Reg-

As you feel the same way that I do (that income tax brackets will be higher in the future than they are today), you should max out your Roth 403(b) in 2007.

Taxes began in 1913 and were to be temporary. The top marginal income tax bracket average has been about 62% since that time.

With the deficit, the war on terror and the fate of social security unknown, the money must come from somewhere.

As for the 457 plan, remember, that money is also at risk if the hospital goes under.

Hope this helps.

Larry

Zip Code: 11797

Larry, I hope you don't mind that I respectfully disagree with you. I'm not a big fan of high income people contributing to the Roth 401k or 403b.

When you contribute to your traditional 401k, the money you contribute reduces your taxable earnings. Assuming your combined federal and state tax rate is 40%, you save $6,000 in taxes on your $15,000 of 401k salary deferrals. If you contribute to a Roth version of your plan, you forego a $6,000 tax break.

To take advantage of tax-free growth, why not consider this strategy? Contribute to your 403b at work, and then take the $6,000 in tax savings, and invest that in a 529 Plan for your kids (assuming you have children). Thanks to the Pension Protection Act of 2006, 529 accounts grow tax-free as long as the money is used to pay qualified post-secondary school education costs.

In addition to losing a current tax break, I don't trust the governement not to change the rules. I wrote about this in the October, 2006 newsletter available at www.mdtaxes.com/news1006.html. I will post a copy of that article on the Message Board shortly.

So to summarize my thoughts about Roth 401k's, since you'll be giving up a substantial current tax break, compounded by the fact that I don't trust the government not to change the rules at some point down the road, I feel that high income individuals should stick with the traditional 401k plan.

Zip Code: 01801

Here's my article from the MDTAXES October newsletter:

CAN YOU TRUST THE GOVERNMENT NOT TO CHANGE THE ROTH RULES DOWN THE ROAD?

by Andrew D. Schwartz, CPA

Since graduating from college in 1987, I have been a practicing tax accountant. On more than one occassion, I have seen the government enact legislation that reversed some of their previously instituted tax breaks. How confident are you that the government won't find some way to tax your Roth accounts down the road?

Three Major Reversals

The first reversal I observed was back in 1997 when the government increased the percentage of social security benefits that is taxable from 50% to 85%. Don't forget that you can't deduct the social security taxes you pay into the system each year, which means you'll essentially be taxed twice on any social security benefits you ultimately receive. Plus, when social security was first introduced, none of the benefit was supposed to be taxable.

Another reversal was part of the 2003 Tax Act. Under the pre-2003 rules, a new 18% capital gains tax rate was slated to take effect, but only for investments purchased subsequent to January 1, 2001 that were held for more than five years before being sold. So to be fair (and to raise tax revenues), the government allowed you to pre-pay taxes on your investments purchased prior to 2001 that had appreciated in value, even though those investments weren't actually sold.

Sounds like a great deal, right? It might have been, until President Bush signed the 2003 Tax Act into law. As part of this tax bill, Congress reduced the capital gains tax rate on investments held for more than one year to 15% through 2008 (which has since been extended through 2010). Anyone who elected to pre-pay taxes in 2001 on their investments did so at a rate of 20%, which is a whopping 33% premium over the new rate of 15%. Plus, they paid their taxes at least 2 years earlier than necessary.

The third reversal happened this year as part of Tax Increase Prevention and Reconciliation Act signed into law on May 17th. As part of this Tax Act, the "Kiddie Tax" age was increased from 13 to 17, retroactive to January 1, 2006. To make matters worse, in 2008, the capital gains tax rate for people in the two lowest tax brackets is slated to be zero percent. There are a lot of parents of college bound children who were saving money in their child's name in anticipation of liquidating those investments in 2008 and not paying any taxes. Now those investments will be taxed at the parent's rate unless the child is 18 or older.

The Roth Dilemma

After reading these three examples, how confident can you be that the government will not find a way to tax Roth IRAs down the road? Don't forget, with a Roth, you forgo a tax break today in anticipation of tax-free distributions in the future.

Let's take a look at some of the new Roth rules:

Effective this year, people can elect to contribute to a Roth 401k instead of a traditional 401k. People in the top tax bracket who max out their 401k at work will give up a $5,250 federal tax break on their $15,000 salary deferral.

Effective 2010, anyone can convert their existing IRAs and other eligible retirement accounts to a Roth IRA. Yes, you pay taxes on the amount converted at your marginal tax rate, but the government has promised that you won't owe taxes on money withdrawn from those accounts later on.

Reversal On Roth Accounts?

The theme of both of these new rules is simple. Pay taxes today, and the government promises that you won't be taxed on that money tomorrow. From what I've seen, if the rules change down the road, don't expect the IRS to refund to you any of the taxes you paid earlier than you otherwise had to.

Whether the government will somehow reverse this tax break down the road is anyone's guess. Even so, the level of confidence you have that the government won't change the Roth rules is something you need to factor in when deciding whether to go with a Roth 401k or to convert your IRAs and other retirement accounts to a Roth IRA in 2010.

Zip Code: 01801

Andrew-

Here are some additional commments that readers might find valuable. I will preface them by saying that there really is no "right answer" and each individual's situation will dictate what is right for them.

In your prior post you stated "To take advantage of tax-free growth, why not consider this strategy? Contribute to your 403b at work, and then take the $6,000 in tax savings, and invest that in a 529 Plan for your kids (assuming you have children)".

Think about this for a moment. A client contributes $15,000 to their 403(b) plan which saves them $6,000 in current tax savings - but where is the savings? It is not in their pocket, but in the 403(b) plan.

Meaning, the $15,000 that they invested ($9,000 that they would "net" if they did not contribute to the plan plus the $6,000 that they would have paid in taxes). Therefore, they really don't have the $6,000 to invest at all in any other type of strategy.

Additionally, this money is now locked up until age 59 1/2 unless the client decides to borrow from the plan (maximum of 50% of their account balance or $50,000) and it will be subject to income taxes at their then current rate upon distribution.

If you don't trust the government, I think it is much more likely that they will increase the marginal tax rates and/or change the age of distributions rather than the Roth rules.

After all, the lure to have clients put their money in the Roth 403(b) is to have them pay taxes today. Therefore, unlike the other changes that you mention in the article, I believe that it is highly unlikely that these rules will change. Just like a 529 plan's tax-free growth was uncertain until the Pension Protection Act of 2006, I think it would be against public policy to do anything different for Roth accounts.

Just one man's opinion.

Larry

Zip Code: 11797

thanks. I think I'm with you lawrence. The public will revolt if they pay taxes now and then are told in x number of years that they have to pay it again, especially if it makes or breaks a viable retirement. Marginal rates will be higher when I retire in 30 years....
Appreciate all the help!

Zip Code: 02114

What about the fact that municipal bond interest is supposed to be tax-free? However, you need to include your muni bond interest when calculating your taxable social security benefits.

If your only income is muni bond interest and social security, the muni bond interest could cause up to 85% of your social security benefit to be taxable.

I can definitely see the government pulling a stunt like this with Roth distributions. Who the heck knows what will happen 30 years down the road?

Call me a bird in the hand type of guy.

Zip Code: 01801