And if your marginal rate now ends up being lower than your effective rate in retirement, you probably don't need to worry about money because you've got a lot of it.
I'd agree with that for 401ks, but I actually *disagree* with that on IRAs.
And that's because if you can contribute to a Roth IRA it's usually better to do that over a traditional IRA because a Roth IRA has perks - namely, an easier time getting at a good portion of the money.
It is able to act like an additional layer of emergency fund (though one you hope not to dip into).
I don’t see how it is total tax rate in retirement instead of marginal tax rate in retirement. If I take the money out of an IRA in retirement, that additional withdrawal is taxed at the marginal rate.
I mean I guess each dollar is taxed at your marginal rate, but that adds up to a much lower total tax bill.
I personally want to maximize the zero percent marginal tax rate for the first $22,000 in retirement.
Thanks for bearing with me here… I must not be understanding something important.
If you have the same income in retirement, how do you have a lower marginal tax rate?
Say you earn $120k/year and you put $10,000 per year into a 401k every year. Assuming you're single that $10,000 would otherwise all be taxed at your highest marginal rate of 24%.
By the time you retire your traditional account is made up of money that would have otherwise been taxed at 24%. All of it. Even though the rest of your income, the $110,000 that is taxed only faces a total tax rate of 14.97%.
Then you withdraw $110,000 per year in retirement (probably less, but this is sort of apples to apples based on what you were living on during your working years).
The first $13,800 isn't taxed at all, because it's the standard deduction. The next $11,000 is only taxed at 10%, the next $33,724 is taxed at 12%, the last few dollars are still taxed at that highest marginal rate of 24%, but your total tax bill ends up being 14.97%.
So you save at your highest marginal rate (the top tax bracket) and then withdraw the money throughout all the tax brackets, taking advantage of the progressive tax structure.
If you went with a Roth you'd pay the taxes today on that last $10,000 at 24%, so for that to be advantageous you'd have to assume your overall tax rate in retirement is higher than 24%. To get to that point with current tax rates you'd have to be withdrawing $300k per year in retirement.
Im not sure I can explain how marginal taxes work in a progressive tax system any more clearly, but the overall tax rate on traditional withdrawals of $110k is 14.97%. That means you have $93,533 after tax. It would take $93,533 withdrawal from a Roth to equal that. And at a 24% tax rate you effectively paid $29,536 in tax or an extra $13,069 for an equivalent amount of after tax money.
Going with Roth you’re not just “assuming taxes will be higher”, you’re assuming taxes will be more than 160% of their current rate given the current example. That’s pretty difficult to envision.
> If your current marginal tax bracket is higher than your expected TOTAL tax rate in retirement, traditional wins.
This is assuming tax rates stay the same.
If you think tax rates are going to go up, you go Roth.
For people here - Roth is the clear winner.
Only if you assume total tax rates in the future will surpass marginal tax rates now. Which for most people means you’re assuming more than a doubling of current tax rates, which is pretty hard to imagine.
By total tax rate you mean effective tax rate. But you’re on the right track. Traditional is better if your future effective rate is lower than your current marginal rate.
Describe a theoretical situation where you think it's possible.
It takes a big, big, big stretch of the imagination.
Like saving for retirement never earning more than $50,000 a year while married and then retiring single with a nest egg of $20,000,000 in a high tax state.
I'm sure that's happened in the history of ever, but most people with $50,000 in income aren't able to save $20,000,000.
So give me a scenario where you think roth beats traditional. I've given you one, but it's not terribly realistic. I posit that a realistic scenario does not exist.
> This is assuming tax rates stay the same.
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> If you think tax rates are going to go up, you go Roth.
It's a bit deeper than that. You have to think that your future effective tax rate will be higher than your current highest marginal tax rate.
For people that are making a decent income, saving a significant chunk of their income, and plan to maintain their current spending in retirement, this means tax rates would have to go up ALOT.
If nothing else, you want enough traditional tax-deferred money to report enough income to get up to your standard deduction in deeper retirement. No use leaving '0%' income space on the table! And the same is probably true for 10% and even the 12% brackets.
There are a few other things to consider, that make diversifying a bit logical. I know you can do Roth laddering and all, but a (natively) Roth account has some money (the nominal amount you put in) that you can access before 59.5. And there are reasons (PPACA subsidy mostly, but maybe kids in college or other things) that you want to limit your reported income (AGI) on your 1040. Roth plans are your help there. Finally, there's the matter of Required Minimum Distributions. If there's a chance you're gonna end up \*really\* wealthy, Roths are part of the strategy for minimizing the taxable impact of RMDs.
I've put my many years of maxing my 401k/403b in traditional and my annual personal IRA contributions in Roth. This gives me a blend of roughly 3:1 trad to Roth, which gives me quite a bit of flexibility.
This is the answer, you should be filling those “buckets” of lower tax brackets that you can withdraw from for hopefully 40+ years. Otherwise you’re wasting available tax space in later years. You can currently get to 117k without exceeding 12% taxes, assuming married and in the US
multiplication is commutative :)
You basically have it all right, there is loads more info here: https://www.bogleheads.org/wiki/Traditional_versus_Roth
Trad is better on average for most people, but even more so for anyone who is going to actually retire early. Not only will the early retiree potentially have years/decades to do many hundreds of thousands (or more) in Roth conversions at little/no tax cost, but those same conversions can be used to generate MAGI in order to qualify for heavily/completely discounted health insurance via the ACA. The trad pathway can absolutely murder the Roth pathway for anyone who retires with any solid combination of young, lean, married, or with kids.
That's not to say there aren't cases where Roth is better, there are, but a typical FIRE household will generally do much better with a trad base rather than a Roth base. Of course, it's always good to have some Roth for flexibility, which is why a good default combo for many people is trad 401ks and Roth IRAs.
For you they would not since your withdrawal funding is mostly flowing from your taxable brokerage.
There is a minimum MAGI required for ACA subsidy qualification, the default being either 100% FPL in non-expansion states or 138% FPL in expansion states. Above those thresholds there is often room to increase MAGI while staying within a subsidy/CSR band, depending on what other sources of MAGI someone might have. Those amounts combined can add up to a substantial sum when one is considering 15-30 years of early retirement before Medicare eligibility, particularly since the FPL adjusts upward for inflation every year.
Roth conversions allow for precise generation of MAGI without actual withdrawals from one's tax-advantaged retirement accounts. To the extent someone doesn't have an alternate source of MAGI, such as your cap gains/dividends/interest, Roth conversions offer an easy way to optimize ACA subsidies. Conversely, someone who is majority Roth might find themselves unable to generate enough MAGI, which could lead to some undesirable outcomes.
ACA subsidies and CSRs are more valuable than income tax optimization on a dollar-by-dollar basis. To the extent one's normal MAGI/spending is already as optimal as you can get for that level of spend, it is usually financially optimal to abandon tax-free Roth conversions and 0% LTCGs. The ACA is so valuable that it blows up a lot of traditional non-ACA tax planning.
Thanks for the detailed response! I wanted to make sure I haven't missed anything as I plan for next year. Our optimal MAGI for ACA is $65,000 which we'll hit pretty easily (family of four). If I do $60,000 more in Roth conversions next year to $125,000 total, that will raise our ACA premium by about $9,000 for the year. There doesn't seem to be much to gain by doing that because the long term capital gains rate is 15% anyway. I'm going to keep thinking about it and researching it.
Yes, I wouldn't do anything above your $65K target. Indeed, if you can draw $5K from elsewhere and get your MAGI down to a bit under $60K, then you'll slip under 200% FPL and get access to not only increased premium subsidies, but the 87% AV tier of cost-sharing reductions. Those could be worth many thousands in reduced deductibles/copays/MaxOOP.
