Traditional vs. Roth IRA clarification

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Triple digit golfer
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Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 10:26 am

Assume the following for simplicity:

$6,000 contribution
25% marginal federal+state tax bracket forever
10% investment return
2% dividend yield, 8% capital return
15% dividend and capital gains rate
Held for 1 year
Tax savings of $1,500 invested in same fund in taxable account.

In this case, the consensus is that there is no difference in traditional vs. Roth IRA, correct?

Ending after-tax value:

Traditional: $4,950 ($6,000 x 1.1 x 0.75)
+Taxable investment: $1,627.50 ($1,500 x 1.1 -$1,500 x 0.02 x 0.15 - $1,500 x 0.08 x 0.15)
=Total Traditional: $6,577.50

Roth: $6,600 ($6,000 x 1.1)

The difference between the two methods is $22.50, which is the capital gains and dividend taxes paid.

Why then, wouldn't Roth be preferred if one expects the same marginal tax rates in retirement?

MotoTrojan
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Re: Traditional vs. Roth IRA clarification

Post by MotoTrojan » Wed Mar 27, 2019 10:42 am

Triple digit golfer wrote:
Wed Mar 27, 2019 10:26 am
Assume the following for simplicity:

$6,000 contribution
25% marginal federal+state tax bracket forever
10% investment return
2% dividend yield, 8% capital return
15% dividend and capital gains rate
Held for 1 year
Tax savings of $1,500 invested in same fund in taxable account.

In this case, the consensus is that there is no difference in traditional vs. Roth IRA, correct?

Ending after-tax value:

Traditional: $4,950 ($6,000 x 1.1 x 0.75)
+Taxable investment: $1,627.50 ($1,500 x 1.1 -$1,500 x 0.02 x 0.15 - $1,500 x 0.08 x 0.15)
=Total Traditional: $6,577.50

Roth: $6,600 ($6,000 x 1.1)

The difference between the two methods is $22.50, which is the capital gains and dividend taxes paid.

Why then, wouldn't Roth be preferred if one expects the same marginal tax rates in retirement?
Because not every dollar in retirement is taxed at the marginal rate; you have to fill up those lower levels too. This can be done via direct withdrawals or if there’s additional space you can also do Roth conversions.

bryanm
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Re: Traditional vs. Roth IRA clarification

Post by bryanm » Wed Mar 27, 2019 10:54 am

Triple digit golfer wrote:
Wed Mar 27, 2019 10:26 am

In this case, the consensus is that there is no difference in traditional vs. Roth IRA, correct?
I don't understand your inclusion of the taxable amount. The consensus has never been that trad+taxable is equivalent to Roth. Rather, the consensus is that $n invested into trad is equivalent to $(n-taxes) invested into Roth, if taxes are the same going in as going out. So trad is (($6,000 x 1.1) x 0.75). Roth is (($6,000 x 0.75) x 1.1). Precisely the same. (Or, alternatively, if you assume that you can contribute $6k to the Roth, you actually have $7,500 pre-tax dollars. So trad is (($7,500 x 1.1) x 0.75) and Roth is (($7,500 x 0.75) x 1.1). Still exactly the same.)

If you're highlighting that the effective cap on Roth contributions is higher because after-tax dollars have a lower ordinal value for an equivalent worth, then yes, that's true. But as MotoTrojan pointed out, the ability to "fill up" low tax brackets in retirement with pre-tax dollars is significant.

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Triple digit golfer
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Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 11:02 am

bryanm wrote:
Wed Mar 27, 2019 10:54 am
Triple digit golfer wrote:
Wed Mar 27, 2019 10:26 am

In this case, the consensus is that there is no difference in traditional vs. Roth IRA, correct?
I don't understand your inclusion of the taxable amount. The consensus has never been that trad+taxable is equivalent to Roth. Rather, the consensus is that $n invested into trad is equivalent to $(n-taxes) invested into Roth, if taxes are the same going in as going out. So trad is (($6,000 x 1.1) x 0.75). Roth is (($6,000 x 0.75) x 1.1). Precisely the same. (Or, alternatively, if you assume that you can contribute $6k to the Roth, you actually have $7,500 pre-tax dollars. So trad is (($7,500 x 1.1) x 0.75) and Roth is (($7,500 x 0.75) x 1.1). Still exactly the same.)

