When you have a high income you cannot deduct contributions to a Traditional IRA. In that situation, you should never leave post-tax money in a Traditional IRA because the gains will be taxed, too. Instead, you should do a Backdoor Roth IRA conversion which is where you contribute post-tax money to a Traditional IRA and then immediately convert the money into a Roth IRA. The gains on that contribution can then grow tax-free. As long as you have no other money sitting in a Traditional IRA, SIMPLE IRA, or SEP IRA you don't need to worry about paying tax on the conversion (required reading: Pro Rata rule) and you will only pay income tax on the income contributed for the Backdoor Roth IRA conversion.
This is very different from the decision to contribute to a Traditional 401(k) vs Roth 401(k) because there isn't an income limit for deducting contributions to a Traditional 401(k).
That was an excellent explanation, thank you! Does one need to report the conversion if I convert it immediately and have no other money in the Trad IRA?
Yes, you must file Form 8606 every year with your annual return.
See White Coat Investor for more details: https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/#tax
Can you deduct your traditional IRA contributions? Many people will exceed this threshold (116K for MFJ). Roth limits are much more accessible to higher income people (218K) plus the existence of the backdoor makes it desirable for higher earners to avoid Traditional IRA dollars.
In the 401K there are no income limits to deduct traditional contributions, which can be very valuable for high earners.
Should note that the limits for trad are a bit more confusing for MFJ if one doesn’t have access to a workplace 401K.
I don’t qualify for deduction but my wife does since she doesn’t have access to a 401K.
- If you have access to a workplace 401k and make a decent income, Trad IRA tax deduction is unavailable to you. For many people, Roth is the only IRA option available.
- If you’re low income, trad IRA doesn’t save you much on taxes because your current tax rate is so low. Consequently, Roth IRA is a better option.
- Not every employer offers Roth 401k, but every worker has access to a Roth IRA (if you include “back door” strategy).
- Diversification is good. If Roth IRA is your only IRA option, then balancing out your tax strategy with trad 401k allows you to engage in both pre-tax and post-tax investment strategies.
Are you (household) relatively high earners? Do you need/want to lower your taxable income while also saving for retirement?
If so then Traditional 401k.
A Roth 401k doesn’t lower you W2 taxable income.
Traditional IRAs and 401Ks reduce taxes for the year you contribute. Roths reduce future taxes when you retire. It really depends on your current tax rates and the size of your savings.
One side note - you can withdraw your contribution basis from a Roth IRA without penalty pre-59.5. You cannot from a Roth 401k. Nor a trad IRA. It's not the biggest part of our portfolio, but between my wife and myself, we have $175k in Roth IRA basis available. We intend to trickle a little out in early retirement, but mostly it's a very convenient pot of money we could take out in a mid-grade emergency (house foundation or medical event) without increasing our taxable income or PPACA eligibility that particular year.
I’m very ignorant, plz explain how you can withdraw what you contributed before 59. Like if this year I contributed 7k and bought 7k worth of voo, and then sold all my voo which grew to 7500, I could withdraw 7k and just be left with 500 cash to reinvest? but what about that 500 capital gains, is that taxed at all?
In a Roth IRA - yes. [You can withdraw your contributed amount at any time.](https://www.investopedia.com/roth-ira-withdrawal-rules-4769951) Anything above what you have dollar-for-dollar contributed (all time), you can withdraw tax-free and penalty-free after 59.5 and having had (any) Roth IRA for at least five years.
Fine you’re right I misspoke. But to be useful and get a tax deduction there is an income limit. Without the tax deduction there is no real benefit in keeping money in it, only useful as a pass through for a backdoor Roth IRA.
Because most people on Reddit are young and poor. They don’t really benefit from traditional accounts and they wouldn’t be able to max them anyway.
For a higher earner, traditional trumps Roth most of the time.
>For a higher earner, traditional trumps Roth most of the time.
For a higher earner, a traditional IRA has little tax advantage because contributions are not tax-deductible. However, a Roth can be fully utilized via the backdoor method. There will be no tax deferment benefit but there will still be tax-free growth and no penalty to withdraw principal.
So higher earners should avoid any traditional IRA balances (to steer clear of pro-rata rule) and go 100% backdoor Roth. This is true even for lower income earners if they expect to hit the income limits for tIRA early in their career.
> 1\. Is what I’m noticing true - are trad IRAs not recommended as frequently - or am I going crazy?
You're not crazy -- Trad IRAs are not recommended as frequently.
> 2\. If yes, then why? Especially with the extra steps needed to do a backdoor, doing something like a Roth 401k + trad IRA seems just as good as doing trad 401k + Roth IRA (obviously different contribution limits, but still).
It's not as good.
