Another Roth vs. Traditional question

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LookingForward
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Joined: Fri Jul 01, 2016 9:27 am

Another Roth vs. Traditional question

Post by LookingForward »

My spouse and I have most of our money in traditional 401K accounts, but some years ago my (now-former) financial advisor recommended putting some money into a Roth 401K account, as a form of tax diversity.

His argument 12-15 years ago was that taxes were as low back then as they were likely to ever be. That hasn’t proven to be the case, but let’s ignore that for now.

The usual discussion that I’ve read, and the argument that the wiki makes, is that if you take taxes out ahead of time, you have less to invest and therefore the result comes out the same, compared to taking taxes out of the amount that has grown through investments.

It occurred to me, however, that we’re not following that “plan” since we’re maxing out the Roth 401K.

So, the usual argument is that we would either put $24,500 (we’re over 50) into a traditional 401K, or ($24,500 * 0.75, assuming 25% tax) into a Roth 401K. Instead, we’re putting $24,500 into a Roth 401K.

Given that, it seems to me that the Roth 401K is the way to go if you’re maxing out the annual contribution, since the entire investment and earnings can be withdrawn tax-free.

I realize that we’re “missing out” on the “extra” money we’d otherwise have, but we so far have sufficient money for our lifestyle, so…

Is there an aspect to this argument that I’m missing?

Thanks as always to this excellent forum and the people who frequent it!
nolesrule
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Re: Another Roth vs. Traditional question

Post by nolesrule »

The decision should be based on your marginal tax rate now, versus the marginal tax rate you will pay on that money in retirement.

Not accounting for pensions or Social Security, MFJ would need the following in traditional assets (assuming a 4% withdrawal rate) to reach the various tax brackets:

Traditional assets needed to reach col. S marginal rate

Bracket AGI 25X Amount
10.0% $12,000 $300,000
12.0% $21,525 $538,125
22.0% $50,700 $1,267,500
24.0% $94,500 $2,362,500
32.0% $169,500 $4,237,500
35.0% $212,000 $5,300,000
37.0% $512,000 $12,800,000
02nz
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Re: Another Roth vs. Traditional question

Post by 02nz »

You are correct that in terms of maxing out tax-advantaged space, contributing the max in Roth is effectively more money than putting the same amount into traditional. But most Americans have a hard time contributing anywhere near the max, so this is not a consideration for most. Those that can afford to contribute the max are likely at the higher end of income, and those people are often better off deferring taxes.

The biggest consideration in Roth vs traditional comes down to 1) expectations about tax rates in retirement vs rates now; and 2) desire to optimize for a retirement in which income is high, or a retirement in which income is low. The first is obvious enough. The second consideration doesn't get enough air time: If you have less income in retirement than expected, deferring now (traditional) makes you better off and may well make the difference between not having enough money and having enough. If you have more income in retirement than expected, Roth makes you better off, but it's the difference between having more than enough, and even more. More money is always nice, but in that situation it doesn't make nearly as much of an impact.

As always this comes down to personal circumstances, but the right answer for the vast majority of people is not either/or but rather a combination of traditional and Roth, hence the advice about maxing out the employer match first, then Roth IRA, then go back to the 401k to contribute more. If you have say 40-50% or more of your retirement savings in Roth, and/or your current marginal tax rate (fed + state combined) is more than about 20%, I'd give serious consideration to deferring taxes via traditional contributions, at least for part of your contributions.
Last edited by 02nz on Sun Dec 09, 2018 11:40 am, edited 1 time in total.
bsteiner
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Location: NYC/NJ/FL

Re: Another Roth vs. Traditional question

Post by bsteiner »

LookingForward wrote: Sun Dec 09, 2018 11:20 am ...
The usual discussion that I’ve read, and the argument that the wiki makes, is that if you take taxes out ahead of time, you have less to invest and therefore the result comes out the same, compared to taking taxes out of the amount that has grown through investments.

It occurred to me, however, that we’re not following that “plan” since we’re maxing out the Roth 401K.

So, the usual argument is that we would either put $24,500 (we’re over 50) into a traditional 401K, or ($24,500 * 0.75, assuming 25% tax) into a Roth 401K. Instead, we’re putting $24,500 into a Roth 401K.

Given that, it seems to me that the Roth 401K is the way to go if you’re maxing out the annual contribution, since the entire investment and earnings can be withdrawn tax-free.
...
That's an important point. The usual discussion is for people who can't put in the maximum. In your case, if you put $24,500 into a Roth, it's like putting $32,667 into a traditional, which you can't do.