If you're highlighting that the effective cap on Roth contributions is higher because after-tax dollars have a lower ordinal value for an equivalent worth, then yes, that's true. But as MotoTrojan pointed out, the ability to "fill up" low tax brackets in retirement with pre-tax dollars is significant.
I am assuming that I have $6,000 to invest. I can put $6,000 in the Roth or I can put $6,000 in traditional, deduct it and have another $1,500 to invest.

That $1,500 will be invested in a taxable account and thus subject to dividend taxes each year and capital gains taxes when withdrawn. Having the $1,500 in the Roth instead will not be subject to any of those taxes.

I was attempting to reconcile the difference in that $1,500. Am I incorrect in my analysis?

bryanm
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Re: Traditional vs. Roth IRA clarification

Post by bryanm » Wed Mar 27, 2019 11:07 am

Triple digit golfer wrote:
Wed Mar 27, 2019 11:02 am

I am assuming that I have $6,000 to invest. I can put $6,000 in the Roth or I can put $6,000 in traditional, deduct it and have another $1,500 to invest.

That $1,500 will be invested in a taxable account and thus subject to dividend taxes each year and capital gains taxes when withdrawn. Having the $1,500 in the Roth instead will not be subject to any of those taxes.

I was attempting to reconcile the difference in that $1,500. Am I incorrect in my analysis?
You're correct under those assumptions. However, I would argue that it's not a fair comparison of Roth vs. Trad. To make a fair comparison, the extra $1,500 from the deduction should go back into the traditional account.

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Triple digit golfer
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Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 11:10 am

bryanm wrote:
Wed Mar 27, 2019 11:07 am
Triple digit golfer wrote:
Wed Mar 27, 2019 11:02 am

I am assuming that I have $6,000 to invest. I can put $6,000 in the Roth or I can put $6,000 in traditional, deduct it and have another $1,500 to invest.

That $1,500 will be invested in a taxable account and thus subject to dividend taxes each year and capital gains taxes when withdrawn. Having the $1,500 in the Roth instead will not be subject to any of those taxes.

I was attempting to reconcile the difference in that $1,500. Am I incorrect in my analysis?
You're correct under those assumptions. However, I would argue that it's not a fair comparison of Roth vs. Trad. To make a fair comparison, the extra $1,500 from the deduction should go back into the traditional account.
Thanks. Why would you say back into traditional? The assumption is that the IRA is maxed out each year regardless.

ralph124cf
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Re: Traditional vs. Roth IRA clarification

Post by ralph124cf » Wed Mar 27, 2019 11:12 am

The primary value of ROTH is tax rate arbitrage.

Given static tax law, the lowest total tax paid results from a constant taxable income.

If, due to events on your personal horizon, you expect a higher total income at some future time in retirement, then a ROTH is an excellent choice. If you expect your income to be lower in retirement, then tIRA would be your choice.

A strategy recommended on this board in keeping with the constant income strategy is to convert pre-tax money to ROTH between actual retirement and commencing age 70 SS and RMDs.

A temporary job loss or disability, or a business loss may also give a window to convert pre-tax to ROTH at favorable tax rates.

Ralph

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Ben Mathew
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Re: Traditional vs. Roth IRA clarification

Post by Ben Mathew » Wed Mar 27, 2019 11:22 am

Triple digit golfer wrote:
Wed Mar 27, 2019 11:02 am
I am assuming that I have $6,000 to invest. I can put $6,000 in the Roth or I can put $6,000 in traditional, deduct it and have another $1,500 to invest.

That $1,500 will be invested in a taxable account and thus subject to dividend taxes each year and capital gains taxes when withdrawn. Having the $1,500 in the Roth instead will not be subject to any of those taxes.

I was attempting to reconcile the difference in that $1,500. Am I incorrect in my analysis?
You are correct that the tax drag on the taxable side account will make Roth better than traditional+taxable if marginal tax rates are the same. This tilts the scale towards Roth when you are in a position to max out the Roth and you expect marginal taxes will be the same in retirement. From the Traditional vs Roth wiki:
The IRS sets a maximum contribution to retirement accounts. If you have reached this maximum, anything else you contribute must be in a taxable account that will (if you pay more than 0% on annual earnings or capital gains) lose money to taxes not incurred in either a traditional or Roth account. The IRS limits do not distinguish between traditional and Roth accounts. If you have more pre-tax money to contribute to a traditional account than the IRS maximum, you will have to invest the extra (after paying tax on it) in a taxable account and suffer whatever tax losses that incurs. Therefore a Roth account may be preferable for equal marginal rates at contribution and withdrawal, or even somewhat lower marginal rates at withdrawal, because it lets you avoid taxes on more money.

bryanm
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Re: Traditional vs. Roth IRA clarification

Post by bryanm » Wed Mar 27, 2019 11:28 am

Triple digit golfer wrote:
Wed Mar 27, 2019 11:10 am
bryanm wrote:
Wed Mar 27, 2019 11:07 am
Triple digit golfer wrote:
Wed Mar 27, 2019 11:02 am

I am assuming that I have $6,000 to invest. I can put $6,000 in the Roth or I can put $6,000 in traditional, deduct it and have another $1,500 to invest.

