Question

Sarina has decided to contribute to a savings program. She can open a traditional 401(k) or a Roth 401(k). She has determined that she can afford a $12,000 contribution. Sarina's salary is $58,500 per year, and she is in the 25% tax bracket. Thus, if Sarina decides to go with a traditional 401(k), what is her contribution amount? $ What amount is offset via a reduced tax bill? $ If, instead, she decides to go with a Roth 401(k), what is her contribution amount? $ What amount is offset via a reduced tax bill? $ Assuming all the same facts, what if Sarina decides to open both 401(k) plans, splitting what she can afford to contribute equally between both plans. Based on this information, what is her contribution amount? $ What is the offset via a reduced tax bill? $ When Sarina retires, which plan's monies will she be able to exclude from taxable income?

Answer 1

Answers:-

Thus, if Sarina decides to go with a traditional 401(k), her contribution amount will be $ 12,000

Amount which will be offset via a reduced will be $ 3,000

It, instead, she decides to go with a Roth 401(k), her contribution amount will be $ 12,000

Amount which will be offset via a reduced will be $ 0

Assuming all the same facts, if Sarina decides to open both 401(k) plans, splitting what she can afford to contribute equally between both plans.

Based on this information, her contribution amount will be $ 12,000

Amount which will be offset via a reduced will be $ 1,500

When Sarina retires, she will be able to exclude Roth 401(k) plan monies from taxable income

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Basis for answers provided:-

Calculation for contribution in both the plans separately

Traditional 401 (k)			Roth 401 (k)
Sr. No.	(Per Year)	Amount	Sr. No.	(Per Year)	Amount
1	Salary	$58,500	1	Salary	$58,500
2	Contribution	$12,000	2	Contribution	$12,000
3	Taxable Income (1-2)	$46,500	3	Taxable Income (1)	$58,500
4	Tax payable @ 25% of (3)	$11,625	4	Tax payable @ 25% of (3)	$14,625
5	Tax payable @ 25% of (1) [Assuming no contribution is made)	$14,625	5	Tax payable @ 25% of (1) [Assuming no contribution is made)	$14,625
6	Offset via a reduced tax bill (5-4)	$3,000	6	Offset via a reduced tax bill (5-4)	$0

Calculation for equal contribution in both the plans

Sr. No.	(Per Year)	Amount
1	Salary	$58,500
2	Contribution in Traditional 401 (k)	$6,000
3	Contribution in Roth 401 (k)	$6,000
4	Taxable Income (1-2)	$52,500
5	Tax payable @ 25% of (4)	$13,125
6	Tax payable @ 25% of (1) [Assuming no contribution is made)	$14,625
7	Offset via a reduced tax bill (6-5)	$1,500

>> Simpler way to calculate offset amount is multiplying contribution in Traditional 401 (k) into tax bracket (here same is 25%)

(1) As per IRS, Sarina can contribute maximum of $ 19,000 per year. She can contribute additional amount of $ 6,000 if her age is more than 50 years. But, as per information provided, she can afford a $ 12,000 contribution only. Thus, here age does not matter and she will be able to contribute a maximum of $ 12,000 per year.

(2) Contribution to traditional 401(k) is done before tax, thus, amount of contribution is not taxed. But same is taxed when one withdraw the amount.

(3) Contribution to Roth 401 (k) is made after tax, thus, contribution under this plan is also taxed. But when one withdraw the amount contributed under this plan, same in not taxed