Wouldn't this make Traditional IRA far superior to Roth?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
jeffyscott
Posts: 8128
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by jeffyscott » Sun May 05, 2019 11:33 am

folkher0 wrote:
Sun May 05, 2019 10:58 am
Still, all other things equal (as they apparently are) I would choose to defer taxes whenever possible.
That does not make a lot of sense to me, if the deferral will (very likely) mean paying more tax in the end. Were I to forgo Roth conversions at a 12% Federal rate now, it is extremely unlikely that any of that money will be subject to a rate less than that and highly likely that a lot of it will be subject to a 22% Federal rate.

For people who are still contributing, I'd probably suggest Roth if the money going to the Roth would otherwise be in the 12% bracket or below. Possible exceptions to that could be deductible making more sense due to saver's tax credit and/or health insurance subsidies for some people.

At 22% or above, I would suggest just going with deductible. And if your income is so high that you lose out as a result, too bad, I don't really care :P .
Time is your friend; impulse is your enemy. - John C. Bogle

folkher0
Posts: 100
Joined: Fri Dec 09, 2016 2:48 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by folkher0 » Sun May 05, 2019 11:44 am

Sure, if you’re sure to have the lower bracket now, by all means Roth away. But In these examples we’re generally talking about assuming the same bracket in accumulation and retirement.

User avatar
jeffyscott
Posts: 8128
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by jeffyscott » Sun May 05, 2019 11:50 am

folkher0 wrote:
Sun May 05, 2019 11:44 am
Sure, if you’re sure to have the lower bracket now, by all means Roth away. But In these examples we’re generally talking about assuming the same bracket in accumulation and retirement.
I see, so you are just disagreeing with the idea that a tie goes to the Roth :) .
Time is your friend; impulse is your enemy. - John C. Bogle

michaeljc70
Posts: 5424
Joined: Thu Oct 15, 2015 3:53 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by michaeljc70 » Mon May 06, 2019 10:05 am

Someone above mentioned it, but if the tIRA is going to be left to heirs, they would be paying the taxes on it while in a Roth you've already paid the taxes. That can be a pro or con depending on how you look at it and the heirs tax brackets.

I've mostly taken the bird in the hand approach and contributed to a tIRA for the tax break upfront. If you are a big saver it stands to reason that in retirement your income will be lower than in your working years if you work only as long as needed. If you retire early (pre SS FRA), you can always do conversions to Roths.

rj342
Posts: 483
Joined: Tue Apr 30, 2019 12:21 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by rj342 » Mon May 06, 2019 10:28 am

I have to emphasize what others have said about traditional IRA contribs not always being tax deductible.
If you have access to an employer 401k or equivalent they are NOT. If your *spouse* (and file jointly?) has access they her employer they are NOT.
Even a traditional pension may disqualify the tax deductibility.

I found this out the hard way (fortunately only a little $$ involved) -- I lost a job and started another. I created a Schwab tradtional IRA and rolled over from a couple prior employers 401k plans to consolidate. There was also a very small after tax amount in a rollover Roth.
I had one year before eligible for 401k participation at new employer, so I put some in the trad IRA. Oops! come tax time -- wifes access to pension menat not tax deductible.

In these cases go with the Roth.

User avatar
jeffyscott
Posts: 8128
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by jeffyscott » Mon May 06, 2019 10:47 am

rj342 wrote:
Mon May 06, 2019 10:28 am
If you have access to an employer 401k or equivalent they are NOT. If your *spouse* (and file jointly?) has access they her employer they are NOT.
Even a traditional pension may disqualify the tax deductibility.
If your income is below the income limit applicable to your situation, you are still eligible to deduct traditional IRA contributions even if covered by 401K or traditional pension.
Time is your friend; impulse is your enemy. - John C. Bogle

Mike Scott
Posts: 1342
Joined: Fri Jul 19, 2013 2:45 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by Mike Scott » Mon May 06, 2019 10:49 am

We split up tax deferred, roth and taxable savings/investments in consideration of the current year federal and state taxes, itemizing, potential for liquidity and whether we are within reach of any particular tax credit threshold. After completing the previous year taxes, it takes a few minutes to estimate the new year forward; a couple of hours checking all of it in August when I know better what the remainder of the year will look like and then doing the end of the year taxes is easy. The payback is more than worth the time spent doing it and I like "the game" as well as understanding the moving pieces that apply to us. I don't expect to ever pay any taxes on our tax deferred accounts but will have to wait and see.