That $1,500 will be invested in a taxable account and thus subject to dividend taxes each year and capital gains taxes when withdrawn. Having the $1,500 in the Roth instead will not be subject to any of those taxes.

I was attempting to reconcile the difference in that $1,500. Am I incorrect in my analysis?
You're correct under those assumptions. However, I would argue that it's not a fair comparison of Roth vs. Trad. To make a fair comparison, the extra $1,500 from the deduction should go back into the traditional account.
Thanks. Why would you say back into traditional? The assumption is that the IRA is maxed out each year regardless.
If we're assuming IRA limits, then it's true that a max contribution to a Roth would "overflow" a traditional account. So a maxed Roth is worth more than a maxed trad under your assumptions. I think the better way to think about that is that the effective cap on Roth contributions is higher than the effective cap on traditional contributions. (Under our example, if we put $6k into a Roth IRA, we would need to put $7500 into a traditional account, violating our $6k cap.) But that only matters when we assume max contributions, and assuming max contributions might violate some of our other assumptions. For example, it may be easy to max a $6k IRA, but it's less easy to max an IRA, 401(k), HSA, and whatever other tax-advantaged vehicles one could have access to.

If we assume someone has the ability to max-out all tax-advantaged space with Roth contributions, I suspect that this person also has high income today, and will likely either be in a lower bracket in retirement or have some ability to play with their bracket. Consider, for example, if someone maxed out Roth's their entire career, and retired early with no other income stream. Before taking SS, their income each year (purely from Roth withdrawals) is considered $0 for tax purposes. If they had some money in a traditional account, they could withdraw $50,700 and pay less than 12%. Instead, they probably paid at least 22% to put the money into the Roth during their working years.

The end result is that you should contribute to traditional accounts until your expected taxable earned income in retirement exceeds your current taxable earned income. Otherwise you leave money on the table. (In reality, you should compare expected marginal rates rather than earned income, since tax brackets might change.)

Pigeye Brewster
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Re: Traditional vs. Roth IRA clarification

Post by Pigeye Brewster » Wed Mar 27, 2019 11:33 am

Triple digit golfer wrote:
Wed Mar 27, 2019 11:02 am
bryanm wrote:
Wed Mar 27, 2019 10:54 am
Triple digit golfer wrote:
Wed Mar 27, 2019 10:26 am

In this case, the consensus is that there is no difference in traditional vs. Roth IRA, correct?
I don't understand your inclusion of the taxable amount. The consensus has never been that trad+taxable is equivalent to Roth. Rather, the consensus is that $n invested into trad is equivalent to $(n-taxes) invested into Roth, if taxes are the same going in as going out. So trad is (($6,000 x 1.1) x 0.75). Roth is (($6,000 x 0.75) x 1.1). Precisely the same. (Or, alternatively, if you assume that you can contribute $6k to the Roth, you actually have $7,500 pre-tax dollars. So trad is (($7,500 x 1.1) x 0.75) and Roth is (($7,500 x 0.75) x 1.1). Still exactly the same.)

If you're highlighting that the effective cap on Roth contributions is higher because after-tax dollars have a lower ordinal value for an equivalent worth, then yes, that's true. But as MotoTrojan pointed out, the ability to "fill up" low tax brackets in retirement with pre-tax dollars is significant.
I am assuming that I have $6,000 to invest. I can put $6,000 in the Roth or I can put $6,000 in traditional, deduct it and have another $1,500 to invest.

That $1,500 will be invested in a taxable account and thus subject to dividend taxes each year and capital gains taxes when withdrawn. Having the $1,500 in the Roth instead will not be subject to any of those taxes.

I was attempting to reconcile the difference in that $1,500. Am I incorrect in my analysis?
You're actually assuming you have $8,000 to invest.

Traditional: $8,000 with $6,000 tIRA contribution with the balance split between $1,500 taxable investment and $500 tax.
Roth: $8,000 with $6,000 rIRA contribution and $2,000 tax.

