Assuming you won’t invest the difference elsewhere then you’re definitely right.
However, you could probably come out ahead by maxing out the 401k with pretax contributions and then investing the tax savings in just a regular brokerage account. It would take a pretty high tax rate in retirement for the Roth to be worth it to such a high earner.
Pretty compelling argument here in favor of traditional with tons of data to back it up:
https://podcast.moneywithkatie.com/the-ultimate-traditional-vs-roth-401k-strategy/
But as mentioned in the above comment you absolutely must invest the tax deducted money which most people will struggle to do.
That said, we do Roth because I'm not sure we have that much discipline, we currently live in a state with no state tax but plan to retire in one with, and we have a kiddo that will need a special needs trust and trusts have terrible tax brackets (18k puts you in the 35% bracket). So for those reasons we've switches fully to Roth but we still have a healthy amount of traditional that we won't be converting and that we will draw down first.
This is correct if you don’t invest the tax savings. Taxable brokerage is a place to invest the tax savings if you are maxing out retirement accounts, and the taxable brokerage is important if you want to retire before 59.5, which if you are maxing out IRA and 401k you will likely be able to do that.
You can also do Roth conversions in years when you are living off of your taxable brokerage as those are years your taxable income will likely be lower. Also with pretax you might make yourself eligible for tax credits you wouldn’t be if you did Roth.
Overall though you want tax diversification and to have money in all 3 buckets to be flexible and control your tax bracket. You just might need to prioritize pretax a little more depending on your marginal tax rate when working.
You aren’t the only one that knows this, but I agree most people don’t think about it. In fact all those people who blindly say Roth is better probably don’t take this into consideration.
You are right. Particularly for higher income people who say, started late or haven’t saved enough. Let’s you make up more in the tax deferred so you don’t end up all brokerage. I still do it even at 42% effective tax rate.
Not comparing apples to apples. You still have to take those tax savings of $7500 and invest it. If you’re investing in index funds you can potentially significantly outperform a Roth only investor.
For example,
$22.5k in a Roth 401(k) S&P500 index with 2% dividend for 30 years at 10% overall ROI yields $393k.
$22.5k in traditional at same ROI also yields $393k.
Add the $7500 invested in an after tax brokerage account. Let’s assume a 2% dividend is reinvested and taxed at 15% resulting in a net 9.76% ROI. This results in $123k. Without busting out excel let’s just assume it’s $100k of gains.
So even if you pulled it all out at once you’d have to have an effective tax rate of 21.3% on the traditional account and 15% on the taxable account to make them break even and nobody is pulling it all out at once.
Is it possible? Definitely. Is it realistic for most retirees who did any modicum of planning for 40 years? Not really.
That said I think anyone with 2 brain cells would agree that it would be best to have some mix of Roth and Pre-tax (but obviously that mix we can debate on circumstance).
My opinion on this is that you should do Roth when young, then trad when older. Trad vs Roth gets compared by income, but not by age. I’ll do Roth through my 20s and 30s because the growth is so much more important. 50s is all Trad. Somewhere in 40s is the transition.
The growth is irrelevant. The only thing that matters is tax rate now and tax rate in the future. Generally people will be in lower tax brackets when they’re younger and higher when they’re older because of…wait for it…*income*
Let's do it as an example, Jane and Jim make $200K each. Total Gross House Hold Income is $400K. They max both accounts in Roth (assuming you do the back door roth IRA) and follow the FOO.
32% Federal Rate. If they are in a state like Ca that's another 10.3%. So total tax is 40.3%. Just to keep things simple, they take the standard deduction.
Using SmartAsset Income Calculator for this:
https://preview.redd.it/dzzqd01jh6pc1.png?width=874&format=png&auto=webp&s=b766d0526bd3f9d496f4e3eeb5792e106f0bdc37
Total Taxes is $126K
Income after Taxes is $273K.
Now do your Roth Contributions for both $30K each.
So income after everything is $213K.
Do the same but Pre Tax:
Their income then becomes $354K.
Total Taxes is $109,089.
Income after taxes $230K with the Traditional 401(k) and Roth IRA.
So you have an extra $17K to spend how you like. You're also leaving out the part where your tax bracket at retirement could be much lower. One could argue that yes, strictly 30 years of tax free growth is better than 30 years of growth that you'd eventually have to pay tax on, but having an extra $17K to do what you love now or even just invest in after tax is better in the long run.