User avatar
dodecahedron
Posts: 4523
Joined: Tue Nov 12, 2013 12:28 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by dodecahedron » Mon May 06, 2019 11:29 am

folkher0 wrote:
Sun May 05, 2019 10:58 am
mbasherp wrote:
Sat May 04, 2019 10:25 am
I’m trying to wrap my head around this because I really enjoy getting ahold of the sneaky inflation beast. But I don’t think the conclusion is correct. You’re already accounting for inflation when you say the investment doubles. Investment return involves inflation + real appreciation. You wouldn’t apply it again. By definition, you have the exact same amount of 2049 dollars in your example ($8000). Uncle Sam’s take either grows by inflation after you pay it ($1k, Roth) or before you pay it ($2k, traditional). But the ending is identical in real or nominal dollars because inflation is included in returns.
You know what? I think you’re right. It would be a wash as far as inflation goes.
Actually to the extent that there are some aspects of the tax code NOT indexed for inflation it is not a wash, it is even worse than a wash. (Examples of things that are not indexed for inflation: the $3K capital loss annual limitation, the parameters in the formula for the taxability of SS.)
folkher0 wrote:
Sun May 05, 2019 10:58 am
Still, all other things equal (as they apparently are) I would choose to defer taxes whenever possible.
Reasonable people can differ about this preference. Personally I like the idea of tax diversification and opportunistic Roth conversions when taxes are temporarily ¨on sale.¨

A big part of my head keeps saying ¨The current federal tax rate schedule is a bargain by historical standards and is automatically--by law--slated to increase back to higher levels just around the time I hit RMD age.¨

But the precisely optimal balance is tricky, because I do plan to take advantage of Qualified Charitable Donations (QCDs) when I reach that age and it is also possible that I may have large deductible medical expenses for LTC at some point down the road. On the other hand, there are IRMAA limits and senior citizen property tax income limits to consider.

A further wrinkle for me is that my state gives a tax exclusion to the first $20K of tax deferred retirement income, including traditional IRA distributions, each year. So my rough heuristic rule of thumb for Roth conversions going forward is to at least take advantage of that state annual exclusion.

User avatar
dodecahedron
Posts: 4523
Joined: Tue Nov 12, 2013 12:28 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by dodecahedron » Mon May 06, 2019 11:34 am

Mike Scott wrote:
Mon May 06, 2019 10:49 am
We split up tax deferred, roth and taxable savings/investments in consideration of the current year federal and state taxes, itemizing, potential for liquidity and whether we are within reach of any particular tax credit threshold. After completing the previous year taxes, it takes a few minutes to estimate the new year forward; a couple of hours checking all of it in August when I know better what the remainder of the year will look like and then doing the end of the year taxes is easy. The payback is more than worth the time spent doing it and I like "the game" as well as understanding the moving pieces that apply to us. I don't expect to ever pay any taxes on our tax deferred accounts but will have to wait and see.
Yes, I did that split this past year. Contributed to a Roth 403b, also contributed roughly 50-50 to a Roth IRA and traditional IRA due to tax credit phaseout and cliff thresholds.

User avatar
dodecahedron
Posts: 4523
Joined: Tue Nov 12, 2013 12:28 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by dodecahedron » Mon May 06, 2019 11:42 am

folkher0 wrote:
Sun May 05, 2019 11:44 am
Sure, if you’re sure to have the lower bracket now, by all means Roth away. But In these examples we’re generally talking about assuming the same bracket in accumulation and retirement.
I think that assumption is just a simple baseline starting point for the analysis.

And it may be a reasonable one in a state of total uncertainty about the future. Nothing is ¨sure¨ but many folks have good reasons for making a different assumption about the future.

I already mentioned that under current tax law, rates are scheduled to increase in a few years. The 22% bracket you are facing now is a relative bargain by historical standards on that level of real income.

For other examples, married folks could be on solid ground to assume that one member is eventually likely to outlive the other and the survivor will face the higher rate schedule for singles, or some people may be in a temporary low earning year (e.g., due to a family member taking time off for education or parental leave) or some folks know that they are going to have a significant DB pension in retirement.

