By Dr. James M. Dahle, WCI Founder
I get lots of questions from readers about whether they should take advantage of their Roth 401(k) (or 403(b)) option to save for retirement. They're usually looking for an easy, straightforward answer. Unfortunately, it isn't that easy.
I only have one rule of thumb, and that's that residents (and military docs) should make Roth contributions and attendings should generally make traditional, tax-advantaged contributions. But there are plenty of exceptions even to that rule. Others have touched on this question before, notably The Finance Buff, in perhaps his best ever column, who made The Case Against the Roth 401(k) and the Bogleheads in their Wiki Page on Traditional vs. Roth.
Here, I'll try to outline the considerations high-income professionals like doctors ought to consider in the Roth or Traditional 401(k) decision.
General Guidelines for Evaluating Roth or Traditional 401(k) Contributions:
- If you’re a resident or military member, maximize Roth contributions.
- If you’re in a low-income year for any reason, such as a sabbatical, use Roth contributions.
- Use a personal and spousal Backdoor Roth IRA each year. That way, even if you choose to make all tax-deferred 401(k) contributions, you’re still getting some money into Roth accounts.
- If you can pay the tax with money in a taxable account and expect to work part-time or retire in your 50s, then consider making Roth conversions during those years before receiving Social Security or a pension to “fill up the lower brackets.”
- If you save and invest more than 20% of your gross income, lean a little more toward Roth investments. If you save and invest less, use tax-deferred accounts preferentially.
Tax Diversification Is Useful
Remember that in retirement you can minimize your effective tax rate by withdrawing some of your income from tax-deferred (traditional 401(k)), some from taxable accounts at preferential long-term capital gains rates, and some from tax-free (primarily Roth, but also borrowing against cash value life insurance or other assets) accounts. No one knows exactly what percentage of a portfolio a retiree will ideally have in Roth accounts on the eve of their retirement, but most experts agree that you ideally want some of both.
Don't Forget the Backdoor Roth IRA
In 2022, a married couple can contribute $6,000 ($7,000 if over 50) each to a Roth IRA each year—usually via the back door for most high-income professionals since they make too much to contribute directly. If you are limited to a $20,500 contribution to your 401(k) in 2022, then making the 401(k) tax-deferred and also maxing out Backdoor Roth IRAs should provide you the tax diversification that you're looking for.
Marginal Tax Rate at Contribution vs. Marginal Tax Rate at Withdrawal
The most important consideration in the Roth vs Traditional 401(k) debate is your tax rate and how it will change when you retire. Most importantly, remember that your contributions are made at your MARGINAL tax rate (i.e. the rate at which the last dollar you made is taxed), but withdrawals may be taken at much lower rates. For example, if your only taxable income in retirement was from 401(k) withdrawals in 2021 and you were a married couple that took the standard deduction, the taxes on those withdrawals were 0% for the first $25,100 that was withdrawn, 10% for the next $19,900, 15% for the next $61,150, and 22% for the next $91,700.
Obviously, if you are saving taxes at 35% when you contribute money and paying taxes at 35% when you withdraw money, then it doesn't matter which account you use. But thanks to the fact you are likely to have a lower marginal rate in retirement and the fact that you contribute at your marginal rate and withdraw at your effective tax rate, most doctors in their peak earning years are going to be better off deferring taxes whenever possible.
But there may be some other considerations.
More information here:
- 2022 Tax Brackets: How They Actually Work
- Roth vs. Tax-Deferred: The Critical Concept of Filling the Tax Brackets
Political/Economic Considerations
Many people hold strong views about future political and economic possibilities that influence their choice of Roth or traditional 401(k). For example, if you believe that future tax rates are going to be much higher than current tax rates, you might be more likely to make Roth contributions and pay your tax now at what you believe will be a lower rate. If rates go up severely, your marginal rate now might even be lower than your effective tax rate later.
Many investors also worry that the government will change “the deal” with Roth accounts and tax them in some way despite promising via the current tax code not to do so. If you're worried about this, you may prefer to get your tax break as soon as possible with a tax-deferred contribution. Some people take their Social Security payments as soon as possible due to similar concerns, despite the fact that under current law it often doesn't make sense mathematically.