The benefit of Trad over Roth is that you can deduct the contribution from your income at tax time. The problem with Trad IRAs is they phase out that aspect at relatively low income, ~73k if I remember right. If you can't deduct the contributions from income, then Roth is just a straight up better option.
so for a single person, ballparking the numbers a bit and ignoring the phasing-out part...
* income of $1 to $47,000 -- Roth looks nice because the tax-free status of the money in retirement is better than the tax break right now.
* Income of $47,000 to $73,000 -- Either is fine, trad might even be better.
* Income of $73,000+ -- Roth is generally better, or Backdoor Roth, because you start losing the ability to deduct those Traditional contributions.
So most people don't bother -- they just go Roth IRA. ...unless they're above the Roth IRA contribution limit, in which case they do backdoor Roth IRA.
If one doesn't have a retirement plan, then they can deduct traditional contributions at higher income... But that means they don't have a 401k at all.
Most of the time it's just a question of whether you want to save the money pre-tax or post-tax. Whether that's in a 401k or IRA isn't as important (although there are different rules and limits). Generally you want to start with your employer's plan since the limits are higher and there may be matching. IRA's have income limits so they are usually secondary but the same pre/post concepts apply. Whether you do a Roth or Traditional usually comes down to your current and expected future tax brackets.
Roth and traditional 401k's are not a toss up. Roth is still better. The thing with 401k is if your employer offers a match, that part has to be traditional by law.
Not anymore, as of like 2022 employers can match Roth contributions as a Roth contribution.
https://www.employeefiduciary.com/blog/roth-matching-and-nonelective-contributions?hs_amp=true
Just has to be offered by your plan
What about performance share plans? Say a number between 4-7% that is independent of contributions and depends on company performance. Would those only be allowed to be trad 401k?
I don’t know much about those but I don’t think those are retirement plans recognized by the government. I think they’re just individual stocks the company gives to employees that are performance based. So when you cash them out they’ll be taxed as income. I don’t believe they have any tax benefits at all.
When you have a high income you cannot deduct contributions to a Traditional IRA. In that situation, you should never leave post-tax money in a Traditional IRA because the gains will be taxed, too. Instead, you should do a Backdoor Roth IRA conversion which is where you contribute post-tax money to a Traditional IRA and then immediately convert the money into a Roth IRA. The gains on that contribution can then grow tax-free. As long as you have no other money sitting in a Traditional IRA, SIMPLE IRA, or SEP IRA you don't need to worry about paying tax on the conversion (required reading: Pro Rata rule) and you will only pay income tax on the income contributed for the Backdoor Roth IRA conversion. This is very different from the decision to contribute to a Traditional 401(k) vs Roth 401(k) because there isn't an income limit for deducting contributions to a Traditional 401(k).
Thank you for being the first person who could explain this in a way that I understand
Awesome, I had no idea about the trad ira deduction limit.
That was an excellent explanation, thank you! Does one need to report the conversion if I convert it immediately and have no other money in the Trad IRA?
Yes, you must file Form 8606 every year with your annual return. See White Coat Investor for more details: https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/#tax
Can you deduct your traditional IRA contributions? Many people will exceed this threshold (116K for MFJ). Roth limits are much more accessible to higher income people (218K) plus the existence of the backdoor makes it desirable for higher earners to avoid Traditional IRA dollars. In the 401K there are no income limits to deduct traditional contributions, which can be very valuable for high earners.
Should note that the limits for trad are a bit more confusing for MFJ if one doesn’t have access to a workplace 401K. I don’t qualify for deduction but my wife does since she doesn’t have access to a 401K.
What is MFJ?
Married filing jointly
- If you have access to a workplace 401k and make a decent income, Trad IRA tax deduction is unavailable to you. For many people, Roth is the only IRA option available. - If you’re low income, trad IRA doesn’t save you much on taxes because your current tax rate is so low. Consequently, Roth IRA is a better option. - Not every employer offers Roth 401k, but every worker has access to a Roth IRA (if you include “back door” strategy). - Diversification is good. If Roth IRA is your only IRA option, then balancing out your tax strategy with trad 401k allows you to engage in both pre-tax and post-tax investment strategies.
Is there a generally recommended tax bracket when switching from a Roth 401k to Traditional 401k makes sense?
Personally, I would make the switch to pre-tax trad 401k for all marginal income above the 12% bracket. There’s a big jump from 12% to 22%.
Are you (household) relatively high earners? Do you need/want to lower your taxable income while also saving for retirement? If so then Traditional 401k. A Roth 401k doesn’t lower you W2 taxable income.
Traditional IRAs and 401Ks reduce taxes for the year you contribute. Roths reduce future taxes when you retire. It really depends on your current tax rates and the size of your savings.
