I understand the differences between the two, but are there any real statistics on whether one pays out better for the average American throughout history than the other? From my preemptory googling, I could not find any indication either way. I could see the post tax paying out better if you have enough contributions in it at a lower tax bracket than you are by the end of your career, but was curious about hard data on the subject.
Traditional versus ROTH 401k
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Last: 2 yr ago by TamuKid
It depends on your marginal tax rate when you are making contributions vs your marginal rate when you are taking distributions. If your marginal rate is the same then it makes no difference. If your marginal rate is lower now compared to when you take distributions then you'll get more from a Roth. If it is higher now than when you take distributions then you'll get more from a traditional.
There are other things to consider as well such as SS tax torpedo, IRMA, and RMDs which may steer you more towards a Roth.
As far as hard data, I haven't seen much. It will vary by individual based on their tax situation. There are a lot of calculators on line where you can enter your info and see the projected difference. Keep in mind that nobody knows for sure what the tax rates will be in 20 years, but most likely they will be higher than now.
There are other things to consider as well such as SS tax torpedo, IRMA, and RMDs which may steer you more towards a Roth.
As far as hard data, I haven't seen much. It will vary by individual based on their tax situation. There are a lot of calculators on line where you can enter your info and see the projected difference. Keep in mind that nobody knows for sure what the tax rates will be in 20 years, but most likely they will be higher than now.
Traditional is better in my opinion unless you're currently in a very low tax bracket.
The money you save and put into the traditional 401k evades your highest tax bracket rate. When you take this money out, it gets taxed first at the lower brackets and as a result an overall lower total tax. It's an instant savings.
Mathematically the traditional account leaves you with more money, except in a rare case where you're in a really low tax bracket today, and will be in a higher one in the future, but that's extremely unlikely for most people. Once your income
Rises you'll want to switch to traditional.
There are also withdrawal management tactics where having the tax free withdrawal can lower your overall taxes, but this in my opinion gets really tricky and hard to predict. With some effort you can figure out what you want to withdrawal and set up back door roth to minimize or make some
Roths contributions, but it feels like a lot of effort for not much gain. Additionally life is hard to predict so I think a lot of this planning doesn't account for reality and life makes these plan's impossible to stick to. You'll be balancing withdrawals and taxes between social security, traditional, and Roth accounts and frankly I don't see the benefit in roth for above average earners.
The money you save and put into the traditional 401k evades your highest tax bracket rate. When you take this money out, it gets taxed first at the lower brackets and as a result an overall lower total tax. It's an instant savings.
Mathematically the traditional account leaves you with more money, except in a rare case where you're in a really low tax bracket today, and will be in a higher one in the future, but that's extremely unlikely for most people. Once your income
Rises you'll want to switch to traditional.
There are also withdrawal management tactics where having the tax free withdrawal can lower your overall taxes, but this in my opinion gets really tricky and hard to predict. With some effort you can figure out what you want to withdrawal and set up back door roth to minimize or make some
Roths contributions, but it feels like a lot of effort for not much gain. Additionally life is hard to predict so I think a lot of this planning doesn't account for reality and life makes these plan's impossible to stick to. You'll be balancing withdrawals and taxes between social security, traditional, and Roth accounts and frankly I don't see the benefit in roth for above average earners.
I don't recall the criteria because it's been a few years but I had my FA run analysis on this (and we were high earners) and the Roth came out slightly ahead.
It's case by case so I would just have your FA run this analysis, if you have one.
It's case by case so I would just have your FA run this analysis, if you have one.
Remember the Roth gets inherited & grows tax free for 10 years. If thinking legacy it's hard to beat.
Also a large traditional IRA RMD can throw a surviving spouse filing as single into a much higher tax bracket.
Lots of things to consider other than just the taxes now vs taxes later. Roth all day for me unless top bracket and in your 60s
Also a large traditional IRA RMD can throw a surviving spouse filing as single into a much higher tax bracket.
Lots of things to consider other than just the taxes now vs taxes later. Roth all day for me unless top bracket and in your 60s
There a lot of unknowns that impact which is the better way to go. Among them are your tax brackets during your working years as well as your tax brackets in retirement. Of course, those cannot be known and are kind of central to the calculation. Your financial advisor is having to guess and may be way off the mark.
