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Good afternoon,

Looking for the 401k tax pros out there. I have four primary 401k tax related questions:


1) Income Tax Bracket at Retirement:
When retiring and "cashing out" on a trad 401k: I understand that we are taxed at whatever income bracket we're in at the time of retirement. How is this determined?Does the income tax bracket take into account how much retirement funds we have (aka will be receiving each month during retirement?)Or, is it literally where a person is immediately prior to retirement? Of course, this can't be the case, because what would prevent someone from taking a low-wage job immediately before retirement? I assume the final tax bracket is calculated by taking a person's total net worth upon retirement and dividing that over their working lifetime...? Is this correct?

This then brings me directly to my 401k specific questions...

2) Taxes on principal contributions, and taxes on 401k earnings / interest (if any):
Are we taxed on only the principal contributions to a traditional 401k upon retirement? Or, are we ALSO taxed on the principal contributions PLUS any gains & compounding interest made over the years? If so, it seems the Roth 401k is the clear choice for almost everyone since the gains/interest is tax free at retirement. If I have this correct, why would anyone choose a traditional 401k over a roth 401k if they have the option, besides a slight monthly takehome pay increase with the trad?

3) Tax payment on a split Trad 401k / Roth 401k account:
If my employer just began offering a roth 401k option, in addition to a trad 401k, and we have the ability to split the contributions between trad (taxes delayed) and roth (taxes paid), how would future contributions / taxes work if my split is (for example) 10% trad and 5% roth? Or do both trad/roth go into the same contribution pool, but each contribution is simply taxed differently come tax time, based on the original trad pool amount, the new trad/roth contribution ratio, and when the ratio was changed? In other words: would I lose out on compounding interest by splitting up my 401k contributions between both trad and roth, or do they go into the same 401k pool regardless?

4) Rolling over a trad 401k into a roth 401k:
Say I have $100k in my trad 401k, and I'm contributing the full $19k per year, and I'm currently in the 24% tax bracket. Now, say, a new big job offer comes by and I anticipate that I'll be moving into the 32% tax bracket in a few months or a year.

Can I roll the $100k (trad 401k) into a roth 401k and pay the trad 401k tax at 24% first, before moving into the 32% bracket, preventing paying 32% taxes on the original $100k? See what I'm saying here? The goal would be to minimize my retirement tax payment to Uncle Sam - surprise!

Thinking about this further... The problem is, I suppose, that if I move into that 32% tax bracket 5/10/20 years down the road, paying the rollover tax of 24% on ~$400k+ could be an extreme amount of cash that I may or may not have laying around (e.g. used for a home down payment instead), and using cash from the 401k itself to pay the rollover taxes would erase years of compounded interest. Is this line of thinking correct?

Thank you very much for taking the time to read through my questions. Looking forward to hearing back and learning more!


Replying to "user's" answer below... Looks like comments are limited in size, so I'll have to reply with an answer.

Great answers, thank you. Follow-up comments... (T plan = trad 401k = T-401k ; R plan = Roth 401k = R-401k)

1) Ok, I believe I understand this correctly. Thinking this through... Depending on how much a person chooses to withdraw from their 401k (RMD + more), plus any other retirement accounts and other sources of income, the combined sum is what determines their bracket. So, if a person just has a 401k upon retirement and they choose to withdraw the RMD, that would put them in the lowest possible tax bracket (trad being better since need to pay taxes still). If they choose to make large withdrawals that come out to greater than what they were earning normally when working, that will likely bump them up into a higher bracket (Roth being better since taxes already paid). A person may have additional income sources upon retirement, so that will play into the final tax bracket.

2) Because the contribution limit for both T & R plans is the same at $19,000 per year (2019), and that earnings ARE taxed with the T plan but NOT taxed with the R plan, I'm not seeing how the math works out. I understand $1 dollar today will (probably...) be worth more than $1 dollar in 30 years due to inflation etc. and that the pre-tax T plan savings are beneficial there --- i.e. the "time value" of money like you mentioned, but I don't see how this trumps NOT being taxed on EARNINGS with the R plan. Yes, contributing $19,000 per year to the R plan means an additional +XX% income tax now on top of that $19k, so I see the time value of money in play here. Perhaps that could be saved and put towards something else (e.g. house down payment, etc.) But, the fact that the yearly principal contributions grow linearly at $19k/year and the earnings (hopefully / theoretically) compound and grow exponentially, and these exponential earnings are NOT taxed with the R plan (but they are with the T plan) makes me think that the R plan is a better choice for most working / middle-class folks and up who contribute regular healthy amounts. This is most certainly the case if a person "thinks" they will be in a higher retirement tax bracket, which I think is the "answer" here, ultimately. Thanks again for your analysis.