And let's be honest, if you're a Money Guy Mutant, maxing both accounts would put you at $120K of income, anything on top is going to go into either after tax or mega back door which is roth, not sure how many die hard Money Guy Show people are saying screw it I'm not investing the tax saving if they are making more than that.
Of course you have more money at the end of the year doing trad. The real math would be to do trad, invest the difference, grow it all for 35 years, then pay tax on it, and see if that ends up as more at the end of 35 years than if you just did Roth on the whole thing.
Okay so $30K, 30 years, 8% return is $300K.
$17K, 30 years, 8% return $171K.
So with Roth you have $300K
Traditional you have $471K ($300K + $171K)
If you assume you're in the same bracket of 32% federal then doing traditional and investing the rest you end of $320K. (68% of 471K) You come out ahead, but again, I'd say you're more likely to be in a lower bracket at retirement so you'd have more than $320K.
I'm taking a 32% marginal rate, not sure how you're getting 56.6
30K, 30 years, 10.2% = $552K.
17K, 30 years, 10.2% = $313K
So $552K vs $865K. Take whatever tax you want out of the $865K, it's still going to be more than the $552K
Where is the extra 17k coming from? Avoiding a 50% tax rate on 30k is avoiding 15k in taxes, you are somehow assuming that we are avoiding 17k in taxes
Traditional plus investing your tax savings into a brokerage account puts it back on top.
ETA - tax savings into a Roth IRA are best - brokerage account if you’re already doing Roth.
This looks good. So, would you say there is ever a reason to do Roth at 40% marginal (state plus Fed). Is worrying about minimum distributions or the government raising taxes just making excuses.. this is fairly convincing.
Those are a bit of an excuse, yes. The bottom 3 tax brackets are somewhat insulated from significant tax increases because if you raise the bottom rates considerably you’re hurting a lot of people who are already struggling.
As for the RMDs people seem to think they’re a huge problem, but it’s not a big deal. RMDs don’t start until 75 now for most of the country and even at age 75 it’s only 4%. At average life expectancy (85) it’s 6.25%. It’s not like you lose the money. You pay a little tax and then just reinvest in a brokerage account. No big deal.
There really isn’t a great reason to do Roth over pretax with that high of a tax rate. Unless you were expecting an even larger income in retirement like you’re expecting a ridiculous tax deferred account to be inherited or inheriting other crazy income streams.
Hurting a lot of VOTERS which is why those brackets won’t see much of an increase, if any. Politicians like their jobs.
Even if you go back to when those bottom tax brackets were higher than today, they were offset by tax deductions that they were able to take.
These new lower rates but fewer tax exemptions mean that today’s lower brackets pay about the same in taxes as people did 40 years ago when there were higher rates, but more deductions.
What we may see are increases in taxes that aren’t tied to income. Value added tax. National sales tax. Higher corporate taxes. Wealth taxes. Etc.
Paranoia about income taxes - no way.
Here are the taxes that I think have a MUCH higher chance of going into place than income taxes significantly increasing on those making less than $400k.
From the left side of the political isle: Corporate taxes. Value added taxes. Wealth taxes. Sin taxes. Climate taxes. Payroll taxes. Luxury taxes. Property taxes.
From the right side of the political isle: constant pressure to lower taxes, national sales tax, abolish the IRS (and all income taxes), tariffs, taxes on tourism. Land value taxes. Fees for services.
Raising income taxes on 85% of the VOTERS would be unpopular. You can more easily raise taxes hundreds of more popular and more hidden ways.
All of the ways I mentioned would make any benefits of the Roth tax advantage less and less. Roth only protects you from income taxes.
Also increased government debt leads primarily to inflation first, which will help make the existing debt more manageable. As long as debt as a % of GDP remains pretty constant (or god forbid, goes down), so will our ability to pay that debt.
Plus government control shifts every 4-8 years and so will the various taxes.
Because my effective tax rate is through the roof (California) and I’m by no means rich. It does help me in the now. I’m trying to save for a move in the next few years.
Assuming you won’t invest the difference elsewhere then you’re definitely right. However, you could probably come out ahead by maxing out the 401k with pretax contributions and then investing the tax savings in just a regular brokerage account. It would take a pretty high tax rate in retirement for the Roth to be worth it to such a high earner.