I have seen some folks in higher tax brackets when they retire than when they were working but for most the opposite is true. So many things can change over a lifetime. If we ever moved toward a consumption tax (not likely I don't think) then that changes things as well.
I have seen some folks in higher tax brackets when they retire than when they were working but for most the opposite is true. So many things can change over a lifetime. If we ever moved toward a consumption tax (not likely I don't think) then that changes things as well.
I've heard some say it's best to do traditional if you're in a higher tax bracket now than you expect to be at retirement, but that's way too simple an equation.
Depending on when you start (let's say 30 years of savings for example) your gains over that time if traditional are then all taxed as you withdraw. So let's say you make $150k per year now (a higher tax bracket for this scenario) which some would suggest then doing traditional. Over your working life, all those gains will then be taxed upon withdrawal. So even if you save ~10 or 15% on taxes now, instead of just the money going in being taxed your now paying taxes on all of it which can cut into the funds quickly. Plus, who is to say what tax rates may look like by the time you retire (assuming earlier in your career).
Depending on when you start (let's say 30 years of savings for example) your gains over that time if traditional are then all taxed as you withdraw. So let's say you make $150k per year now (a higher tax bracket for this scenario) which some would suggest then doing traditional. Over your working life, all those gains will then be taxed upon withdrawal. So even if you save ~10 or 15% on taxes now, instead of just the money going in being taxed your now paying taxes on all of it which can cut into the funds quickly. Plus, who is to say what tax rates may look like by the time you retire (assuming earlier in your career).
Even if you're in the same tax bracket in retirement, traditional is still better because the tax rates are progressive.
I've run a lot of numbers and traditional has always come out way ahead.
Also, if you want to leave an inheritance, a regular brokerage account is the best. Retirement accounts will leave your heirs with big tax bills and less money than if you left them a regular brokerage account. Even if that brokerage account balance is lower because it didn't get special tax treatment, it leaves your heirs with no taxes, which puts them in a much better spot. I've run the numbers on this as well.
Also, with the numbers I've run the boost in after tax retirement income from tax advantaged accounts is only about 5% compared to saving in a regulate taxable brokerage account, using the same withdrawal percentage and assuming no state income tax.
No analysis can account for unknown future changes to the tax code.
With only a 5% boost to take home, the draw backs of a 401k may not be worth it. Locked up money you can't access, and will leave less for your heirs. Pretty big drawbacks over your lifetime. Probably good to still find the 401k to take the company match and maybe a little more for a retirement income boost, but I think it's good to consider the benefits and flexibility of saving using a taxable account as well.
The traditional 401k is a lot more attractive if you live in a state with high income taxes. Especially if you plan to later retire to a state without income taxes.
I've run a lot of numbers and traditional has always come out way ahead.
Also, if you want to leave an inheritance, a regular brokerage account is the best. Retirement accounts will leave your heirs with big tax bills and less money than if you left them a regular brokerage account. Even if that brokerage account balance is lower because it didn't get special tax treatment, it leaves your heirs with no taxes, which puts them in a much better spot. I've run the numbers on this as well.
Also, with the numbers I've run the boost in after tax retirement income from tax advantaged accounts is only about 5% compared to saving in a regulate taxable brokerage account, using the same withdrawal percentage and assuming no state income tax.
No analysis can account for unknown future changes to the tax code.
With only a 5% boost to take home, the draw backs of a 401k may not be worth it. Locked up money you can't access, and will leave less for your heirs. Pretty big drawbacks over your lifetime. Probably good to still find the 401k to take the company match and maybe a little more for a retirement income boost, but I think it's good to consider the benefits and flexibility of saving using a taxable account as well.
The traditional 401k is a lot more attractive if you live in a state with high income taxes. Especially if you plan to later retire to a state without income taxes.
If tax rates are the same, the two perform identically when comparing money spent today vs money available tomorrow. You could speculate endlessly in either direction about the future of tax rates or even your future finances, which I think makes for a good argument for a mix of both. This also gives you some flexibility to audible if your situation changes. Specific to 401k, if you're getting a company match it will be traditional, so it might be a good reason to consider Roth.