Finally, if you are constrained for tax advantaged space, then a Roth allows you to buy a little more than the traditional does.

randomguy
Posts: 8117
Joined: Wed Sep 17, 2014 9:00 am

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by randomguy » Mon May 06, 2019 12:36 pm

jeffyscott wrote:
Sun May 05, 2019 11:50 am
folkher0 wrote:
Sun May 05, 2019 11:44 am
Sure, if you’re sure to have the lower bracket now, by all means Roth away. But In these examples we’re generally talking about assuming the same bracket in accumulation and retirement.
I see, so you are just disagreeing with the idea that a tie goes to the Roth :) .
Tie goes to the ROTH is fine but in reality you are looking at a bunch of probabilistic out comes. Imagine it is something like
25% traditional wins
50% tie
25% ROTH wins.

What do you do? You could argue that traditional is the way to go since those are likely to be the worst cases (i.e. you didn't save enough to stay in the same tax bracket) and it is better to make the worst cases better than making the best cases better.

And people will talk about how low are taxes are now so that makes a ROTH a deal.People have been saying that for 20 years now. Eventually they will be right:) Of course if that tax increase comes in the form of a 22% VAT, all the people that bet on ROTH will have lost.

In the end this is one of those choices that is really unlikely to make much of a difference in your financial situation. There are some cases where the choice is really clear but for most of us it is pretty much a wash. You make your guess and hope things work out.

aristotelian
Posts: 6043
Joined: Wed Jan 11, 2017 8:05 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by aristotelian » Mon May 06, 2019 12:40 pm

CurledMoss wrote:
Fri May 03, 2019 7:22 am
I have been putting my money into a Roth account for the last 3 years but this is really bothering me. If you have $5,500 to invest post-tax every year, would it make more sense to invest in a traditional ($5,500 pre-tax). Then if you are in a 22% tax bracket that would save $1,210 on taxes. So you really only have $4,290 tied up. Then take the tax savings of $1,210 and invest that into a taxable account. Over 30 years that would give you like an additional $123,508 of savings. Thoughts? I'd had to be leaving that much money on the table, assuming I'm in the same tax bracket present and future.

I would say yes, traditional wins for most people. However, there is something to be said for diversification in case taxes are higher than you think in retirement. The law could change, you could get a surprise inheritance, or maybe you will work longer than you think (whether by choice or something else). Traditional 401k + Roth IRA is generally a powerful combination.

Also, your math is ignoring dividend drag on the front end and taxes in retirement on the back end. Generally taxes in retirement will be lower, but any tax in retirement will negate some of the gains you are projecting.

User avatar
jeffyscott
Posts: 8128
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by jeffyscott » Mon May 06, 2019 12:47 pm

randomguy wrote:
Mon May 06, 2019 12:36 pm
And people will talk about how low are taxes are now so that makes a ROTH a deal.People have been saying that for 20 years now. Eventually they will be right:)
Yep, for basically my entire working life I was hearing that, yet tax rates applicable to my income level did nothing but decrease.
Of course if that tax increase comes in the form of a 22% VAT, all the people that bet on ROTH will have lost.
Only if the VAT were to be implemented as a replacement of the income tax (or at least a partial replacement). If it were just a new added tax, it would not affect money in Roth any more than it would money in traditional or taxable.
Time is your friend; impulse is your enemy. - John C. Bogle

Topic Author
CurledMoss
Posts: 17
Joined: Fri May 03, 2019 7:08 am

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by CurledMoss » Sun May 19, 2019 9:27 am

Thanks, everyone. This has given me a lot to think about.

bradpevans
Posts: 561
Joined: Sun Apr 08, 2018 1:09 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by bradpevans » Sun May 19, 2019 9:58 am

CurledMoss wrote:
Fri May 03, 2019 7:22 am
This is my first time posting on here. Be gentle :wink:

I have been putting my money into a Roth account for the last 3 years but this is really bothering me. If you have $5,500 to invest post-tax every year, would it make more sense to invest in a traditional ($5,500 pre-tax). Then if you are in a 22% tax bracket that would save $1,210 on taxes. So you really only have $4,290 tied up. Then take the tax savings of $1,210 and invest that into a taxable account. Over 30 years that would give you like an additional $123,508 of savings. Thoughts? I'd had to be leaving that much money on the table, assuming I'm in the same tax bracket present and future.
I've never viewed pre-tax investments through the lens of "tax savings". (I view it as simply as before tax /as if I never made that money).

From a cash flow or "spendable dollars per month", saving $5500 pre tax allows you to spend more money than $5500 pre-tax AND $1210 into taxable.

