Unmistakable Marks

Reasons to Hate Thomas Friedman, #43 in a series

For making “flat-Earth” signify hyper-modernity rather than pathetic backwardness, as in this sentence from Slate:

Dell has been adored because it is the very model of a flat-earth, New Economy business.

Comments | August 30, 2005

Tax Shelters for the Rich or Reality-Based

If you haven’t been paying attention, you may not have noticed that there’s a new retirement savings vehicle being created next year — the Roth 401(k). The quick summary is that it is to a regular 401(k) what a Roth IRA is to a regular IRA: You pay your taxes up-front and take money out tax-free at the end instead of putting tax-free money in and paying taxes at the end.

Mathematically, if tax rates stay the same, there’s no difference between a Roth and non-Roth account, so it doesn’t really matter whether you use a Roth or a regular account. (An example if you don’t believe this: You could put $1000 in pre-tax money into a non-Roth account, let it double to $2000, and pay 25% taxes on withdrawal, ending up with $1500; or you could take $1K in pre-tax money, pay 25% in taxes to get $750 that you put into a Roth account, let it double to $1500 and withdraw it tax-free. Either way, you have $1500 at the end and an initial $750 hit to your post-tax paycheck.) But there are two reasons you might want to contribute to a Roth 401(k) instead of a regular one:

1. You’re well off. Like all of Bush’s policies, the Roth 401(k) is primarily a boon to those who make a lot of money. Why? Because 401(k) accounts have a contribution limit of $15K a year. For most people, this isn’t much of a limitation — with a median family income around $50K, a $30K cap on 401(k) savings isn’t presenting a real obstacle. But for the highly well-off, it’s limiting their tax-sheltered saving, and the Roth 401(k) helps them get around that limitation by keeping the contribution cap at the same $15K level as the regular 401(k) — but with the Roth, that’s $15K of post-tax money, not pre-tax money; which means that, if you’re in the top tax bracket, you can now shelter the equivalent of $23K of investment money from taxes. Not a bad deal at all.
2. You believe George W. Bush’s fiscal policies are insane and unsustainable. Massive budget deficits don’t keep going forever, and spending is never going to fall to a rate that’d allow current tax rates to bring the budget to balance. So, inevitably, taxes are going to go up in the future. With a Roth 401(k), you effectively get to lock in the low rates of current taxes, rather than having to pay the higher rates that you’d otherwise pay in retirement.

If either of these reasons apply to you — and especially if both of them do — you’ll want to check with your HR department to see if they plan to offer the Roth 401(k) next year.

Special bonus tip: If the second reason applies to you, but not the first, take a look at the Roth IRA. You can’t contribute as much as you can in a 401(k), and you can’t contribute at all if your household makes more than about $160K, but if those aren’t problems, it offers all the benefits of the Roth 401(k) immediately.

Comments | August 28, 2005