible tIRA and convert it to Roth IRA for a backdoor Roth IRA (as long as he has no previous tIRA to trigger pro-rata rules). Max HSA. Any additional savings go into a taxable account.

Teen,

That's a nice explanation of what he should do. I'm still reading and digesting the bogleheads wiki. Thank you.

[minnesotapaintlady]

Mar 9, 2023 9:59:59 GMT -5 Annie7 said:

Mar 8, 2023 20:29:34 GMT -5 minnesotapaintlady said:

This article explains my feelings on this better.  It's a little dated...like the RMD age is now 75 for most people...but the meat of it is still valid.

www.gocurrycracker.com/roth-sucks/?fbclid=IwAR0p9E39N64VxYBBIwXZQfdpTajKIO-pA_0ZttWywfFgkGQxzAg5SbmSWXs

..

MPL,

Is the article assuming that the amount in the Roth is NOT invested? I don't think it's taking into account the accumulation of earnings which can be withdrawn tax free. 

No.  It is not assuming that at all.   You, however, seem to be ignoring the loss of 40 years of growth on what is being paid in taxes now.   If your son maxed a Traditional 401K at 22,500, his tax savings would be enough to fully fund a Roth IRA.  So, the same dollars out of his pocket every year would get him 29K in savings instead of 22,500 going the all Roth 401K route.  Then in retirement if he doesn't have a pension he can use the traditional to fill the 0% tax standard deduction (didn't pay taxes going in, won't pay taxes taking out) and the lower brackets, then start tapping that Roth if he needs more.

[Annie7]

Mar 9, 2023 10:19:31 GMT -5 minnesotapaintlady said:

Mar 9, 2023 9:59:59 GMT -5 Annie7 said:

MPL,

Is the article assuming that the amount in the Roth is NOT invested? I don't think it's taking into account the accumulation of earnings which can be withdrawn tax free. 

No.  It is not assuming that at all.   You, however, seem to be ignoring the loss of 40 years of growth on what is being paid in taxes now.   If your son maxed a Traditional 401K at 22,500, his tax savings would be enough to fully fund a Roth IRA.  So, the same dollars out of his pocket every year would get him 29K in savings instead of 22,500 going the all Roth 401K route.  Then in retirement if he doesn't have a pension he can use the traditional to fill the 0% tax standard deduction (didn't pay taxes going in, won't pay taxes taking out) and the lower brackets, then start tapping that Roth if he needs more.

I do seem hung up on Roth, don't I

I hear what you are saying. Yes, he won't have a pension. So, I'll advise him to continue to put it into traditional first and then roth if he has capacity - following Teen Persuasion's order.

Thank you for your help.