Doing both represents a greater savings than just one or the other

infotrader
Posts: 261
Joined: Tue Feb 28, 2017 2:39 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by infotrader » Sun May 19, 2019 10:23 am

The complexity of this discussion is due to the fact that everyone's situation is different, and we don't have a crystal ball for the future. For those who will continue to stay in low tax brackets after retirement, tax-deferred money is very good, period. However, for many BHers, they make more in retirement. Since it is hard to predict, the best way to deal with it is not to fixate on one approach, and diversify your savings.

The way I see it:

Taxable money is good for: spending and paying taxes, otherwise, the worst kind of money, since you have to pay tax on it again and again, and is the terminal kind of money: you cannot convert it to Roth.

Tax-deferred money: in a kind of neutral status but could be a potential time bomb. It gives you some flexibility to deal with tax situations: when you have lower income, so you can do some Roth conversion, or withdraw it when you move to a no state income tax state after retirement.

Roth money: the good money, you don't have to worry about RMD, tax, etc. The only drawback: while all the gains are tax free, there is no tax loss write-off either, so you should be careful about how to invest it.

There is also the dimension of time: taxable is short term, tax-deferred good until 70, roth is beyond your life time.

MotoTrojan
Posts: 5856
Joined: Wed Feb 01, 2017 8:39 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by MotoTrojan » Sun May 19, 2019 12:02 pm

jeffyscott wrote:
Sun May 05, 2019 11:50 am
folkher0 wrote:
Sun May 05, 2019 11:44 am
Sure, if you’re sure to have the lower bracket now, by all means Roth away. But In these examples we’re generally talking about assuming the same bracket in accumulation and retirement.
I see, so you are just disagreeing with the idea that a tie goes to the Roth :) .
Tie in marginal rate goes to pre-tax since you’ll have lower brackets to fill.

User avatar
neurosphere
Posts: 3181
Joined: Sun Jan 17, 2010 1:55 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by neurosphere » Sun May 19, 2019 12:34 pm

MotoTrojan wrote:
Sun May 19, 2019 12:02 pm
jeffyscott wrote:
Sun May 05, 2019 11:50 am
folkher0 wrote:
Sun May 05, 2019 11:44 am
Sure, if you’re sure to have the lower bracket now, by all means Roth away. But In these examples we’re generally talking about assuming the same bracket in accumulation and retirement.
I see, so you are just disagreeing with the idea that a tie goes to the Roth :) .
Tie in marginal rate goes to pre-tax since you’ll have lower brackets to fill.
Wait, I thought the tie goes to the Roth, as a hedge against unexpected too-big RMDs if one does better then expected in the markets and/or works past 70, and also for the purpose of passing to heirs if needed? Boy, predicting the future is COMPLICATED. :D
If you have to ask "Is a Target Date fund right for me?", the answer is "Yes".

User avatar
FiveK
Posts: 7359
Joined: Sun Mar 16, 2014 2:43 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by FiveK » Sun May 19, 2019 1:50 pm

MotoTrojan wrote:
Sun May 19, 2019 12:02 pm
jeffyscott wrote:
Sun May 05, 2019 11:50 am
folkher0 wrote:
Sun May 05, 2019 11:44 am
Sure, if you’re sure to have the lower bracket now, by all means Roth away. But In these examples we’re generally talking about assuming the same bracket in accumulation and retirement.
I see, so you are just disagreeing with the idea that a tie goes to the Roth :) .
Tie in marginal rate goes to pre-tax since you’ll have lower brackets to fill.
A tie in marginal rates is impossible unless the lower brackets are already full (assuming marginal rate = nominal bracket rate). ;)

MotoTrojan
Posts: 5856
Joined: Wed Feb 01, 2017 8:39 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by MotoTrojan » Sun May 19, 2019 3:31 pm

FiveK wrote:
Sun May 19, 2019 1:50 pm
MotoTrojan wrote:
Sun May 19, 2019 12:02 pm
jeffyscott wrote:
Sun May 05, 2019 11:50 am
folkher0 wrote:
Sun May 05, 2019 11:44 am
Sure, if you’re sure to have the lower bracket now, by all means Roth away. But In these examples we’re generally talking about assuming the same bracket in accumulation and retirement.
I see, so you are just disagreeing with the idea that a tie goes to the Roth :) .
Tie in marginal rate goes to pre-tax since you’ll have lower brackets to fill.
A tie in marginal rates is impossible unless the lower brackets are already full (assuming marginal rate = nominal bracket rate). ;)
Simplified example:

I make $100K a year and $25K of that goes to savings, let's say the marginal rate is for everything >$50K for simplicity. I save solely in pre-tax. In retirement I continue the same expenses of $75K pre-tax, and pay an effective tax-rate of <25% since a good chunk of that $75K is being withdrawn to fill up my lower brackets.

