Traditional vs Roth 401K

My company just started offering a Roth 401k in addition to the traditional 401k. They allow any combination of the two up to the $16,500 annual contribution limit. (Matching always occurs in the pre-tax account.) So, which is better?

The conventional wisdom is that in most cases the Roth is better because the account can grow faster with after-tax dollars, especially if you are far from retirement. (Plus the Roth doesn't require minimum distributions, is easier on beneficiaries, and can be withdrawn early under certain circumstances.) If you invest the same amount in both accounts, the traditional 401K will be taxed on withdrawal so it will be smaller.

However, to be fair the money saved by using pre-tax dollars should be invested in a side account. If that tax savings (for example $16,500 x 25% = $4,125) is invested in a Roth IRA (so you don't have to pay taxes on the growth) and your marginal tax rate doesn't change between now and retirement, then they are equal.

Assuming you can afford to maximize your contributions, the ideal situation is to max out the Roth 401k ($16,500) and a Roth IRA ($6,000, or $12,000 for you and your spouse). Of course you're not elegible to contribute the maximum to a Roth IRA unless your AGI is less than $156,000. (Partial contributions are allowed up to $166,000.) Here's where things can get interesting.

Let's say your AGI is $156,500. If you choose the Roth 401k, then you are not eligible for a full Roth IRA contribution (because your AGI is over $156,000). However, if you split your retirement contribution into $500 for the traditional 401K and $16,000 for the Roth 401k, then your AGI is decreased by the amount of the traditional 401K such that now you can contribute the maximum to the Roth IRA.

So, the objective here is to use the traditional 401k to keep your AGI under $156,000 so you can maximize your contribution to the Roth IRA. If you do this right, you could potentially sock away up to $28,500 a year.

The best calculator I could find for comparisons is Bloomberg's. Note that the calculator offers to reinvest tax savings in a taxable account, not a Roth IRA. Play with the numbers and see what's best for your situation.