Using AI Legalese Decoder to Optimize Your Roth vs Traditional 401(k) Allocation
- November 11, 2023
- Posted by: legaleseblogger
- Category: Related News
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Adjusting Retirement Allocations for Financial Planning
As a 31-year-old high-income earner making $158,000, I have carefully allocated my retirement contributions. Currently, I have 1% going to traditional 401(k), 4% from my employer match to traditional 401(k), and 9% going to Roth 401(k). However, I am considering making some adjustments to simplify my financial planning and ensure a more secure retirement.
My rationale for these changes includes a desire to have a clear understanding of my retirement savings and a more manageable financial plan moving forward. By reallocating 5% towards traditional 401(k) and 9% to Roth 401(k), I believe I will have a more confident grasp of my overall financial picture when I retire. Additionally, I see the benefit of being able to withdraw from the traditional 401(k) at a lower income level while allowing my Roth 401(k) to continue growing if necessary.
Despite these considerations, I am still curious about whether my current allocation is the best option for me. I am seeking feedback on my allocation, including whether it is sufficient for my retirement goals and how to gain confidence in my decision-making process. Furthermore, I am interested in hearing from retirees who may have regretted their contribution choices and if they wished they had contributed differently to their retirement plans.
AI Legalese Decoder can help in this situation by providing personalized and data-driven insights into retirement planning. By analyzing your financial information and goals, the AI Legalese Decoder can offer recommendations for optimizing your retirement allocations. It can also simulate various allocation strategies and their potential outcomes, giving you confidence in your decision-making process. Additionally, the AI Legalese Decoder can provide insights from retirees and financial experts, offering valuable perspectives on retirement contribution choices. With its comprehensive analysis and expert guidance, the AI Legalese Decoder can assist in making informed and effective decisions for your retirement planning.
By utilizing the AI Legalese Decoder, you can gain a better understanding of your retirement allocations and feel more secure in your financial planning for the future.
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****** just grabbed a
**TLDR: Trad. 100% trad.**
The numbers to compare are:
* What is your marginal tax rate while working?
* What is your effective tax rate in retirement?
Marginal tax rate = every further dollar I make, how much of it is taxed
Effective tax rate = based on my whole income, how much of it is taxed
If we look at a single person with 158k income using the $13,850 standard deduction:
Taxable income is ~144k
Marginal tax rate: 24%. If you make $1,000 more, you’ll pay $240 in taxes and keep $760
Effective tax rate: You’ll pay $28k in taxes. /158k gross income = 18% effective tax rate
*Note: FICA is another tax; 401k does not impact it, so it is best to ignore it for this discussion. State taxes vary and can push towards either roth or trad; with 50+ rules, too many unknowns to factor in.*
Most people have lower taxes in retirement.
* You don’t need to save money for retirement, reducing your anecdotal expenses by 10%.
* Social Security kicks in and isn’t taxed at 100% face value.
* You no longer have to cover FICA, which is a 7.65% reduction in your gross expenses.
* Often there is a paid off home, reducing your living costs.
* Taxes on roth and taxable brokerage are kinder than wage based taxes.
Lower expenses = lower taxable income = lower effective tax rate
If your effective tax rate in retirement is lower than your marginal now, traditional wins.
If your effective tax rate in retirement is higher than your marginal now, roth wins.
Let’s look at your case and compare traditional vs roth:
* Roth: you invest 10% (16k)
* Traditional: you invest 10% + the tax savings (21k)
We need to factor in the value of the tax savings somehow.
Otherwise, our analysis is skewed. Your comparison now of 10% in trad or 10% in roth is really saying “If I throw an extra 5k at the roth, the roth is better!” Of course it is. You’re throwing an extra 5k. It’s a flawed approach
What happens if you do this for 34 years?
*Assumption: We’re starting from $0 in both cases. 6% real growth. All dollars are in 2023 values*
Trad: You’ll retire at 65 with 2.3 mil and still owe taxes
Roth: You’ll retire at 65 with 1.7 mil and owe no taxes
Trad gets you 0.5 mil extra before taxes
0.5 / 2.3 = 24%
If your effective tax rate at the federal level alone is <24% in retirement, trad wins over roth.
In retirement, you’ll need < 130k gross.
With 2023 taxes, a high end estimate for your effective retirement taxes is ~16%.
Your taxes need to increase by 50% for roth to break even with trad.
If you want to be super confident in your answer, you can do a simulation by year.
Figure out how much you’ll realistically spend in retirement using 2023 dollars.