Other Retirement Income
If you expect a relatively high amount of taxable income in retirement besides 401(k)/IRA withdrawals, you may be more likely to want to pre-pay your taxes by making Roth contributions. The most common type of income is Social Security. For most retired professionals, 85% of their Social Security income will be taxable. Although individual circumstances vary, most will want to delay their Social Security to age 70, so this effect won't be seen in earlier retirement years. Other retirement income may include a spouse who continues to work, rental income from investment properties, income from taxable investing accounts, and pensions. The more of it you have, the higher the rate at which those 401(k) withdrawals will be taxed.
Estate Planning Considerations
There is no doubt that if you don't plan on spending the money in your retirement accounts and plan to give it to your heirs instead, Roth contributions are very useful. The main reason is that Roth IRAs (although interestingly, not Roth 401(k)s) don't have Required Minimum Distributions (RMDs) starting at age 72. If you take RMDs out of an account from age 72 until your death at age 90, the account is going to be a lot smaller than if you didn't have to take those. Even if the money is still given to the heir, it will be a smaller amount without the tax-deferred growth available in the retirement account.
Once the IRA or Roth IRA is inherited (Stretch IRA), RMDs start based on the age of the heir. But if the heir is very young, the account is likely to continue to grow if only the RMDs are withdrawn. A tax-free Stretch Roth IRA has the potential to grow to an even larger sum of completely tax-free money (since it can grow tax-free for an additional 10 years after death before withdrawals are made). Your heirs will, of course, prefer that you pay the taxes instead of them. If your heirs don't make much money, though, it's possible that they may have a lower tax rate than you. That means the overall tax rate paid by the family will be lower if the heirs pay the taxes.
Need a new challenge? Try to teach a 4-year-old to snorkel.
If you would prefer to give your retirement account money to charities, you're probably better off with a tax-deferred account, since neither you nor the charity will have to pay taxes on that money at all. Of course, you don't get the usual tax deduction for the contribution if you use your never-taxed IRA money to make the donation.
If you are above the estate tax exemption limits, Roth money counts exactly the same as tax-deferred money when it comes to calculating estate taxes, but it is actually more after-income-tax money.
Future Conversions
One of the best arguments against pre-paying your taxes by making Roth 401(k) contributions is that you don't know what the future holds. You can do Roth conversions in later years when your income may be lower. This might be due to cutting back on hours, getting paid less, taking unpaid maternity/paternity leave, doing a sabbatical, or early retirement years prior to taking Social Security. It's much better to do a Roth conversion at 10%-22% than to make Roth contributions paying tax at 28% or more.
Ability to Contribute More
If you are already maxing out your available retirement accounts, you may lean a little more toward making Roth contributions so you can get more money (on an after-tax basis) into retirement accounts where it will enjoy preferential tax and asset protection treatment. For example, if your marginal tax rate is 37%, putting $20,500 into a traditional 401(k) in 2022 is the equivalent of $12,915 after-tax. If you instead put it into a Roth 401(k), the amount of after-tax money in the retirement account is the full $20,500. Keep in mind that Roth contributions are limited to $20,500 even if your profit-sharing plan otherwise allows you to contribute $61,000 (so you could do $20,500 into the Roth 401(k) and $40,500 into the traditional 401(k)). There is no such thing as a Roth SEP IRA, so if you're using a SEP as your retirement account, Roth contributions aren't even an option.
State Taxes
All of the discussion above has focused on the federal tax laws. State tax laws also affect the Roth or traditional 401(k) decision. Perhaps the most common is when you plan to retire in a different state than the one you spent your working years in. If you plan to move to a state without an income tax in retirement, tax-deferred contributions now will be that much better. If you plan to return to New York or California from your job in Florida or Nevada, however, you may wish to pay those taxes up front.