The two big advantages I like about a Roth:
The two big advantages I like about a Roth:
- If you're hitting the contribution limits, you can squeeze more equity into a Roth. The '24 IRA limit for individuals is $7,000. $7k of Roth has more value than $7k of Traditional, but you've paid for that in taxes today.
- The contributions in a Roth can be taken out penalty-free, so you've got some access to your wealth before age 59-1/2. So if you retire early, it gives you some extra options that a traditional doesn't.
BenTheGoodAg said:
If tax rates are the same, the two perform identically when comparing money spent today vs money available tomorrow. You could speculate endlessly in either direction about the future of tax rates or even your future finances, which I think makes for a good argument for a mix of both. This also gives you some flexibility to audible if your situation changes. You didn't specify 401k vs IRA, but regarding 401k, if you're getting a match it will be traditional, so it might be a good reason to consider Roth.
The two big advantages I like about a Roth:
- If you're hitting the contribution limits, you can squeeze more equity into a Roth. The '24 IRA limit for individuals is $7,000. $7k of Roth has more value than $7k of Traditional, but you've paid for that in taxes today.
- The contributions in a Roth can be taken out penalty-free, so you've got some access to your wealth before age 59-1/2. So if you retire early, it gives you some extra options that a traditional doesn't.
They DO NOT perform identically!!!
Withdrawal of a traditional account pays less tax than they evaded at the time of saving because the tax rates are progressive!
If you're in a 22% tax bracket, you can save 22% in taxes, but then when you withdrawal in the same tax bracket and income, your effective tax rate will be much lower, in the teens. That's an instant advantage to the traditional.
But yes the Roth does let you save on a larger pre-tax amount.
I don't disagree with your clarification, and maybe I should state that if your marginal tax rate today is equal to your effective tax rate tomorrow, the results would be the exact same. But I stand by what I said as intended.
The point I was trying to make is related to some of the misconceptions about the growth potential of those two strategies. Examples:
Traditional misconception - because you have a larger sum of money, your compounding growth does more work
Roth misconception - because your money is growing tax free, you'll have more money in the end
If the (marginal vs effective) tax rates are the same, the results of these two methods will yield the exact same results.
That said, I think it's hard to make a sweeping endorsement of either given the range of life circumstances, and predict how it will exactly compare to the tax environment of your retirement years. Early in my career, when I was single, I had moderate income, but a higher tax rate. As I got married and had kids, my income has gone up and my tax rate has gone down. As they leave the house, the tax rate will creep back up. As I get closer to retirement, I expect my expenses and income will go down, and so will my tax rate. But even our idea of retirement has changed as we've gotten older and had kids. My retirement spending projections have gone up since I was 22 and entered the workforce. I think there's a big value in mixing the two.
The point I was trying to make is related to some of the misconceptions about the growth potential of those two strategies. Examples:
Traditional misconception - because you have a larger sum of money, your compounding growth does more work
Roth misconception - because your money is growing tax free, you'll have more money in the end
If the (marginal vs effective) tax rates are the same, the results of these two methods will yield the exact same results.
That said, I think it's hard to make a sweeping endorsement of either given the range of life circumstances, and predict how it will exactly compare to the tax environment of your retirement years. Early in my career, when I was single, I had moderate income, but a higher tax rate. As I got married and had kids, my income has gone up and my tax rate has gone down. As they leave the house, the tax rate will creep back up. As I get closer to retirement, I expect my expenses and income will go down, and so will my tax rate. But even our idea of retirement has changed as we've gotten older and had kids. My retirement spending projections have gone up since I was 22 and entered the workforce. I think there's a big value in mixing the two.
Yeah, you're right, and I was wrong in my post. If your the majority of your retirement income is your 401K distribution then your effective tax rate will be less (assuming only marginal increases in future tax rates).bmks270 said:BenTheGoodAg said:
If tax rates are the same, the two perform identically when comparing money spent today vs money available tomorrow. You could speculate endlessly in either direction about the future of tax rates or even your future finances, which I think makes for a good argument for a mix of both. This also gives you some flexibility to audible if your situation changes. You didn't specify 401k vs IRA, but regarding 401k, if you're getting a match it will be traditional, so it might be a good reason to consider Roth.
The two big advantages I like about a Roth:
- If you're hitting the contribution limits, you can squeeze more equity into a Roth. The '24 IRA limit for individuals is $7,000. $7k of Roth has more value than $7k of Traditional, but you've paid for that in taxes today.
