Can someone explain the 16% DC Plan and Roth vs. Traditional?

[ajm757]

Hey guys,

I wanted to get a better understanding on the 401k (DC) plan and how the 16% DC works. I also want to see if it's better to go the Traditional or Roth option.

Let's say I have 35+ years at a Legacy. I know I can, right now, put $19.5k in as my employee contribution. (This is also what I am doing at current shop). Should I put my contribution as pre-tax (traditional) or post-tax (Roth)?

After I max out my employee contribution, how does the 16% get added to the account? Can this be pre-tax or post-tax, or both? I am somewhat familiar with the 415 limits up to the $58k or so.

Just looking for general info on how to make this work the best way possible for me in my situation. Thanks!

 

[Minuteman]

Just to review some terms:

DC = defined contribution plan, like a 401(k) plan, typically where the account is hosted by a vendor selected by an employer and controlled by the employee (i.e., which of the available investment options are funded)

"Traditional" usually means a tax-deferred account where funds going into the account are not subject to most taxes and withdrawals during retirement are taxed as income. (I say "most taxes" because I don't know if some states do things differently or maybe some kinds of compensation are exempt?)

"Roth" is the complement, where the funds going into the account are taxed as income, but are tax-free during later withdrawal.

In general, Roth makes more sense when your income is in the lower tax brackets (i.e., just starting your career) and you expect to make bank and withdrawal at a rate during retirement that would put you in a high tax bracket (tax-free withdrawals = good there). If you're later in your career, making catch-up contributions like crazy, or expect your annual withdrawals to be more modest, taxes on withdrawals may not be a big deal, and you would prefer to have more pre-tax money available at the start to invest and grow.

I'm not an accountant or a financial planner, and I'm not really sure what the 16% number you're talking about is. If I had to guess, it would be related to IRS restrictions on Highly Compensated Employees (HCE) and fairness to all employees. The specific limit as an amount or percentage will vary by plan/company, but that is probably the maximum amount of pay your employer can match within the rules of the plan. You are not restricted from further contributions, but they won't be matched, and will eventually hit the ultimate 415 limit ($58,000/year).

The limit of $19,500 comes from HCE restrictions, but if you've been there for 35+ years, you may be over 50 years-old and be eligible to make catch-up contributions of an additional $6,500 if the plan allows it.

It definitely makes sense almost always to max-out employer matching. Beyond that is more varied. If you are satisfied with the investment options available under your employer's plan, go sick and take advantage of the tax-deferred income. Sometimes the plan's options are limited and undesirable; you won't be able to become a horrible landlord with a 401(k), or maybe you want to funnel more savings into some treasury notes that aren't available in the employer's plans. In those cases, you might be better-off paying taxes on that income and making your own investments outside your employer's plan.

Everything I've said assumes immediate vesting and there aren't any options as compensation involved. You may hear about Roth IRA rollovers from a 401(k) as a tax workaround; hopefully they are going away soon and the people doing that are technically-legal, but bad.

 

[Stone Cold]

Find a good financial planner and accountant. Do not use random internet people, pilots especially, for investment and retirement advice.

 

[Dphoenix]

This is my understanding... and open to correction if I'm wrong but... Always Roth if you can. It lets it grow completely tax free. Let's say you have $19.5k put in. Under roth post tax, you pay your effective marginal rate on it, let's say 28%. So, $14,040 gets invested into the market. With a 6% gain, you'd end up with $80,638 after 30 years with no additional contributions. Compare that to traditional .. $19500 put in at 6% after 30 years compounds to $111,998. So, better! But, you'll pay tax on that $92,498 gain. Even if you only paid 20%, you're behind the roth guy.

 

[ajm757]

Thanks for posts so far. I should clarify that I would have more than 35 years left to go before retirement.

 

[SteveC]

Thanks for posts so far. I should clarify that I would have more than 35 years left to go before retirement.

Make it a priority and max it out, whatever way(s!) you go. Have someone calculate how much money you won’t have because of not contributing the last five years…you’ll truly learn the time/value of compounding interest.

The first line item on your budget should be funding retirement. Cut back on auto expense, housing expense, food budget…everything else…to make sure you take care of your future self first.

 

[derg]

Make it a priority and max it out, whatever way(s!) you go. Have someone calculate how much money you won’t have because of not contributing the last five years…you’ll truly learn the time/value of compounding interest.

The first line item on your budget should be funding retirement. Cut back on auto expense, housing expense, food budget…everything else…to make sure you take care of your future self first.

From day one for me. And a good non-airline related financial advisor.