If we do the same thing but replace the savings with Roth, I will be putting away $18.75K/year after-tax. In retirement I have a fixed effective tax-rate of 25% since my entire nest-egg was filled as-such.

What was so impossible about my marginal rates being a tie but not being able to utilize the lower brackets to reduce overall effective tax? Marginal and effective are different things.

User avatar
FiveK
Posts: 7359
Joined: Sun Mar 16, 2014 2:43 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by FiveK » Sun May 19, 2019 4:30 pm

MotoTrojan wrote:
Sun May 19, 2019 3:31 pm
Simplified example:

I make $100K a year and $25K of that goes to savings, let's say the marginal rate is for everything >$50K for simplicity. I save solely in pre-tax. In retirement I continue the same expenses of $75K pre-tax, and pay an effective tax-rate of <25% since a good chunk of that $75K is being withdrawn to fill up my lower brackets.
It may be counterintuitive, but the effective rate is irrelevant.

Let's say you have contributed enough in previous years that you expect your traditional balance at the start of retirement will be $1,875,000. Withdrawing at 4%/yr give you $75K/yr, even if you never contribute another dollar to a traditional account. Any extra withdrawals, due to future traditional contributions, will be added to the $75K and thus taxed at the marginal rate there.

Does that make sense?
If we do the same thing but replace the savings with Roth, I will be putting away $18.75K/year after-tax. In retirement I have a fixed effective tax-rate of 25% since my entire nest-egg was filled as-such.
Not sure whether "replace savings" occurred in the past or you are looking at future events - could you clarify?
What was so impossible about my marginal rates being a tie but not being able to utilize the lower brackets to reduce overall effective tax? Marginal and effective are different things.
Yes, marginal and effective are different things. E.g., see Marginal Vs Effective Tax Rates And When To Use Each.

The only way your withdrawal marginal rate for a new contribution (and new contributions are all that matter, because old ones can't be changed) can be the same as your current marginal rate is if all those lower brackets are already filled with other "unavoidable" income, e.g., withdrawals based on past contributions.

If the lower brackets aren't yet filled, the marginal withdrawal rate is the highest unfilled lower bracket.

Does that make sense?

MotoTrojan
Posts: 5856
Joined: Wed Feb 01, 2017 8:39 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by MotoTrojan » Sun May 19, 2019 4:36 pm

FiveK wrote:
Sun May 19, 2019 4:30 pm
MotoTrojan wrote:
Sun May 19, 2019 3:31 pm
Simplified example:

I make $100K a year and $25K of that goes to savings, let's say the marginal rate is for everything >$50K for simplicity. I save solely in pre-tax. In retirement I continue the same expenses of $75K pre-tax, and pay an effective tax-rate of <25% since a good chunk of that $75K is being withdrawn to fill up my lower brackets.
It may be counterintuitive, but the effective rate is irrelevant.

Let's say you have contributed enough in previous years that you expect your traditional balance at the start of retirement will be $1,875,000. Withdrawing at 4%/yr give you $75K/yr, even if you never contribute another dollar to a traditional account. Any extra withdrawals, due to future traditional contributions, will be added to the $75K and thus taxed at the marginal rate there.

Does that make sense?
If we do the same thing but replace the savings with Roth, I will be putting away $18.75K/year after-tax. In retirement I have a fixed effective tax-rate of 25% since my entire nest-egg was filled as-such.
Not sure whether "replace savings" occurred in the past or you are looking at future events - could you clarify?
What was so impossible about my marginal rates being a tie but not being able to utilize the lower brackets to reduce overall effective tax? Marginal and effective are different things.
Yes, marginal and effective are different things. E.g., see Marginal Vs Effective Tax Rates And When To Use Each.

The only way your withdrawal marginal rate for a new contribution (and new contributions are all that matter, because old ones can't be changed) can be the same as your current marginal rate is if all those lower brackets are already filled with other "unavoidable" income, e.g., withdrawals based on past contributions.

If the lower brackets aren't yet filled, the marginal withdrawal rate is the highest unfilled lower bracket.

Does that make sense?
No it doesn't make sense. Let me try to clarify. EDIT: Actually it does make sense, but I am looking more at an investor with nothing saved yet that is deciding whether to go 100% Roth or 100% traditional. If we assume their marginal rate would be equal if they went traditional, then traditional beats Roth.