- The contributions in a Roth can be taken out penalty-free, so you've got some access to your wealth before age 59-1/2. So if you retire early, it gives you some extra options that a traditional doesn't.
They DO NOT perform identically!!!
Withdrawal of a traditional account pays less tax than they evaded at the time of saving because the tax rates are progressive!
If you're in a 22% tax bracket, you can save 22% in taxes, but then when you withdrawal in the same tax bracket and income, your effective tax rate will be much lower, in the teens. That's an instant advantage to the traditional.
But yes the Roth does let you save on a larger pre-tax amount.
I confused myself based on some roth now vs roth conversions post retirement I was looking at a couple of weeks ago.
Here's why I always pick Roth…
With a Roth, you're entering into an agreement with the government that the money contributed will remain untaxed in the future.
With a traditional, you're essentially gambling what the tax rate will be on those funds when you need them.
You can't "crunch the numbers" on what our government will do with tax rates 30 years from now.
While I might be forgoing some money on a financial advisor's spreadsheet by opting into a Roth...
Given that today's tax rates are historically low and bleak outlook for national debt / social security…
I'm not willing to gamble my retirement funds on the assumption that our government won't significantly increase taxes
With a Roth, you're entering into an agreement with the government that the money contributed will remain untaxed in the future.
With a traditional, you're essentially gambling what the tax rate will be on those funds when you need them.
You can't "crunch the numbers" on what our government will do with tax rates 30 years from now.
While I might be forgoing some money on a financial advisor's spreadsheet by opting into a Roth...
Given that today's tax rates are historically low and bleak outlook for national debt / social security…
I'm not willing to gamble my retirement funds on the assumption that our government won't significantly increase taxes
Roth all day... especially for young folks with long horizons; regardless of income level.
Nothing beats compounding interest / market appreciation over the long haul.
If you have more than 8 years to go; go Roth... money doubles every 8.
Gives you the option to pull out huge chunks of money once in retirement if wanted/needed; without worrying about taxes. Want to buy a ranch for 1.2 million your first year of retirement? Go for it!
Also has better legacy benefits for your heirs.
Nothing beats compounding interest / market appreciation over the long haul.
If you have more than 8 years to go; go Roth... money doubles every 8.
Gives you the option to pull out huge chunks of money once in retirement if wanted/needed; without worrying about taxes. Want to buy a ranch for 1.2 million your first year of retirement? Go for it!
Also has better legacy benefits for your heirs.
Quote:
Who qualifies for Roth IRA?
If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $144,000 for tax year 2022 and $153,000 for tax year 2023 to contribute to a Roth IRA, and if you're married and filing jointly, your MAGI must be under $214,000 for tax year 2022 and $228,000 for tax year 2023.
So it looks like I cannot create a Roth IRA account. What are my options? I have an IRA though. Any smart things I can do at this point?
You contribute after tax to a regular IRA and immediately convert to Roth. It's called a backdoor Roth, just google it. If you have an IRA already w/ pre-tax contributions then you have to follow the pro rata rule.infinity ag said:Quote:
Who qualifies for Roth IRA?
If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $144,000 for tax year 2022 and $153,000 for tax year 2023 to contribute to a Roth IRA, and if you're married and filing jointly, your MAGI must be under $214,000 for tax year 2022 and $228,000 for tax year 2023.
So it looks like I cannot create a Roth IRA account. What are my options? I have an IRA though. Any smart things I can do at this point?
gggmann said:You contribute after tax to a regular IRA and immediately convert to Roth. It's called a backdoor Roth, just google it. If you have an IRA already w/ pre-tax contributions then you have to follow the pro rata rule.infinity ag said:Quote:
Who qualifies for Roth IRA?
If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $144,000 for tax year 2022 and $153,000 for tax year 2023 to contribute to a Roth IRA, and if you're married and filing jointly, your MAGI must be under $214,000 for tax year 2022 and $228,000 for tax year 2023.
So it looks like I cannot create a Roth IRA account. What are my options? I have an IRA though. Any smart things I can do at this point?
Thanks, will take a look!
Does this mean I create a NEW IRA account, sent my post tax money and convert that to a backdoor Roth?