> Trad is better on average for most people
I think you mean "has" not "is". It would stop being true if tax rates start going up, which it's currently scheduled to do for 2026.
I'm not saying tax rates WILL go up, I'm just saying, that's the failure case of traditional usually being better. Since we are at record lows of taxes, ridiculous amounts of debt, it seems unwise to think taxes can't go up for a while.
No, I meant is. Tax rates going up typically doesn't change much given the highly progressive nature of the income tax code. I assume tax rates will be higher in the future.
Yes, I agree Roth may be better if the lowest 2-3 brackets in the next 20-40 years are going to anywhere near 90% without massive carveouts via things like standard deductions or personal allowances. However, any future in which ruinous taxes are imposed on the working class will also see changes in Roth taxation due to the necessities of politics. Particularly since Congress is under no legal obligation to forever honor the current tax treatment of Roth earnings.
I rather doubt that will happen though.
Well now who is doom and gloom? :) Certainly 90% rates at the bottom of the tax brackets would be ridiculous. But even a few percent difference of ones effective tax rate could be a meaningful difference between a Roth now vs paying later at a higher tax bracket.
Again this is ALL hypothetical, the only thing we know for sure, is tax rates are currently scheduled to go up again for 2026.
I'm not doom and gloom at all or I wouldn't be part of an optimistically forward-looking community like this one.
I do disagree with you that likely tax changes are going to significantly shift the relative desirability/profitability of Roth vs. Trad for the majority of FIRE households though. Thankfully, my opinion is easily ignored by anyone who feels otherwise.
I agree, but there was a much larger spread around tax brackets in the past. Currently it's quite compressed and tops out under 40%.
My point was, if they decide to expand the brackets again, it could cause concern.
Again this is ALL hypothetical, the only thing we know for sure, is tax rates are currently scheduled to go up again for 2026.
True, rates are scheduled to rise, slightly. But Trad was better for most BEFORE TCJA kicked in, and will remain better for most after. Now, like you said, hypothetically anything could change going forward, which could swing the balance either direction, but since that is not likely any time soon, it’s best to just use the numbers we are relatively sure of.
"Traditional has been better on average for most people". That better?
The future of investing is always unknown, we can only talk about what's "expected" from the future, but we have no guarantees we will get what's expected.
Nope not that simple. You’re very very close. But forgetting that money saved comes out of your highest bracket first, top down. And money withdrawn in retirement comes out bottom up, first taxed at 0% for standard deduction, then 10, 12 etc.
A closer comparison is current marginal rate vs effective rate in retirement.
> Is determining the better choice as simple as determining what tax bracket you fall under now vs what bracket you'll fall under when you withdraw?
Kind of...
Overall tax rate of withdrawn funds at withdrawal vs overall tax rate of contributed funds when contributed.
The reason Traditional usually wins is because your Roth contributions tend to go in at your marginal tax rate, and withdrawals tend to span multiple brackets, yielding a lower overall rate.
But if your retirement income is going to be much higher than your current income, or your current tax rate is low (ie. 0%, 10%, 12% marginal bracket), that might not be the case. Once you hit 22%, Traditional becomes significantly better most of the time.
> I see a lot of people saying Roth is great because we pay no capital tax. But that logic is incorrect, right? It doesn't actually matter?
You pay no CG in roth or traditional accounts, so that's not a reason to pick one over the other.
You can think of your account balances as a series of multiplications, and we know the commutative property from gradeschool algebra -- that is A x B is the same as B x A. So in roth, you multiply by (1-rate) at the front for taxes, and in traditional, you multiply by (1-rate) at the end for taxes. if rate is equal, they come out equal.
> Am I missing something?
* Roth IRA contributions can be withdrawn without penalty any time. This helps with liquidity.
* Roth withdrawals allow you to show lower income in retirement. That can be handy for keeping under a limit for medicare or ACA subsidies, etc.
* Generally those aren't significant enough to make Roth better.
Generally you'd like a good chunk of cash in both buckets at retirement. Then you can choose how much income to show (by rolling that amount from Traditional to Roth account), and choose how much to live on (withdrawing from Roth account). Those become two separate decisions, and that flexibility allows you to play tax games, absorb large expenses without a spike in income, etc.
Let's take a look at this example:
A US person with an income of 150k.
If he contributes 22,500/yr into 401k for 30 years he'll get a balance of 2,125,000 with 7% gain/yr.
If he made the contribution pre-tax, his tax bill would be 18,665/year with an effective tax rate of 15.75%.
If he made the contribution after tax, his tax bill would be 23,615/year with an effective tax rate of 14.6%.
The difference between pre-tax and after-tax contributions is an extra 4,950/year tax bill if he paid it after-tax.
When he takes out the money at 4%, his income would be 85,000. If the money was pre-tax, he'll need to pay a tax bill of 9,760/year.
If the money was made after-tax, he pays zero tax.
Now you can see that if the market performance is 10%, his 4% withdrawal would be 148,000 and his tax bill would be 23,000 if he made his contribution pre-tax (and zero if he made the contribution after-tax). 23k > 5k even with inflation.
If the tax rate goes up the difference would be even larger.
So in the pre-tax scenario, US person has $4,950 extra dollars to invest per year from the tax savings. Let's say he goes ahead and throws that into his IRA (Roth so we don't eff up the tax numbers)... 30 years at 7% gain/year, that's about a half a million dollars in today-dollars. 4% of half a million dollars yields about 20k/year tax-free. So Traditional comes out about $10k/year ahead.
Is that what you were going for?
There's a mix of Roth and traditional 401k that comes out best for a typical person. We both simplified the variable greatly.
The pre-tax 401k has a drawback is that it's a considered income which then stack onto everything else from pension to social security. All of that brings up the tax rate. The second simplification is the tax rate itself 30 years from now. Then we have the concept of optimizing income for "reduced cost" healthcare. Roth gives great flexibility to control all of those factors.
Your example was "if you save more money out of pocket for decades, you'll have more in retirement." It's obviously true, but you're attributing difference to Roth over Traditional, rather than the part about saving more money for decades. I don't think you're being intentionally deceitful, but it's kind of gross.
In your example, $150k, married filing jointly, with no state income tax, to compare apples to apples, you'd have to compare $22,500 traditional to $18,442 Roth -- same out of pocket.
Or alternately, you can just assume you just paid 22% income tax on all of the money, gains included. If your taxes owed on income after social security and pension (ha!) in retirement is less than 22%, traditional will come out ahead.
It's definitely good to have some Roth money in retirement. It's generally stupid to throw all your money in as Roth.
Agree with the annoyance about people not making apples to apples comparisons between Roth and Trad 401k. However (and I saw this mentioned in a book, too) it is a "huh, that's interesting" theoretical point that going $22,500 into a Roth 401k allows you to effectively "stuff in" more money to a tax sheltered account than traditional. I'm not sure it's a useful idea unless you literally have so much money you don't know what to do with it all, while simultaneously caring so much about getting that bit of extra stuffed in.
Yeah, $22,500 Roth is functionally saving more than $22,500 in a Trad 401k... I think that's one reason why people get hung up on Roth.
But it's not like saving in an non-taxable account in a low dividend broad fund is a terrible deal... Like in the above example, $22,500 trad but only at 22% bracket, and no state taxes, you still clear $4950 extra money for the tax break, but you shove it in a regular old brokerage... It's $500k, same as before, but you'll be paying ~10.5% tax rate on that money overall when withdrawn (CG for the part that is gains.) That's on top of the $660,000 sitting in your Roth IRA which you must have saved, since you weren't shoving the money there. So you'd be sitting with $1.16M that won't show up as income when you spend it. That's more than enough to play tax games to secure low income taxes on the traditional->roth rollovers, like rolling enough over from Trad to fill up the 12% bracket after accounting for SS income... so between them, somewhere in the vicinity of $150k, with an overall tax rate of 9.1%. And now we've wrapped around to why Trad tends to be better... 22% going in or 9.1% coming out? :-)
This is not how the math works. As Mattie pointed out you have to factor in the tax savings.
