Roth 401K and the High-Income Earner—Whacky Thoughts
One of the most common questions posed to me as a tax professional is whether to choose the Roth option for a 401K contribution. As you all know, the Roth contribution is not deductible now, but it is also not taxable in retirement. The regular “traditional” 401K contribution tax treatment is simply opposite of the Roth.
Most of the time, the answer is very simple. You will be mathematically ahead with the regular deductible 401K contributions if you are in a higher tax bracket today than when you are in retirement. If you are married, you reach the 32% bracket at $326,600 of income and the maximum 37% bracket at $622,050 of income. But wait. How in the world will you know the tax bracket when you retire—which could well be 30 years down the road? We all know tax laws constantly change. Also, your retirement income may be entirely unpredictable at this time.
So how do you make this decision?
If you google the “Roth vs. Regular” decision you will find a lot of interesting stuff. What you will not find is my frankly whacky observation of money withdrawn from 401K/IRAs in retirement years. Ha…just to be clear, my clients are not whacky, just my observation.
My whacky observation is that it is highly unlikely that the bulk of your traditional (non-Roth) retirement funds will be taxed in a higher bracket in retirement. Here’s why:
- Most retirees (who are the subject of this article) only take the minimum distributions, which now begin at age 72.
- Most retirees die with most of their retirement funds fully intact. At that point, the funds might go to a charity which pays no tax on the distributions. Or commonly the funds are paid out to a number of children, who are usually in a low tax bracket.
- It often takes a very large amount of wealth to earn over $326,000 in retirement. If your net worth is less than $10,000,000 in retirement, it is unlikely you will be in a higher bracket—especially in your 70s and early 80s before high RMDs might kick in.
- In retirement, very wealthy people often invest in tax free municipal bonds, or other tax-advantaged investments —-like higher dividend common stocks or publicly traded partnerships.
In conclusion, a bird in the hand is worth two in the bush. Enjoy your tax savings now and spend it on something fun!