Two investors both make $100K/year pre-tax and expect to spend $75K/year pre-tax in retirement, thus saving $25K/year pre-tax today. Their marginal rate today will be the same as it will in retirement. For simplicity, let's assume the marginal rate is on every dollar of income above $50K. Let's call the marginal rate 25%, and for ease say every dollar at/under $50K is taxed at 10%.

Person A invests $25K/year in pre-tax.

Person B invests the equivalent pre-tax amount in a Roth, $18.75K.

Person B will have paid an effective rate of 25% on their savings, no? What about person A? They will pay 10% on the first $50K withdrawn, and 25% on the rest, giving them an effective rate closer to 15%.

Please let me know where I am wrong. If we are arguing semantics then yes, person B actually does have a lower marginal rate in retirement because every dollar saved was in Roth, but my point is if you think your marginal rate assuming pre-tax savings will be the same in retirement as your marginal rate today, then saving in pre-tax wins.

User avatar
FiveK
Posts: 7359
Joined: Sun Mar 16, 2014 2:43 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by FiveK » Sun May 19, 2019 5:12 pm

MotoTrojan wrote:
Sun May 19, 2019 4:36 pm
No it doesn't make sense. Let me try to clarify. EDIT: Actually it does make sense, but I am looking more at an investor with nothing saved yet that is deciding whether to go 100% Roth or 100% traditional. If we assume their marginal rate would be equal if they went traditional, then traditional beats Roth.
...
If we are arguing semantics then yes, person B actually does have a lower marginal rate in retirement because every dollar saved was in Roth, but my point is if you think your marginal rate assuming pre-tax savings will be the same in retirement as your marginal rate today, then saving in pre-tax wins.
Yes, it's a combination of semantics and assumptions. No doubt if we were having this conversation across a table with our favorite beverages in hand, consensus would be quickly reached. :beer

For someone with nothing saved yet, no expectation of pension, planning not to start SS immediately after retiring, etc., both expected marginal and effective rates on withdrawals from that first contribution are probably 0%, so "use traditional" is an easy call.
Two investors both make $100K/year pre-tax and expect to spend $75K/year pre-tax in retirement, thus saving $25K/year pre-tax today. Their marginal rate today will be the same as it will in retirement.
How do we know that? E.g., if all contributions during the career were Roth, the marginal rate in retirement will likely be 0%.
For simplicity, let's assume the marginal rate is on every dollar of income above $50K. Let's call the marginal rate 25%, and for ease say every dollar at/under $50K is taxed at 10%.

Person A invests $25K/year in pre-tax.

Person B invests the equivalent pre-tax amount in a Roth, $18.75K.

Person B will have paid an effective rate of 25% on their savings, no? What about person A? They will pay 10% on the first $50K withdrawn, and 25% on the rest, giving them an effective rate closer to 15%.
Yes. And if an irrevocable career-long selection of traditional or Roth had to be made at the first contribution, this would be a reasonable way to look at it. Fortunately, tax law allows us to change between the two pretty much at will.

In this case, contributing to traditional until the expected taxable income in retirement exceeds the 10% bracket is a straightforward choice. Once that point is reached, and additional contributions will be withdrawn at a 25% rate, we can debate "who the tie goes to".

Are we in agreement?

bsteiner
Posts: 4265
Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by bsteiner » Sun May 19, 2019 5:25 pm

CurledMoss wrote:
Fri May 03, 2019 7:22 am
This is my first time posting on here. Be gentle :wink:

I have been putting my money into a Roth account for the last 3 years but this is really bothering me. If you have $5,500 to invest post-tax every year, would it make more sense to invest in a traditional ($5,500 pre-tax). Then if you are in a 22% tax bracket that would save $1,210 on taxes. So you really only have $4,290 tied up. Then take the tax savings of $1,210 and invest that into a taxable account. Over 30 years that would give you like an additional $123,508 of savings. Thoughts? I'd had to be leaving that much money on the table, assuming I'm in the same tax bracket present and future.
You had it right the first time. At a constant tax bracket, the Roth is a big winner.

Example 1: you put $5,500 in a Roth. Over 30 years, if you earn 6%, it grows to $31,589, all of which is yours.

Example 2: you put $5,500 in a traditional. Over 30 years, if you earn 6%, it grows to $31,589. You or your beneficiaries pay 22% tax, or $6,950, and have $24,640 left. You also have your $1,210 of tax savings. Over 30 years, if you earned the same 6% on it, it would grow to $6,950, and you would be equally well off.