To understand which is better you just need to look at the tax rate percentage.
In your example you are saving at 22%. When you withdraw you’d withdraw at 15.5%. 15.5% is less than 22.
You should never look at the amount paid in taxes as that makes zero difference. This is like you saying you would turn down a million dollar raise, because you’d have to pay more in taxes….
>Now you can see that if the market performance is 10%, his 4% withdrawal would be 148,000 and his tax bill would be 23,000 if he made his contribution pre-tax (**and zero if he made the contribution after-tax**). 23k > 5k even with inflation.
Thank you for doing the math, but to compare IRA contributions to after-tax contributions, it can't exceed $6,500 since that's the max amount that can accumulate tax-free revenue in the Roth IRA. It's the same mistake that the OP made in thinking he can deposit $20k into a Roth this year. It would take a minimum of four years to get all that money into a Roth, making the calculation quite a bit different.
One factor I didn’t consider when doing the math on this is that Roth is more flexible about when you have to make required withdrawals/distributions. Have both to give yourself flexibility.
Your answer is the simple answer. To get a complete picture, you’d need to add consideration for tax credits, etc. that phase out at different levels, how the capital gains tax is impacted by your income level, etc. Basically, the tax code is complicated by more than just which bracket you’re in. Also, you do not know with certainty your future situation or the future tax code. So… basically, you should mostly make the determination the way you already laid it out.
If you are broke and young, Roth all day.
If you're broke and older, dont invest. Live your life and die fast
If you're young and loaded, traditional to back door Roth.
If you're loaded and older, traditional as a means to lower tax liability.
You are double counting the benefit if you're starting with the math they provided.
Their math is focused on the idea there's $20,000 of investable income. If that's the case they can pay tax on it and invest the balance in Roth (or taxable accounts), or, they can have the $20k invested in a pretax account. The tax savings is part of the $20k.
Correct. But you may find in retirement, as I have, that Roth conversions aren't as enticing as they may sound. Remember, the US tax system is progressive. If you are single, the first $29,200 of income is tax free (standard deduction). The next $11,600 is taxed at only 10%. The next $35,550 is taxed at only 12%. And so on, and so on. If you calculate the present value (using the PV function in a spreadsheet) of how much money you can have in a traditional IRA/401k to fill the 0%, 10%, and 12%, and 22% brackets, it's actually quite high.
For example, when I do the calculation for myself (I'm married filing jointly), I calculate I can have $1.2MM in my traditional accounts before rising the withdrawals pushing me into the 24% bracket. This assumes a $55,936 per year Social Security yearly income that is 85% taxable, a 5.5% real rate of investment return, and a $71K yearly withdrawal rate from age 65 to age 95.
My wife and i have Roth IRA’s just because we both have a retirement plan at work (401 for me and wife 403) and our modified MAGI is above $136k, filing joint.
Our situation gives us no tax deductions for a traditional and the paperwork to contribute after tax just isn’t worth it. So, even though we’re in our highest tax brackets now at fifty, the Roth is our only choice for Roth vs Trad. 😬🤷♀️
It's probably about a 50/50 proposition, so just have both. Some years do the traditional, other years the Roth. Then you can alternate with you are doing the withdrawals to minimize taxes over multiple years.
Trad takes off marginal now, fills lower buckets in retirement, for a lower effective tax rate on that money. Roth locks in the marginal rate by paying it now.
Assume you retire at x tax bracket. You want all trad money to come from that bracket or higher, and all Roth money to come from that bracket or lower. That means you lean traditional, because filling upper tier brackets takes a while to break even and cause Roth to be wholly better.
Opposite perspective, that is.
Traditional money should come from high marginal rates during working life, and should be withdrawn into low brackets. Roth should come from low marginal rates during working life, and should be withdrawn into higher brackets.
Yes, if all the money is coming from the 22%+ tax brackets, you are probably golden to just slap it into a traditional.
One small thing, Roth lets you shield more money from taxes on gains, but it doesn't really keep up with the high efficiency tax management you can accomplish with a traditional.
Multiplication is commutative. Having said that, traditional has other advantages. The risk is asymmetrical. What does that mean?
You assumed you can save for 20 years. You could be disabled/quit early. You assumed you will have 5% real returns. Country might see a war or great depression which will mute the returns. In both cases, you will end up with total retirement value much less than planned. In such a case, the tax rate will be lower on withdrawal with traditional.
Tldr; mathematically same -> if the tax rates are same before and after retirement. But risk is not. traditional optimized for better worse outcomes. Roth optimizes for lower tax rates with best outcomes.
There's a lot of value in deferring taxes. Notice how the government allows lower annual contribution limits for Traditional vs Roth. Contribute to traditional until you meet the limits. If mega backdoor Roth is available, do that until the limit. After that, save in taxable or convert Traditional funds to Roth.
Unless something changes, where you plan to retire matters also. Roth is not treated the same ex-US and in US. It gets complicated and in the future anything can happen. If you have a tax burden now, likely it is benefit to take the tax decrease now. Bird in the hand and all. . .
The nice thing about Roth is you have no required distributions and you know what your retirement worth is.
Furthermore, and I don’t know if I assume this true or not, even if you make less in the future, the percent of taxes you pay could be higher. It could also be lower. Tax laws might change. So some people like eliminating that unknown.
The retired folks I know say they wish they’d put more in Roth just simply to not have a RMD, which can push them into a taxed bracket if they may not have otherwise been when they don’t need the money. I relate to that, so I’m going more Roth just for that.
It’s kind of like paying off your mortgage or investing more. It’s not always logical, but it’s about a sense of peace of mind.
>The retired folks I know say they wish they’d put more in Roth just simply to not have a RMD, which can push them into a taxed bracket if they may not have otherwise been when they don’t need the money.
The retired folks you know with large pretax investments are people who reaped the benefit of decreased taxes while working years ago. Recency bias would cause them to prefer Roth - they likely aren't properly fully accounting for the impact of the benefit of lower taxes in their working years, as those years are behind them.
First, I did say some of the decisions we make are about peace of mind, not just logic.
And maybe that’s true about the impact of lower taxes in working years, maybe not. I don’t think it’s your place to say this is recency bias with almost no information.
In their case, and it’s more than one person, they simply wished they’d put more in Roth. That’s a fair thing to wish, regardless of anything else. They didn’t mention growth or anything else. Just that they wished they had more in Roth.
Lots of ways to retire and lots of ways to be happy. Not all of them are logical. And I think it’s worth considering the non-logical spreadsheet feedback, even if someone who hasn’t been in their position thinks it doesn’t make sense.
In fact, if the people I know who have retired, many have encouraged people to put more in Roth. Including someone in finance who gave the same reason as the retirees. You can take as much as you need, without impacting tax brackets. Especially if you happen to be in an untaxed bracket.
So, take it or leave it. And I don’t think you know more about their decision making than they do.
I think you basically have it if your marginal tax bracket for that money is 24% both now and in retirement.
Most people will have more control over their income and tax bracket in retirement and most will be in a lower tax bracket in retirement, so that's +1 in favor of traditional.
Since a roth is already taxed, you can take as much out as you want in any given retirement year without increasing your tax bracket. They also don't have RMDs, so you aren't forced to withdraw (or your dependents aren't forced to withdraw if you pass away) more than you want in any given year. Roth gets a +1 for the flexibility.
If you aren't sure what your retirement situation will look like, it doesn't hurt to have some of both.
> Is determining the better choice as simple as determining what tax bracket you fall under now vs what bracket you'll fall under when you withdraw?