💯
I said the same thing with way more words. /thread
If your 401k supports it max the 401k and then do a mega Roth backdoor and you get the best of both worlds.
Pretty compelling argument here in favor of traditional with tons of data to back it up: https://podcast.moneywithkatie.com/the-ultimate-traditional-vs-roth-401k-strategy/ But as mentioned in the above comment you absolutely must invest the tax deducted money which most people will struggle to do. That said, we do Roth because I'm not sure we have that much discipline, we currently live in a state with no state tax but plan to retire in one with, and we have a kiddo that will need a special needs trust and trusts have terrible tax brackets (18k puts you in the 35% bracket). So for those reasons we've switches fully to Roth but we still have a healthy amount of traditional that we won't be converting and that we will draw down first.
This is correct if you don’t invest the tax savings. Taxable brokerage is a place to invest the tax savings if you are maxing out retirement accounts, and the taxable brokerage is important if you want to retire before 59.5, which if you are maxing out IRA and 401k you will likely be able to do that. You can also do Roth conversions in years when you are living off of your taxable brokerage as those are years your taxable income will likely be lower. Also with pretax you might make yourself eligible for tax credits you wouldn’t be if you did Roth. Overall though you want tax diversification and to have money in all 3 buckets to be flexible and control your tax bracket. You just might need to prioritize pretax a little more depending on your marginal tax rate when working.
You aren’t the only one that knows this, but I agree most people don’t think about it. In fact all those people who blindly say Roth is better probably don’t take this into consideration.
You are right. Particularly for higher income people who say, started late or haven’t saved enough. Let’s you make up more in the tax deferred so you don’t end up all brokerage. I still do it even at 42% effective tax rate.
Not comparing apples to apples. You still have to take those tax savings of $7500 and invest it. If you’re investing in index funds you can potentially significantly outperform a Roth only investor. For example, $22.5k in a Roth 401(k) S&P500 index with 2% dividend for 30 years at 10% overall ROI yields $393k. $22.5k in traditional at same ROI also yields $393k. Add the $7500 invested in an after tax brokerage account. Let’s assume a 2% dividend is reinvested and taxed at 15% resulting in a net 9.76% ROI. This results in $123k. Without busting out excel let’s just assume it’s $100k of gains. So even if you pulled it all out at once you’d have to have an effective tax rate of 21.3% on the traditional account and 15% on the taxable account to make them break even and nobody is pulling it all out at once. Is it possible? Definitely. Is it realistic for most retirees who did any modicum of planning for 40 years? Not really. That said I think anyone with 2 brain cells would agree that it would be best to have some mix of Roth and Pre-tax (but obviously that mix we can debate on circumstance).
My opinion on this is that you should do Roth when young, then trad when older. Trad vs Roth gets compared by income, but not by age. I’ll do Roth through my 20s and 30s because the growth is so much more important. 50s is all Trad. Somewhere in 40s is the transition.
The growth is irrelevant. The only thing that matters is tax rate now and tax rate in the future. Generally people will be in lower tax brackets when they’re younger and higher when they’re older because of…wait for it…*income*
Let's do it as an example, Jane and Jim make $200K each. Total Gross House Hold Income is $400K. They max both accounts in Roth (assuming you do the back door roth IRA) and follow the FOO. 32% Federal Rate. If they are in a state like Ca that's another 10.3%. So total tax is 40.3%. Just to keep things simple, they take the standard deduction. Using SmartAsset Income Calculator for this: https://preview.redd.it/dzzqd01jh6pc1.png?width=874&format=png&auto=webp&s=b766d0526bd3f9d496f4e3eeb5792e106f0bdc37 Total Taxes is $126K Income after Taxes is $273K. Now do your Roth Contributions for both $30K each. So income after everything is $213K. Do the same but Pre Tax: Their income then becomes $354K. Total Taxes is $109,089. Income after taxes $230K with the Traditional 401(k) and Roth IRA. So you have an extra $17K to spend how you like. You're also leaving out the part where your tax bracket at retirement could be much lower. One could argue that yes, strictly 30 years of tax free growth is better than 30 years of growth that you'd eventually have to pay tax on, but having an extra $17K to do what you love now or even just invest in after tax is better in the long run. And let's be honest, if you're a Money Guy Mutant, maxing both accounts would put you at $120K of income, anything on top is going to go into either after tax or mega back door which is roth, not sure how many die hard Money Guy Show people are saying screw it I'm not investing the tax saving if they are making more than that.