 

[ajm757]

Yeah I’ve been maxing it all out since first year at the regionals. Now that I’m moving up to a place with a real plan in place (16%), I can definitely making a bigger contribution.

I’m thinking of doing the Roth 401k and rolling over my old plan. Im just confused as to how the employer contributions go. Sounds like I should talk to a financial advisor or at least do some more research.

 

[SteveC]

From day one for me. And a good non-airline related financial advisor.

Yep.

We got a good Merrill-Lynch guy early on, and let him make the day-to-day decisions based on our goals/needs. We talk on the phone every month or so, do an in-person every year, and it has worked great for us. Rely on experts that you trust, and that understand your situation.

I just did a Google-thing on “how much money should I have at retirement”, and we have at least two to four times as much in our retirement accounts as every rule-of-thumb guideline that my 30 second research came up with. We’re good to go.

 

[SteveC]

Yeah I’ve been maxing it all out since first year at the regionals. Now that I’m moving up to a place with a real plan in place (16%), I can definitely making a bigger contribution.

I’m thinking of doing the Roth 401k and rolling over my old plan. Im just confused as to how the employer contributions go. Sounds like I should talk to a financial advisor or at least do some more research.

Good job on maxing - you’ll be so glad you did!

For what it’s worth, we did our 401k (or 403b) accounts AND maxed out our yearly contributions to Roth IRA’s.

Some people like doing their own research and making decisions as they see fit. I was/am in the group that gets a professional on it, and then don’t think/worry about it in anything other than long-term planning mode.

 

[GypsyPilot]

If you have an HSA, definitely max that out as a priority. You get a very unique advantage of pre-tax and tax free growth. It’s better than a 401k or Roth IRA.

Stop Making 401(k) Contributions -- Fill Up Your HSA First

Are triple-tax-free HSA contributions more valuable and versatile than your 401(k)?

www.forbes.com

 

[derg]

Yep.

We got a good Merrill-Lynch guy early on, and let him make the day-to-day decisions based on our goals/needs. We talk on the phone every month or so, do an in-person every year, and it has worked great for us. Rely on experts that you trust, and that understand your situation.

I just did a Google-thing on “how much money should I have at retirement”, and we have at least two to four times as much in our retirement accounts as every rule-of-thumb guideline that my 30 second research came up with. We’re good to go.

I knew I could trust you!

We’ve had the same advisor for the last couple decades and I’m the • that said, “I’m going to ask you some crazy questions, from time to time, during our conference calls” just as a checksum.

A couple of years ago, I asked “Elizabeth? I’m thinking of Universal Life Insurance and and maybe going in with some guys from work who are starting their own REIT”, she asked some questions, maintain professionalism and basically told me I was a fool, with specifics!

 

[derg]

If you have an HSA, definitely max that out as a priority. You get a very unique advantage of pre-tax and tax free growth. It’s better than a 401k or Roth IRA.

Stop Making 401(k) Contributions -- Fill Up Your HSA First

Are triple-tax-free HSA contributions more valuable and versatile than your 401(k)?

www.forbes.com

I think we just ended our HSA programs at SouthernJets. I never got involved with it.

 

[Ian_J]

Yeah I’ve been maxing it all out since first year at the regionals. Now that I’m moving up to a place with a real plan in place (16%), I can definitely making a bigger contribution.

I’m thinking of doing the Roth 401k and rolling over my old plan. Im just confused as to how the employer contributions go. Sounds like I should talk to a financial advisor or at least do some more research.

If you really are going to a shop with a 16% DC, that contribution doesn’t not count against your personal contributions as it relates to maximum yearly contributions if that’s what you’re asking.

 

[ajm757]

So my plan is to continue ma i

If you really are going to a shop with a 16% DC, that contribution doesn’t not count against your personal contributions as it relates to maximum yearly contributions if that’s what you’re asking.

Mike,

I understand that the employer contributions do not affect my personal contributions. I max it out with the $19.5k and will continue this when moving to the new place., but I will put my contributions into the Roth 401k.

Will the employer contributions be pre or post tax? I guess what I am asking is I will have my contributions to Roth 401k, and what happens to employer contributions? Will they also go to the Roth or are they also pre-tax?

Thanks everyone. I am disciplined in my investing but do not know all the finer points.

 

[woodreau]

I wish I would have looked into HSA sooner

The biggest drawback of an HSA is …. Not to use it for medical expenses.

But from what I’ve been reading it’s triple advantaged.

Contributions are pretax.
Grows tax free.
Distributions aren’t taxed if used for medical expenses.

So it’s a Roth IRA on steroids

At my company the airline contributes a small sum. So over a 35 year career it’s $70k the airline gave you for free.

