Pay Taxes Now (401k) or Later (Roth) If You're in the Same Tax Rate Wh

[Guest jemedwards]

As a Goverment Employee, I have a 401k plan called the TSP. And shortly, there will be no maximum limit (other than the Federal limit of $10,500). Therefore my contributions are not taxed until I withdraw the contributions when I retire.

My question is, due to all the taxable income I'll receive when I retire - a military pension, social security benefits, civilian retirement pension and 401k distribution, I believe that I'll be in the same tax rate when I retire as I am now, so why should I open a Roth? Then I'll be contributing both to the 401k (pre-tax) and a Roth IRA (after-tax).

I'm considering opening a Roth but I like not paying the tax on the contributions to my TSP. So should I even bother opening the Roth and just keep making all the contributions to my TSP?

I figure I'm probably going to pay the same amount of tax either today on the Roth or 20 years from now on my 401k plan.

I'm just trying to get some alternate points of view that maybe I'm not seeing.

Thanks!

[John G]

Any questions about future tax policy involves a lot of guessing about annual asset growth rates, tax policies, etc. and more than enough political and financial unknowns. If you are very young, an aggressive saver and an equity investor... you may find that your retirement "draw" will push you to higher tax brackets. If you are more of a spender than a saver, or closer to retirement age then your conclusion has a higher probability. If your health and family genetics indicate a very long life then the math tips towards a Roth... in my view. Upside surprises probably favor the Roth (higher annual yields, longer life, inheriting from others, real estate asset growth, etc.) since bracket bump becomes more likely.

One factor to consider is that the Roth assets (unlike conventional IRAs, SSN and pension funds) have no set distribution requirement, having some retirement assets in this catagory gives you some flexibility. The Roth tax shelter can also extend via inheritance.

[wmyer]

Not only is there no required minimum distribution with a Roth, but the earnings can be withdrawn tax-free. So you're paying tax now on the principal, but you'll never pay tax on the earnings. With a 401(k), you are deferring tax on principal and earnings, but you'll have to pay tax on both, and you'll have to take an RMD once you hit 70 1/2.

[John G]

Not so fast Wmyer...

His contributions to the 401k are pre-tax. The implied tax savings if invested year after year would go a long way to paying the taxes due on 401k distributions in future years. Granted, it is hard to create a separate tax set-aside fund and the earnings from that set-aside typically are eroded by taxes. My point is that when you assume equal tax rates now and in retirement, the comparison with a 401K or standard IRA to a Roth is more difficult and some of the financial advantages of a Roth shrink.

Note, if the 401K has matching funds, the math starts to swing in favor of the 401k over the Roth. For example, working in industry you might encounter a 401k with a 6% match. This can give a 100% return at the front end. (no claim that Jemedwards has something like this related to a government job)

Another advantage of the 401K is that the annual shelter amount often exceeds the 2k Roth max... a blessing for those that start investing late in life.

There is no way to precisely answer the original question. You might think you could answer this question with an accurate spreadsheet model (no small accomplishment to create) and assumptions about life expectancy, tax rates, other income, investment yields, etc. As a former consultant who specialized in models, I can safely say that over even such a short period of time as 5 years this would be a very difficult problem, over 20+ you are mostly using any model to make "guesses".