But you won't earn the same 6% on the $1,210 of initial tax savings. That money will be in a taxable account, and the income and gains on it will be taxable each year. So it will grow to something less than $6,950. So if everything else is equal (which isn't always the case), the Roth will be preferable.

The Roth has other advantages, which I discuss in my articles on this in the April 2013, https://www.kkwc.com/wp-content/uploads ... r_ATRA.pdf, and June 2018, https://www.kkwc.com/wp-content/uploads ... ations.pdf, issues of Trusts & Estates.

The articles focus on Roth conversions, but the analysis is the same for contributions.

Of course, there are countervailing factors and situations where the traditional is preferable for some or all of the IRA.

User avatar
jeffyscott
Posts: 8128
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by jeffyscott » Sun May 19, 2019 5:58 pm

FiveK wrote:
Sun May 19, 2019 5:12 pm
In this case, contributing to traditional until the expected taxable income in retirement exceeds the 10% bracket is a straightforward choice. Once that point is reached, and additional contributions will be withdrawn at a 25% rate, we can debate "who the tie goes to".
Butting back in to note that my version of "tie" was based on the taxes on the dollar for which the decision to Roth or not is being made, not the taxpayers marginal rate.

Fed tax rates go 10, 12, 22, BTW.
Time is your friend; impulse is your enemy. - John C. Bogle

User avatar
FiveK
Posts: 7359
Joined: Sun Mar 16, 2014 2:43 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by FiveK » Sun May 19, 2019 6:45 pm

jeffyscott wrote:
Sun May 19, 2019 5:58 pm
...the taxes on the dollar for which the decision to Roth or not is being made, not the taxpayers marginal rate.
Isn't the tax on that dollar, divided by one dollar, that dollar's marginal rate?

lkar
Posts: 109
Joined: Sat May 04, 2019 4:02 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by lkar » Sun May 19, 2019 6:54 pm

bsteiner wrote:
Sun May 19, 2019 5:25 pm
CurledMoss wrote:
Fri May 03, 2019 7:22 am
This is my first time posting on here. Be gentle :wink:

I have been putting my money into a Roth account for the last 3 years but this is really bothering me. If you have $5,500 to invest post-tax every year, would it make more sense to invest in a traditional ($5,500 pre-tax). Then if you are in a 22% tax bracket that would save $1,210 on taxes. So you really only have $4,290 tied up. Then take the tax savings of $1,210 and invest that into a taxable account. Over 30 years that would give you like an additional $123,508 of savings. Thoughts? I'd had to be leaving that much money on the table, assuming I'm in the same tax bracket present and future.
You had it right the first time. At a constant tax bracket, the Roth is a big winner.

Example 1: you put $5,500 in a Roth. Over 30 years, if you earn 6%, it grows to $31,589, all of which is yours.

Example 2: you put $5,500 in a traditional. Over 30 years, if you earn 6%, it grows to $31,589. You or your beneficiaries pay 22% tax, or $6,950, and have $24,640 left. You also have your $1,210 of tax savings. Over 30 years, if you earned the same 6% on it, it would grow to $6,950, and you would be equally well off.

But you won't earn the same 6% on the $1,210 of initial tax savings. That money will be in a taxable account, and the income and gains on it will be taxable each year. So it will grow to something less than $6,950. So if everything else is equal (which isn't always the case), the Roth will be preferable.

The Roth has other advantages, which I discuss in my articles on this in the April 2013, https://www.kkwc.com/wp-content/uploads ... r_ATRA.pdf, and June 2018, https://www.kkwc.com/wp-content/uploads ... ations.pdf, issues of Trusts & Estates.

The articles focus on Roth conversions, but the analysis is the same for contributions.

Of course, there are countervailing factors and situations where the traditional is preferable for some or all of the IRA.
All the stuff you read also assumes that people actually will invest the tax savings they get by going with traditional. The reality is that most people won’t or won’t invest in the same manner that retirement funds are invested. Some will just use it as discretionary income and buy a big house or a better car. Still more would perhaps intend to save for retirement but without the punitive effect of the IRA rules might be tempted to spend it. So, behavior and discipline matters.

On the flip side, if the deduction makes it so that those who are not max contributors will invest more, traditional might be better now.

MotoTrojan
Posts: 5856
Joined: Wed Feb 01, 2017 8:39 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by MotoTrojan » Sun May 19, 2019 10:03 pm

FiveK wrote:
Sun May 19, 2019 5:12 pm
In this case, contributing to traditional until the expected taxable income in retirement exceeds the 10% bracket is a straightforward choice. Once that point is reached, and additional contributions will be withdrawn at a 25% rate, we can debate "who the tie goes to".