You keep all HSA funds when you leave your employer before or after retirement. After retirement at age 65 you can now use the HSA for anything - withdrawals are still tax free for medical expenses but non medical expenses are taxed but now there is no penalty for withdrawal for nonmedical expenses.

I’m planning on setting aside a cash account to cover my out of pocket maximums and pay medical expenses with the cash account.

contribute the max to an HSA until I retire in 15 years and leave Yellow with $129500 assuming 0% return/growth with Yellow contributing $30k of that.
And use the HSA to pay for medical expenses in retirement.

Plus take the 401k with me as well.

 

[woodreau]

So my plan is to continue ma i

Mike,

I understand that the employer contributions do not affect my personal contributions. I max it out with the $19.5k and will continue this when moving to the new place., but I will put my contributions into the Roth 401k.

Will the employer contributions be pre or post tax? I guess what I am asking is I will have my contributions to Roth 401k, and what happens to employer contributions? Will they also go to the Roth or are they also pre-tax?

Thanks everyone. I am disciplined in my investing but do not know all the finer points.

Employer contributions are “pretax”.(not technically correct - I don’t know what the term is). The employer contribution and earnings from the employer contribution are taxed when distributed. Plus you’ll be subject to RMD after 72.


Instead of rolling your current employer 401k (assuming it’s a 401k and not a Roth 401k) into your new employers 401k, if it’s a normal pretax 401k, consider rolling your current employers 401k into a traditional IRA. Then convert it into a Roth IRA. You’ll have to pay taxes now. But you’re on first year pay, so if you have a huge 401k balance you may want to do the Roth conversion over multiple years depending on your tax bracket.

If you currently have any traditional IRAs you’ll have to keep in mind the pro rata rule when you do the Roth conversion.

since you’re going to a legacy you’ll find that for the first yearyou’ll be able to contribute to a Roth IRA but you’ll soon reach a point where you can’t contribute to a Roth IRA anymore due to AGI limitations. At that point only the traditional ira will be available to you but you’ll probably also be at the point where your AGI is also too high to take an ira deduction so you have a post-tax traditional IRA balance vs a pre-tax traditional IRA.

you’ll have to keep track of the post-tax ira balance.

You can either keep the post-tax traditional IRA or you can convert it to a Roth IRA. It’s up to you.

 

[Autothrust Blue]

Contributions are pretax.
Grows tax free.
Distributions aren’t taxed if used for medical expenses.

Perverse, isn't it?

 

[Crockrocket94]

The DC plan most airlines use these days are Tax deferred 401k NEC contributions based on your salary up to a maximum amount depending on the year. I have a 15 percent NEC and contribute an additional 10 percent into a trad. 401K along with a HSA I max out.
The short answer is if you can max everything, HSA, NEC trad 401k and a Roth, while maintaining capital and acquiring assets such as a house... do it.


Here is a good infographic.

Charles Schwab

 

[BobDDuck]

since you’re going to a legacy you’ll find that for the first yearyou’ll be able to contribute to a Roth IRA but you’ll soon reach a point where you can’t contribute to a Roth IRA anymore due to AGI limitations. At that point only the traditional ira will be available to you but you’ll probably also be at the point where your AGI is also too high to take an ira deduction so you have a post-tax traditional IRA balance vs a pre-tax traditional IRA.

The current limits are about $140k for filing single and $210k for filing jointly. You'll blow through those limits within a year or so at a major, especially if you have a spouse that works. That takes the Roth option off the table (other than the whole backdoor thing, which most accountants will tell you not to do).

There are two limits (which vary every year) on the 401k. 415c and 401a. The 415 limit is how much can go into the account each year. The total amount is $58k, of which you are limited to putting in $19.5k. The 401a limit prevents any company contributions to be made once your yearly earnings reach $275k. Almost any captain at a major will be hitting that limit prior to the end of the year. We have some topped out instructors who hit the limits in July. That means that (for most properties) any company contributions that are made after that point come back to you as taxable income. It's a nice 15% or 16% pay bump, but you are getting taxed on it. This is one reason why increasing the company contribution to a higher number really isn't a big bargaining priority for many captains as it doesn't do anything for them. It would benefit more junior pilots however who don't hit the 401a limits yet.

Short version of the story...

Find a good financial planner and accountant.
Don't worry too much about roth or not roth, as you won't be eligible to put money in a roth after a year or so.
Max out your portion of the 401k (up to $19.5).
If your property doesn't already have an HRA or HSA, make sure they negotiate one in the future.
Expect to see Market Based Cash Balance plans appear during the next few bargaining cycles.