Phaseouts
The tax code is complex and not always logical or fair. If your taxable income is in the range of a phaseout, choosing to make Roth contributions over traditional contributions may cost you a lot more than you think. Most of these phaseouts occur in the $25,000-$250,000 taxable income range which can catch a lot of physicians. Be sure to run the numbers both ways prior to making Roth 401(k) contributions. It might not be worth it if you lose a valuable deduction due to a phaseout. The 199A deduction can cause people to want to do all kinds of interesting things with their retirement accounts.
Going for PSLF
If you are going for PSLF, you are likely trying to keep your IDR payments low to maximize the amount forgiven. A great way to lower your taxable income is to make tax-deferred account contributions.
More information here:
Roth vs. Traditional When Going for PSLF
College Aid
The expected family contribution that is an important factor in determining what grants and loans your college student is eligible for also could have a minor effect on this decision. The calculation uses your after-tax income PLUS any retirement contributions. So, the same amount of after-tax money contributed to a Roth 401(k) instead of a traditional 401(k) lowers your expected family contribution. Also, remember that any Roth conversions done during the college years will also increase your expected family contribution. Let's be honest, though, the children of most physicians won't qualify for any financial aid anyway.
Very High-Income Professionals
If you have a very high income, which I usually define as $500,000-$2 million, you may prefer to make Roth contributions. It allows you to provide asset protection and tax-advantaged growth to more money on an after-tax basis, and if most of your income is going to be taxed at the highest tax rate in retirement, there is little advantage to withdrawing at your effective tax rate (since it is nearly the same as your marginal rate). Along the same lines, you may wish to do Roth conversions of your tax-deferred accounts.
Super Savers
Those who save a lot of money may also want to preferentially use Roth accounts. Basically, because they save so much, they'll accumulate so much wealth that they'll actually be in a higher bracket in retirement than even most of their peak earnings years. This is one reason Katie and I are doing Roth contributions in our 401(k)s these days.
More information here:
Supersavers and the Roth vs. Traditional 401(k) Dilemma
What do you think? Do you use a Roth 401(k)/403(b)? Why or why not? Any other factors that should be considered in this decision? Comment below!
Seems silly to post this question on such an ancient post, but I’m panicking since there are only a few months left to contribute to my Roth IRA for 2016. In 2017, my income will be too high, and I’ll be focusing on my 401k before I can think about a backdoor Roth contribution. Does it make any sense to try to come up with 5500×2 (for my spouse) right now since this is likely our last shot at a Roth contribution ever, now that fellowship is ending shortly? This would mean borrowing the money since we’re lucky if we can scrape together $1000.
I did that back in residency because I expected to never make a Roth IRA contribution again. Then my income was low enough in the military to do it each year. Then the backdoor Roth IRA became possible. Bottom line, I’ve been doing Roth IRA contributions every year since 2004. You do know about a backdoor Roth IRA, right?
Wow, thanks for your super-quick response!! Yes, I do know I can continue doing this each year, but this is my last year doing it the regular way, and I know that if I don’t do it by April, it’ll be 11k we can never invest in a Roth IRA again. Assuming we do borrow, would you say there’s a limit to how much interest we should pay, assuming we can get a very low-interest loan to do this, which we’d pay back within a year? Or are we being stupid, and we should just skip it? We’re not worried about our student loans because we’re hoping for PSLF.
As low as possible. For less than a year it’s pretty easy to get a 0% credit card although these days there is usually a 2-4% transaction fee on that type of borrowing.
Hi! Thank you for your post! I’m a new attending just out of fellowship, making about 200K, but without much salary growth potential, so you can say I’m peaking right now. I did Roth IRA and Roth 403B in fellowship, and have a total of about 25K at this point. Should I just do pre-tax 403B with my new employer going forward and leave what I have in the Roth for tax diversification? Or is there a benefit to continuing to put some of the money into a Roth 403B since my new employer offers that option as well? Also, I am confused about the difference of doing that vs. the backdoor Roth IRA?
Assuming you came out of fellowship last July, this would be the first year of your peak earnings. So this should be the first year you start doing a traditional 403b instead of a Roth one. Continue to do the Backdoor Roth IRA of course. That $5,500 IRA limit is in addition to the $18K employee contribution into a 403(b).