Your contributions (i.e. principal) are taxed in both. Your earnings off the principal are not taxed in roth, but will be taxed in traditional. Do the Roth first, always, and for as long as your income allows you to. If/when you max out roth, then pivot to traditional.
BenTheGoodAg said:
If tax rates are the same, the two perform identically when comparing money spent today vs money available tomorrow.
This argument breaks down once you start looking at effective vs marginal tax rates. A single person making with 100k in taxable income (after deductions etc) would be in the 22% marginal rate but really just a 15% effective rate. Assuming tax rates are the same this person would do much better picking traditional over roth.
i.e.
Person A makes 100k and save 10% of it, choses Roth but can only save $7800 annually after paying tax on the 10%. Assuming 7% growth, they would have a little over $1.5 million in Roth 40 years later. Assuming they switch to less aggressive allocations in retirement and only saw 3% growth, they could draw $75k a year from that and it would last almost 33 years (I chose 75k b/c that was how much this person previously lived on after savings and paying taxes: 100k - 10k (savings) -15k (taxes)).
Person B makes the same 100k and saves 10% but since its tax deferred, they are making the full $10000 into the saving plan per year. After 40 years with the same 7% growth the account would be worth just a hair under $2million. Person B would need to draw down (at 3% growth again) the full 90k since they would need to pay taxes on that, but this account would last 37 years before running out of money.
So in this example the traditional beats the Roth by 5 years.
how exactly do you pivot to traditional when you max out the roth in a 401k?JSKolache said:
Your contributions (i.e. principal) are taxed in both. Your earnings off the principal are not taxed in roth, but will be taxed in traditional. Do the Roth first, always, and for as long as your income allows you to. If/when you max out roth, then pivot to traditional.
The sum of your Roth 401k and Traditional 401k count towards the max. Some plans allow after tax contributions you can contribute to, but I don't see how you can go to traditional after maxing out your Roth 401k bucket.
So based on the great info provided in this thread, it looks like nobody has really studied this from a macroeconomic view, being which one pays out better on average historically. It's only being studied at the individual level with each persons FA.
There are not enough historical data. Roth 401k was implemented in 2006 and not available widely until some time after that. There are no data available for a full career cycle, much less a career + retirement cycle.Definitely Not A Cop said:
So based on the great info provided in this thread, it looks like nobody has really studied this from a macroeconomic view, being which one pays out better on average historically. It's only being studied at the individual level with each persons FA.
Can't answer any of those questions but my financial advisor during my last meeting with him advised me to switch over to the Roth 401k. We had been doing all pretax, but based on their analysis they've advised me to switch it over. I'm 51 with net worth of a little over $3mm. Not sure if that is relevant but I post it in case it is. Definitely not a brag and so hope it wasn't interpreted that way.
Our taxes are going to take a hit this year as all the 401k contributions are going in after tax. We fully find the 401k to the tune of $77.5m (catch up contributions with $30.5m in personal contributions allowed.)
Our taxes are going to take a hit this year as all the 401k contributions are going in after tax. We fully find the 401k to the tune of $77.5m (catch up contributions with $30.5m in personal contributions allowed.)
Definitely Not A Cop said:
So based on the great info provided in this thread, it looks like nobody has really studied this from a macroeconomic view, being which one pays out better on average historically. It's only being studied at the individual level with each persons FA.
I would say on average, the traditional "pays out better" but I would only guess that because most high earners live in states with high state income tax. That being the best average doesn't really mean much to someone living in a state without income tax sitting in a low tax bracket today where Roth might make more sense.
I don't think its as complicated as each person needing a FA to figure it out, but I think there are definite groups that people can fall into. It all depends on what tax bracket you are in today and where you think you will be in the future. It can also have to do with what state are you paying taxes in today, and what state do you think you will you paying taxes in the future.
At the end of the day most people can't nail all those decisions down perfectly so its probably better to have a mix. Most people's employer match is always pre-tax anyway so even if you are going full Roth 401k you are likely at least getting a little bit of a mix.
I would guess he is suggesting that for legacy planning, which adds a whole other wrinkle to the debate of Roth vs Traditional... do you think you are going to spend the money or do you want it to go to your kids?
permabull said:BenTheGoodAg said:
If tax rates are the same, the two perform identically when comparing money spent today vs money available tomorrow.