Of course, for someone who's in a high bracket now but expects to be in a substantially lower bracket later, which is the case for many people, more often than not it would make sense to contribute to a traditional and convert later. But that may not be your situation if you're in a 25% bracket now and expect to be in a 22% or higher bracket in retirement.
KlangFool
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Re: Another Roth vs. Traditional question

Post by KlangFool »

LookingForward wrote: Sun Dec 09, 2018 11:20 am
So, the usual argument is that we would either put $24,500 (we’re over 50) into a traditional 401K, or ($24,500 * 0.75, assuming 25% tax) into a Roth 401K. Instead, we’re putting $24,500 into a Roth 401K.
LookingForward,

You are wrong. The usual argument is between.

A) Putting $24,500 into Trad. 401K and 8K (25% tax savings) into Roth IRAs.

versus

B) Putting $24,500 into Roth IRA.

So, why do you think (B) is better than (A)?

If you like Roth, you can contribute to Roth IRAs up to 13K. Roth 401K is the wrong answer.

Trad. 401K with Roth IRAs is the best combination. Why do you think that Trad 401K with Roth IRAs will not work for you?

KlangFool
marcopolo
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Re: Another Roth vs. Traditional question

Post by marcopolo »

KlangFool wrote: Sun Dec 09, 2018 11:47 am
LookingForward wrote: Sun Dec 09, 2018 11:20 am
So, the usual argument is that we would either put $24,500 (we’re over 50) into a traditional 401K, or ($24,500 * 0.75, assuming 25% tax) into a Roth 401K. Instead, we’re putting $24,500 into a Roth 401K.
LookingForward,

You are wrong. The usual argument is between.

A) Putting $24,500 into Trad. 401K and 8K (25% tax savings) into Roth IRAs.

versus

B) Putting $24,500 into Roth IRA.

So, why do you think (B) is better than (A)?

If you like Roth, you can contribute to Roth IRAs up to 13K. Roth 401K is the wrong answer.

Trad. 401K with Roth IRAs is the best combination. Why do you think that Trad 401K with Roth IRAs will not work for you?

KlangFool

I think it depends on what whether you are limited by the tax-advantaged space available, or the dollars to invest available.

Your example assumes you are limited by the dollars available. If that is not the case, you could put $24.5k into Roth IRA (equivalent to $32k in Trad 401k) and still max out your Roth IRA as well. If your tax rate will be same or higher when withdrawing, this option would be better than either of the scenarios you outlined.
Once in a while you get shown the light, in the strangest of places if you look at it right.
KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Another Roth vs. Traditional question

Post by KlangFool »

marcopolo wrote: Sun Dec 09, 2018 11:54 am
KlangFool wrote: Sun Dec 09, 2018 11:47 am
LookingForward wrote: Sun Dec 09, 2018 11:20 am
So, the usual argument is that we would either put $24,500 (we’re over 50) into a traditional 401K, or ($24,500 * 0.75, assuming 25% tax) into a Roth 401K. Instead, we’re putting $24,500 into a Roth 401K.
LookingForward,

You are wrong. The usual argument is between.

A) Putting $24,500 into Trad. 401K and 8K (25% tax savings) into Roth IRAs.

versus

B) Putting $24,500 into Roth IRA.

So, why do you think (B) is better than (A)?

If you like Roth, you can contribute to Roth IRAs up to 13K. Roth 401K is the wrong answer.

Trad. 401K with Roth IRAs is the best combination. Why do you think that Trad 401K with Roth IRAs will not work for you?

KlangFool

I think it depends on what whether you are limited by the tax-advantaged space available, or the dollars to invest available.

Your example assumes you are limited by the dollars available. If that is not the case, you could put $24.5k into Roth IRA (equivalent to $32k in Trad 401k) and still max out your Roth IRA as well. If your tax rate will be same or higher when withdrawing, this option would be better than either of the scenarios you outlined.
marcopolo,

1) The maximum limit for Roth IRA is 13K.

<<If your tax rate will be same or higher when withdrawing,>>

2) This is false anyhow except for folks with a good pension. Doubly false for folks with Roth IRAs and Roth 401K. Those withdrawals are not taxable.

3) For folks not limited with money like me, Trad 401K with Roth IRAs plus the taxable account is the best combination.

KlangFool
BSBHead
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Re: Another Roth vs. Traditional question

Post by BSBHead »

I've long debated this and believe the right approach is a mix between Roth and Trad 401k is best bet as it is a non-bet. Reasons are:

(1) Tax rates: Who knows about where tax rates will be when we retire. My brain trap tells me they will be higher than expected due to entitlement costs and other budget deficit mechanisms.
(2) Caps: President Obama proposed a lifetime cap on retirement assets in 2015 that didn't pass. There is some political will there for a cap ($2.5 to $3 million was discussed at the time). To me, this favors having those assets in a Roth, but who knows how that would be implemented.
(3) Conversions: I've thought about this, but I also don't want to assume this will be available.
(4) Income: Again, who knows if I decide to continue to work for a long-time, get promoted to a better job, or get fired and need to use assets.

