401K vs. Roth 401K

Investing
#1

Hello Jeremy,

I’m trying to better understand how my company matching works, as well as the difference between traditional 401k and Roth 401k.

I have a traditional 401k and a Roth 401k at work with a 6% company match. I currently contribute 4% to the Roth and 2% to the traditional. I know the max contribution limit for both is $19500… Can I max out both?

Does it even make sense to have both 401k accounts?
Can I convert the traditional to the Roth? (Any penalty/tax complications?)
Should I open a Roth IRA with a different company and only keep the Roth 401k with my job?

I’m guessing my job is matching up to the 6% (not the entire $19500, correct?). Should I just contribute up to the 6% and contribute the rest to a Roth IRA? I hope I’m making sense here and sorry in advance for any confusions.

Thanks,
Greg

#2

Hi @Gre_Go,

I am sure @Jeremy can answer this question better but here is what I would so according to my understanding. You cannot “max out” both. Your 401K limits are $19,500. You have to understand both of them go into the same 401K but the “Roth Contributions” grow tax free. It is a really important factor people miss, they are not “2 different 401Ks” they are the one 401K but with different type of contributions.

You can convert traditional 401K to Roth 401K but you will have to pay income tax to convert it. If you do this you will need to work with your CPA and most likely will want to do it over a few years so you don’t get an insane tax bill in one year.

If you really have the extra money and really want to invest more into your 401K accounts. You can do something called an “After Tax Contribution” and convert it to Roth. My employer allows me to do an after tax contribution. I believe the after tax contribution limit for 2020 is $57,000. So you could do $19,500 into your Roth 401K. Then you could have a Roth IRA with $6000, and then you could do another $37,500 as an “After Tax Contribution” and convert it to your Roth 401K. This is something you have to be really careful doing. I have provided some links. I am sure you will have some questions, so let me know.

References:

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#3

@Nirav Thanks! I appreciate you taking the time to answer my questions. I’ll definitely look more into the After Tax Contribution. I’m liking this site already.

#4

Hi @Gre_Go,

Remember everything you put into your 401K, you won’t be able to access it until you retire unless you want to pay a 10% penalty. I have the option through my employer to do after tax contributions and convert them to Roth. I may not choose to do that is because I want to have access to my money before I turn 60.

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#5

Hey @Gre_Go!

Yeah, your total contribution can’t exceed $19,500 (so like $9,750 each is ok, but not $19,500 each).

You CAN have both… and it’s fine… but it might be adding unnecessary complexity to your life. Picking one or the other is fine too. I think Roth usually works out better for more people, but if you’re in a high income bracket and/or you plan to retire early and do a “Roth ladder” then Traditional might be a good choice.

I wouldn’t recommend CONVERTING traditional to roth, at least not without talking to a CPA, because yes, all that money will be added to your taxable income at your highest marginal tax rate. (I’m also not sure if converting inside of an active 401k is even possible… generally that’s done between two different IRAs)

Yes, the 6% match is how much of your SALARY they will match. So for example if you make $100K/year, you can contribute up to $19,500 by law, and your company will basically pay you another 6% ($6,000) in this case as long as you contribute $6,000 of your own. It’s an incentive to get you to put money into your 401k. STRANGELY, the match money is ALWAYS “traditional” tax status (not yet taxed). So if you put $6,000 into your Roth 401k, they’ll add $6,000 of traditional status money. CONFUSING, RIGHT?!

And yeah, my strategy is to just max out the MATCH first, then put go to your Roth IRA until that is maxed out. The reason being that Roth IRAs generally have lower fees and better investment options than 401ks, plus they’re not unnecessarily intertwined with your employer.

Here’s my post on how to prioritize your investment contributions:

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#6

@Jeremy

Would you advise to do a taxable brokerage account over after tax 401K contributions? My company allows me to convert my after tax contributions to my Roth 401K instantly.

#7

Awesome! Thanks for replying Jeremy.

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