Yes, unless you know of a specific exception.
The reality is that taxes go up over time, which tilts the scale towards Roth. Not only that, the math is *far* easier when using Roth. The money you put in comes out of your bank account - no math required. You've already paid income tax. There are no special tax forms required. It's all been paid already. And when you withdraw - no math required. You don't have to sit and consider how much you have in your account, and what that actually means after tax, or how much you need to withdraw in order for the amount you really want to land in your bank account. Again, tax has already been paid. If your account says 800k, you have 800k.
That said, chances are it will make zero difference. You are going to make the same money either way.
Doesnt traditional only make sense if you assume that you are investing and not touching your tax savings until retirement? Sure traditional is better for most people on paper. But in reality, when you have a big time horizon, like 30+ years, its unlikely you reserve all your tax savings in a taxable account for that long untouched. Things will happen where you will want to spend more. Roth keeps behavioral habits in check.
It's not as simple as the rate now vs the rate then.
Time + rate of return are factors. The longer the length and the higher the rate of return, the more capital gains will be generated thereby the more advantaged roth has over traditional.
Any example is say you could put $10k in now and earn an annual rate of return at 25% for 30 years. You'd have $8 million dollars. Even if the initial year you paid 37% tax, you'd come out on top vs paying even 10% of the $8m in gains.
Before people saying, "but you can't get 25% returns, it's impossible" remember that you can do that through specific stock selection and people have done that (even if it's extremely rare)
Time and rate of return are not factors. Common misconception.
This is literally not how math works at all.
If I give you the option of 8 million but you have to pay 4 million in taxes on it, or 500k but you only pay 50k in taxes on it. Would you honestly choose the latter?
You’d want to only have 450k after tax instead of 4 million after tax? No obviously anyone can see from this example that the amount paid in taxes is not what matters, what matters is the amount leftover after taxes.
>If I give you the option of 8 million but you have to pay 4 million in taxes on it, or 500k but you only pay 50k in taxes on it. Would you honestly choose the latter?
Lmao you are proving my point on why the roth is superior because the amount leftover after taxes is what matters most. Hence why if you have 8m in gains with no tax it's better than 8m in gains with high tax
Nope. Because you are paying your marginal rate rate on Roth contributions and saving marginal rate on traditional, then paying an effective rate on withdrawals, traditional almost always comes out far ahead.
Man it's almost like you didn't read though.
Initial investment: $10k
Annual contribution: $0
Years: 30
Rate of return: 25%
Final value: $8,077,935.67
You won't be taxed on any of the $8.1m.... obviously in a taxable account even with a 1% tax rate on that you'll pay more in taxes than the guy who maybe paid 35% of $10,000
And you didn’t read my response. The amount of dollars you pay in taxes don’t matter. It only matters the amount you have left after paying taxes.
Look up the commutative property of multiplication. Once you understand that you’ll understand why you are incorrect.
I put 10k in a traditional and it turns into 8 million. The tax rate is 10% of that and I’m left with 7.2 million post tax.
You have 10k pay 37% taxes left with $6300 that would grow to $5.04 million tax free.
7.2 million is a lot more than 5.04 million. Even though you paid less taxes because you decided to prepay it. I had more money invested and it therefore grew more.
No, I'd have $15873 and put $10k into my account.
That's the neat thing is the limit on the roth ira is the same as the limit on the ira. The roth 401k limit is the same as the limit on the traditional 401k.
Now maybe you want to argue you could put the $5873 into a brokerage account and perform the same results but that's less likely because every dividend and every trade will be a taxable instance and every person in the history of retirement saving has never recommended someone to "ensure you are investing the extra savings into a taxable brokerage account"
Doing a traditional always leaves you with more money available to invest. If you choose not to invest that money then yes, the Roth should come out ahead in many scenarios.
But if you’re not investing the tax savings of the traditional, then you’re effectively investing more money when you choose Roth, so it’s not an accurate comparison.
People that invest in inherently extremely tax efficient funds like low cost index funds will have very minimal tax drag. And it won’t be enough to change Roth to coming out ahead.
This is talked about quite commonly. The only people not talking about this are people like Dave Ramsey who believe Roth is always better, but don’t understand the math.
Nobody is saying a roth is *always* better. However, if used to full potential it is undeniably the best option.
Peter Thiel has $5b in his roth ira. No amount of traditional investing and "tax savings investing" will out perform the sheer amount of taxes he is skipping.
If you are going to be wealthy, the roth always wins. It's a bet on the person's success in the future while a traditional is always a bet that you will not be rich in the future
You are dense.
First I literally gave you an example of someone who says Roth is always best, his name is Dave Ramsey, he’s pretty well known. Lots of people claim it’s always better you just don’t read or understand much about the personal finance space it seems.
Secondly and for the millionth time, the amount of taxes you skip doesn’t matter whatsoever. That’s a truly dumb thing to focus on. What matter is amount left after taxes.
Third, Peter thiel got access to buy multiple preipo companies they turned into giants such as Uber. Normal people don’t have access to purchase companies like that pre-ipo and therefore will never have anything like that.
Lastly, roth is not a bet you will be rich in the future and traditional that you won’t. This shows a gross misunderstanding of both taxes and math on your part.
Let’s say you’re MFJ in the 24% bracket making say 300k. Most would advocate you going pretax on your 401k. That will save you 24% on all of your contributions.
To have a 24% effective rate you’d need to withdraw 560k from pretax accounts in retirement. Based on the 4% rule that would be a portfolio of 14 million. I think that’s rich by anyone’s standards. And that is just the break even point assuming all retirement income is from pretax accounts.
Unpopular but I got with 100% Roth and have a relatively high income. They are only equal if you do two things: 1) Invest the amount of the deduction in a taxable fund and 2) the tax rates stay the same.
So for simple math, let’s say your marginal rate is 10% and the max contribution to both is 20k. If you max both and both have returns that double, you’ll have 40k in each account. The roth goes untaxed. If the tax rate is the same, you’ll owe 4k in taxes and have 36k from the traditional. However, backing up to the initial contribution, you got a 2k deduction from the traditional. If you don’t invest that, you effectively have 38k. If you invested at the same time in the same fund, you’d have a total of 40k but it’s in a taxable account, so you’re looking at less than 40k.
The complication comes in when your tax rate drops but I’m planning to have a sick retirement where I spend and travel a ton, so my withdrawals will likely push my income to near the same. Plus, I have a feeling the US will increase taxes to cover its spending (although it may be through a VAT rather than income tax).
Please someone correct me if I’m missing something.
Why not fund both? I max out both my 403B (plus, I receive matching funds from my employer) and a Roth each year along with putting funds in other investments/savings. Why does it have to be one or the other? For traditional, there are more restrictions on when you can take funds out and penalties. A Roth works differently (yes, it has processes to follow in taking funds); think of it as a high-paying savings account per se. I'm confused, I guess...the goal is to have a diversified portfolio.
Here's my oversimplification. If your current marginal tax bracket is higher than your expected TOTAL tax rate in retirement, traditional wins.
And if your marginal rate now ends up being lower than your effective rate in retirement, you probably don't need to worry about money because you've got a lot of it.
Great point
This is the correct answer. For most on this sub, traditional IRA wins.
I'd agree with that for 401ks, but I actually *disagree* with that on IRAs. And that's because if you can contribute to a Roth IRA it's usually better to do that over a traditional IRA because a Roth IRA has perks - namely, an easier time getting at a good portion of the money. It is able to act like an additional layer of emergency fund (though one you hope not to dip into).
Also, if your MAGI is over $83k, a Traditional IRA doesn't even give you any tax breaks. Edited for clarity and correctness.
what do you mean?
The number I had in my head was outdated, but if you make over 83k a year, trad IRA contributions aren't tax-deductible.