I guess I’m confused as to how attendings are “supposed to do traditional IRA” if most of us probably make too much money. I have rollover funds that came from three different employments prior to becoming an attending. I’m fairly certain these all came out pretax, but to be honest I don’t know. I know that I never made any contributions that were tax-deductible come April. Are these the type of accounts that are at risk of being taxed in the event that I try to do a back door? Currently I do have a employer 401(k), but there is no match until later in the year.
Remember the post is about 401(k)s. Attendings don’t make too much for 401(k)s even if they make too much for IRAs.
Also bear in mind the income limit is for DEDUCTING the contribution, not making it (and even that assumes you have a workplace plan like a 401(k) or similar available to you.) Anyone with earned income can contribute to a traditional IRA.
The only accounts that screw up a backdoor Roth IRA (due to line 6 on Form 8606 i.e. the pro-rata rule) are traditional IRAs, SEP-IRAs, and SIMPLE IRAs.
So if you have a rollover IRA somewhere, just roll it into your 401(k) as soon as you are eligible and THEN do the conversion step for your backdoor Roth IRA.
But all of that has nothing to do with this post, which is about 401(k) contributions.
Ah, thanks. In my mind wasn’t making the distinction between an IRA and 401k. Clearly “need to read more”.
I’m a PGY1 Resident and going to put money away in a Roth IRA. My university offers Fidelity and TIAA… Does anyone have experience with either one and have any recommendations? I’m just looking to easily save money for retirement.
Thanks!
Universities don’t offer IRAs. The I in IRA stands for individual. It’s something you buy on the private market. Your employer likely offers a Roth 401(k), and if they offer a match, you should at least contribute enough to the 401(k) to get it all. But then I’d invest in the Roth IRA you open on your own at Vanguard or similar.
There are good and bad Fidelity and TIAA funds. We would need more info to help. Look for low-cost, broadly diversified, index mutual funds.
Hi WCI – Thank you so much for all of the content you have put together for traditional v. roth contributions. It’s clear that there is lots of information and many options, with no clear one-way or correct answer for any one person. After reading through a few of your articles, I wanted to hear more about your thoughts in regards to traditional v. roth with the perspective of prioritizing paying down medical school debt. I noted you mentioning a *general* rule of thumb that residents should consider investing in a roth in the early years. However, for my husband (currently a 4th year, about to match in just over a month) and myself – we already have a 6 figure income from my employment. It’s no doctor salary, but it’s been a big benefit to us during his medical school years. It looks like I will most likely be able to keep my job when he begins residency.
With my low 6 figure income and his resident salary, we are very focused on paying down his debt from medical school. We don’t anticipate paying it down fully, as many first jobs (at least for family medicine) include debt repayment up to a certain amount (often up to $100K) as part of the contract. We’d like to pay down his debt aggressively so we can put principal and interest payments behind us by the time he starts his first job as an attending and focus on saving and investing from there. For context, we have already been contributing the max amount to my 401(k) at my employer, and we both have individual IRAs (currently we each have a roth and have maxed in 2018 & 2019), in addition to a brokerage account that is roughly 6 figures invested.
All of this being said, our current thought is that we would maximize my 401(k) traditional contributions, paying less money to taxes now and using those funds instead to pay down debt. I would be curious to hear your thought process or any holes that you can poke in our theory. We know there are lots of considerations and no clear correct answer, but always appreciate ideas and suggestions of things to think through!
I know it seems like a good idea, but if you look at the entire course of your life, you’re almost surely going to end up with more money by doing Roth contributions now.
The pay debt vs invest question is completely separate. You feel like you have more money to put toward debt if you do traditional IRA contributions, but that’s not actually true. If you put the same amount of tax-adjusted money in the 401(k), you would have the same amount to go toward loans. For example, if your marginal tax rate is 30%, you can put $10K into the traditional 401(k) or $7K into the Roth IRA. It’s really the same thing and you’ll have the same amount of money to put toward loans either way. But if you’re comparing putting $10K into the traditional 401(k) and $10K into the Roth 401(k), in the second situation you’re putting a lot more money in there. Of course you won’t have as much to pay down your loans.