3) Rephrasing this question: imagine a 401k account with $100k. Would splitting a current T plan contribution level of $19k into a 50/50 T/R 401k split ($9,500 T & R each) have a reduced compounding effect on the original T-401k already at $100k? Or, would that $9,500 going into a $0 balance new R-401k be better served going into the original T-401k already chugging along? Answering my own question after writing this... it shouldn't matter, correct? Mathematically I believe it comes out the same and a new split shouldn't have any negative interest & earnings effects. The only thing to be concerned with is the pre/post tax differences of the T and R plans, which we discussed above.

4) Got it, thanks.

  • Regarding #1, it sounds like you are thinking you distribute the entire IRA upon turning 65. On one hand, you are allowed to do this. On the other hand most people withdraw an amount per year of the greater of: their annual needs or their statutory RMD, required minimum distribution. This is 0 until age 70.5 then is a percent per year based on generic life expectancy. As described in the answer, the distribution is part of your income each year. – user662852 Oct 26 at 18:08
  • Given the multiple questions contained here, I understand comments won't fit. I converted to an edit. You are welcome to clarify your question to finish all the details you are attempting to add. a lot going on here. – JTP - Apologise to Monica Oct 30 at 19:23
  • "Would the new roth portion be going into a new, separate roth pool, and completely lose out on previous years of compounded interest earned by the trad account?" I don't understand this question, how would future contributions ever benefit from previous years earnings? – Glen Yates Oct 30 at 20:21
  • @GlenYates -- yes, that was unclear. I have deleted that original statement. Essentially, I was asking if redirecting contributions from the current T plan to a new R plan would have any overall negative performance effects. In other words: if these contributions would better benefit from continuing to be contributed to the already healthy T plan, or if starting a new R plan with say a 50/50 T/R split would have no "mathematical" performance impact overall to either account (not talking about tax differences). – The_Ders Oct 31 at 20:48
  • .... of course the T plan would start to grow slower, but the new R plan is now there and growing from the diverted contributions. In summary, to answer that original question -- no, there is no overall "penalty" or negative impact to diverting contributions from a T plan to a new R plan. – The_Ders Oct 31 at 20:55
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  1. It's not correct to say that a 401(k) withdrawal is "taxed at" a certain bracket. Rather, a Traditional 401(k) withdrawal (assuming no after-tax contributions) is simply added to your taxable income, along with your wages and other income. And you are taxed based on that total income, basically the same as if the 401(k) withdrawal were wages. The 401(k) withdrawal is not separately taxed.

    So, if you think of the 401(k) withdrawal as being the "last" chunk of income on top of the other income you would have without the 401(k) withdrawal, the first dollars of the 401(k) withdrawal would be taxed at the rate of the marginal tax bracket you were without the 401(k) withdrawal, but as you withdraw more, it might break into the next higher bracket, in which case the withdrawal would be spread over multiple brackets (some dollars at one rate, and some dollars at a higher rate).

  2. You are taxed on the principal and earnings in a Traditional 401(k) withdrawal.

    The nominal amount of tax paid for Roth 401(k) is lower than Traditional 401(k), but that tax is paid at a different time, so you have to consider the time value of money. If tax rates are the same, the paying tax on the principal at the time of contribution is the same as paying tax on the principal + earnings at the time of withdrawal. The amount of money you are left at the end for Roth 401(k) is (pre-tax contribution) * (1 - tax rate) * (growth over the years), whereas the amount of money you are left at the end for Traditional 401(k) is (pre-tax contribution) * (growth over the years) * (1 - tax rate), which is the same since multiplication is commutative.