As such, I think a mix provides flexibility no matter the circumstances. I see benefits under both. While I'm biased for Roth due to point #1, I understand I need to protect my assets from my own behavioral biases.
stan1
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Re: Another Roth vs. Traditional question

Post by stan1 »

Even more fodder for thought:

Part or all of RMD can now be taken out as a qualified charitable distribution. If you will be donating to charity during retirement anyways you get the benefit of the current year tax deductions at your current tax rate and tax free dividend and appreciation that you would have in a Roth IRA. More valid in one's 70s when RMDs are lower than 90s when RMDs are much bigger, if one is still alive. Also depends on what your income streams in retirement will be.

Heirs will prefer an inherited Roth IRA over an inherited Traditional IRA. If you think you are going to leave a lot of your retirement account assets to your heirs do you want to pay their tax now or let them take care of it?

Taxable investing isn't bad. Qualified dividends, preferential capital gains tax rates, carryover realized losses offsetting ordinary income, and stepped up cost basis for heirs.

WIth all that I have decided to keep the sure thing of the current year tax deduction on a Traditional contribution even as our marginal federal rate has dropped from 28% to 22% and a stable 9.3% state rate.
BSBHead
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Joined: Sun Nov 11, 2018 12:45 pm

Re: Another Roth vs. Traditional question

Post by BSBHead »

And to clarify my points above, I think your age makes a difference in how to "tilt" Roth v. Traditional 401k. There is more certainty about the points I raise if you are closer to retirement. For those of us 20-30 years out, I think diversifying your tax strategy is not dissimilar to a passive investing strategy (or at least in the same spirit).
marcopolo
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Re: Another Roth vs. Traditional question

Post by marcopolo »

KlangFool wrote: Sun Dec 09, 2018 12:02 pm
marcopolo wrote: Sun Dec 09, 2018 11:54 am
KlangFool wrote: Sun Dec 09, 2018 11:47 am
LookingForward wrote: Sun Dec 09, 2018 11:20 am
So, the usual argument is that we would either put $24,500 (we’re over 50) into a traditional 401K, or ($24,500 * 0.75, assuming 25% tax) into a Roth 401K. Instead, we’re putting $24,500 into a Roth 401K.
LookingForward,

You are wrong. The usual argument is between.

A) Putting $24,500 into Trad. 401K and 8K (25% tax savings) into Roth IRAs.

versus

B) Putting $24,500 into Roth IRA.

So, why do you think (B) is better than (A)?

If you like Roth, you can contribute to Roth IRAs up to 13K. Roth 401K is the wrong answer.

Trad. 401K with Roth IRAs is the best combination. Why do you think that Trad 401K with Roth IRAs will not work for you?

KlangFool

I think it depends on what whether you are limited by the tax-advantaged space available, or the dollars to invest available.

Your example assumes you are limited by the dollars available. If that is not the case, you could put $24.5k into Roth IRA (equivalent to $32k in Trad 401k) and still max out your Roth IRA as well. If your tax rate will be same or higher when withdrawing, this option would be better than either of the scenarios you outlined.
marcopolo,

1) The maximum limit for Roth IRA is 13K.

<<If your tax rate will be same or higher when withdrawing,>>

2) This is false anyhow except for folks with a good pension. Doubly false for folks with Roth IRAs and Roth 401K. Those withdrawals are not taxable.

3) For folks not limited with money like me, Trad 401K with Roth IRAs plus the taxable account is the best combination.

KlangFool
Sorry, that was a typo. I meant Roth 401k.

You could put max into Roth401k and the max into Roth IRA.
That provides more effective tax-advantaged space than a Trad 401k + Roth IRA, and could make sense for some folks who will have high tax rates even in retirement.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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TomatoTomahto
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Re: Another Roth vs. Traditional question

Post by TomatoTomahto »

stan1 wrote: Sun Dec 09, 2018 12:27 pm Heirs will prefer an inherited Roth IRA over an inherited Traditional IRA. If you think you are going to leave a lot of your retirement account assets to your heirs do you want to pay their tax now or let them take care of it?

Taxable investing isn't bad. Qualified dividends, preferential capital gains tax rates, carryover realized losses offsetting ordinary income, and stepped up cost basis for heirs.

WIth all that I have decided to keep the sure thing of the current year tax deduction on a Traditional contribution even as our marginal federal rate has dropped from 28% to 22% and a stable 9.3% state rate.
That's an interesting point. What doesn't go into tax-deferred accounts goes into taxable, and presumably our heirs (and charity and government) will divvy up what's left. One of our heirs will likely be at the maximum tax bracket when we die; the others probably not.

