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I am trying to figure out a reasonable strategy for my situation.

I make over the limit to write off traditional IRA contributions on my taxes starting in 2020. I currently contribute 8% to my 401k. As a result, I am trying to justify where to place my retirement now because the primary benefit of the IRA has been removed for my income bracket.

I see a few different options:

  1. Raise traditional 401k contributions to 10-15% (somewhere in there) and do not put any money into the IRA anymore (essentially moving my IRA contribution % into the 401k).

  2. Raise traditional 401k contributions slightly (1-2%) and continue contributing to the IRA.

(1) is straight forward. However (2) presents some different complications.

I am currently returning around 9% a year in my IRA. My 401k is lagging, producing around 7% per year. There's not a whole lot I can do inside of my 401k. I am forced to invest in mutual funds they provide. Their expense ratios are approximately equal to the expense ratios on the mutual funds in my IRA (~.25-.35%). My thoughts with (2) are to contribute a little more into my 401k in order to reduce my taxable income some, and contribute the rest into my IRA to (up to the contribution limit of $6000) in order to take advantage of superior returns. Given my financial situation at the moment, I do not make enough to max out my 401k and the IRA without significant sacrifices in my lifestyle. Maxing out my IRA however, is not a problem.

Is there a better way to look at this? I've gotten advice that amounts to "just max out your 401k" but the lack of flexibility in the 401k bothers me, and I don't get a match to boot.

EDIT:

For (2) I would create a roth IRA for any further contributions, mirroring the position in my original IRA. Due to the amount of money in my IRA presently, a backdoor roth would incur significant costs.

  • The most important factor of Roth vs traditional is age. At 20 the Roth is vastly better, at 50 the Roth is vastly worse (To be more specific, what matters is the difference in tax brackets now vs in retirement). – xyious Nov 20 '19 at 16:24
  • "For (2) I would create a roth IRA for any further contributions, mirroring the position in my original IRA. Due to the amount of money in my IRA presently, a backdoor roth would incur significant costs." Usually people would only do a backdoor Roth IRA contribution if they are not eligible to contribute to a Roth IRA directly. If you are eligible to contribute to Roth IRA directly, as you plan, you don't even need to think about the backdoor. – user102008 Nov 20 '19 at 22:13
  • Another option is to not contribute to your 401k the entire year at all, and contribute to Traditional IRA, which you can deduct since you are not covered by a 401k. However, you will be subject to the $6000 annual contribution limit for IRAs. But you will be able to use the investment choices in the IRA which you prefer. – user102008 Nov 20 '19 at 22:16
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It sounds like your question can be boiled down to: is it worth contributing to a potentially less tax-optimal Roth account (versus a pre-tax account) in order to access better investment options?

You are probably the only one that can answer that. But some points to consider:

  • How superior would pre-tax versus Roth contributions be for you? The main factor here is tax rate now versus tax rate in retirement. In general I think many overestimate their tax rate in retirement, and pre-tax is usually the way to go. But with that said, locking in a 10 or 12% federal tax rate right now isn't terrible. Tax diversification is a good thing too.
  • What investments can you access in your IRA that you can't in your 401(k)? It sounds like the funds in your 401(k) are fairly inexpensive, so that's not a major concern. Remember past performance does not guarantee future results, so 9% versus 7% return may not continue forever.
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  • I have full access to any instrument I want in my IRA. I just can’t short, I don’t think. For the first bulletpoint, how could I spreadsheet that and figure it out? – CL40 Nov 20 '19 at 2:00
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    @CL40 What can you not access in your 401(k) that you would invest in with your IRA? – Craig W Nov 20 '19 at 2:14
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    @CL40 For the first bullet point, you can take a pre-tax amount, compound the growth until retirement, then subtract off your estimated tax in retirement. Versus for Roth, you subtract off your current marginal tax rate up front and then compound the growth until retirement. (For the pre-tax case you might want to also simulate investing the up-front tax savings.) But really it will just come down to tax rate now versus tax rate in retirement. If now > retirement then pre-tax is best; now < retirement then Roth is best. It's just a matter of how close they are. – Craig W Nov 20 '19 at 2:16
  • It seems my marginal tax rate is 24%, so this would mean that keeping the money in a traditional expecting ~50% of my income per year in withdrawal would mean I'd pay less taxes then, right? So my traditional IRA is the one I should move money into and not use a roth IRA going forward despite not getting a write off every year. – CL40 Nov 20 '19 at 19:03
  • If you can't deduct the contributions to the IRA, use the 401k to achieve the same goal. Roth IRA sounds like it's possible but not optimal unless you're already maxing out the 401k. I wouldn't worry too much about investment options with your long-term investments, just stay invested with low costs (preferably in index funds). – wide.writing.immediately Nov 20 '19 at 19:07
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My thoughts with (2) are to contribute a little more into my 401k in order to reduce my taxable income some, and contribute the rest into my IRA to (up to the contribution limit of $6000) in order to take advantage of superior returns.

This is making the best of the "bad" situation of earning $196K+/annum.

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  • So your suggestion is to up my traditional 401k contributions slightly and begin putting money into a roth? Could you elaborate? – CL40 Nov 20 '19 at 18:48
  • @CL40 what I mean is that I think this is a good plan. – RonJohn Nov 20 '19 at 21:07

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