    This comparison assumes that you can make the same "pre-tax contribution" in both cases, but since the nominal contribution limits for Traditional and Roth 401(k) are the same, Roth has an effectively higher "pre-tax contribution limit", since its contribution limit is after-tax, so is equivalent to a higher pre-tax amount. This comparison also assumes that the tax rates are the same. If the tax rate is lower in contribution than withdrawal, than Roth is better; if the tax rate is lower in withdrawal than contribution than Traditional is better. I've also ignored other effects, e.g. Traditional withdrawal might make Social Security taxable.

  3. Roth 401(k) amounts are required to be maintained in a separate account from the Traditional, and you can withdraw only from Roth 401(k) or only from Traditional 401(k) if you want. I am not sure what you mean by "lose out on compounding interest". Every time you make a contribution (Traditional or Roth), the compounding of interest for that contribution starts at that time.

  4. You can convert from Traditional 401(k) to Roth 401(k) while still employed if your plan allows it. (Or, since you are changing jobs, you can roll it over to IRA, and/or convert it to Roth IRA.) The amount of the conversion is added to your taxable income, so see the discussion from question 1. The initial dollars added will be in your marginal bracket, but it might go into a higher bracket, so the whole conversion might be spread over multiple brackets. Yes, you would need to be able to pay the increased taxes. You would not want to take out of your IRA/401(k) to pay the taxes, because that would be an early withdrawal with a penalty. In deciding whether it is a good idea to convert now, you would not only have to consider your tax rate in your new job, but your tax rate at retirement, because if your tax rate will be lower in retirement than now, you might want to leave it in Traditional and either withdraw or convert it at retirement.

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When retiring and "cashing out" on a trad 401k: I understand that we are taxed at whatever income bracket we're in at the time of retirement. How is this determined?

It is treated as income, and taxed as if it was income.

(Keep in mind that taxes in the US are progressive; you do not pay your marginal tax rate on 100% of your earnings, but instead work through each bracket in turn. Ie, after all deductions, you would be taxed 10% on your first $9,700, 12% on the next $29,775, etc, until all of your income has been accounted for. Double all numbers for married couples filing jointly.)

If I have this correct, why would anyone choose a traditional 401k over a roth 401k if they have the option, besides a slight monthly takehome pay increase with the trad?

Multiplication is transitive. If you imagine a flat tax rate with no deductions, (contributions * earnings rate) * tax rate is the exact same as (contributions * tax rate) * earnings rate. It does not matter if the taxing is before or after earnings.

(Due to the tax structure -- deductions and progressive tax brackets -- the Traditional 401k would actually come out better if the tax rates were the same, because the deductions and progressive tax brackets would be "used" twice, once in the year you made the contribution and again in the year you make the withdrawal.)

If you are in a position to fully maximize your 401k contribution, the Roth 401k provides an advantage that $19,000 post-tax is worth more than $19,000 pre-tax. But this also increases the chance that your tax rate will be lower in retirement, which would make the Traditional 401k the better choice.

how would future contributions / taxes work if my split is (for example) 10% trad and 5% roth?

You would have 10% of your money taken out pre-tax. You would have the remaining 90% taxed. You would then have 5% of the original amount taken out post-tax.

would I lose out on compounding interest by splitting up my 401k contributions between both trad and roth, or do they go into the same 401k pool regardless?

Multiplication is distributive, so it doesn't matter how many accounts you split your money up amongst. (Roth contribution + Traditional contribution) * earnings rate is the same as (Roth contribution * earnings rate) + (Traditional contribution * earnings rate).

The only difference is how much tax you pay now versus how much tax you pay later.

Can I roll the $100k (trad 401k) into a roth 401k and pay the trad 401k tax at 24% first, before moving into the 32% bracket, preventing paying 32% taxes on the original $100k?

See the point above about progressive tax brackets. If you roll $100,000 from a Traditional 401k to a Roth 401k, you will be taxed on $100,000 of additional income, some of which may overflow into the 32% (or even 35%) bracket anyways.

Depending upon your income, it may still be advantageous to do, or it may be advantageous to split it up over multiple years, rolling over as much as possible until it would step into a higher bracket...or it may be advantageous to not roll it over at all. It depends.

  • Magua - thank you! This is also very helpful. – The_Ders Nov 2 at 15:48

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