My wife has been doing the max in traditional 401k, a backdoor Roth, and a significant amount into taxable. I wonder if we should consider switching the 401k to Roth 401k:
1. It increases the tax advantaged space by our tax rate
2. given her age, RMDs are less than a decade away
3. our marginal tax rate at her retirement is likely to be the max rate at the time
4. we don't expect much opportunity to convert to Roth between retirement and RMDs, since a good bit of her compensation is deferred
I get the FI part but not the RE part of FIRE.
KlangFool
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Re: Another Roth vs. Traditional question

Post by KlangFool »

marcopolo wrote: Sun Dec 09, 2018 1:11 pm Sorry, that was a typo. I meant Roth 401k.

You could put max into Roth401k and the max into Roth IRA.

That provides more effective tax-advantaged space than a Trad 401k + Roth IRA, and could make sense for some folks who will have high tax rates even in retirement.
marcopolo,

<<That provides more effective tax-advantaged space than a Trad 401k + Roth IRA, and could make sense for some folks who will have high tax rates even in retirement.>>

The bottom line is whether this approach ended up with fewer taxes and more money in retirement. I disputed that totally.

You are comparing

A) Trad 401K with Roth IRAs

versus

B) Trad 401K, Roth IRAs and the Taxable account.

Please noted that long-term capital gain tax is taxed lower than ordinary income.

I have this combination now. My portfolio is 45/45/10 (Tax-deferred/Taxable/Roth). I could tax managed my way to generate any taxable income.

KlangFool
marcopolo
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Re: Another Roth vs. Traditional question

Post by marcopolo »

KlangFool wrote: Sun Dec 09, 2018 2:53 pm
marcopolo wrote: Sun Dec 09, 2018 1:11 pm Sorry, that was a typo. I meant Roth 401k.

You could put max into Roth401k and the max into Roth IRA.

That provides more effective tax-advantaged space than a Trad 401k + Roth IRA, and could make sense for some folks who will have high tax rates even in retirement.
marcopolo,

<<That provides more effective tax-advantaged space than a Trad 401k + Roth IRA, and could make sense for some folks who will have high tax rates even in retirement.>>

The bottom line is whether this approach ended up with fewer taxes and more money in retirement. I disputed that totally.

You are comparing

A) Trad 401K with Roth IRAs

versus

B) Trad 401K, Roth IRAs and the Taxable account.

Please noted that long-term capital gain tax is taxed lower than ordinary income.

I have this combination now. My portfolio is 45/45/10 (Tax-deferred/Taxable/Roth). I could tax managed my way to generate any taxable income.

KlangFool

Lets try an actual example:
Assume 25% tax rate both during accumulation and during withdrawal.

Scenario 1:
$24k in Trad401k
$6k in Taxable (from the tax savings of using)
$13k in Roth IRA

Scenario 2:
$24k in Roth401k
$0 in taxable, since you did not have any tax savings from 401k.
$13k in Roth IRA


Both scenarios have the same amount in Roth IRA, so we can ignore.
At equal tax rate of 25%, the $24k in the Trad 401k is the same as having $18k in the Roth 401k.

So, difference in the two scenarios is whether you would rather have the extra $6k in a Roth 401k, or in a taxable account.

I would certainly prefer the extra money in the Roth (scenario 2). Why do you think scenario 1 is better?

If you would prefer scenario 1 for some reason, then why do contribute to the Roth IRA at all, why not keep that in taxable as well?
That is essentially the decision you are making by choosing scenario 1 over scenario 2, to give up Roth IRA space in favor of a taxable account.

All this assumes equal tax rate on both ends (or higher during withdrawal), so only applicable in those scenario. I cases where your tax rates will go down during withdrawal phase (most people?), the analysis is more complicated, and USUALLY favors scenario 1.
Once in a while you get shown the light, in the strangest of places if you look at it right.
KlangFool
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Re: Another Roth vs. Traditional question

Post by KlangFool »

marcopolo wrote: Sun Dec 09, 2018 5:06 pm
All this assumes equal tax rate on both ends (or higher during withdrawal), so only applicable in those scenario. I cases where your tax rates will go down during withdrawal phase (most people?), the analysis is more complicated, and USUALLY favors scenario 1.
marcopolo,

<<All this assumes equal tax rate on both ends (or higher during withdrawal), so only applicable in those scenario. >>

This assumption is wrong.

<<I cases where your tax rates will go down during withdrawal phase (most people?), the analysis is more complicated, and USUALLY favors scenario 1.>>

This is true except for folks with a great pension.

Just think about this for a moment.

Folks in scenario 1 essentially has the complete tax freedom to generate any amount of taxable income at retirement or early retirement with a combination of

A) Roth IRA -> tax-free

B) Taxable -> long-term capital gain tax/loss, short-term capital gain/loss

C) Roth conversion -> ordinary income.