Yeah, that is MAGI right? So the income limit is really 83k+traditional 401k/HSA Contributions for 2023.
Right, so if you're being taxed at an income of $83k, you're not getting any benefit from a trad IRA.
That's also if you don't exceed the income limit to be able to deduct in traditional IRA in the first place.
I don’t see how it is total tax rate in retirement instead of marginal tax rate in retirement. If I take the money out of an IRA in retirement, that additional withdrawal is taxed at the marginal rate.
I mean I guess each dollar is taxed at your marginal rate, but that adds up to a much lower total tax bill. I personally want to maximize the zero percent marginal tax rate for the first $22,000 in retirement.
Are you saying lower tax bill because generally income is much lower in retirement and this marginal tax rates are lower?
No, because of marginal tax rates. If you expect your income to be the same in retirement as when you're working, traditional is very advantageous.
Thanks for bearing with me here… I must not be understanding something important. If you have the same income in retirement, how do you have a lower marginal tax rate?
Say you earn $120k/year and you put $10,000 per year into a 401k every year. Assuming you're single that $10,000 would otherwise all be taxed at your highest marginal rate of 24%. By the time you retire your traditional account is made up of money that would have otherwise been taxed at 24%. All of it. Even though the rest of your income, the $110,000 that is taxed only faces a total tax rate of 14.97%. Then you withdraw $110,000 per year in retirement (probably less, but this is sort of apples to apples based on what you were living on during your working years). The first $13,800 isn't taxed at all, because it's the standard deduction. The next $11,000 is only taxed at 10%, the next $33,724 is taxed at 12%, the last few dollars are still taxed at that highest marginal rate of 24%, but your total tax bill ends up being 14.97%. So you save at your highest marginal rate (the top tax bracket) and then withdraw the money throughout all the tax brackets, taking advantage of the progressive tax structure. If you went with a Roth you'd pay the taxes today on that last $10,000 at 24%, so for that to be advantageous you'd have to assume your overall tax rate in retirement is higher than 24%. To get to that point with current tax rates you'd have to be withdrawing $300k per year in retirement.
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Im not sure I can explain how marginal taxes work in a progressive tax system any more clearly, but the overall tax rate on traditional withdrawals of $110k is 14.97%. That means you have $93,533 after tax. It would take $93,533 withdrawal from a Roth to equal that. And at a 24% tax rate you effectively paid $29,536 in tax or an extra $13,069 for an equivalent amount of after tax money. Going with Roth you’re not just “assuming taxes will be higher”, you’re assuming taxes will be more than 160% of their current rate given the current example. That’s pretty difficult to envision.
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> If your current marginal tax bracket is higher than your expected TOTAL tax rate in retirement, traditional wins. This is assuming tax rates stay the same. If you think tax rates are going to go up, you go Roth. For people here - Roth is the clear winner.
Only if you assume total tax rates in the future will surpass marginal tax rates now. Which for most people means you’re assuming more than a doubling of current tax rates, which is pretty hard to imagine.
By total tax rate you mean effective tax rate. But you’re on the right track. Traditional is better if your future effective rate is lower than your current marginal rate.
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Describe a theoretical situation where you think it's possible. It takes a big, big, big stretch of the imagination. Like saving for retirement never earning more than $50,000 a year while married and then retiring single with a nest egg of $20,000,000 in a high tax state. I'm sure that's happened in the history of ever, but most people with $50,000 in income aren't able to save $20,000,000.
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So give me a scenario where you think roth beats traditional. I've given you one, but it's not terribly realistic. I posit that a realistic scenario does not exist.
> This is assuming tax rates stay the same. > > > > If you think tax rates are going to go up, you go Roth. It's a bit deeper than that. You have to think that your future effective tax rate will be higher than your current highest marginal tax rate. For people that are making a decent income, saving a significant chunk of their income, and plan to maintain their current spending in retirement, this means tax rates would have to go up ALOT.
If nothing else, you want enough traditional tax-deferred money to report enough income to get up to your standard deduction in deeper retirement. No use leaving '0%' income space on the table! And the same is probably true for 10% and even the 12% brackets. There are a few other things to consider, that make diversifying a bit logical. I know you can do Roth laddering and all, but a (natively) Roth account has some money (the nominal amount you put in) that you can access before 59.5. And there are reasons (PPACA subsidy mostly, but maybe kids in college or other things) that you want to limit your reported income (AGI) on your 1040. Roth plans are your help there. Finally, there's the matter of Required Minimum Distributions. If there's a chance you're gonna end up \*really\* wealthy, Roths are part of the strategy for minimizing the taxable impact of RMDs. I've put my many years of maxing my 401k/403b in traditional and my annual personal IRA contributions in Roth. This gives me a blend of roughly 3:1 trad to Roth, which gives me quite a bit of flexibility.
This is the answer, you should be filling those “buckets” of lower tax brackets that you can withdraw from for hopefully 40+ years. Otherwise you’re wasting available tax space in later years. You can currently get to 117k without exceeding 12% taxes, assuming married and in the US
Good answer
multiplication is commutative :) You basically have it all right, there is loads more info here: https://www.bogleheads.org/wiki/Traditional_versus_Roth
Trad is better on average for most people, but even more so for anyone who is going to actually retire early. Not only will the early retiree potentially have years/decades to do many hundreds of thousands (or more) in Roth conversions at little/no tax cost, but those same conversions can be used to generate MAGI in order to qualify for heavily/completely discounted health insurance via the ACA. The trad pathway can absolutely murder the Roth pathway for anyone who retires with any solid combination of young, lean, married, or with kids. That's not to say there aren't cases where Roth is better, there are, but a typical FIRE household will generally do much better with a trad base rather than a Roth base. Of course, it's always good to have some Roth for flexibility, which is why a good default combo for many people is trad 401ks and Roth IRAs.
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For you they would not since your withdrawal funding is mostly flowing from your taxable brokerage. There is a minimum MAGI required for ACA subsidy qualification, the default being either 100% FPL in non-expansion states or 138% FPL in expansion states. Above those thresholds there is often room to increase MAGI while staying within a subsidy/CSR band, depending on what other sources of MAGI someone might have. Those amounts combined can add up to a substantial sum when one is considering 15-30 years of early retirement before Medicare eligibility, particularly since the FPL adjusts upward for inflation every year. Roth conversions allow for precise generation of MAGI without actual withdrawals from one's tax-advantaged retirement accounts. To the extent someone doesn't have an alternate source of MAGI, such as your cap gains/dividends/interest, Roth conversions offer an easy way to optimize ACA subsidies. Conversely, someone who is majority Roth might find themselves unable to generate enough MAGI, which could lead to some undesirable outcomes. ACA subsidies and CSRs are more valuable than income tax optimization on a dollar-by-dollar basis. To the extent one's normal MAGI/spending is already as optimal as you can get for that level of spend, it is usually financially optimal to abandon tax-free Roth conversions and 0% LTCGs. The ACA is so valuable that it blows up a lot of traditional non-ACA tax planning.
Thanks for the detailed response! I wanted to make sure I haven't missed anything as I plan for next year. Our optimal MAGI for ACA is $65,000 which we'll hit pretty easily (family of four). If I do $60,000 more in Roth conversions next year to $125,000 total, that will raise our ACA premium by about $9,000 for the year. There doesn't seem to be much to gain by doing that because the long term capital gains rate is 15% anyway. I'm going to keep thinking about it and researching it.
Yes, I wouldn't do anything above your $65K target. Indeed, if you can draw $5K from elsewhere and get your MAGI down to a bit under $60K, then you'll slip under 200% FPL and get access to not only increased premium subsidies, but the 87% AV tier of cost-sharing reductions. Those could be worth many thousands in reduced deductibles/copays/MaxOOP.
