El Turk
Level 14 Insurance Salesman
The point I'm covering below has been glossed over in a couple of places online, but I didn't see it covered here, so I thought I'd throw it out to the community.
As many in the forum discussed in the past, for those contributing to the max, a Roth 401(k) allows them to effectively shelter more money. This factor alone can result in Roth contributions offering a sizable advantage over contributing to a traditional 401(k). And, of course, Roth 401(k) contributions are more appropriate for those in lower income brackets, who don't think they will stay there.
However, as many have noted, traditional 401(k) plans offer their own benefits, which must be considered alongside Roth benefits in order to determine whether one or the other (or a mix of both) will offer the greatest benefit. One of the benefits of a traditional 401(k) is that it gives you an option of converting to a Roth later on, when tax rates might be more advantageous (because you are making less money, living in an area with lower state or city taxes, etc.). But, as I have argued, converting during low tax periods is often not realistic: it's often not feasible to increase one's taxable income, and pay higher taxes, when he or she is making less money to begin with. The argument is especially true if conversion the window (the period of reduced earnings) is small.
But what about the opposite? What about converting Traditional to Roth when one is making MORE money?
If you are making enough money, and have enough deductions (often the very state and city taxes that made a traditional 401(k) more attractive in the first instance), sooner or later you'll get hit with AMT. If, and only if, you know that your AGI is going to go up in the coming years, but you are on the edge of AMT this year (i.e., each additional dollar you make is phasing you out of the AMT exemption) you can use traditional 401(k) contributions (and a few other tactics, such as deferring property taxes) to keep you within the exemption. If, however, you are reaching the end of the exemption, and you are done being phased out, you are in what is known as the "AMT sweet spot," since your marginal tax rate is 28%. In situations where a person is already in the AMT sweet spot, it might make sense to do Traditional to Roth conversions, then, and take advantage of all of that "28%" space that AMT affords you.
Obviously, this has a somewhat narrow application, for a select group of people, and the AMT sweet spot doesn't last forever: if you accelerate too much income, you'll move out of AMT, back to regular taxes, which would, at that point, be higher than 28%. But I thought it was cool to point out that (with a bit of planning) their is a way to take advantage of traditional 401(k) to Roth conversions, even if you don't think low income windows will ever open up, so long as you have sufficiently high income windows.
As many in the forum discussed in the past, for those contributing to the max, a Roth 401(k) allows them to effectively shelter more money. This factor alone can result in Roth contributions offering a sizable advantage over contributing to a traditional 401(k). And, of course, Roth 401(k) contributions are more appropriate for those in lower income brackets, who don't think they will stay there.
However, as many have noted, traditional 401(k) plans offer their own benefits, which must be considered alongside Roth benefits in order to determine whether one or the other (or a mix of both) will offer the greatest benefit. One of the benefits of a traditional 401(k) is that it gives you an option of converting to a Roth later on, when tax rates might be more advantageous (because you are making less money, living in an area with lower state or city taxes, etc.). But, as I have argued, converting during low tax periods is often not realistic: it's often not feasible to increase one's taxable income, and pay higher taxes, when he or she is making less money to begin with. The argument is especially true if conversion the window (the period of reduced earnings) is small.
But what about the opposite? What about converting Traditional to Roth when one is making MORE money?
If you are making enough money, and have enough deductions (often the very state and city taxes that made a traditional 401(k) more attractive in the first instance), sooner or later you'll get hit with AMT. If, and only if, you know that your AGI is going to go up in the coming years, but you are on the edge of AMT this year (i.e., each additional dollar you make is phasing you out of the AMT exemption) you can use traditional 401(k) contributions (and a few other tactics, such as deferring property taxes) to keep you within the exemption. If, however, you are reaching the end of the exemption, and you are done being phased out, you are in what is known as the "AMT sweet spot," since your marginal tax rate is 28%. In situations where a person is already in the AMT sweet spot, it might make sense to do Traditional to Roth conversions, then, and take advantage of all of that "28%" space that AMT affords you.
Obviously, this has a somewhat narrow application, for a select group of people, and the AMT sweet spot doesn't last forever: if you accelerate too much income, you'll move out of AMT, back to regular taxes, which would, at that point, be higher than 28%. But I thought it was cool to point out that (with a bit of planning) their is a way to take advantage of traditional 401(k) to Roth conversions, even if you don't think low income windows will ever open up, so long as you have sufficiently high income windows.
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