Meanwhile, folks in scenario 2 had paid their taxes. They have no tax freedom. They cannot get money back from IRS.

Check out the calculation below.

viewtopic.php?t=87471
<<How to pay ZERO taxes in retirement with 6-figure expenses>>

This is a fundamental flaw in your thinking anyhow. We could switch to Roth 401K when our tax-deferred portfolio is big enough (500K for single, 1 million for married). We do not have stay at the same contribution system for the whole 10 to 20 years.

KlangFool
Last edited by KlangFool on Sun Dec 09, 2018 5:48 pm, edited 1 time in total.
JustinR
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Re: Another Roth vs. Traditional question

Post by JustinR »

Traditional is superior for 99% of people.

The only reason you should ever do a Roth is if you're not allowed to do traditional (high earners).

You can control your income during retirement. You can't control your income right now while you're working.

More control during retirement = more options. If you pay tax now (Roth), you forever forfeit those options.
JBTX
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Re: Another Roth vs. Traditional question

Post by JBTX »

LookingForward wrote: Sun Dec 09, 2018 11:20 am My spouse and I have most of our money in traditional 401K accounts, but some years ago my (now-former) financial advisor recommended putting some money into a Roth 401K account, as a form of tax diversity.

His argument 12-15 years ago was that taxes were as low back then as they were likely to ever be. That hasn’t proven to be the case, but let’s ignore that for now.

The usual discussion that I’ve read, and the argument that the wiki makes, is that if you take taxes out ahead of time, you have less to invest and therefore the result comes out the same, compared to taking taxes out of the amount that has grown through investments.

It occurred to me, however, that we’re not following that “plan” since we’re maxing out the Roth 401K.

So, the usual argument is that we would either put $24,500 (we’re over 50) into a traditional 401K, or ($24,500 * 0.75, assuming 25% tax) into a Roth 401K. Instead, we’re putting $24,500 into a Roth 401K.

Given that, it seems to me that the Roth 401K is the way to go if you’re maxing out the annual contribution, since the entire investment and earnings can be withdrawn tax-free.

I realize that we’re “missing out” on the “extra” money we’d otherwise have, but we so far have sufficient money for our lifestyle, so…

Is there an aspect to this argument that I’m missing?

Thanks as always to this excellent forum and the people who frequent it!
As you can tell from above posts, the opinions vary on this subject. People tend to extract their personal situation and apply it to others.

You are correct all else equal you can put more after tax dollars in a Roth than a traditional with the same limit. But whether it is superior is dependent upon a lot of factors, but primarily

1. Marginal rate now vs marginal rate in the future
2. How would (or would) the tax savings generated by the traditional 401k be invested.

As to #1, there are quite a few things affecting your future marginal rate:

- will tax rates stay the same or go up or down
- when will you retire, will you retire early?
- if you retire early can/will you do Roth conversions.
- will you have other income sources during retirement such as pension, real estate, etc
- how much capital gains you will have to recognize in retirement
- will you be eligible for ACA subsidies prior to drawing Medicare
- minor impacts on marginal rate due to Medicare.
- the amount and timing of yours and spouses social security
- your marginal tax rate will not be uniform in retirement
- traditional RMDs
- what state will you live in during retirement and will there be a state income tax.

As to #2, what do you with tax savings of traditional, depending on your situation

- the tax savings may go to additional traditional contributions (which is not the case you are talking about)
- the tax savings may go to funding a Roth IRA- this is only relevant if you otherwise could not fund the tax savings without the traditional 401k.
- the tax savings could go to a taxable account
- the tax savings could be spent


Until all those questions are answered nobody really knows the correct answer. FWIW I personally think there is value in having diversity in tax advantaged accounts. There are different ways to accomplish that diversity ( Roth ira contributions, Roth 401k, backdoor Roths, Mega backdoor Roths, Roth conversions now or in the future)


Then there are other factors such as estate planning and how much do you value the flexibility of Roth.


Not withstanding all that, my own personal tae is current tax rates over 30% (which includes state and local income taxes) are going to lean to traditional. 25-30 % lean traditional but some Roth may make sense. 20-25% mix of traditional and Roth, less than 20% emphasize Roth but still have a mix. But those are not hard and fast guidelines (which are only my own) and each situation can vary.
123
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Re: Another Roth vs. Traditional question

Post by 123 »

BSBHead wrote: Sun Dec 09, 2018 12:42 pm And to clarify my points above, I think your age makes a difference in how to "tilt" Roth v. Traditional 401k. There is more certainty about the points I raise if you are closer to retirement. For those of us 20-30 years out, I think diversifying your tax strategy is not dissimilar to a passive investing strategy (or at least in the same spirit).
+1 For someone under 40 who expects 20 or more years before retirement I think maximizing the Roth side of things is almost a no-brainer. With potential unlimited upside tax-free gain I can't see how it makes sense to bypass the Roth even if you are in the max tax bracket. The admission price to a Roth can be high but the (absence of a subsequent tax) show can't be beat.
The closest helping hand is at the end of your own arm.
marcopolo
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Re: Another Roth vs. Traditional question