This argument breaks down once you start looking at effective vs marginal tax rates. A single person making with 100k in taxable income (after deductions etc) would be in the 22% marginal rate but really just a 15% effective rate. Assuming tax rates are the same this person would do much better picking traditional over roth.
i.e.
Person A makes 100k and save 10% of it, choses Roth but can only save $7800 annually after paying tax on the 10%. Assuming 7% growth, they would have a little over $1.5 million in Roth 40 years later. Assuming they switch to less aggressive allocations in retirement and only saw 3% growth, they could draw $75k a year from that and it would last almost 33 years (I chose 75k b/c that was how much this person previously lived on after savings and paying taxes: 100k - 10k (savings) -15k (taxes)).
Person B makes the same 100k and saves 10% but since its tax deferred, they are making the full $10000 into the saving plan per year. After 40 years with the same 7% growth the account would be worth just a hair under $2million. Person B would need to draw down (at 3% growth again) the full 90k since they would need to pay taxes on that, but this account would last 37 years before running out of money.
So in this example the traditional beats the Roth by 5 years.
Thanks for putting numbers to it.
Traditional almost always beats Roth.
You compared "years" of drawdowns, but really it could also be compared by how much net after tax income for the same number of years, and the traditional will be higher income after taxes.
My current employer allows Roth 401k, so I currently split my savings into Roth and traditional. More heavy on Roth as employer match is all pre-tax. Just figured it's best to be diverse at this point. Most of my retirement savings is pretax, and I'd like to increase my post-tax savings. I'm still probably 30 years from retirement, so figure it's best to be diversified for now and see where things sit as I approach retirement and the best way to tap into that savings at that time.
The government giveth, the government taketh away. They also said I could pass my IRA down to my kids after wife and I were both gone. Who's to say they won't say something lime "We're in trouble therefore all "Roths will become taxable in the year 20xx...?"BTHOtrolls said:
Here's why I always pick Roth…
With a Roth, you're entering into an agreement with the government that the money contributed will remain untaxed in the future.
With a traditional, you're essentially gambling what the tax rate will be on those funds when you need them.
You can't "crunch the numbers" on what our government will do with tax rates 30 years from now.
While I might be forgoing some money on a financial advisor's spreadsheet by opting into a Roth...
Given that today's tax rates are historically low and bleak outlook for national debt / social security…
I'm not willing to gamble my retirement funds on the assumption that our government won't significantly increase taxes
bmks270 said:BenTheGoodAg said:
If tax rates are the same, the two perform identically when comparing money spent today vs money available tomorrow. You could speculate endlessly in either direction about the future of tax rates or even your future finances, which I think makes for a good argument for a mix of both. This also gives you some flexibility to audible if your situation changes. You didn't specify 401k vs IRA, but regarding 401k, if you're getting a match it will be traditional, so it might be a good reason to consider Roth.
The two big advantages I like about a Roth:
- If you're hitting the contribution limits, you can squeeze more equity into a Roth. The '24 IRA limit for individuals is $7,000. $7k of Roth has more value than $7k of Traditional, but you've paid for that in taxes today.
- The contributions in a Roth can be taken out penalty-free, so you've got some access to your wealth before age 59-1/2. So if you retire early, it gives you some extra options that a traditional doesn't.
They DO NOT perform identically!!!
Withdrawal of a traditional account pays less tax than they evaded at the time of saving because the tax rates are progressive!
If you're in a 22% tax bracket, you can save 22% in taxes, but then when you withdrawal in the same tax bracket and income, your effective tax rate will be much lower, in the teens. That's an instant advantage to the traditional.
But yes the Roth does let you save on a larger pre-tax amount.
Bogleheads disagrees.
https://www.bogleheads.org/wiki/Traditional_versus_Roth#Common_misconceptions
P.H. Dexippus said:bmks270 said:BenTheGoodAg said:
If tax rates are the same, the two perform identically when comparing money spent today vs money available tomorrow. You could speculate endlessly in either direction about the future of tax rates or even your future finances, which I think makes for a good argument for a mix of both. This also gives you some flexibility to audible if your situation changes. You didn't specify 401k vs IRA, but regarding 401k, if you're getting a match it will be traditional, so it might be a good reason to consider Roth.