But your analysis is correct. When you compare contributing the maximum, Roth is marginally better due to the tax drag on the taxable account. And the difference increases the longer the time horizon and the higher the return on the investment.

Topic Author
Triple digit golfer
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Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 12:16 pm

Thank you all. The last four posts were exactly what I was looking for.

I read the wiki last night and missed the key part that Ben Mathew posted.

What bryanm said, "The end result is that you should contribute to traditional accounts until your expected taxable earned income in retirement exceeds your current taxable earned income" is the conclusion I came to as well, but I wanted to validate the taxable account difference just so I understand it all.

Ultimately, I expect to have nowhere near the income in retirement that I do now. Taxable income will be an even larger difference because much of what I draw in retirement will come from Roth or taxable accounts. Therefore, traditional, when deductible, seems to be the winner for me.

I am covered by a workplace plan but my wife (stay at home mom) is not. Therefore, we have been considering shifting her IRA contributions, which have historically been Roth like mine, to traditional and thus deductible.

Ralph124cf's post was also especially helpful.

DonIce
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Re: Traditional vs. Roth IRA clarification

Post by DonIce » Wed Mar 27, 2019 12:24 pm

ralph124cf wrote:
Wed Mar 27, 2019 11:12 am
The primary value of ROTH is tax rate arbitrage.

Given static tax law, the lowest total tax paid results from a constant taxable income.
I disagree. The primary value of ROTH is that you can contribute more of today's income to save for your retirement tax free. If you're in the 24% tax bracket, contributing $6000 to a ROTH is the same as contributing $7895 to a traditional IRA (which you can't do since the cap is $6000).

bryanm
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Re: Traditional vs. Roth IRA clarification

Post by bryanm » Wed Mar 27, 2019 2:15 pm

DonIce wrote:
Wed Mar 27, 2019 12:24 pm
ralph124cf wrote:
Wed Mar 27, 2019 11:12 am
The primary value of ROTH is tax rate arbitrage.

Given static tax law, the lowest total tax paid results from a constant taxable income.
I disagree. The primary value of ROTH is that you can contribute more of today's income to save for your retirement tax free. If you're in the 24% tax bracket, contributing $6000 to a ROTH is the same as contributing $7895 to a traditional IRA (which you can't do since the cap is $6000).
Different people may have different "primary values," and we shouldn't look at IRAs in particular (to the exclusion of other tax-advantaged space, like 401ks). Having higher effective contribution limits is great, but if you only invest post-tax dollars, you're probably leaving money on the table later by ignoring the tax rate arbitrage that's available to you. If you have a choice of paying 24% now (Roth), or 12% later (trad) plus capital gains on some taxable portion you can't fit in the traditional, mathematically you should choose the traditional.

Pigeye Brewster
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Re: Traditional vs. Roth IRA clarification

Post by Pigeye Brewster » Wed Mar 27, 2019 2:29 pm

Triple digit golfer wrote:
Wed Mar 27, 2019 12:16 pm

I am covered by a workplace plan but my wife (stay at home mom) is not. Therefore, we have been considering shifting her IRA contributions, which have historically been Roth like mine, to traditional and thus deductible.
Your situation is similar to mine. We shifted her contributions to traditional a few years ago once her Roth balance got high enough to reach my tax diversity target.

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Re: Traditional vs. Roth IRA clarification

Post by ThrustVectoring » Wed Mar 27, 2019 3:09 pm

The tax-deferred retirement account can be converted to Roth at any point in the future, paying your marginal tax rate for that year on the converted amount. This has some option value that can be worth quite a lot. For example, if you get ill and end up replacing your taxed income from your job with your untaxed income from private disability insurance, you can then convert your tax-deferred accounts to Roth up to the top of the 0% bracket, coming out ahead by a full 25%!
Current portfolio: 60% VTI / 40% VXUS

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Triple digit golfer
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Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 4:26 pm

ThrustVectoring wrote:
Wed Mar 27, 2019 3:09 pm
The tax-deferred retirement account can be converted to Roth at any point in the future, paying your marginal tax rate for that year on the converted amount. This has some option value that can be worth quite a lot. For example, if you get ill and end up replacing your taxed income from your job with your untaxed income from private disability insurance, you can then convert your tax-deferred accounts to Roth up to the top of the 0% bracket, coming out ahead by a full 25%!
Good point; that option is an excellent pro for Traditional.