Post by marcopolo »

KlangFool wrote: Sun Dec 09, 2018 5:20 pm
marcopolo wrote: Sun Dec 09, 2018 5:06 pm
All this assumes equal tax rate on both ends (or higher during withdrawal), so only applicable in those scenario. I cases where your tax rates will go down during withdrawal phase (most people?), the analysis is more complicated, and USUALLY favors scenario 1.
marcopolo,

<<All this assumes equal tax rate on both ends (or higher during withdrawal), so only applicable in those scenario. >>

This assumption is wrong.

<<I cases where your tax rates will go down during withdrawal phase (most people?), the analysis is more complicated, and USUALLY favors scenario 1.>>

This is true except for folks with a great pension.

Just think about this for a moment.

Folks in scenario 1 essentially has the complete tax freedom to generate any amount of taxable income at retirement or early retirement with a combination of

A) Roth IRA -> tax-free

B) Taxable -> long-term capital gain tax/loss, short-term capital gain/loss

C) Roth conversion -> ordinary income.

Meanwhile, folks in scenario 2 had paid their taxes. They have no tax freedom. They cannot get money back from IRS.

Check out the calculation below.

viewtopic.php?t=87471
<<How to pay ZERO taxes in retirement with 6-figure expenses>>

This is a fundamental flaw in your thinking anyhow. We could switch to Roth 401K when our tax-deferred portfolio is big enough (500K for single, 1 million for married). We do not have stay at the same contribution system for the whole 10 to 20 years.

KlangFool

I really do not understand what you mean by the assumption being wrong.

That is the specific case I was talking about. I agree for the vast majority of people, the trad401k makes more sense. No argument there.

What i pointed out in my original post, and tried to show you through an example, is that for a small minority of people, who will have just as high, or higher tax rates in the withdrawal stage, there are definitely scenarios where doing the Roth401k (to get more money into tax sheltered accounts) makes sense. As for your point about flexibility, those high income people will almost certainly also have plenty of taxable investments as well, so no flexibility is lost. Just more of their savings are tax sheltered.

These assumptions may not apply to you, but they are a valid scenario that people in those circumstances should consider.
Once in a while you get shown the light, in the strangest of places if you look at it right.
rkhusky
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Joined: Thu Aug 18, 2011 8:09 pm

Re: Another Roth vs. Traditional question

Post by rkhusky »

123 wrote: Sun Dec 09, 2018 6:35 pm
BSBHead wrote: Sun Dec 09, 2018 12:42 pm And to clarify my points above, I think your age makes a difference in how to "tilt" Roth v. Traditional 401k. There is more certainty about the points I raise if you are closer to retirement. For those of us 20-30 years out, I think diversifying your tax strategy is not dissimilar to a passive investing strategy (or at least in the same spirit).
+1 For someone under 40 who expects 20 or more years before retirement I think maximizing the Roth side of things is almost a no-brainer. With potential unlimited upside tax-free gain I can't see how it makes sense to bypass the Roth even if you are in the max tax bracket. The admission price to a Roth can be high but the (absence of a subsequent tax) show can't be beat.
The number of years until retirement is completely irrelevant to the Roth vs Traditional decision, as is the cumulative gain in the accounts.

If you are not maxing all tax-advantaged accounts, the math is:
Tax-deferred value = Cont*G*(1-ftax)
Roth value = Cont(1-ctax)*G

Here Cont is a contribution amount, G is the total gain (e.g. 3X or 10X), ftax is the future tax rate, ctax is the current tax rate.

You can see that tax-deferred is exactly the same as Roth, if the current and future tax rates are the same. The contribution amount and the gain G don't matter since they are the same in both cases. If the current tax rate is lower, then Roth is better. If the future tax rate is lower, then Traditional (tax-deferred) is better.


If you are maxing all tax-advantaged accounts and investing tax savings in a taxable account, the math is:
Tax-deferred value = Cont*G*(1-ftax) + Cont*ctax*G*(1-q) = Cont*G*(1-(ftax-ctax*(1-q)))
Roth value = Cont*G

q is a factor that takes into account the yearly taxing of dividends and cap gains in a taxable account, plus the taxing of cap gains that arise when you sell the taxable shares in retirement.

Tax deferred and Roth end up being exactly the same if the future tax rate is (1-q) times the current tax rate. Roth is better if the future tax rate is higher than (1-q)*ctax and Traditional is better if the future tax rate is lower than (1-q)*ctax.