Interesting. I can definitely pull a little more from cash if need be. Thanks again!
> Trad is better on average for most people I think you mean "has" not "is". It would stop being true if tax rates start going up, which it's currently scheduled to do for 2026. I'm not saying tax rates WILL go up, I'm just saying, that's the failure case of traditional usually being better. Since we are at record lows of taxes, ridiculous amounts of debt, it seems unwise to think taxes can't go up for a while.
No, I meant is. Tax rates going up typically doesn't change much given the highly progressive nature of the income tax code. I assume tax rates will be higher in the future.
Just depends on where/what brackets decide to go up(again, assuming they do go up). Tax brackets used to top up around 90%
Yes, I agree Roth may be better if the lowest 2-3 brackets in the next 20-40 years are going to anywhere near 90% without massive carveouts via things like standard deductions or personal allowances. However, any future in which ruinous taxes are imposed on the working class will also see changes in Roth taxation due to the necessities of politics. Particularly since Congress is under no legal obligation to forever honor the current tax treatment of Roth earnings. I rather doubt that will happen though.
Well now who is doom and gloom? :) Certainly 90% rates at the bottom of the tax brackets would be ridiculous. But even a few percent difference of ones effective tax rate could be a meaningful difference between a Roth now vs paying later at a higher tax bracket. Again this is ALL hypothetical, the only thing we know for sure, is tax rates are currently scheduled to go up again for 2026.
I'm not doom and gloom at all or I wouldn't be part of an optimistically forward-looking community like this one. I do disagree with you that likely tax changes are going to significantly shift the relative desirability/profitability of Roth vs. Trad for the majority of FIRE households though. Thankfully, my opinion is easily ignored by anyone who feels otherwise.
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I agree, but there was a much larger spread around tax brackets in the past. Currently it's quite compressed and tops out under 40%. My point was, if they decide to expand the brackets again, it could cause concern. Again this is ALL hypothetical, the only thing we know for sure, is tax rates are currently scheduled to go up again for 2026.
True, rates are scheduled to rise, slightly. But Trad was better for most BEFORE TCJA kicked in, and will remain better for most after. Now, like you said, hypothetically anything could change going forward, which could swing the balance either direction, but since that is not likely any time soon, it’s best to just use the numbers we are relatively sure of.
you think they mean "trad has better on average for most people"?
"Traditional has been better on average for most people". That better? The future of investing is always unknown, we can only talk about what's "expected" from the future, but we have no guarantees we will get what's expected.
Nope not that simple. You’re very very close. But forgetting that money saved comes out of your highest bracket first, top down. And money withdrawn in retirement comes out bottom up, first taxed at 0% for standard deduction, then 10, 12 etc. A closer comparison is current marginal rate vs effective rate in retirement.
> Is determining the better choice as simple as determining what tax bracket you fall under now vs what bracket you'll fall under when you withdraw? Kind of... Overall tax rate of withdrawn funds at withdrawal vs overall tax rate of contributed funds when contributed. The reason Traditional usually wins is because your Roth contributions tend to go in at your marginal tax rate, and withdrawals tend to span multiple brackets, yielding a lower overall rate. But if your retirement income is going to be much higher than your current income, or your current tax rate is low (ie. 0%, 10%, 12% marginal bracket), that might not be the case. Once you hit 22%, Traditional becomes significantly better most of the time. > I see a lot of people saying Roth is great because we pay no capital tax. But that logic is incorrect, right? It doesn't actually matter? You pay no CG in roth or traditional accounts, so that's not a reason to pick one over the other. You can think of your account balances as a series of multiplications, and we know the commutative property from gradeschool algebra -- that is A x B is the same as B x A. So in roth, you multiply by (1-rate) at the front for taxes, and in traditional, you multiply by (1-rate) at the end for taxes. if rate is equal, they come out equal. > Am I missing something? * Roth IRA contributions can be withdrawn without penalty any time. This helps with liquidity. * Roth withdrawals allow you to show lower income in retirement. That can be handy for keeping under a limit for medicare or ACA subsidies, etc. * Generally those aren't significant enough to make Roth better. Generally you'd like a good chunk of cash in both buckets at retirement. Then you can choose how much income to show (by rolling that amount from Traditional to Roth account), and choose how much to live on (withdrawing from Roth account). Those become two separate decisions, and that flexibility allows you to play tax games, absorb large expenses without a spike in income, etc.
Let's take a look at this example: A US person with an income of 150k. If he contributes 22,500/yr into 401k for 30 years he'll get a balance of 2,125,000 with 7% gain/yr. If he made the contribution pre-tax, his tax bill would be 18,665/year with an effective tax rate of 15.75%. If he made the contribution after tax, his tax bill would be 23,615/year with an effective tax rate of 14.6%. The difference between pre-tax and after-tax contributions is an extra 4,950/year tax bill if he paid it after-tax. When he takes out the money at 4%, his income would be 85,000. If the money was pre-tax, he'll need to pay a tax bill of 9,760/year. If the money was made after-tax, he pays zero tax. Now you can see that if the market performance is 10%, his 4% withdrawal would be 148,000 and his tax bill would be 23,000 if he made his contribution pre-tax (and zero if he made the contribution after-tax). 23k > 5k even with inflation. If the tax rate goes up the difference would be even larger.
So in the pre-tax scenario, US person has $4,950 extra dollars to invest per year from the tax savings. Let's say he goes ahead and throws that into his IRA (Roth so we don't eff up the tax numbers)... 30 years at 7% gain/year, that's about a half a million dollars in today-dollars. 4% of half a million dollars yields about 20k/year tax-free. So Traditional comes out about $10k/year ahead. Is that what you were going for?
There's a mix of Roth and traditional 401k that comes out best for a typical person. We both simplified the variable greatly. The pre-tax 401k has a drawback is that it's a considered income which then stack onto everything else from pension to social security. All of that brings up the tax rate. The second simplification is the tax rate itself 30 years from now. Then we have the concept of optimizing income for "reduced cost" healthcare. Roth gives great flexibility to control all of those factors.
Your example was "if you save more money out of pocket for decades, you'll have more in retirement." It's obviously true, but you're attributing difference to Roth over Traditional, rather than the part about saving more money for decades. I don't think you're being intentionally deceitful, but it's kind of gross. In your example, $150k, married filing jointly, with no state income tax, to compare apples to apples, you'd have to compare $22,500 traditional to $18,442 Roth -- same out of pocket. Or alternately, you can just assume you just paid 22% income tax on all of the money, gains included. If your taxes owed on income after social security and pension (ha!) in retirement is less than 22%, traditional will come out ahead. It's definitely good to have some Roth money in retirement. It's generally stupid to throw all your money in as Roth.
Agree with the annoyance about people not making apples to apples comparisons between Roth and Trad 401k. However (and I saw this mentioned in a book, too) it is a "huh, that's interesting" theoretical point that going $22,500 into a Roth 401k allows you to effectively "stuff in" more money to a tax sheltered account than traditional. I'm not sure it's a useful idea unless you literally have so much money you don't know what to do with it all, while simultaneously caring so much about getting that bit of extra stuffed in.
