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Salary deduction/reduction for a young person

Well, I never heard of 'reduction' until now. WDIK? But the S and DIL want to know which to pick for her. She's 29, teaches at a college and now after two years is eligible to contribute.
Should she pony up, I suppose like a Roth, or do deferred like I suppose a 403B?
Your thoughts are always welcome.
best,hawk


Comments

  • Is there any match? That's the chief question.
    My 30yo dau is revisiting this as we speak, with a (small) effective salary reduction due to lower match at new gig.
    If no match (unlikely?) and she can swing it (may be unlikely), then Roth is the clear winner. Or combo: 403b up to match, then Roth.
  • edited April 2016
    Hi Hawk,

    (Added late): Here's a substantive publication explaining the difference between deduction and reduction. http://www.ofm.wa.gov/policy/25.50.htm. It's been too long since I contributed to a 403B (20 years), but some of the fog is clearing as I read this. A 403B actually represents deferred income. That's why you're able to defer paying taxes on the income. A Roth, by contrast, is funded with current income on which taxes must be paid up front.

    Psychologically, I suspect she may be more apt to stick with a pre-tax workplace plan (like a 403B) - and they're fine long-term investments. As I understand Roths, the after-tax contribution portion can be withdrawn at any time. There's a lot more hoops to jump through with the pre-tax contributions.

    But I really like Roths. Tax free compounding and tax free withdrawals are hard to beat. Tough call. Just be sure that either way she socs the $$ away and leaves it alone during the working years. One caveat with Roths is that it's a pretty generous tax provision and so the law could potentially be altered in the future to where they'll find some way to tax them.

    While there's good arguments on both sides, I'd think that in most cases over very long periods one comes out dollars ahead with the Roth. But it's not a slam-dunk. Too much depends on the tax bracket you're in when contributing and again when you're withdrawing.

    One source which attempts to compare the benefits of Roths vs Traditional plans: http://www.401khelpcenter.com/401k/whitehouse_roth.html#.VyLHAtT3aK0

  • Hi hank,

    Although the purists will shoot me, the 403B is sort of the municipal version of the 401K of the private sector and the 457 at the state level. All forms of deferred compensation, albeit with minor differences (much less today than in the past).

    Hawk has the first question. Is there any employer match they she can capture (e.g. Michigan's DC pension puts in 4% and will match up to 3% more if the employee contributes equaling a total of 10% going in.

    The second question is about investment choices and transparency as to fees.

    Third is trading platform choices.

    Michigan was the cat's ass. I had online brokerage options via the Fido network for both my 401K and my 457 and it cost me $50 a year for each.

    At the other end of the spectrum was wife's original with Ma Bell. 5 choices of 'house' funds without ticker symbols and trading was limited to once a month on the last day of the month. Take it or leave it. teehehe;-)I still parlayed Iraq I into a sizeable gain buying after the market puked.

    feh, only lemons? anyone got any vodka?

    and so it goes,

    peace,

    rono
  • msf
    edited April 2016
    As Hank wrote, salary reduction is a pre-tax contribution to an employer-sponsored retirement plan (401(k), 403(b), SIMPLE IRA, etc.) that allows you to defer income. In contrast, salary deduction does not reduce your current income.

    A salary deduction is a contribution to the retirement plan made by having the employer "deduct" the money from your paycheck. What isn't clear from the question is whether the employer is treating this as a "classic" (pre-Roth-era) after-tax contribution to the plan or a contribution to a "Roth Option" within the plan. See IRS's "Types of Employee Contributions" here.

    The old-style after-tax contributions come out tax free (like Roth contributions), but their earnings are taxable (like traditional contributions). The good news is that a fairly new (2014) IRS rule makes it easier to roll over those pre-tax contributions (still not the earnings, though) into a Roth IRA. So once you leave the company, you can move the pre-tax money into a Roth making future earnings tax-free.

    The Roth Option that's attached to an employer plan (401k, etc.) is still part of that plan and still has the same withdrawal restrictions as the pre-tax (salary reduction) money. It's not the same as a Roth IRA. As the IRS writes: "the same restrictions on withdrawals that apply to pre-tax elective contributions also apply to designated Roth contributions."

    It is important to keep the vehicles straight: there are employer plans (401k, etc.) and IRAs. Roth is a modifier meaning "after tax, and earnings may be tax-free". There are Roth 401(k)s (and 403(b)s, etc.), and there are Roth IRAs. In employer plans, in addition to Roth option contributions there are "classic" after-tax contributions.

    The total contributions you make to an employer plan via pre-tax and Roth Option moneys is limited to $18K (plus possible catch-up). This is independent of whatever you contribute to an IRA, which has its own limit.

    The "classic" after-tax contributions are not restricted by this limit. They are subject to a total defined contribution limit (employer plus employee contributions) of $53,000.

    In case I've been as clear as mud, here's M*'s writeup of pre-tax vs. Roth vs. after-tax:
    Should You Make Aftertax Contributions to Your 401(k)?


  • @Hawkmountain: One nice thing about a roth is that if she holds it for 5 years, she can use up to $10,000 (one time limit) towards the purchase of her first home. Admittedly, you lose the compounding of that money if you withdraw it, but for some, it's a nice option to have. You can also withdraw principal at any time for the same purchase.
  • My daughter has a 403b and I advised her to put in as much as she can. The match is only around 5%, but she contributes about 25% a year of her salary.
  • edited April 2016
    Yikes - Just when I thought these retirement options couldn't get any more complicated ...:)

    Nice summary msf.