[Grab the historical taxes](https://taxfoundation.org/data/all/federal/historical-income-tax-rates-brackets/)
Make sure to look up the standard deduction
Adjust your income by year for inflation
See what your effective tax rate is in each year
See how many years you’ll have higher than 24% effective tax rate
I did a similar exercise. I’m in the 22% tax bracket now, going down to 12% in retirement.
There were two years or so out of the last 150 where roth beat trad, and that was being biased in favor of roth.
If I had your income IÔÇÖd be maxing out traditional 401k without hesitation.
At your income IÔÇÖd go heavy traditional in your 401(k) and then Roth IRA (may have to backdoor).
Generally the way the math works, you only have to compare dollar-for-dollar tax rates now to tax rates in the future. We canÔÇÖt predict future tax rates, so the best information we have are tax rates now.
Because of things like deductions and how tax brackets start low every year, itÔÇÖs generally advantageous to have a decent chunk of taxable income.
There are caveats though, things like FIRE who retire early need Roth to hold them early because it avoids penalties. Also people who save a ton have to be wary about high RMDs.
Still, generally heavy traditional is beneficial for those in high tax brackets.
What you’d likely want to do is calculate all of your pretax deductions and arrive at your AGI. Then, determine whether or not you could reach a lower tax bracket by higher traditional contributions. If so, do so, and any remainder of investable cash can go to Roth.
0% Roth 401k and 100% Traditional 401k is perfect
Why on earth are you currently only putting 1% into a 401k if your company matches 4%? YouÔÇÖve essentially rejected a 3% tax-deferred raise. Fix that ASAP!
Personally, I would go with
– 4% into 401k
– Max an HSA, if available; invest it like an IRA and donÔÇÖt touch it until you retire (HSA is the best kept secret in retirement savings.)
– Go back and put as much more into 401k as you are comfortable with
As for Roth vs Traditional, it depends on the rest of your tax situation and your best guess for what your tax situation (and tax laws) will be when you retire. As a high-earner, maxing retirement savings with a 35+ year runway, and an assumption of increasing tax rates, you could end up in a situation where your RMDs and social security puts you into a situation where your income in retirement  and therefore tax burden  is higher than it is now.
The main thing is to sock away as much as you can, every year, for as long as you can.
Match 401k to your employer, max out roth, then back to 401k.
Incomed out of roth and wish id listened to my own advice earlier.
Of course the long view of “what tax bracket will I be in retirement?” is also important. You want the flexibility to take taxable distributions from various accounts only up to a certain point, most likely the 12% bracket for most Americans, and then after that use tax free distributions from a Roth or cash savings for living expenses.
Which tax brackets and how much benefit you get from this strategy depends on asset levels and yearly expenses, clearly.
Do you know,
1. Age when you will you will start to draw SS?
2. Age when you will retire?
If (2) < (1), then the greater the difference between (2) and (1) the more traditional you want so that you can convert trad to Roth paying zero to 12 percent frderal income taxes, also while keeping ACA tax credits in mind.
Otherwise there are arguments to be made for 100 percent Roth:
https://www.reddit.com/r/financialindependence/comments/117jqsn/why_i_converted_100_of_my_pretax_accounts_to_roth/
https://www.reddit.com/r/financialindependence/comments/116f0h3/the_mathematical_benefits_of_roth_accounts/
For the group as much as OP, I see strong benefits to maximizing traditional to reduce the amount being taxed at 24%, but is there some benefit to also contributing to a Roth account to provide some flexibility in taxes in retirement?
I was recently fortunate enough to end up with enough income to put me just into the 22% tax bracket this year. I switched from Roth contributions to traditional contributions to get me back just below the 22% bracket. My thought process in going Roth until now is that I will already also have a taxable pension in retirement, so I want to minimize my taxable income (i.e. traditional 401k mandatory withdrawals) in retirement. Having a Roth account available will allow me to supplement my pension, trad withdrawals and SS income to meet my spending needs without increasing what the government wants to tax.
Step 1 should be putting $22,500 in the employer’s 401k – that is the max amount for someone under 50 yrs old in 2023.
Step 2 Max out your HSA contribution. That is tax deferred too and a great augment to your retirement strategy.
Step 3 – Your call at this point. Contribute to a Roth IRA or at least throw your remaining cash into a HYSA.
Single $158k a year Id do 100% pretax for sure no question. Roth is a distant distant second.
YouÔÇÖre effectively paying more in taxes just to ÔÇ£know exactly what you haveÔÇØ. Not worth it to me.