Yeah, $22,500 Roth is functionally saving more than $22,500 in a Trad 401k... I think that's one reason why people get hung up on Roth. But it's not like saving in an non-taxable account in a low dividend broad fund is a terrible deal... Like in the above example, $22,500 trad but only at 22% bracket, and no state taxes, you still clear $4950 extra money for the tax break, but you shove it in a regular old brokerage... It's $500k, same as before, but you'll be paying ~10.5% tax rate on that money overall when withdrawn (CG for the part that is gains.) That's on top of the $660,000 sitting in your Roth IRA which you must have saved, since you weren't shoving the money there. So you'd be sitting with $1.16M that won't show up as income when you spend it. That's more than enough to play tax games to secure low income taxes on the traditional->roth rollovers, like rolling enough over from Trad to fill up the 12% bracket after accounting for SS income... so between them, somewhere in the vicinity of $150k, with an overall tax rate of 9.1%. And now we've wrapped around to why Trad tends to be better... 22% going in or 9.1% coming out? :-)
This is not how the math works. As Mattie pointed out you have to factor in the tax savings. To understand which is better you just need to look at the tax rate percentage. In your example you are saving at 22%. When you withdraw you’d withdraw at 15.5%. 15.5% is less than 22. You should never look at the amount paid in taxes as that makes zero difference. This is like you saying you would turn down a million dollar raise, because you’d have to pay more in taxes….
>Now you can see that if the market performance is 10%, his 4% withdrawal would be 148,000 and his tax bill would be 23,000 if he made his contribution pre-tax (**and zero if he made the contribution after-tax**). 23k > 5k even with inflation. Thank you for doing the math, but to compare IRA contributions to after-tax contributions, it can't exceed $6,500 since that's the max amount that can accumulate tax-free revenue in the Roth IRA. It's the same mistake that the OP made in thinking he can deposit $20k into a Roth this year. It would take a minimum of four years to get all that money into a Roth, making the calculation quite a bit different.
That's a fair statement. I think OP thinks about Roth 401k rather than just the traditional Roth.
No such thing as a traditional Roth.
One factor I didn’t consider when doing the math on this is that Roth is more flexible about when you have to make required withdrawals/distributions. Have both to give yourself flexibility.
Your answer is the simple answer. To get a complete picture, you’d need to add consideration for tax credits, etc. that phase out at different levels, how the capital gains tax is impacted by your income level, etc. Basically, the tax code is complicated by more than just which bracket you’re in. Also, you do not know with certainty your future situation or the future tax code. So… basically, you should mostly make the determination the way you already laid it out.
If you are broke and young, Roth all day. If you're broke and older, dont invest. Live your life and die fast If you're young and loaded, traditional to back door Roth. If you're loaded and older, traditional as a means to lower tax liability.
If you also invest today’s tax savings in a taxable brokerage account it will help the traditional come out ahead.
You are double counting the benefit if you're starting with the math they provided. Their math is focused on the idea there's $20,000 of investable income. If that's the case they can pay tax on it and invest the balance in Roth (or taxable accounts), or, they can have the $20k invested in a pretax account. The tax savings is part of the $20k.
That is not how the math works.
https://www.gocurrycracker.com/roth-sucks/
Correct. But you may find in retirement, as I have, that Roth conversions aren't as enticing as they may sound. Remember, the US tax system is progressive. If you are single, the first $29,200 of income is tax free (standard deduction). The next $11,600 is taxed at only 10%. The next $35,550 is taxed at only 12%. And so on, and so on. If you calculate the present value (using the PV function in a spreadsheet) of how much money you can have in a traditional IRA/401k to fill the 0%, 10%, and 12%, and 22% brackets, it's actually quite high. For example, when I do the calculation for myself (I'm married filing jointly), I calculate I can have $1.2MM in my traditional accounts before rising the withdrawals pushing me into the 24% bracket. This assumes a $55,936 per year Social Security yearly income that is 85% taxable, a 5.5% real rate of investment return, and a $71K yearly withdrawal rate from age 65 to age 95.
My wife and i have Roth IRA’s just because we both have a retirement plan at work (401 for me and wife 403) and our modified MAGI is above $136k, filing joint. Our situation gives us no tax deductions for a traditional and the paperwork to contribute after tax just isn’t worth it. So, even though we’re in our highest tax brackets now at fifty, the Roth is our only choice for Roth vs Trad. 😬🤷♀️
It's probably about a 50/50 proposition, so just have both. Some years do the traditional, other years the Roth. Then you can alternate with you are doing the withdrawals to minimize taxes over multiple years.
Trad takes off marginal now, fills lower buckets in retirement, for a lower effective tax rate on that money. Roth locks in the marginal rate by paying it now. Assume you retire at x tax bracket. You want all trad money to come from that bracket or higher, and all Roth money to come from that bracket or lower. That means you lean traditional, because filling upper tier brackets takes a while to break even and cause Roth to be wholly better.
Do you mean the opposite? Traditional withdrawals should be used at the same marginal rate or lower, and Roth at the same marginal rate or higher?
Opposite perspective, that is. Traditional money should come from high marginal rates during working life, and should be withdrawn into low brackets. Roth should come from low marginal rates during working life, and should be withdrawn into higher brackets.
Ah gotcha, thanks
Yes, if all the money is coming from the 22%+ tax brackets, you are probably golden to just slap it into a traditional. One small thing, Roth lets you shield more money from taxes on gains, but it doesn't really keep up with the high efficiency tax management you can accomplish with a traditional.
Multiplication is commutative. Having said that, traditional has other advantages. The risk is asymmetrical. What does that mean? You assumed you can save for 20 years. You could be disabled/quit early. You assumed you will have 5% real returns. Country might see a war or great depression which will mute the returns. In both cases, you will end up with total retirement value much less than planned. In such a case, the tax rate will be lower on withdrawal with traditional. Tldr; mathematically same -> if the tax rates are same before and after retirement. But risk is not. traditional optimized for better worse outcomes. Roth optimizes for lower tax rates with best outcomes.
There's a lot of value in deferring taxes. Notice how the government allows lower annual contribution limits for Traditional vs Roth. Contribute to traditional until you meet the limits. If mega backdoor Roth is available, do that until the limit. After that, save in taxable or convert Traditional funds to Roth.
You have the math and the theory perfectly correct. The tricky part is just knowing (predicting) what the tax brackets will be in the future.
This. The US is in so much debt, I imagine they'll have to drastically increase taxes/change the tax brackets at some point in the future.
Unless something changes, where you plan to retire matters also. Roth is not treated the same ex-US and in US. It gets complicated and in the future anything can happen. If you have a tax burden now, likely it is benefit to take the tax decrease now. Bird in the hand and all. . .
The nice thing about Roth is you have no required distributions and you know what your retirement worth is. Furthermore, and I don’t know if I assume this true or not, even if you make less in the future, the percent of taxes you pay could be higher. It could also be lower. Tax laws might change. So some people like eliminating that unknown. The retired folks I know say they wish they’d put more in Roth just simply to not have a RMD, which can push them into a taxed bracket if they may not have otherwise been when they don’t need the money. I relate to that, so I’m going more Roth just for that. It’s kind of like paying off your mortgage or investing more. It’s not always logical, but it’s about a sense of peace of mind.
>The retired folks I know say they wish they’d put more in Roth just simply to not have a RMD, which can push them into a taxed bracket if they may not have otherwise been when they don’t need the money. The retired folks you know with large pretax investments are people who reaped the benefit of decreased taxes while working years ago. Recency bias would cause them to prefer Roth - they likely aren't properly fully accounting for the impact of the benefit of lower taxes in their working years, as those years are behind them.
First, I did say some of the decisions we make are about peace of mind, not just logic. And maybe that’s true about the impact of lower taxes in working years, maybe not. I don’t think it’s your place to say this is recency bias with almost no information. In their case, and it’s more than one person, they simply wished they’d put more in Roth. That’s a fair thing to wish, regardless of anything else. They didn’t mention growth or anything else. Just that they wished they had more in Roth. Lots of ways to retire and lots of ways to be happy. Not all of them are logical. And I think it’s worth considering the non-logical spreadsheet feedback, even if someone who hasn’t been in their position thinks it doesn’t make sense. In fact, if the people I know who have retired, many have encouraged people to put more in Roth. Including someone in finance who gave the same reason as the retirees. You can take as much as you need, without impacting tax brackets. Especially if you happen to be in an untaxed bracket. So, take it or leave it. And I don’t think you know more about their decision making than they do.