If you are in the 22%+ tax bracket, where long term capital gains are taxed at 15%, q is about 15-20%. If you are in the 12% tax bracket, where long term capital gains are taxed at 0%, q could be as low as 8%.

You can see a worked out example in the second table of https://www.bogleheads.org/wiki/Non-ded ... tional_IRA, which shows that Roth and Traditional are exactly the same if the current and future tax rates are the same and one is not maxing all tax-advantaged accounts.

Note that if you retire early, you may have many years to do Roth conversions at a low tax rate before SS, pensions, or RMD's take effect. For example, I contributed to Traditional and saved 30% in taxes, which I contributed to Roth IRA and taxable accounts. Now I am using the taxable in retirement to fund living expenses, while doing Roth conversions at 12%. It would have been foolish to pay 30% to contribute to a Roth while working, when I can pay just 12% now, and end up with the same amount in a Roth account when I am all said and done.
KlangFool
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Re: Another Roth vs. Traditional question

Post by KlangFool »

marcopolo wrote: Sun Dec 09, 2018 6:55 pm
What i pointed out in my original post, and tried to show you through an example, is that for a small minority of people, who will have just as high, or higher tax rates in the withdrawal stage, there are definitely scenarios where doing the Roth401k (to get more money into tax sheltered accounts) makes sense. As for your point about flexibility, those high income people will almost certainly also have plenty of taxable investments as well, so no flexibility is lost. Just more of their savings are tax sheltered.

These assumptions may not apply to you, but they are a valid scenario that people in those circumstances should consider.
marcopolo,

There is only one valid exception. Folks with a very good pension that is vested at a certain age.

<< a small minority of people, who will have just as high, or higher tax rates in the withdrawal stage, there are definitely scenarios where doing the Roth401k (to get more money into tax sheltered accounts) makes sense. >>

For other groups of people, if they go with Trad. 401K, they could early retire. So, why would they face higher taxes in the withdrawal stage unless they want to? Roth 401K is a bad choice too.

Folks with the Trad 401K, Roth IRAs and the taxable account have more money invested versus Roth 401K folks. Hence, they could reach their number earlier. They have the choice of continuing work if they want to. Meanwhile, the Roth 401K folk do not have this choice with 8K less per year invested.

It is simple math.

KlangFool
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FiveK
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Re: Another Roth vs. Traditional question

Post by FiveK »

LookingForward wrote: Sun Dec 09, 2018 11:20 am The usual discussion that I’ve read, and the argument that the wiki makes, is that if you take taxes out ahead of time, you have less to invest and therefore the result comes out the same, compared to taking taxes out of the amount that has grown through investments.

It occurred to me, however, that we’re not following that “plan” since we’re maxing out the Roth 401K.
Have you had a chance to read the part of the wiki that discusses maxing out your retirement accounts?

There are two spreadsheets linked in that section. Either of those, and/or the analysis rkhusky showed a few posts ago, can be useful to understand your specific situation.

There are many exceptions to the "general rules" in this area....
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TomatoTomahto
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Re: Another Roth vs. Traditional question

Post by TomatoTomahto »

Folks with the Trad 401K, Roth IRAs and the taxable account have more money invested versus Roth 401K folks. Hence, they could reach their number earlier. They have the choice of continuing work if they want to. Meanwhile, the Roth 401K folk do not have this choice with 8K less per year invested.

It is simple math.

KlangFool
Math isn’t my long suit, and perhaps I’m being simplistic, but the “$8k less per year invested” comes with the benefit of the money not only having been already taxed (so it can be taken out tax free), but also not being subject to RMDs. One reason our tax brackets will be so high in retirement are the damned RMDs.

ETA; Reaching your number earlier will be an empty victory if it’s NOT your number when you take it out.
I get the FI part but not the RE part of FIRE.
pdavi21
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Re: Another Roth vs. Traditional question

Post by pdavi21 »

ROTH or Trad depends on marginal tax when you put it in and take it out. Higher bracket or qualify for low income credits, high state tax? Trad. Lower bracket, no special credits for low income, no state tax? ROTH.

Where to ROTH and where to Trad is the other issue. IRAs better for ROTH (no interest free loan to the IRS + no RMDs required). 401ks are better for Trad (directly reduces wages where Trad IRA only reduces AGI). This can lead to lower tax, higher credits, and increase eligibility for low income aid programs.

EDIT: ROTH is better overall because you are putting more money into the tax advantaged space. (Assuming constant tax rates).
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking
JustinR
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Re: Another Roth vs. Traditional question

Post by JustinR »

TomatoTomahto wrote: Sun Dec 09, 2018 9:06 pm
Folks with the Trad 401K, Roth IRAs and the taxable account have more money invested versus Roth 401K folks. Hence, they could reach their number earlier. They have the choice of continuing work if they want to. Meanwhile, the Roth 401K folk do not have this choice with 8K less per year invested.

