[RyanR]

I've been investing in my company's 401(k) program through Fidelity for the last 1.5 years. Starting this month we have the option of staying in the standard 401(k) program or switching to a new ROTH 401(k) program. The roth option will offer the same funds and company matching policy.

I'm currently in the 25% federal bracket for taxes. And I currently contribute 20% to my 401(k) (I live with my parents so I have few expenses). I'm currently saving for a down payment on a house and marriage expenses (read: ring) are possible in the not to distant future. Switching to a ROTH account would increase my AGI by ~25%. As such it would decrease my take home by a decent amount. This would delay the house down payment and marriage expense savings. Unless I decreased my 401(k) contribution to say 15% when I went to the roth. But then I'd be investing less in my retirement.

Thoughts?

Thanks,
Ryan

[ScottGem]

I've heard about the ROTH 401Ks. As I understand the difference is that the Roth version is funded with after-tax dollars while the traditional 401(k) is funded with pre-tax dollars. Typically, the earnings on Roth contributions will be tax free as long as the distribution is made at least 5 years after the first Roth contribution.

The idea of a 401K and an IRA is that, by using pre-tax dollars, you are differing your tax liability to when your tax bracket will be lower. Since first time home purchase is a valid hardship withdrawal reason I would tend to stay with the regular 401K. I would even consider borrowing against the 401K for the down payment rather than withdrawing.

[RyanR]

Scott, thanks for the reply. Let me clarify a couple things.

1. Yes, the ROTH is taxed immediately and earnings are tax free as long as you're >59.5 years old. Where the regular 401(k) is taxed only at the end.

2. I don't intend to borrow against or withdrawing from my 401(k). I am living with parents so I am currently saving most of my paycheck toward the expenses I mentioned above. My only current expenses are my car (payment + insurance + gas = ~600/month), my internet service (~40/month) and my student loans ($160/month) (~800/month total). This is less then half of my take home pay so I'm lucky to be able to save a lot each month.

If I contributed 14% to a roth 401(k) that would give me almost the same take home pay I currently get. My company matches the first 3% so I'd contribute 17% total instead of my current 23% total. This is about 74% of my current contribution.

So what's better? Putting in (to keep the numbers simple) $100/year and getting taxed at the end. Or putting in $74/year and keeping everything at the end? I'll be 59.5 in 35 years... I know it depends to an extent on what my tax rate will be in 35 years. But that's hard to guess. I mean we just had a presidential candidate propose a national health care system. That would certainly raise the tax rate.

Thanks,
Ryan

[ScottGem]

Its real hard to judge given your age. Since your retirement nest egg has time to grow hugely, you might wind up in a fairly high tax bracket at retirement. But a lot can change in 35 years and I'd be inclined to put away as much as I can.

[RyanR]

Well then the question transforms to the following. Should I consider putting the federal maximum of $15,500 / year in my 401(k)? This would be higher then my current contribution, but it would be doable. The only immediate effect is that it would push back those two savings goals.

[kp2171]

Article I read earlier today that addresses this exact issue, sort of. Doesn't spend a ton of time on the roth401k, but close enough to read and think about. Basically he says run both trad 401ks and roths to "diversify" your tax hit.

Which has priority? My 401(k) or my Roth IRA? - Jan. 3, 2007

And related...

Cut your taxes in retirement - Mar. 25, 2004

Of course my $100 an hour answer is to find a CFA you can trust. We just spent $250 on a couple of hours of investing advice from our tax guy concerning how to minimize penalties for a inheritance and it saved us tens of thousands of dollars easily. We walked into his office pretty certain about what we intended to do, and his advice was not opposite, but enough of a difference we had to think a day or two, and in the end we went in between. So great professional advice is something you might start to seek out. Its great to have that resource when its needed.

[AtlantaTaxExpert]

As a general rule, for the last eight years, I have been telling my financial planning clients that if they are OVER the age of 50, they should put their retirement money in tax-deferred investments like 401K and traditional IRAs.

If they are UNDER the age of 40, then the ROTH IRA and now the ROTH 401K is the better deal. You more than make up for the lost tax deduction by the long-term tax free growth of your investments.

In fact, after you have established a base with index mutual funds, you can gamble with an occasional high-growth, high-risk stock like Microsoft was in the 1980s or Google was recently. People who put Microsoft in the IRA portfolios in 1985 have IRAs worth millions today. They will eventually have to pay taxes on that money. Had they had the Roth IRA option back in 1985, those people would be able to access that money TAX-FREE!

All things considered, I agree with KP2171. You really should sit down with either a CFA or a CFP (fee-only, of course) and crunch the numbers. It will be well-worth the $500 or so fee you would pay!

[ScottGem]

You have plenty of time to save. I would put in the max that is matched by the company and from there as much more as you can afford.