The two big advantages I like about a Roth:
- If you're hitting the contribution limits, you can squeeze more equity into a Roth. The '24 IRA limit for individuals is $7,000. $7k of Roth has more value than $7k of Traditional, but you've paid for that in taxes today.
- The contributions in a Roth can be taken out penalty-free, so you've got some access to your wealth before age 59-1/2. So if you retire early, it gives you some extra options that a traditional doesn't.
They DO NOT perform identically!!!
Withdrawal of a traditional account pays less tax than they evaded at the time of saving because the tax rates are progressive!
If you're in a 22% tax bracket, you can save 22% in taxes, but then when you withdrawal in the same tax bracket and income, your effective tax rate will be much lower, in the teens. That's an instant advantage to the traditional.
But yes the Roth does let you save on a larger pre-tax amount.
Bogleheads disagrees.
https://www.bogleheads.org/wiki/Traditional_versus_Roth#Common_misconceptions
This is nuanced but even this article is recognizing that the first $1million accumulated pays less tax because of the progressive tax rates. So this would mean it's better to save in a traditional IRA up until the point that your future withdrawals would put you into the same marginal tax bracket. So this still favors saving in the traditional before a Roth.
You have to consider social security income + 401k withdrawal will determine your marginal tax bracket.
And social security income has really confusing tax rules, too complex for me to dive into in this post, but yes, for simplicity just say you defer receiving SSI but take from you're 401k at age 60.
Let's use the standard 4% withdrawal rate.
In todays tax brackets, here's what your traditional account balance would have to be for a 4 % withdrawal to put you into the marginal tax brackets for single / married.
10%: 0 / 0
12%: 275k / 500k
22%: 1.1M / 2.2M
24%: 2.3M / 4.6M
32%: 4.5M / 9.0M
And so on…
A $110,000 income puts a single filer into the 24% bracket.
bmks270 said:permabull said:BenTheGoodAg said:
If tax rates are the same, the two perform identically when comparing money spent today vs money available tomorrow.
This argument breaks down once you start looking at effective vs marginal tax rates. A single person making with 100k in taxable income (after deductions etc) would be in the 22% marginal rate but really just a 15% effective rate. Assuming tax rates are the same this person would do much better picking traditional over roth.
i.e.
Person A makes 100k and save 10% of it, choses Roth but can only save $7800 annually after paying tax on the 10%. Assuming 7% growth, they would have a little over $1.5 million in Roth 40 years later. Assuming they switch to less aggressive allocations in retirement and only saw 3% growth, they could draw $75k a year from that and it would last almost 33 years (I chose 75k b/c that was how much this person previously lived on after savings and paying taxes: 100k - 10k (savings) -15k (taxes)).
Person B makes the same 100k and saves 10% but since its tax deferred, they are making the full $10000 into the saving plan per year. After 40 years with the same 7% growth the account would be worth just a hair under $2million. Person B would need to draw down (at 3% growth again) the full 90k since they would need to pay taxes on that, but this account would last 37 years before running out of money.
So in this example the traditional beats the Roth by 5 years.
Thanks for putting numbers to it.
Traditional almost always beats Roth.
You compared "years" of drawdowns, but really it could also be compared by how much net after tax income for the same number of years, and the traditional will be higher income after taxes.
You need to look at the overall picture, not just the tax on 401k distributions.
If you retire before you are eligible for medicare and use ACA exchange for health insurance then your price will most likely be much higher if you are using traditional due to loss of subsidies from having a higher taxable income.
Also, once you start SS distributions, traditional 401k distributions can push you into a 40.7% (42.7% starting in 2026) marginal tax bracket for part of your income range, and that range starts at a pretty low income level.
There are IRMA penalties for medicare B & D that can impact people taking large traditional distributions.
Of course once RMDs start they can push you into a higher marginal tax bracket as well.
Quote:
Let's use the standard 4% withdrawal rate.
In todays tax brackets, here's what your traditional account balance would have to be for a 4 % withdrawal to put you into the marginal tax brackets for single / married.
10%: 0 / 0
12%: 275k / 500k
22%: 1.1M / 2.2M
24%: 2.3M / 4.6M
32%: 4.5M / 9.0M
And so on…
A $110,000 income puts a single filer into the 24% bracket.