If I were you, I’d max out that Roth 401(k), two Backdoor Roth IRAs, and put whatever else I could toward the loans. Then after finding out how much the new job will pay toward loans, I’d wipe the rest of them out in my first 2-5 years as an attending.
Good luck with your decision.
Hi,
I became an attending August 2018 and so for 2018 will have made too much money to contribute to a roth IRA. I did not realize this and so Feb 1st 2019 transferred money into my roth IRA as a 2018 contribution for my fidelity account. I am trying to figure out the best way to rectify this situation without paying too much in taxes/penalties but also not breaking the law. The money is just in the fidelity roth IRA account and has not actually been invested in anything yet so has not made any money. I’ve come up with a couple of solutions but unsure if actually the right thing to do.
1. Move the money from the roth out of the account and into a traditional IRA and then a couple of days later move it back to the Roth as the “backdoor roth IRA”
2. leave the money where it is at and invest it with the other roth and then pay the fees at the end of the year
3. Move the money out and back to savings account and then skip 2018 contribution and try for the 2019 backdoor IRA
Any advice on what to do in this situation?
Thank you!
Hi WCI,
I just finished fellowship and started my first attending job last year. I have contributed about 5k in my fellowship employer sponsored 403b and have room to put 14k in my hospital’s 401k for 2019. My question is, should I be doing a roth 401k contribution this year as I will still be in a lower tax bracket this year (6 months of fellowship salary, 2 weeks locum, 3 months attending salary) or just do traditional 401k?
I’d do Roth.
Hi WCI,
I was wondering what your take was for residents in REPAYE/PAYE for Roth vs 403B. I know based on your book, and website, you tend to recommend Roth, however based on what I have read, I was not sure if it was as clear cut choosing rIRA vs traditional 403B. As a PGY-3 who has 3 more years of fellowship, my thinking is as follows:
Current federal income tax: 22%
Current state tax (NYC): 7%
Tax Total: 29%
However, I also save 10% on every dollar given to a traditional 403B, as it lowers my REPAYE payments by 10% for every dollar contributed. Therefore my true tax rate for contributing to Roth vs 403B is 39%.
If this is in fact true, it means for every $6,000 I contribute to rIRA, I could instead contribute $9,836 to a 403B (calculated by 6,000/0.61). I ran both of these situations Bankrate.com’s rIRA and 403b calculator (assuming 39% tax rate for rIRA, and 5% annual rate of return) and the results showed that after 35 years the rIRA was worth $33,096 and 403b $54,256. Thus it appears that the 403b comes out ahead assuming my tax rate is <39% during retirement. Is my thinking wrong here?
If you’re not going for forgiveness, I’d ignore the lower IDR payments because it just means you pay more later instead of now, not a real benefit. If you’re going for PSLF, using a tax-deferred account will maximize the amount forgiven. But whether that will overcome the benefit of tax free over tax deferred is a bit more subtle.
I am currently a military resident with at least 4 more years of service and have been maxing out my Roth TSP and a personal Roth IRA (with Vanguard) since starting residency. While it is still years away, I was wondering whether you thought it would be beneficial to roll the Roth TSP into the IRA when I separate? I know the ERs are slightly higher with Vanguard, but given the relative liquidity of a Roth IRA compared to the TSP (although they have slightly more options now), as well as the requirement to take RMDs with the Roth TSP, I assume rolling the TSP into the IRA makes the most sense? I just haven’t seen anyone answer this question before.
Either is fine. If you want to be able to access the G Fund then leave it, otherwise, roll it over.
I’m about to start an orthopedic residency with the likelihood of doing a 1 year fellowship after I finish. The program I’m going to offers a 403b annuity with no match. My plan is to max out a Roth IRA, but I don’t know what to do after that. Do you recommend that I contribute to the 403b while maxing out the Roth IRA, or should I not use the 403b and max out a backdoor Roth?
With no match, I’d do a personal and if applicable, a spousal Roth IRA first. Then I’d check to see if the 403b has a Roth option. If so, I’d use that next. If it doesn’t, I’d just use the traditional 403b and plan to convert it to a Roth IRA the year you leave the employer.
