My wife now has the new option of contributing to Roth 403b plan with her new position, and we had to make a decision on whether or not to go with it. Here is our thinking process, which should also apply to Roth 401ks.
I found a few good articles online, including Is the Roth 401(k) Right for You? by Emily Brandon at US News, and Choosing Between Traditional and Roth 401(k)s from Yahoo Finance. Here is a nice table outlining the major differences:
As my last video post outlined, the main difference between a Roth 401k and a Traditional 401k is when you pay the taxes. With the Traditional, you get to defer your income taxes now, but you must pay taxes up on withdrawal. With the Roth, you pay tax now, but you don’t own any taxes upon withdrawal.
So the first question is – when do you want to pay the taxes? Obviously this takes a bit of guessing as who know what tax rates will be in the future. You can also try and look at the 2007 tax brackets for a little guidance. Historically, I believe our tax rates are actually on the low side. If your income is relatively low now compared to what you think you’ll make when withdrawing, you should lean towards the Roth. If you expect an especially high income this year, it may be better to go Traditional. Be sure to take into any big tax deductions that you might have now but not in retirement (think mortgages and child credits). If you think it will be the same, I think you’ll see below that the Roth tends to win any tie-breakers.
(There are also those that think Roth accounts will be double-taxed in the future, so you might as well get the tax break now.)
Before, when our incomes were lower, it was an easy choice to go with the Roth. Now, we may get bumped into the 33% bracket. I doubt we’ll be making this much in retirement, I just don’t plan on saving up long enough to generate that much income. But I have a suspicion that tax rates will also be higher later. And I haven’t even considered possible AMT consequences.
The Roth has “bigger” contribution limits. Sure, the official employee contribution limit for both of them is $15,500 for 2007, but you can see that $100 in post-tax contributions requires a bigger out-of-pocket sacrifice than $100 of pre-tax money. This means that maxing out a Roth effectively allows you to defer taxes on more money. Since we aren’t eligible for a Roth IRA anymore, perhaps we should take advantage of this additional opportunity.
Matching works the same either way. Employer matches can only go in your Traditional 401(k) pool of funds, so we don’t have to worry about this here.
Roth 401(k)s get rolled over into Roth IRAs, which don’t have Required Minimum Distributions (RMDs) and other attractive estate features. I like the idea being able to delay withdrawing any money until I want to, which I can’t do with a Traditional 401(k). I’m not really concerned with inheritance stuff right now.
Final Decision? I still need to look into AMT effects, but for now I think we will be going with the Roth. Here is our plan: I want to max out my Traditional 401k this year in order to lower our taxable income and keep us in the 28% marginal bracket. Then, I think we can take full advantage of the Roth 403(b) on my wife’s side. This also gives us some diversification between accounts – If we have a high-tax year in retirement, we can withdraw Roth funds. If we have a low-tax year, we can withdraw and pay tax on Traditional funds. Did I miss anything?