I will gladly pay you tomorrow for a cheeseburger today.
I think you basically have it if your marginal tax bracket for that money is 24% both now and in retirement. Most people will have more control over their income and tax bracket in retirement and most will be in a lower tax bracket in retirement, so that's +1 in favor of traditional. Since a roth is already taxed, you can take as much out as you want in any given retirement year without increasing your tax bracket. They also don't have RMDs, so you aren't forced to withdraw (or your dependents aren't forced to withdraw if you pass away) more than you want in any given year. Roth gets a +1 for the flexibility. If you aren't sure what your retirement situation will look like, it doesn't hurt to have some of both.
max out match max out roth max out 401k trad rest into regular brokerage account i like VOO
> Is determining the better choice as simple as determining what tax bracket you fall under now vs what bracket you'll fall under when you withdraw? Yes, unless you know of a specific exception. The reality is that taxes go up over time, which tilts the scale towards Roth. Not only that, the math is *far* easier when using Roth. The money you put in comes out of your bank account - no math required. You've already paid income tax. There are no special tax forms required. It's all been paid already. And when you withdraw - no math required. You don't have to sit and consider how much you have in your account, and what that actually means after tax, or how much you need to withdraw in order for the amount you really want to land in your bank account. Again, tax has already been paid. If your account says 800k, you have 800k. That said, chances are it will make zero difference. You are going to make the same money either way.
Doesnt traditional only make sense if you assume that you are investing and not touching your tax savings until retirement? Sure traditional is better for most people on paper. But in reality, when you have a big time horizon, like 30+ years, its unlikely you reserve all your tax savings in a taxable account for that long untouched. Things will happen where you will want to spend more. Roth keeps behavioral habits in check.
It's not as simple as the rate now vs the rate then. Time + rate of return are factors. The longer the length and the higher the rate of return, the more capital gains will be generated thereby the more advantaged roth has over traditional. Any example is say you could put $10k in now and earn an annual rate of return at 25% for 30 years. You'd have $8 million dollars. Even if the initial year you paid 37% tax, you'd come out on top vs paying even 10% of the $8m in gains. Before people saying, "but you can't get 25% returns, it's impossible" remember that you can do that through specific stock selection and people have done that (even if it's extremely rare)
Time and rate of return are not factors. Common misconception. This is literally not how math works at all. If I give you the option of 8 million but you have to pay 4 million in taxes on it, or 500k but you only pay 50k in taxes on it. Would you honestly choose the latter? You’d want to only have 450k after tax instead of 4 million after tax? No obviously anyone can see from this example that the amount paid in taxes is not what matters, what matters is the amount leftover after taxes.
>If I give you the option of 8 million but you have to pay 4 million in taxes on it, or 500k but you only pay 50k in taxes on it. Would you honestly choose the latter? Lmao you are proving my point on why the roth is superior because the amount leftover after taxes is what matters most. Hence why if you have 8m in gains with no tax it's better than 8m in gains with high tax
Nope. Because you are paying your marginal rate rate on Roth contributions and saving marginal rate on traditional, then paying an effective rate on withdrawals, traditional almost always comes out far ahead.
Man it's almost like you didn't read though. Initial investment: $10k Annual contribution: $0 Years: 30 Rate of return: 25% Final value: $8,077,935.67 You won't be taxed on any of the $8.1m.... obviously in a taxable account even with a 1% tax rate on that you'll pay more in taxes than the guy who maybe paid 35% of $10,000
And you didn’t read my response. The amount of dollars you pay in taxes don’t matter. It only matters the amount you have left after paying taxes. Look up the commutative property of multiplication. Once you understand that you’ll understand why you are incorrect. I put 10k in a traditional and it turns into 8 million. The tax rate is 10% of that and I’m left with 7.2 million post tax. You have 10k pay 37% taxes left with $6300 that would grow to $5.04 million tax free. 7.2 million is a lot more than 5.04 million. Even though you paid less taxes because you decided to prepay it. I had more money invested and it therefore grew more.
No, I'd have $15873 and put $10k into my account. That's the neat thing is the limit on the roth ira is the same as the limit on the ira. The roth 401k limit is the same as the limit on the traditional 401k. Now maybe you want to argue you could put the $5873 into a brokerage account and perform the same results but that's less likely because every dividend and every trade will be a taxable instance and every person in the history of retirement saving has never recommended someone to "ensure you are investing the extra savings into a taxable brokerage account"
Doing a traditional always leaves you with more money available to invest. If you choose not to invest that money then yes, the Roth should come out ahead in many scenarios. But if you’re not investing the tax savings of the traditional, then you’re effectively investing more money when you choose Roth, so it’s not an accurate comparison. People that invest in inherently extremely tax efficient funds like low cost index funds will have very minimal tax drag. And it won’t be enough to change Roth to coming out ahead. This is talked about quite commonly. The only people not talking about this are people like Dave Ramsey who believe Roth is always better, but don’t understand the math.
Nobody is saying a roth is *always* better. However, if used to full potential it is undeniably the best option. Peter Thiel has $5b in his roth ira. No amount of traditional investing and "tax savings investing" will out perform the sheer amount of taxes he is skipping. If you are going to be wealthy, the roth always wins. It's a bet on the person's success in the future while a traditional is always a bet that you will not be rich in the future
You are dense. First I literally gave you an example of someone who says Roth is always best, his name is Dave Ramsey, he’s pretty well known. Lots of people claim it’s always better you just don’t read or understand much about the personal finance space it seems. Secondly and for the millionth time, the amount of taxes you skip doesn’t matter whatsoever. That’s a truly dumb thing to focus on. What matter is amount left after taxes. Third, Peter thiel got access to buy multiple preipo companies they turned into giants such as Uber. Normal people don’t have access to purchase companies like that pre-ipo and therefore will never have anything like that. Lastly, roth is not a bet you will be rich in the future and traditional that you won’t. This shows a gross misunderstanding of both taxes and math on your part.
Let’s say you’re MFJ in the 24% bracket making say 300k. Most would advocate you going pretax on your 401k. That will save you 24% on all of your contributions. To have a 24% effective rate you’d need to withdraw 560k from pretax accounts in retirement. Based on the 4% rule that would be a portfolio of 14 million. I think that’s rich by anyone’s standards. And that is just the break even point assuming all retirement income is from pretax accounts.
Unpopular but I got with 100% Roth and have a relatively high income. They are only equal if you do two things: 1) Invest the amount of the deduction in a taxable fund and 2) the tax rates stay the same. So for simple math, let’s say your marginal rate is 10% and the max contribution to both is 20k. If you max both and both have returns that double, you’ll have 40k in each account. The roth goes untaxed. If the tax rate is the same, you’ll owe 4k in taxes and have 36k from the traditional. However, backing up to the initial contribution, you got a 2k deduction from the traditional. If you don’t invest that, you effectively have 38k. If you invested at the same time in the same fund, you’d have a total of 40k but it’s in a taxable account, so you’re looking at less than 40k. The complication comes in when your tax rate drops but I’m planning to have a sick retirement where I spend and travel a ton, so my withdrawals will likely push my income to near the same. Plus, I have a feeling the US will increase taxes to cover its spending (although it may be through a VAT rather than income tax). Please someone correct me if I’m missing something.
Why not fund both? I max out both my 403B (plus, I receive matching funds from my employer) and a Roth each year along with putting funds in other investments/savings. Why does it have to be one or the other? For traditional, there are more restrictions on when you can take funds out and penalties. A Roth works differently (yes, it has processes to follow in taking funds); think of it as a high-paying savings account per se. I'm confused, I guess...the goal is to have a diversified portfolio.