The decision whether or not to fund the Roth with after tax dollars when you’re in the highest marginal tax bracket certainly favors the non-Roth traditional deferred IRA/401k. However, one cannot easily predict what their income and associated tax bracket will be in retirement, particularly when they are in their 30’s and early 40’s, potentially before their peak earning years or before venturing into other investments that will produce ongoing streams of income that will follow them into retirement such as real estate, interest in a surgical center, etc. Since the benefit of the Roth over a tax-deferred IRA is maximized the longer the IRA is allowed to compound tax free either prior to withdrawal of funds in retirement or as part of estate planning as tax free money left to heirs, do you think that it makes sense for a high earner / high saver to favor the Roth (either fully or partially) early in their career and switching to tax-deferred a bit later in their 40’s perhaps? Then, in retirement, if your marginal tax rate turns out to be favorable, strategically maximize Roth conversions. If it turns out that your tax bracket is too high for Roth conversions, you still will have the Roth account from 25-40 years prior, for which the tax free compounding more than compensated for the initial tax bite at the time that money was invested. Using this strategy you sort of increase your hedge/diversify against potentially higher tax brackets in retirement. Depending on the scenario, one could also end up tapping the Roth prior to retirement for other uses, such as college expenses if their 529 accounts end up underfunded if they wanted to but this wouldn’t be the primary motivation of course. What are your thoughts?
It’s a complicated decision, but no, I don’t think that particular factor should be a big one. Even if you’re only 35, if you’re in your peak earnings years, if you’re like most docs, you’re better off with a tax-deferred account. But you might qualify as a “super-saver” if you’re really putting a ton of money away at 35, and that is certainly a factor that would tilt you toward Roth contributions.
Roth vs traditional 401k was and still is a hard decision for me. I paid a financial advisor a one time fee of $100 to gain access to the software (Right Capital) that many of them use to generate a financial plan. I plugged all my info into it. It will link to most savings, credit card, banks, investment accounts etc. You get to play with the variables (age of retirement, income, expenses, etc) and set goals (college savings, investments etc). So I can see what my cash flows will be if I want to spend 10k per month in retirement vs 15k, and retire at 55 vs 65, while saving at a 20% rate and investing in an aggressive fashion for example. It calculates a likelihood of success from 0-99% chance. It shows me what my income would be and therefore, a good estimate for which tax bracket I will be at. Obviously, if brackets change, I will be off. But I used this to see that I will likely be in a lower tax bracket, and thus a tax deferred 401k is what I chose.
Always nice to have confirmation. Of course, any calculation is garbage in/garbage out. Assumptions matter a lot.
Thanks for churning out good content on the blog. Might want to mosey on over to the forum and you’ll see how your disciples are just crying about hypothetical tax increases and venting about their political stances… good riddance!
Tell them to take it to the lounge and stay out of there yourself!
My speculation based on U.S. government fiscal policy is higher taxes in the future. I’m also not planning to be poor and have a low income when older. Higher-income and higher tax rates mean I would rather pay now at historically low rates than later. Only the future will tell us whether that turns out to be a smart bet.
I’m a big fan of ROTH.
All of my IRA money is there.
I also contribute to a ROTH 401K.
I do have a 457b & 403b (pre-tax) to hedge my bets with some “tax diversification.”
I like the roth 401k to simply save as much money as possible in that account. A couple sticklers at work wont even hear it, and will harp on the numbers saying to go tax deferred. But I save a ton, and want the max in that account. And ROTH dollars are better than pre-tax dollars. I dont have to worry about the growth, I dont have to worry about taxes, I know how much I have regardless of what they do with tax rates later.
Plus when you are saving 40-50% of a pretty high income, the min/max decision of 19,000 pre vs not pre tax starts to seem less meaningful to be honest. If 100% of my savings was in retirement accounts alone, I guess I would be more of a stickler about it, but frankly the majority of everything I end up saving has to go in a taxable vanguard account anyways.
If you’re saving 50% of your income for anywhere near a full career, you probably should do Roth as you’re likely to be in a higher bracket in retirement. It’s the super saver issue mentioned above.