After my own research, my opinion is that the Roth option is overrated in media. In most cases I believe the tax deferral is worth it because most people will have much lower income in retirement than when working. Why pay 25%+ combined federal and state now when later my rate may be zero? At the very least, traditional gives more options and flexibility and is likely better for most people. Just my opinion.

ThrustVectoring
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Re: Traditional vs. Roth IRA clarification

Post by ThrustVectoring » Wed Mar 27, 2019 4:35 pm

Triple digit golfer wrote:
Wed Mar 27, 2019 4:26 pm
ThrustVectoring wrote:
Wed Mar 27, 2019 3:09 pm
The tax-deferred retirement account can be converted to Roth at any point in the future, paying your marginal tax rate for that year on the converted amount. This has some option value that can be worth quite a lot. For example, if you get ill and end up replacing your taxed income from your job with your untaxed income from private disability insurance, you can then convert your tax-deferred accounts to Roth up to the top of the 0% bracket, coming out ahead by a full 25%!
Good point; that option is an excellent pro for Traditional.

After my own research, my opinion is that the Roth option is overrated in media. In most cases I believe the tax deferral is worth it because most people will have much lower income in retirement than when working. Why pay 25%+ combined federal and state now when later my rate may be zero? At the very least, traditional gives more options and flexibility and is likely better for most people. Just my opinion.
Yeah, I came to the same conclusion. Most people can expect to be in a lower tax bracket at some point the future, so they should be deferring taxes until then. The notable exceptions are people with very predictable career paths with large known salary jumps or pensions. Eg, medical residents and junior career military officers.

Practically speaking though, there's often situations where it's Roth or taxable, in which case you do Roth.
Current portfolio: 60% VTI / 40% VXUS

DonIce
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Re: Traditional vs. Roth IRA clarification

Post by DonIce » Wed Mar 27, 2019 4:40 pm

bryanm wrote:
Wed Mar 27, 2019 2:15 pm
Different people may have different "primary values," and we shouldn't look at IRAs in particular (to the exclusion of other tax-advantaged space, like 401ks). Having higher effective contribution limits is great, but if you only invest post-tax dollars, you're probably leaving money on the table later by ignoring the tax rate arbitrage that's available to you. If you have a choice of paying 24% now (Roth), or 12% later (trad) plus capital gains on some taxable portion you can't fit in the traditional, mathematically you should choose the traditional.
Paying 24% on your contribution now seems better than paying 12% later on the withdrawals, which if they are (for example) 30 years down the road should have grown by a factor of 5-10 (depending on what return rate you assume over that period). I'd rather pay 24% on $8,000 now than 12% on $40,000 later.

Or am I missing something here?

Topic Author
Triple digit golfer
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Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 4:50 pm

ThrustVectoring wrote:
Wed Mar 27, 2019 4:35 pm
Triple digit golfer wrote:
Wed Mar 27, 2019 4:26 pm
ThrustVectoring wrote:
Wed Mar 27, 2019 3:09 pm
The tax-deferred retirement account can be converted to Roth at any point in the future, paying your marginal tax rate for that year on the converted amount. This has some option value that can be worth quite a lot. For example, if you get ill and end up replacing your taxed income from your job with your untaxed income from private disability insurance, you can then convert your tax-deferred accounts to Roth up to the top of the 0% bracket, coming out ahead by a full 25%!
Good point; that option is an excellent pro for Traditional.

After my own research, my opinion is that the Roth option is overrated in media. In most cases I believe the tax deferral is worth it because most people will have much lower income in retirement than when working. Why pay 25%+ combined federal and state now when later my rate may be zero? At the very least, traditional gives more options and flexibility and is likely better for most people. Just my opinion.
Yeah, I came to the same conclusion. Most people can expect to be in a lower tax bracket at some point the future, so they should be deferring taxes until then. The notable exceptions are people with very predictable career paths with large known salary jumps or pensions. Eg, medical residents and junior career military officers.

Practically speaking though, there's often situations where it's Roth or taxable, in which case you do Roth.
Definitely. I use a Roth since I have a 401k at work.

I saw an article where the author even preferred taxable to Roth because he advocated early retirement in a low tax bracket.

