Choice of Tax Deferred or Roth 401(k)/403(b)
Dimitrios Paskoudniakis
option.
The current system is:
-There are two plans, the plan where the employer contributes and the plan
where the employee contributes.
-The employer gives you 2.5% up front
-The employer gives you 2:1 on up to 4% of your contributions, so if you
contribute 4%, they contribute an additional 8% above their 2.5%
-The employee can contribute additional unmatched funds up to the ceiling
prescribed by federal law, $15.5K under age 50, $20.5K over age 50, which
includes the first 4% to get matching funds
Up to now, all of the employee contributions are tax deferred, so all
principal and growth taken out at retirement is considered ordinary income.
Of course, all of the employer contributions and growth have been and will
continue to be fully taxable upon withdrawal.
Starting July, we can also contribute to a Roth 403(b) after tax, so after 5
years and above age 59 1/2, all withdrawals including growth are tax free.
The employee can contribute any combination of tax-deferred and Roth into
their plan, as long as the sum does not exceed the $15.5K/$20.5K limit.
I'm 44, have been working at the company since age 20 (while a college
student), and have been contributing no less than the minimum to maximize
company matching funds. I've got quite a nest egg already and financial
advisors have told me if I stopped contributing today, the growth of the
current retirement holdings will meet my retirement needs.
My current income is such that I'm in the 25% marginal tax bracket, I'm in a
high state income tax state (8% state plus county), and my current taxable
income with 4% pre-tax retirement contribution puts me toward almost being
completely phased out of the Child Tax Credit. I have two kids, 14 and 10.
Until this year, I contributed the maximum to Roth IRAs for myself and my
wife (stay at home mom) since they started in 1998, and converted her prior
job retirement to a Roth IRA. We have about as much as you can have in Roth
IRAs given the max contribution allowance since they started, plus growth.
In a couple of years, our income (basically mine) will exceed the current
limit for being able to contribute to Roth IRAs, though I think I read that
this limit will either be raised or eliminated eventually which would allow
me to continue to invest in Roth IRAs for both of us.
Here we go - I need to assess the implications of switching from pre-tax
retirement contributions to Roth contributions. This will add 4% of my
salary back as taxable income now, so about 33% (of the 4%) will go to
federal and state tax. I will also lose about an additional 5% (of the 4%)
in lost Child Tax Credit as long as both kids are 17 and under. Once my
income is so much higher than the Child Tax Credit upper limit, this credit
should not be a factor in the decision of pre-tax or Roth contribution, but
right now it is a factor.
Given the amount already in my retirement nest egg, going all Roth makes
sense to me to add tax diversification. If tax rates hypothetically would
always stay the same, I would be in the same or higher marginal tax bracket
in 20 years, so again Roth makes sense. I just wonder if issues like the
Child Tax Credit should temporarily keep me on the pre-tax contribution
side, and further, if I should switch my contribution to my wife's IRA from
Roth to tax deductible to buy back $50 per $1000 of Child Tax Credit.
What makes more sense for my situation - continue pre-tax contributions, or
go Roth? Wife's IRA - deductible or Roth? Is the decision outcome enough
to suggest hiring a tax advisor, or is the answer obvious?