    There seem to be (from my cursory reading) about an equal number of proponents of the Roth vrs. Traditional IRA. With the traditional you put a lot more money to work right away (since it's pre-tax money). With the Roth you make out like a bandit during the withdrawal years (unless the rules change).

    Both good ways to invest. Whatever plan is selected, through diligent online research, one can uncover the fine points. I'd encourage Hawk's daughter to do this, regardless of plan. It took me 6-7 years after I did the first (of 3) Roth conversions to fully understand all the restrictions and "ins & outs." Really complex rules - and even the experts sometimes offer seemingly contradictory answers.

    Ah-em ... if I may say ... We 403B people paved the road for the later 401K. Originally the deferred compensation concept was designed for public employees. The private sector plans came after. An interesting (not widely known) quirk in the early 403B rules allowed us to transfer money out to other custodians while we were still employed. Uncle Sam later plugged that loophole - I believe sometime after 2000. Nice while it lasted.
  • Once matching (free money) is maxed, I have not read anyone (I think) actually advocate traditional over Roth. Maybe if cashflow is impossibly tight otherwise - ?
  • Matching shouldn't have much to do in deciding whether to contribute to an employer plan (e.g. 403(b)) as a salary reduction (pre-tax) or a salary deduction (Roth option). You get the match either way. (See this IRS FAQ on Roth contributions to employer plans.)

    The argument you may have in mind is that one should contribute to an employer plan as opposed to an IRA until the match limit is reached. But that's a different question from whether contributions to the plan should be pre- or post-tax.

    I don't believe you get the match on the older (non-Roth) type of after-tax contributions. No proof, just some inferences. That's one case in which matching (might) affect the choice of contributions to the employer plan.

    Employer contributions, whether profit sharing, matching, or anything else, are always pre-tax. That's a small argument for making all contributions (from the first dollar) to the 403(b) as Roth contributions (if available). You may want to have a mix of pre- and post-tax dollars. (FWIW, opinions differ on the merits of "tax diversification".)

    The most common argument for making deductible contributions is that your tax rate may be higher now when you're working than after you retire. This argument applies equally to 403(b) pre-tax vs. Roth and to IRA pre-tax vs. Roth.

    Another argument for making contributions to the employer plan pre-tax as opposed to post tax (Roth option) is that if you're close to the income limit for Roth IRA contributions, pre-tax contributions can keep you under the limit. But you may be able to get around the limit anyway with a backdoor IRA Roth conversion (if you've got no money in a traditional IRA).

    Bottom line: matching is likely not a concern when deciding whether to contribute to an employer plan pre-tax or post-tax; the considerations for the employer plan are largely the same as they are for deciding between traditional and Roth IRA contributions.
  • edited April 2016
    Did not mean employer Roth; sorry for lack of clarity.

    Good high-level synopsis, much of which others have covered in part:
    http://fairmark.com/retirement/roth-accounts/to-roth-or-not-to-roth/roth-ira-rules-of-thumb/
  • I return to employer Roth because this thread is entitled salary deduction/reduction (retirement plan contributions). Of course that doesn't preclude raising the question (as you did) of whether one wants to do either, or instead (or in addition) contribute to an IRA, Roth or otherwise.
  • beebee
    edited May 2016
    Just wanted to chime with regard to Roth 401K plans.

    Roth 401k plans grow tax free and can be withdrawn tax free, but must follow RMD (required minimum distributions) rules after age 70.5.

    Individual Roth IRA plans do not have RMD requirements.
  • Great responses from all. Thanks to everyone. DIL has good info to go on and lots of ideas to mull over. MFO rocks!
  • bee said:

    Just wanted to chime with regard to Roth 401K plans.

    Roth 401k plans grow tax free and can be withdrawn tax free, but must follow RMD (required minimum distributions) rules after age 70.5.

    Individual Roth IRA plans do not have RMD requirements.

    If only things were that simple:-)

    The IRS does not impose RMDs on Roth 401(k)s or regular 401(k)s so long as you are working where the money is held. (That is, if you are working at company B, you might not have an RMD at company B, though your money at your former company A would be subject to RMDs.) Same for 403(b)s, but SIMPLEs and SEPs follow IRA rules - RMDs even while you're working.

    https://www.irs.gov/Retirement-Plans/RMD-Comparison-Chart-IRAs-vs.-Defined-Contribution-Plans
    https://www.irahelp.com/slottreport/still-working-and-past-age-70-12-answers-7-frequently-asked-questions

    That's the IRS rule. Still, the plan itself may require you to take RMDs after age 70.5, so you have to check the plan rules also.

    Depending on the terms of the plan, you can often take an "in-service" distribution from a 401(k) or similar once you turn 59.5. That enables you to transfer the Roth contributions to a Roth IRA to avoid the RMD issue, assuming you're still working. (If you're not, you're free to take the money out at any age and transfer it to an IRA or use however you'd like.)

    Finally, a couple of obscure exceptions to all of the above:
    1) In a 403(b) (but not a 401(k)) pre-1987 contributions may not have to be taken out until age 75
    2) Inherited Roth IRAs do have RMDs. (If a spouse rolls over an inherited IRA into his/her own IRA, then it is no longer inherited and no longer subject to RMDs.)
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