Friday, November 30, 2007

Roth 401k vs Traditional 401k

I recently received the following question from an intelligent reader of moneyconversations:

How can we sign up for the Roth 401k? Does the money convo guru have any thoughts on that besides "If you expect to have a higher tax rate later or have many years of growth (hence more money to tax), then pay them now with the Roth?"

Well, the money conversations masta of finances, me, will happily answer all questions. Disclaimer: I am only highly qualified primarily because I have read about Rich Dad. Don't worry my advice isn't "quit your job and buy real estate"

Now, the only wisdom on the Roth 401k choice that I am pretty sure about is this, which I got from listening to money-guy (Listen to this show to get the details, or just read the site:

Put the assets that you expect to gain the most value (like small cap) in the roth 401k. Put the assets you expect to grow the least (like bond funds) in traditional 401k. Since the advantage of Roth is you don't get taxed on the earnings, you want to get most of your investment gains in the Roth. Since your bond fund isn't going to grow much put in in the traditional 401k, it's probably a better idea not to lose the initial capital by having it taxed.

This is an opinion:

As for that formula for Roth vs Non-Roth, it's an interesting one. Given our long horizon, it probably fine to go with the Roth and fine to go with Both too. Both is good to give us more flexibility when we reach retirement age. I could also scare you with facts about the government's social security liability which would make you want more Roth.

And here's another fact pointed out by another avid reader of this popular blog:

If you can afford it, you can effectively put more money into a Roth account than a traditional account. If you put $15.5k a traditional 401k, you'd only have ~$10k were you could withdraw tomorrow. However, if you put $15.5k into a Roth 401k, you'd still have $15.5k.

My personal take away:

Personally, I'm going to beef up my Roth because right now I have nothing in Roth assets and because I am young enough for it to be worth it. I plan to move my assets in the direction of small cap and international stocks in the Roth and large and bond funds in the traditional, but that will take some time because I don't think you can transfer funds between the two.

See you in 40 years at retirement. We shall see who is buying a boat and who is working at McDonalds!

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