For all my previous jobs I've used the regular 401k. New employer has an option to invest in 401k Roth. I understand the difference of pre vs post tax.
Also I generally do the the traditional to Roth conversion ($6k per year using backdoor). Can I continue to do this if I go with 401k
Which one should I sign up for?
EDIT: Here's my understanding of the different vehicles:
1. Regular 401K - Everyone knows and loves this
2. Roth 401K - Similar to 401K except that its funded from after tax money. Withdrawals are not taxed after retirement
3. Traditional IRA - Invest in IRA with after tax money no income restrictions
4. Roth IRA - You can only invest if you earn < $x. So those who are not eligible do a rollover from Traditional to Roth aka Backdoor roth
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If you are in a high tax bracket, then do regular 401k (you don’t pay taxes now, but you pay when you withdraw the money). If you are in a low tax bracket, then do Roth 401k (you pay taxes now, but you don’t pay when you withdraw)
The sum of your regular 401k + Roth 401k contributions can be $19.5k
Typically these contributions get some matching from your employer as well.
The employer’s contributions are pre-tax money and do not count towards the $19.5k limit
Most people in tech are in high tax brackets, so regular 401k is better.
2. Mega backdoor Roth (401k)
If you have enough money to fully fund the regular/roth 401k, the next step is to fully fund your after-tax 401k and convert it to Roth. This way you get additional Roth money.
The total amount that you can put in the after-tax 401k and convert it to roth 401k is $57k minus the sum of (pre-tax 401k + roth 401k + employer contributions)
3. Backdoor Roth (IRA)
If you are done with all the above, you can also fund your IRA. The IRA limits are independent of what you put in the 401k.
If you have relatively low income (most people in tech are above this threshold), then you can put $6k in a traditional IRA. You won’t pay tax now, but you pay when you withdraw.
Most tech people are above the previous limit, so if you put $6k in a traditional IRA, then you still pay taxes now (in addition to when you withdraw). What you can do, though, is to rollover this $6k from your traditional IRA to a Roth IRA, so you won’t pay taxes when you withdraw this money. You can withdraw the principal at any point in time. There are specific limitations on when you can withdraw the gains.
4. Limits for the 401k
The limit for the pre-tax+Roth 401k is $19.5k/year per person. This means that you can only contribute $19.5k in one year.
The limit for the 401k total is $58k/year per employer. So, if you change employers (or work for multiple employers, eg doctors might work in multiple hospitals), then you can contribute 2*58k=$116k/year. Out of this amount, $19.5k will be pre-tax+roth and the rest will be in the mega-backdoor roth.
Take a look at https://engineerseekingfire.com/how-much-do-you-know-about-401k-and-ira/ for additional information about the different 401k and IRA limits, as well as strategies on how you can withdraw the money from these accounts early (ie before you hit the retirement age of 59.5) without any fee.
I'm not clear on the early withdrawal rules from roth 401k.
Is it true that even if you withdraw principal only from roth 401k ,you are still subjected to taxes and 10 percent penalty on part of that withdrawal?
You can withdraw the principal from a Roth IRA anytime tax-free.
It’s more complicated for a Roth 401k. Read https://fitaxguy.com/roth-401k-withdrawals/ for an example that might help clarify.
In general, it’s easier to just convert your Roth 401k to a Roth IRA and then withdraw from the Roth IRA. This can definitely happen when you change jobs.Some employers (eg Google) allow you to convert even while employed.
One sidenote from the above article is that if you decide to convert from the Roth 401k to a Roth IRA, then you can withdraw tax-free only if your oldest Roth IRA was opened 5+ years ago. So, it does make sense to just open a Roth IRA now even it just has $1 in it, just to start the 5-year clock.