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Triple digit golfer
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Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 4:57 pm

DonIce wrote:
Wed Mar 27, 2019 4:40 pm
bryanm wrote:
Wed Mar 27, 2019 2:15 pm
Different people may have different "primary values," and we shouldn't look at IRAs in particular (to the exclusion of other tax-advantaged space, like 401ks). Having higher effective contribution limits is great, but if you only invest post-tax dollars, you're probably leaving money on the table later by ignoring the tax rate arbitrage that's available to you. If you have a choice of paying 24% now (Roth), or 12% later (trad) plus capital gains on some taxable portion you can't fit in the traditional, mathematically you should choose the traditional.
Paying 24% on your contribution now seems better than paying 12% later on the withdrawals, which if they are (for example) 30 years down the road should have grown by a factor of 5-10 (depending on what return rate you assume over that period). I'd rather pay 24% on $8,000 now than 12% on $40,000 later.

Or am I missing something here?
You are missing that the traditional leaves money in your pocket now that can also be invested and attain the same returns

bryanm
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Re: Traditional vs. Roth IRA clarification

Post by bryanm » Wed Mar 27, 2019 5:03 pm

DonIce wrote:
Wed Mar 27, 2019 4:40 pm
bryanm wrote:
Wed Mar 27, 2019 2:15 pm
Different people may have different "primary values," and we shouldn't look at IRAs in particular (to the exclusion of other tax-advantaged space, like 401ks). Having higher effective contribution limits is great, but if you only invest post-tax dollars, you're probably leaving money on the table later by ignoring the tax rate arbitrage that's available to you. If you have a choice of paying 24% now (Roth), or 12% later (trad) plus capital gains on some taxable portion you can't fit in the traditional, mathematically you should choose the traditional.
Paying 24% on your contribution now seems better than paying 12% later on the withdrawals, which if they are (for example) 30 years down the road should have grown by a factor of 5-10 (depending on what return rate you assume over that period). I'd rather pay 24% on $8,000 now than 12% on $40,000 later.

Or am I missing something here?
It's counter-intuitive, but if you run some numbers you'll see that the lower rate always wins.

Assume 10x growth, and a starting investment of $100 (for simplicity). In Roth, you pay 24% up front, meaning you invest $76. After 10x, you have $760. No tax, so that's your take. In traditional, you invest $100. After 10x, you have $1000. Now you pay 12%, and you have $880. You paid more in taxes with traditional—$120 instead of $24—but traditional wins as far as putting more money in your pocket. (Note that if tax rates are the same, the outcome is the same. That's why it's purely about playing with the percentages.)

The missing "thing" is that the traditional gives you more money to invest up front, so even though you pay absolute dollars in taxes at the back-end, the excess cash at the front-end means your money grows enough to cover the increase in absolute taxes paid.
Last edited by bryanm on Wed Mar 27, 2019 5:14 pm, edited 1 time in total.

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Triple digit golfer
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Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 5:13 pm

bryanm wrote:
Wed Mar 27, 2019 5:03 pm
DonIce wrote:
Wed Mar 27, 2019 4:40 pm
bryanm wrote:
Wed Mar 27, 2019 2:15 pm
Different people may have different "primary values," and we shouldn't look at IRAs in particular (to the exclusion of other tax-advantaged space, like 401ks). Having higher effective contribution limits is great, but if you only invest post-tax dollars, you're probably leaving money on the table later by ignoring the tax rate arbitrage that's available to you. If you have a choice of paying 24% now (Roth), or 12% later (trad) plus capital gains on some taxable portion you can't fit in the traditional, mathematically you should choose the traditional.
Paying 24% on your contribution now seems better than paying 12% later on the withdrawals, which if they are (for example) 30 years down the road should have grown by a factor of 5-10 (depending on what return rate you assume over that period). I'd rather pay 24% on $8,000 now than 12% on $40,000 later.

Or am I missing something here?
It's counter-intuitive, but if you run some numbers you'll see that the lower rate always wins.

Assume 10x growth, and a starting investment of $100 (for simplicity). In Roth, you pay 24% up front, meaning you invest $76. After 10x, you have $760. No tax, so that's your take. In traditional, you invest $100. After 10x, you have $1000. Now you pay 12%, and you have $880. You paid more in taxes with traditional—$120 instead of $24, but traditional wins as far as putting more money in your pocket. (Note that if tax rates are the same, the outcome is the same. That's why it's purely about playing with the percentages.)

The missing "thing" is that the traditional gives you more money to invest up front, so even though you pay absolute dollars in taxes at the back-end, the excess cash at the front-end means your money grows enough to cover the increase in absolute taxes paid.
Much better than my explanation.

JustinR
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Re: Traditional vs. Roth IRA clarification

Post by JustinR » Wed Mar 27, 2019 5:17 pm

Always do traditional unless you're absolutely forced to do a Roth.

