Asked by Ben Roussel  |  Submitted March 09, 2016

My company starting offering a Roth 401(k). Since the dollars I now contribute are taxed, what options do I have to offset the pretax dollars that I was contributing?

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  Answers  |  2

March 16, 2016

The glib answer is simply that you could put in less. For example, if your marginal tax rate was 25% and you put $1,000 pre-tax into the 401(k), your taxes would go down by $250. So, effectively, that $1,000 which went into your 401(k) only "cost" you $750 out of pocket.

(Naturally, eventually, taxes will be owed on that money and its growth when it comes back out.)

So to leave your "spendable" (after-tax) income the same, but make contributions to the Roth 401(k) instead of the pre-tax 401(k) -- you'd simply put $750 into the Roth 401(k).

Now, before you get too upset at saving so much less -- consider the future -- if your 401(k) is invested the same way (Roth versus traditional) and therefore got the same growth over time -- look at what eventually happens: Suppose the value of your 401(k) triples over the next 20 years, and then you withdraw the resulting money. Further, suppose your tax rate 20 years from now is the same as it is now:

$1,000 in the traditional 401(k) triples to $3,000. You withdraw it all, but pay 25% in taxes. You end up with $2,250 to spend.

versus $750 in the Roth 401k over the same time, it also triples -- to $2,250. You can then take out that amount, tax-free, and you spend -- exactly the same -- $2,250.

The real power of the Roth comes in a variety of other forms.

For one, since it has the same maximum limit $18,000 -- if you put the full $18,000 into the Roth, you've effectively saved a lot *more* than if you put the max $18,000 in the traditional. (See the example above - where $750 in the Roth was equivalent to $1,000 in the traditional). So the tax-equivalent effective limit on the Roth is a lot higher.

There are a variety of other advantages to the Roth, too -- eventually if you rolled it into a Roth IRA, at least under current law, it would not be subject to required distributions. Eventual distributions don't affect your Annual Gross Income and may have other tax benefits. It would provide some "tax diversification" -- eventually you may have pre-tax, taxable, and Roth assets. Having that variety may help you optimize distributions and even optimize the portfolio (i.e. put the "growthiest" things into the Roth).

$commenter.renderDisplayableName() | 09.20.20 @ 04:12


May 10, 2016

Hi Ben,

David has given you a great summation on the role your future tax rate has on retirement plans. How can you offset those pretax dollars? Let's dig deeper and discuss your bottom line. Ideally, Efficient investing nets you an ROI greater than your losses through taxes. Tax offsets are also good if you have an adequate portfolio size that can withstand the tax erosion during your time frame.

For example:
With a 15% tax rate, put $10K into a ROTH with a CAGR of 20%.. The $1,500 portion in taxes are offset by the higher return of 20% which would be $2,000 on a $10K contribution.

If your firms ROTH 401(k) does not offer sufficient options you have choices with this. Always do what is in your best interest and there are pros/cons with all investment choices.
1). Transfer funds from your existing account to one that does (The amount you can transfer may be limited by your administrator).
2. Stop contributing or limit your contributions (i.e employer match) to your current plan and set up one that does (we love the self-directed ROTH 401(k)
3. Seek employment that satisfies your lifestyle needs. Meaning you enjoy the work and you can live comfortably now and later. Invest in yourself.

We offer lots of no cost educational materials to assist you in getting where you need to be and staying there. No obligation.

Feel free to contact us directly.There are many ways to invest. Invest efficiently according to your lifestyle needs.

Also, here is some information on obtaining your annual participant fee disclosure form:

It's not what you make, It's what you keep that determines your lifestyle.

$commenter.renderDisplayableName() | 09.20.20 @ 04:12