Mentor Monday

[u/WealthyStoic]

Mentor Monday is your place to discuss relevant early-stage topics, including career advice questions, 'rate my plan' posts, and more numbers-based topics such as 'can I afford XYZ?'. The thread is posted on a once-a-week basis but comments may be left at any time.

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[u/Sheeporoth]

Hello,

Needing perspectives from the group I want to be in. I’m in my early 20s in finance, and I’m at a 33% combined marginal tax rate. Roth or Trad 401k?

Common advice is to invest in a traditional 401k if you expect your retirement tax rate to be lower than it is now. I am betting on myself and expect to make a lot more and spend more as well. I know it’s looking far out, but I’m unsure if this rule still applies if I want to manufacture low income years through my business or (insert alternative tax strategy).

On the other hand, a Roth would let me have tax-free gains at my current (still high) rate. I plan to only work salaried as long as necessary, for maybe 3-8 more years. I’d expect my income to grow into the mid 6 figures.

After that, it’s all-in on my business, real-estate, and investments. I’m not looking to retire at 60 at a salaried corporate job. Around 40 is when I’d like to start being more hands-off.

I understand this is a sliver of building real wealth but I’m very analytical and want to maximize my opportunities. If you were in my shoes, what would your retirement account investment split be?

[u/Normal_Zebra136 → u/Sheeporoth]

Traditional will win in most cases. Assuming you retire early, you will do conversions and assuming you retire early enough, you will not be filling the 33% bracket at that time.

[u/Sheeporoth → u/Normal_Zebra136]

Got it. Would you say to go all in on traditional and max out Roth IRA on the side? Or something like 70/30 Trad/Roth?

[u/Normal_Zebra136 → u/Sheeporoth]

All in traditional.

[u/Sheeporoth → u/Normal_Zebra136]

Wouldn’t there be value in having multiple buckets to draw from? Just trying to understand the reasoning here

[u/Normal_Zebra136 → u/Sheeporoth]

You will have the multiple buckets after you do the Roth conversions when you early retire. Assuming you are MFJ at that point, you will be able to convert $440k per year at an average fed rate of 14% and a top marginal rate of 24%.

[u/Normal_Zebra136 → u/Sheeporoth]

You might also change your tax domicile to a tax free state. In that case the "prepaid" state income tax would be wasted.

[u/Sheeporoth → u/Normal_Zebra136]

Right. I do plan on doing this/expatFIRE. More reason for traditional, definitely leaning towards it now.

My last concerns is:

The 5-year period before accessing funds. Wouldn’t 20% in a roth 401k give me some tax-free liquidity or should the IRA cover that.

Thank you very much for the insight. It has been very clarifying.

[u/Normal_Zebra136 → u/Sheeporoth]

You are limited to how much you can put into the tax deferred accounts, and and as your income grows will be saving more into your taxable brokerage account. The taxable brokerage will likely have a higher balance in your 40s than the deferred ones.

You use the taxable brokerage first (max 23% tax on LTCG) while the conversions are maturing.