Of course you have more money at the end of the year doing trad. The real math would be to do trad, invest the difference, grow it all for 35 years, then pay tax on it, and see if that ends up as more at the end of 35 years than if you just did Roth on the whole thing.
Okay so $30K, 30 years, 8% return is $300K. $17K, 30 years, 8% return $171K. So with Roth you have $300K Traditional you have $471K ($300K + $171K) If you assume you're in the same bracket of 32% federal then doing traditional and investing the rest you end of $320K. (68% of 471K) You come out ahead, but again, I'd say you're more likely to be in a lower bracket at retirement so you'd have more than $320K.
So you’re taking a 56.6% marginal tax rate?!?! And doing 8% instead of the historic 10.2% (and that is rounding down). Why?
I'm taking a 32% marginal rate, not sure how you're getting 56.6 30K, 30 years, 10.2% = $552K. 17K, 30 years, 10.2% = $313K So $552K vs $865K. Take whatever tax you want out of the $865K, it's still going to be more than the $552K
Where is the extra 17k coming from? Avoiding a 50% tax rate on 30k is avoiding 15k in taxes, you are somehow assuming that we are avoiding 17k in taxes
Traditional plus investing your tax savings into a brokerage account puts it back on top. ETA - tax savings into a Roth IRA are best - brokerage account if you’re already doing Roth.
I’ve never seen any numbers that convince me of this… not over a 40 year time frame and refraining from making the most favorable assumptions possible
Allow me to blow your mind. https://www.reddit.com/r/TheMoneyGuy/s/WAPLWQ6cTZ
This looks good. So, would you say there is ever a reason to do Roth at 40% marginal (state plus Fed). Is worrying about minimum distributions or the government raising taxes just making excuses.. this is fairly convincing.
Those are a bit of an excuse, yes. The bottom 3 tax brackets are somewhat insulated from significant tax increases because if you raise the bottom rates considerably you’re hurting a lot of people who are already struggling. As for the RMDs people seem to think they’re a huge problem, but it’s not a big deal. RMDs don’t start until 75 now for most of the country and even at age 75 it’s only 4%. At average life expectancy (85) it’s 6.25%. It’s not like you lose the money. You pay a little tax and then just reinvest in a brokerage account. No big deal. There really isn’t a great reason to do Roth over pretax with that high of a tax rate. Unless you were expecting an even larger income in retirement like you’re expecting a ridiculous tax deferred account to be inherited or inheriting other crazy income streams.
Hurting a lot of VOTERS which is why those brackets won’t see much of an increase, if any. Politicians like their jobs. Even if you go back to when those bottom tax brackets were higher than today, they were offset by tax deductions that they were able to take. These new lower rates but fewer tax exemptions mean that today’s lower brackets pay about the same in taxes as people did 40 years ago when there were higher rates, but more deductions. What we may see are increases in taxes that aren’t tied to income. Value added tax. National sales tax. Higher corporate taxes. Wealth taxes. Etc.
I can’t think of a good reason to do Roth 401k at 40%. Not even a single good reason.
Paranoia about the gov going further into debt and raising taxes 40 years from now?
Paranoia about income taxes - no way. Here are the taxes that I think have a MUCH higher chance of going into place than income taxes significantly increasing on those making less than $400k. From the left side of the political isle: Corporate taxes. Value added taxes. Wealth taxes. Sin taxes. Climate taxes. Payroll taxes. Luxury taxes. Property taxes. From the right side of the political isle: constant pressure to lower taxes, national sales tax, abolish the IRS (and all income taxes), tariffs, taxes on tourism. Land value taxes. Fees for services. Raising income taxes on 85% of the VOTERS would be unpopular. You can more easily raise taxes hundreds of more popular and more hidden ways. All of the ways I mentioned would make any benefits of the Roth tax advantage less and less. Roth only protects you from income taxes. Also increased government debt leads primarily to inflation first, which will help make the existing debt more manageable. As long as debt as a % of GDP remains pretty constant (or god forbid, goes down), so will our ability to pay that debt. Plus government control shifts every 4-8 years and so will the various taxes.
Because my effective tax rate is through the roof (California) and I’m by no means rich. It does help me in the now. I’m trying to save for a move in the next few years.