It is simple math.

KlangFool
Math isn’t my long suit, and perhaps I’m being simplistic, but the “$8k less per year invested” comes with the benefit of the money not only having been already taxed (so it can be taken out tax free), but also not being subject to RMDs. One reason our tax brackets will be so high in retirement are the damned RMDs.

ETA; Reaching your number earlier will be an empty victory if it’s NOT your number when you take it out.
You can do conversions to a Roth later, tax free or at very low tax rates. This makes traditional 401Ks a triple tax savings. Roth can't come remotely close to that.

Traditional is superior for 99% of people. Doing a Roth (if you don't have to) during your working years is a mistake.
fennewaldaj
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Re: Another Roth vs. Traditional question

Post by fennewaldaj »

KlangFool wrote: Sun Dec 09, 2018 11:47 am

If you like Roth, you can contribute to Roth IRAs up to 13K. Roth 401K is the wrong answer.

KlangFool
Just curious does your opinion change for people that have 403bs and 457s. Two Roth IRA plus two 401ks gives you ~24% Roth. For a couple where one party has a 457 and a 403b and the other has a 401k it is 17.3 % Roth. For a single person or a couple who both have access to 403b plus 457 it is 13.6% Roth. Also worth noting that the couple with only 401ks will have more taxable savings and taxable savings is more like Roth than traditional. So the couple with only 401ks has much more Roth and Roth like space than the couple with 403bs and 457s.
fennewaldaj
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Re: Another Roth vs. Traditional question

Post by fennewaldaj »

JBTX wrote: Sun Dec 09, 2018 6:28 pm

- the tax savings could be spent
I think for a large part of the non boglehead population this is what is happening. Like a person decides to save say $300 a month. They will be fairly likely to save that dollar amount in either account. In that case the Roth is clearly better because they have tricked themselves into saving more money.
KlangFool
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Re: Another Roth vs. Traditional question

Post by KlangFool »

fennewaldaj wrote: Mon Dec 10, 2018 3:29 am
KlangFool wrote: Sun Dec 09, 2018 11:47 am

If you like Roth, you can contribute to Roth IRAs up to 13K. Roth 401K is the wrong answer.

KlangFool
Just curious does your opinion change for people that have 403bs and 457s. Two Roth IRA plus two 401ks gives you ~24% Roth. For a couple where one party has a 457 and a 403b and the other has a 401k it is 17.3 % Roth. For a single person or a couple who both have access to 403b plus 457 it is 13.6% Roth. Also worth noting that the couple with only 401ks will have more taxable savings and taxable savings is more like Roth than traditional. So the couple with only 401ks has much more Roth and Roth like space than the couple with 403bs and 457s.
fennewaldaj,

1) Percentage of the asset in Roth does not matter. Our goal/system is to defer tax until the marginal tax rate in the retirement is the same or higher than now. This is based on the calculation of the 4% withdrawal of the current tax-deferred portfolio value.

2) For most people, we recommend IRAs to be Roth IRAs because of the Roth contribution could be withdrawn at any time for any purposes without tax penalty. It could use as the emergency fund or college education funding too.

KlangFool
KlangFool
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Re: Another Roth vs. Traditional question

Post by KlangFool »

fennewaldaj wrote: Mon Dec 10, 2018 3:35 am
JBTX wrote: Sun Dec 09, 2018 6:28 pm

- the tax savings could be spent
I think for a large part of the non boglehead population this is what is happening. Like a person decides to save say $300 a month. They will be fairly likely to save that dollar amount in either account. In that case the Roth is clearly better because they have tricked themselves into saving more money.
fennewaldaj,

If someone chooses to spend their own money instead of paying more taxes legally, that is not a problem.

KlangFool
JBTX
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Re: Another Roth vs. Traditional question

Post by JBTX »

fennewaldaj wrote: Mon Dec 10, 2018 3:35 am
JBTX wrote: Sun Dec 09, 2018 6:28 pm

- the tax savings could be spent
I think for a large part of the non boglehead population this is what is happening. Like a person decides to save say $300 a month. They will be fairly likely to save that dollar amount in either account. In that case the Roth is clearly better because they have tricked themselves into saving more money.
Totally agree. One advantage of tax advantaged accounts is they are segregated and I suspect they are much less likely to be liquidated before retirement. They are viewed as "off limits" I suspect that has been true even in my case. Any of the following could happen:

- Money is just spent on day to day expenses, or large expenditures, cars, etc
- More money is spent on home purchase/down payment or home improvements
- More likely to pay off mortgage faster (this one could actually affect Bogleheads, given the numerous pay off mortgage threads in here)
- Taxable may be invested more conservatively compared to a retirement account
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