Roth and Traditional 401(k): Why not invest in both?

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The question of whether to invest in a Roth or traditional has come up a lot lately. Yesterday I wrote about these retirement accounts in the The Ultimate Guide to Traditional and Roth 401(k) and IRA Retirement Accounts. In that article I linked to a Roth 401(k) calculator that can help you determine what’s best for you. I wanted to point out, however, that the decision is not necessarily one or the other. If your employer offers both Roth and traditional 401(k) plans, typically you can chose to invest in both. Your total contributions cannot exceed the IRS limits ($15,500 in 2008 + $5,000 catch up for those 50 and older). But within this limit, you can invest a portion in a traditional plan and a portion in a Roth plan. I can think of at least two good reasons to consider splitting your investment into both types of plans.

First, you may conclude that the best plan for you depends on what your tax rate will be during retirement. The problem is, of course, that we can’t know for sure what the tax situation will be many years from now. Since we don’t know, why not invest some of your money in both plans? By doing so, you hedge against the possibility that you’ll put all your money in one plan that turns out to be the second best choice.

Second, you may conclude that the Roth is best, but can’t afford to lose the current tax savings that a traditional 401(k) offers. If that’s the case, you can start off investing some small portion in the Roth plan, and as your income grows (and your need for the tax deduction diminishes), you can gradually switch your contributions from the traditional plan to a Roth plan.

It’s this second option that I’m seriously considering beginning in 2008 when my employer begins offering the Roth 401(k). And since my company matches dollar for dollar up to 6%, putting all my money in a Roth 401(k) would result in the first option. Why? Because matching contributions are placed in a traditional 401(k), even if the employee contributions go to a Roth 401(k).

Published or Updated: February 13, 2013
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Randall says:

    I like the Roth 401(k), it’s just that no company I’ve worked at has ever offered one yet. I ‘believe’ that taxes will have to go up, maybe even significantly, with all the pending issues the U.S. is facing in the coming decades; Social Security solvency, Boomers retiring, Economic slowdowns, etc.

    If I’m wrong, then I lost a little money. If I’m right, those in a taxable account stand to possibly lose a LOT of money.

    The other thing I like is the ‘don’t have to take disbursements at 70 1/2′ If I want to leave it in there to accumulate interest, I can. Conventional Roths and IRAs force you to take it out whether you want/need to or not.

    • DR says:

      Randall, I too suspect that taxes will have to go up. Social Security and medicare will cost us a fortune. You’d be surprised, though, how close a call a traditional versus Roth 401(k) is even if you assume taxes will go up. The calculator I link to in the article allows you to set different tax scenarios to test this. Good luck!

  2. Emeka says:

    I have read some of your articles and think they are brilliant. They are very great and relevant for everyone more especially the younger generation.

    I contribute to my company’s 401k and am matched at 75% for the first 6%. Currently am putting in the 6% which is in a traditional 401k and also contributing to a Roth IRA. My personal contribution is about equal for both the Roth IRA and the traditional 401k . My company offers the Roth 401k and I want to know if I should switch over. Should I stay how I am and be tax diversified as we dont know what future tax laws are OR should I go with the Roth and enjoy the tax-free withdrawals. I am 24 years old and believe my tax rate will go up.

  3. George Adams says:

    Another advantage of the Roth 401(k) over a Traditional 401(k) is with unqualified distributions.

    Say you put in $10,000 in both a Traditional 401(k) and Roth 401(k), and both grow in value to $15,000. Later, you leave your company and roll both accounts over into (respectively) a Traditional IRA and Roth IRA.

    And then let’s say you need some money, but you haven’t hit age 59 1/2 or any other qualifying event.

    With the Traditional IRA, you will be hit with penalties if you try to withdraw any of that money. But with the Roth IRA, you can withdraw any or all of your contributions without penalty at any time. So if you need up to $10,000 from that IRA, it’s yours for the taking.

    We plan on using that as a form of college savings for our kids. Almost all our excess money will be going to my Roth 401(k) rather than a 529 college savings plan. Later, if we need extra money for our kids’ college, I’ll be able to pull out some of my contributions to my Roth IRA (rolled over from the Roth 401(k)) to help foot the bill.

  4. komrad says:

    Let’s say your income is too high for a TIRA or RIRA, but if you invest in a 401k to reduce your taxable income, then you can participate in a Roth IRA. Given that scenario, how would you allocate your stocks versus your bonds? ie. would stocks go into the 401k, and bonds in the Roth, or the opposite?

    • Rob Berger says:

      One theory is to invest in stocks in a Roth as they are more likely to grow more than bonds.

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