I dont know if this has been mentioned or discussed before, but the following article from NerdWallet makes a good case that Roth comes out ahead of Traditional IRA contributions in almost every situation.
Take a look:
https://www.nerdwallet.com/blog/investing/roth-ira/roth-tops-traditional-iras-up-to-six-figures/
Ha ha. Funny article. Here are their key findings:
Uh…yes. If you invest more money, you usually come out ahead of investing less money. $10K into Roth is more money than $10K into traditional. Duh.
Yes, if you’re in the highest brackets now and in retirement, you should use a Roth 401(k) account. Totally agree. This is the super saver issue I’ve written about.
The whole article reflects some ignorance. Most high earners (those in the highest tax brackets) CAN’T deduct traditional IRA contributions during their careers. So ignore the fact that they’re talking about IRA and apply it to 401ks. That last sentence is referring to most doctors, so yes, traditional tax deferred contributions during peak earnings years come out ahead for most of them.
But if it was straightforward (always Roth or always traditional) there would be no need to write articles like either of these.
If you are a “super saver,” at what level of wealth/retirement savings should you switch from contributing to a traditional IRA/401k to a Roth IRA/401k?
https://www.whitecoatinvestor.com/supersavers-and-the-roth-vs-tax-deferred-401k-dilemma/
No definite amount, but a large 7 figure tax-deferred account or a bunch of rental properties should make you start wondering.
A question on tax advantaged investing without earned income.
I (age 67) retired recently, and my wife (65) plans to soon. We have good pensions, which should pay more than our living expenses. We could put the excess into a taxable account, but a tax advantaged account would be preferred. But with no earned income, there are few tax advantaged options. We have a lot of money already in tax deferred accounts. The plan is to transfer some tax deferred money to a Roth account, and pay tax on the transfer from a taxable account. I think this is functionally almost equivalent to having access to a “Roth” account with no income limits, no earned income requirements, and almost no contribution limits (aside from concerns about being bumped into a higher tax bracket). Is this correct? Anything else I should consider?
[Suppose I transfer $10K, on which the tax is ~$4K. My tax advantaged accounts are now worth $4K more, because Roth withdrawals are tax free, and my checking account is down $4K. The only odd aspect is that the check is made out to the IRS rather than the fund company.]
It seems that this is an option for many people, but almost the only tax advantaged option for people without earned income?
You got it. Roth conversions are your (and many other people’s) best way to move money from taxable and exposed to tax-protected and asset-protected.
Thanks for this info and guidance. I am a fellow, soon to graduate in a few months. Currently making 60K plus about 20K in moonlighting per year. Will make 200K as first year attending, then ~300K after 3 years. Currently I have maxed out my Roth IRA for this year. My wife is a non-physician hospital employee making 50K, and has the option for Roth 403b vs standard 403b contribution.
We have built a 3-6 months savings, and now want to increase her retirement contribution. Since we are married and filing jointly, should we max out her Roth 403b given that we are in a lower-income year for my career? I don’t have a Roth option for my 401k.
I would.
MS4 here with no student loans (medical school paid by a scholarship) and a non-medical spouse, thinking about what adjustments we should make to our retirement contributions once I’m in residency in a few months. His income has put us in the 12% marginal federal tax bracket through my medical school years, so we’ve maxed $12k/year to our Roth IRAs ($6k each/year) over the past four years, along with maxing our HSA contributions ($7.2k/year), and contributing 10% of his gross income to his Roth 401k each year–the amount needed to get his full employer match. This has been a fairly aggressive retirement savings rate of more than 30% of our gross joint income annually, but we’ve been trying to take advantage of every Roth dollar we can afford to part with while in the 12% bracket.