DonIce
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Re: Traditional vs. Roth IRA clarification

Post by DonIce » Wed Mar 27, 2019 5:31 pm

Triple digit golfer wrote:
Wed Mar 27, 2019 4:57 pm
You are missing that the traditional leaves money in your pocket now that can also be invested and attain the same returns
Ok let me run some numbers assuming 25% tax bracket for rounder numbers. You have $8000 pre-tax money to invest.

Option 1: Put $6000 in the Roth, the other $2000 is paid in current taxes.
  • -In 30 years, this amount has grown to $30,000. You withdraw it tax free as needed.
    -Total lifetime taxes paid = $2,000.
    -Total after tax money available = $30,000
Option 2: You put $6000 in a traditional. You receive a tax deduction of $1500 and pay only $500 in taxes.
  • -In 30 years, $6000 in the tIRA has grown to $30,000. You withdraw it in the 12% tax bracket. Taxes on this = $3600
    -You put the $1500 you saved on your taxes into a taxable account. After 30 years, it is worth $7500. The difference is taxed at the long term cap gains rate of 15%. Your taxes are (7500-1500)*0.15 = 900.
    -Total lifetime taxes paid = 500+3600+900 = $5,000
    -Total after tax money available = 30000+7500-3600-900 = $33,000
Option 3. Redo the above assuming withdrawal tax bracket is the same as contribution tax bracket.
  • -In 30 years, $6000 in the tIRA has grown to $30,000. You withdraw it in the 25% tax bracket. Taxes on this = $7500
    -You put the $1500 you saved on your taxes into a taxable account. After 30 years, it is worth $7500. The difference is taxed at the long term cap gains rate of 15%. Your taxes are (7500-1500)*0.15 = 900.
    -Total lifetime taxes paid = 500+7500+900 = $8,900
    -Total after tax money available = $29,100
Option 4: Just for comparison, assume you put it all ($6000) in taxable (and pay $2000 in current taxes).
  • -In 30 years, this amount has grown to $30,000. The difference is taxed at the long term capital gains tax rate of 15%. Your taxes are (30000-6000)*0.15 = $3600
    -Total lifetime taxes paid = 2000 + 3600 = $5,600.
    -Total after tax money available = $26,400
Hmm, interesting.
Last edited by DonIce on Wed Mar 27, 2019 5:39 pm, edited 1 time in total.

bryanm
Posts: 226
Joined: Mon Aug 13, 2018 3:48 pm

Re: Traditional vs. Roth IRA clarification

Post by bryanm » Wed Mar 27, 2019 5:39 pm

DonIce wrote:
Wed Mar 27, 2019 5:31 pm
Triple digit golfer wrote:
Wed Mar 27, 2019 4:57 pm
You are missing that the traditional leaves money in your pocket now that can also be invested and attain the same returns
Ok let me run some numbers assuming 25% tax bracket for rounder numbers. You have $8000 pre-tax money to invest.
You ninja-edited my comment into oblivion :). I believe I agree with the updated numbers.

DonIce
Posts: 740
Joined: Thu Feb 21, 2019 6:44 pm

Re: Traditional vs. Roth IRA clarification

Post by DonIce » Wed Mar 27, 2019 5:40 pm

bryanm wrote:
Wed Mar 27, 2019 5:39 pm
You ninja-edited my comment into oblivion :). I believe I agree with the updated numbers.
Yeah I caught some errors after I posted as I was re-reading my post and fixed them :)

ThrustVectoring
Posts: 771
Joined: Wed Jul 12, 2017 2:51 pm

Re: Traditional vs. Roth IRA clarification

Post by ThrustVectoring » Wed Mar 27, 2019 6:16 pm

Triple digit golfer wrote:
Wed Mar 27, 2019 4:50 pm
ThrustVectoring wrote:
Wed Mar 27, 2019 4:35 pm
Yeah, I came to the same conclusion. Most people can expect to be in a lower tax bracket at some point the future, so they should be deferring taxes until then. The notable exceptions are people with very predictable career paths with large known salary jumps or pensions. Eg, medical residents and junior career military officers.

Practically speaking though, there's often situations where it's Roth or taxable, in which case you do Roth.
Definitely. I use a Roth since I have a 401k at work.