To expand further on this, most people able to save 2+ million as a single person are going to be in the 24% bracket or higher. If you're in the 24% bracket, then until you have balance predicted to grow to 2.3M the traditional seems to be the winner.
Also consider traditional lowers your AGI which has a lot of tax credits tied to it and so on. And can keep you out of the next higher tax bracket.
For example, for a single person if they take the standard deduction and put away max traditional 401k, they can have a gross income of up to 129k but their AGI will be 95k so they'll stay in the 22% marginal tax bracket. If they did a Roth instead they'd be paying 24% tax on all of their contributions, which wouldn't make sense for them to do unless they've already saved enough that their withdrawals will put them into that same tax bracket which would require them to have a future balance of 2.3M for a 4% withdrawal rate.
If you start saving earlier in life the amount you need to save to reach the above account balances is far lower.
For someone age 30, assuming an 7% inflation adjusted growth in an index for the next 30 years until age 60, they'd need only $310,000 in their traditional 401k to reach 2.3M in todays dollars at age 60. That's actually quite a lot to have saved by age 30, if we assume someone began their career at age 22. With the contribution limits, it's actually impossible if the rate of return is only 7%. Even maxing it every year from age 22 to 30 would only get a person to 230k with a 7% return rate.
For the large majority of people who have income to spare for their 401k, they'll be in the 24% bracket and above. And they'll take a number of years, a decade or more to seed their traditional account to the point where their withdrawals will put them into the same marginal tax bracket. So traditional having a lower taxes at withdrawal because of the lower brackets is absolutely valid and makes traditional take priority over roth. And the higher your income, the more it applies.
I think once in the 24% marginal tax bracket it's better to be prioritizing traditional instead of Roth at least until you'll have inflation adjusted withdrawal that put you into the same marginal tax rate, which frankly still requires a lot of savings.
And I'd argue if you accomplished that then you've sort of already won the savings game and have saved enough to maintain your standard of living. You'd arguably be better off to stop using tax advantaged retirement savings accounts at this point and just begin diverting that savings into a taxable account that will leave a lot more to your heirs. And as a bonus you'll have access to the money to retire early without penalties and the growth will be taxed at lower long term capital gains tax rates instead of your marginal tax rate, which is actually quite tax efficient. This philosophy makes roth irrelevant.
I'm going to live my life as I wish, and any left over I'll evenly distribute among my three daughters. I'm of the opinion that inheritance should not be counted on. We instill in our girls to not count on any money at all and to make good decisions throughout their life without assuming a safety net. My advisor is planning on us retiring at 55, but I intend to work as long as my employer finds me useful - probably around 60. I just want to be able to retire at 55. Not sure how much of that played into his recommendation to switch to the Roth 401k.
Early retirement brings up another wrinkle as to why there is no one size fits all solution.
I plan to retire early as well and have 20+ years before I need to worry about RMDs after I retire. I have enough money in after tax accounts to bridge what I'll need for the first decade or so in retirement so my tax income is going to plummet from the 24% bracket down to the 12%. It is during this time I plan to do large roth conversions annually to cap out the 12% bracket which would be the effective rate slightly less than that do the progressive tax structure.
So right now I am saving 24% tax on the way in to traditional, and in early retirement I'll be roth converting it and paying uner 12% on that conversion (not to mention setting up a roth conversion ladder which will let me get to that money sooner than 59.5 if needed).
By the time I hit RMD age I will already have converted the tax deferred account so much, it won't be a huge tax surprise.
I plan to retire early as well and have 20+ years before I need to worry about RMDs after I retire. I have enough money in after tax accounts to bridge what I'll need for the first decade or so in retirement so my tax income is going to plummet from the 24% bracket down to the 12%. It is during this time I plan to do large roth conversions annually to cap out the 12% bracket which would be the effective rate slightly less than that do the progressive tax structure.
So right now I am saving 24% tax on the way in to traditional, and in early retirement I'll be roth converting it and paying uner 12% on that conversion (not to mention setting up a roth conversion ladder which will let me get to that money sooner than 59.5 if needed).
By the time I hit RMD age I will already have converted the tax deferred account so much, it won't be a huge tax surprise.
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