Once in residency I will have a traditional 403b with no Roth option, and my question is as follows: in residency, when we’ll be at the 22% federal marginal bracket (and, I expect, subject to AMT), should we increase his Roth 401k contributions (his current contributions are not quite halfway to the annual maximum) before making any contributions to my traditional 403b beyond the amount needed, if any, for me to get an employer 403b match? Having put essentially every dollar we could save toward Roth space in medical school while at such a low tax rate, we would like to start saving for other non-retirement goals in residency and therefore do not plan to be able to both maximize his Roth 401k and also make significant contributions to my traditional 403b, on top of continuing to max our Roth IRAs and HSA. Thus, our decision is between increasing his Roth 401k contributions to the maximum, vs. contributing that difference to my traditional 403b.
They say personal finance is 80% behavior and 20% knowledge, and the “behavior” part of my brain wants to contribute that figure to my 403b to start “catching up” since his 401k has such a head start over mine, but the “knowledge” part of my brain tells me that taking advantage of his still-available Roth space first while in my training years is mathematically preferable. We treat our finances as 100% joint, so I tell myself it shouldn’t really matter whose account is growing faster, but I still find myself desiring to “catch up” despite what’s mathematically best. As a result, I just want to make sure we are considering all the tax implications correctly when concluding that maxing his Roth space before contributing to my 403b is the mathematically correct decision.
Thanks so much for these resources and your input!
You guys are killing it. No loans, all this money going into Roths. Nice work.
It would be really weird for you to be subject to AMT. Why do you think that? Almost no one will be subject to AMT until 2026.
I agree with your brain not your gut. Assuming no match, or after the match, do Roth first. If you get divorced, you’ll split it 50/50. It’s not a competition. Take the best of what’s offered to you.
If you contribute to yours too, consider doing a Roth conversion the year you separate from the employer.
Thanks so much! We’ll stick with maxing out his Roth 401k after any 403b match for me. Great catch regarding the AMT–I like to consider myself somewhat savvy with the tax code but somehow completely missed that the AMT was suspended for most income levels by the TCJA. In that case, I expect we’ll be solidly in the 22% bracket until at least 2026.
I’m an ER doc but my wife works for large tech company. We currently max out her 401K personal contribution plus employer max. We do an HSA and a backdoor roth ira, but ideally would have more tax-protected ways to save.
So possible good news(!) when we logged on to her benefits page and saw a new banner noting: “Beginning October 1 [2021], you’ll be able to make up to $10,000 annually in after-tax contributions to your Retirement Savings Plan. This new contribution option will allow you to contribute more to your account, as the total IRS contributions limit for this year, including pre-tax, Roth 401(k), employer and after-tax, is $58,000. You’ll also be able to convert after-tax contributions into a Roth 401(k) account.”
Is there any real downside for this? Is this as good as a backdoor roth or am I missing something? Would this limit our ability to contribute $20,500 to her regular 401k? Thank you!!
It’s funny they added it just when Congress started talking about taking the MBDR option away.
This is known as a “Mega Backdoor Roth IRA” and it’s still allowed for now.
https://www.whitecoatinvestor.com/the-mega-backdoor-roth-ira/
Super helpful!! Any idea why her company would arbitrarily cap the after-tax contribution she can make at $10,000?
People write 401(k)s in different ways for different reasons. But there is a testing rule that applies even to after-tax contributions that I suspect drove that decision. It’s harder than it looks to let everyone max out the 401(k). I know; we spent a year trying to figure it all out for the WCI 401(k). The only thing that made it work was my willingness to make “penalty” contributions into the accounts of those who don’t/can’t put enough in themselves.
I’m an Intensivist 3 years out of training, my wife finished her residency and just started fellowship. We have been maxing out our 403b’s, backdoor Roth IRAs, and HSA’s. We also save in a taxable account. We save just over 30% of our gross income in these retirement accounts.
My wife has a Roth 403b option this year and we are debating whether or not to make Roth or traditional contributions (no employer match for either). We are currently in the 35% federal tax bracket and will be 37% when she becomes an attending. State income tax is about 6% for us, and we are not sure where we will retire, but plan to retire in our 50’s (we are currently in our mid-30’s). Leaning towards the Roth option for her 403b but we are interested in hearing thoughts and suggestions about this.
No wrong answer here. But at 35% I’d probably lean toward tax deferred. You’re going to have lots of time to do Roth conversions, potentially in a lower bracket than 35%.