I saw an article where the author even preferred taxable to Roth because he advocated early retirement in a low tax bracket.
If you can avoid the early withdrawal penalty for Roth, Roth is strictly better than taxable. And early access without a penalty is definitely doable.
Current portfolio: 60% VTI / 40% VXUS

Topic Author
Triple digit golfer
Posts: 3913
Joined: Mon May 18, 2009 5:57 pm

Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 6:23 pm

ThrustVectoring wrote:
Wed Mar 27, 2019 6:16 pm
Triple digit golfer wrote:
Wed Mar 27, 2019 4:50 pm
ThrustVectoring wrote:
Wed Mar 27, 2019 4:35 pm
Yeah, I came to the same conclusion. Most people can expect to be in a lower tax bracket at some point the future, so they should be deferring taxes until then. The notable exceptions are people with very predictable career paths with large known salary jumps or pensions. Eg, medical residents and junior career military officers.

Practically speaking though, there's often situations where it's Roth or taxable, in which case you do Roth.
Definitely. I use a Roth since I have a 401k at work.

I saw an article where the author even preferred taxable to Roth because he advocated early retirement in a low tax bracket.
If you can avoid the early withdrawal penalty for Roth, Roth is strictly better than taxable. And early access without a penalty is definitely doable.
On contributions only, though, right?

ThrustVectoring
Posts: 771
Joined: Wed Jul 12, 2017 2:51 pm

Re: Traditional vs. Roth IRA clarification

Post by ThrustVectoring » Wed Mar 27, 2019 6:26 pm

Triple digit golfer wrote:
Wed Mar 27, 2019 6:23 pm
ThrustVectoring wrote:
Wed Mar 27, 2019 6:16 pm
Triple digit golfer wrote:
Wed Mar 27, 2019 4:50 pm
ThrustVectoring wrote:
Wed Mar 27, 2019 4:35 pm
Yeah, I came to the same conclusion. Most people can expect to be in a lower tax bracket at some point the future, so they should be deferring taxes until then. The notable exceptions are people with very predictable career paths with large known salary jumps or pensions. Eg, medical residents and junior career military officers.

Practically speaking though, there's often situations where it's Roth or taxable, in which case you do Roth.
Definitely. I use a Roth since I have a 401k at work.

I saw an article where the author even preferred taxable to Roth because he advocated early retirement in a low tax bracket.
If you can avoid the early withdrawal penalty for Roth, Roth is strictly better than taxable. And early access without a penalty is definitely doable.
On contributions only, though, right?
Well that's what you do at first, along with conversions from your tax-deferred accounts that are over 5 years of age. Once you've run out of that you have to switch over to 72(t) periodic distributions (which are a pain to comply with properly, but do let you avoid early withdrawal penalties).

There's other exemptions for Roth withdrawals prior to age 59.5 as well, like I think first time homebuyer or educational purposes? Not up to date on these, but they can help out as well.
Current portfolio: 60% VTI / 40% VXUS

Topic Author
Triple digit golfer
Posts: 3913
Joined: Mon May 18, 2009 5:57 pm

Re: Traditional vs. Roth IRA clarification

Post by Triple digit golfer » Wed Mar 27, 2019 6:43 pm

ThrustVectoring wrote:
Wed Mar 27, 2019 6:26 pm
Triple digit golfer wrote:
Wed Mar 27, 2019 6:23 pm
ThrustVectoring wrote:
Wed Mar 27, 2019 6:16 pm
Triple digit golfer wrote:
Wed Mar 27, 2019 4:50 pm
ThrustVectoring wrote:
Wed Mar 27, 2019 4:35 pm
Yeah, I came to the same conclusion. Most people can expect to be in a lower tax bracket at some point the future, so they should be deferring taxes until then. The notable exceptions are people with very predictable career paths with large known salary jumps or pensions. Eg, medical residents and junior career military officers.

Practically speaking though, there's often situations where it's Roth or taxable, in which case you do Roth.
Definitely. I use a Roth since I have a 401k at work.

I saw an article where the author even preferred taxable to Roth because he advocated early retirement in a low tax bracket.
If you can avoid the early withdrawal penalty for Roth, Roth is strictly better than taxable. And early access without a penalty is definitely doable.
On contributions only, though, right?
Well that's what you do at first, along with conversions from your tax-deferred accounts that are over 5 years of age. Once you've run out of that you have to switch over to 72(t) periodic distributions (which are a pain to comply with properly, but do let you avoid early withdrawal penalties).

There's other exemptions for Roth withdrawals prior to age 59.5 as well, like I think first time homebuyer or educational purposes? Not up to date on these, but they can help out as well.
Thanks. I'm at least a couple decades away from having to be concerned! I know enough to be dangerous and that's probably enough at this point. For now, it's save save save tax efficiently and the rest will fall into place.

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