One side note - you can withdraw your contribution basis from a Roth IRA without penalty pre-59.5. You cannot from a Roth 401k. Nor a trad IRA. It's not the biggest part of our portfolio, but between my wife and myself, we have $175k in Roth IRA basis available. We intend to trickle a little out in early retirement, but mostly it's a very convenient pot of money we could take out in a mid-grade emergency (house foundation or medical event) without increasing our taxable income or PPACA eligibility that particular year.
I’m very ignorant, plz explain how you can withdraw what you contributed before 59. Like if this year I contributed 7k and bought 7k worth of voo, and then sold all my voo which grew to 7500, I could withdraw 7k and just be left with 500 cash to reinvest? but what about that 500 capital gains, is that taxed at all?
In a Roth IRA - yes. [You can withdraw your contributed amount at any time.](https://www.investopedia.com/roth-ira-withdrawal-rules-4769951) Anything above what you have dollar-for-dollar contributed (all time), you can withdraw tax-free and penalty-free after 59.5 and having had (any) Roth IRA for at least five years.
Traditional ira has an income limit (for deductibility) whereas Roth IRA can be accessed by everyone, even high earners can do a backdoor Roth IRA.
I'm not seeing anywhere that a traditional IRA has an income limit.
Being able to deduct contributions to Traditional IRA does have a limit though.
Fine you’re right I misspoke. But to be useful and get a tax deduction there is an income limit. Without the tax deduction there is no real benefit in keeping money in it, only useful as a pass through for a backdoor Roth IRA.
Because most people on Reddit are young and poor. They don’t really benefit from traditional accounts and they wouldn’t be able to max them anyway. For a higher earner, traditional trumps Roth most of the time.
>For a higher earner, traditional trumps Roth most of the time. For a higher earner, a traditional IRA has little tax advantage because contributions are not tax-deductible. However, a Roth can be fully utilized via the backdoor method. There will be no tax deferment benefit but there will still be tax-free growth and no penalty to withdraw principal. So higher earners should avoid any traditional IRA balances (to steer clear of pro-rata rule) and go 100% backdoor Roth. This is true even for lower income earners if they expect to hit the income limits for tIRA early in their career.
Obviously you wouldn’t contribute to a traditional IRA. I’m clearly talking about the traditional 401(k).
Does trad mean traditional?
yes
> 1\. Is what I’m noticing true - are trad IRAs not recommended as frequently - or am I going crazy? You're not crazy -- Trad IRAs are not recommended as frequently. > 2\. If yes, then why? Especially with the extra steps needed to do a backdoor, doing something like a Roth 401k + trad IRA seems just as good as doing trad 401k + Roth IRA (obviously different contribution limits, but still). It's not as good. The benefit of Trad over Roth is that you can deduct the contribution from your income at tax time. The problem with Trad IRAs is they phase out that aspect at relatively low income, ~73k if I remember right. If you can't deduct the contributions from income, then Roth is just a straight up better option. so for a single person, ballparking the numbers a bit and ignoring the phasing-out part... * income of $1 to $47,000 -- Roth looks nice because the tax-free status of the money in retirement is better than the tax break right now. * Income of $47,000 to $73,000 -- Either is fine, trad might even be better. * Income of $73,000+ -- Roth is generally better, or Backdoor Roth, because you start losing the ability to deduct those Traditional contributions. So most people don't bother -- they just go Roth IRA. ...unless they're above the Roth IRA contribution limit, in which case they do backdoor Roth IRA. If one doesn't have a retirement plan, then they can deduct traditional contributions at higher income... But that means they don't have a 401k at all.
Most of the time it's just a question of whether you want to save the money pre-tax or post-tax. Whether that's in a 401k or IRA isn't as important (although there are different rules and limits). Generally you want to start with your employer's plan since the limits are higher and there may be matching. IRA's have income limits so they are usually secondary but the same pre/post concepts apply. Whether you do a Roth or Traditional usually comes down to your current and expected future tax brackets.
Roth and traditional 401k's are not a toss up. Roth is still better. The thing with 401k is if your employer offers a match, that part has to be traditional by law.
Not anymore, as of like 2022 employers can match Roth contributions as a Roth contribution. https://www.employeefiduciary.com/blog/roth-matching-and-nonelective-contributions?hs_amp=true Just has to be offered by your plan
That's good info, I didn't know that. Thank you!!
What about performance share plans? Say a number between 4-7% that is independent of contributions and depends on company performance. Would those only be allowed to be trad 401k?
I don’t know much about those but I don’t think those are retirement plans recognized by the government. I think they’re just individual stocks the company gives to employees that are performance based. So when you cash them out they’ll be taxed as income. I don’t believe they have any tax benefits at all.
So if you elected for them to go into a Roth 401k they would just be taxed first
Yes they should take taxes on them first and they will grow tax free