Are we in agreement?
Yes. I guess my real point was in this example if you use Roth your whole life you are losing.

Maid of the Mist
Posts: 148
Joined: Sat Dec 04, 2010 5:50 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by Maid of the Mist » Mon May 20, 2019 1:17 pm

I have a dear former co worker who was convinced that you shouldn’t pay taxes until you had to. He and his wife plowed money into 401ks both maxing out most years. My spouse and I were big fans of diversifying our savings. Very roughly 1/3 pretax 401k, 1/3 Roth, and 1/3 after tax. Fast forward 25 years and we are all retired. My husband and I are taking his rmds and we are still not in a premium Medicare bracket. We are further able to control our distributions from Roth and after tax (no rmds required for these accounts) to keep our taxes low and we still take large distributions. And when we want a major purchase, we can pull from Roth and not affect our taxes. My friend and his wife have to take much larger rmds and are trapped in a higher tax bracket and pay higher Medicare premiums with little flexibility.

Now I agree things could have worked out differently if tax law was different. However, I believe diversification of your retirement savings is key when you have uncertainty. And one thing I think we can be sure of is that we cannot predict tax law twenty or twenty five years from now.

And also, I do point out to my friend and his wife that they have a “good” problem. While they pay higher taxes and higher Medicare premiums, they are still have plenty of money to do the things they want to do in retirement.

So in summary, I would suggest, the major thing to do is save as much as you can reasonably and you will be fine. And second, I would recommend diversification of retirement savings.

infotrader
Posts: 261
Joined: Tue Feb 28, 2017 2:39 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by infotrader » Mon May 20, 2019 1:49 pm

Maid of the Mist wrote:
Mon May 20, 2019 1:17 pm
I have a dear former co worker who was convinced that you shouldn’t pay taxes until you had to. He and his wife plowed money into 401ks both maxing out most years. My spouse and I were big fans of diversifying our savings. Very roughly 1/3 pretax 401k, 1/3 Roth, and 1/3 after tax. Fast forward 25 years and we are all retired. My husband and I are taking his rmds and we are still not in a premium Medicare bracket. We are further able to control our distributions from Roth and after tax (no rmds required for these accounts) to keep our taxes low and we still take large distributions. And when we want a major purchase, we can pull from Roth and not affect our taxes. My friend and his wife have to take much larger rmds and are trapped in a higher tax bracket and pay higher Medicare premiums with little flexibility.

Now I agree things could have worked out differently if tax law was different. However, I believe diversification of your retirement savings is key when you have uncertainty. And one thing I think we can be sure of is that we cannot predict tax law twenty or twenty five years from now.

And also, I do point out to my friend and his wife that they have a “good” problem. While they pay higher taxes and higher Medicare premiums, they are still have plenty of money to do the things they want to do in retirement.

So in summary, I would suggest, the major thing to do is save as much as you can reasonably and you will be fine. And second, I would recommend diversification of retirement savings.
I totally agree. Diversification is the key, since there is no single option that is the best for all scenarios.

JustinR
Posts: 1107
Joined: Tue Apr 27, 2010 11:43 pm

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by JustinR » Mon May 20, 2019 2:56 pm

In general you should defer taxes as much as possible. Which means traditional > Roth if possible.

This is especially true if you plan to retire early. You can pay 0% in taxes ever by doing a traditional IRA/401k and then doing a Roth conversion ladder.

Thesaints
Posts: 2828
Joined: Tue Jun 20, 2017 12:25 am

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by Thesaints » Mon May 20, 2019 3:02 pm

Clearly, if one as a deductible IRA available and a sufficiently high tax bracket, tIRA + taxable account is the way to go.
On the other hand, many can't contribute to a tIRA, or their marginal tax rate is so low to make a Roth the best choice.

Lee_WSP
Posts: 811
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: Wouldn't this make Traditional IRA far superior to Roth?

Post by Lee_WSP » Tue May 21, 2019 4:23 pm

folkher0 wrote:
Sat May 04, 2019 10:07 am
mbasherp wrote:
Sat May 04, 2019 12:52 am
folkher0 wrote:
Fri May 03, 2019 6:08 pm
For some reason no one ever talks about inflation when comparing Roth to Traditional.

I will always choose to keep today's dollars and pay taxes later. Tomorrow's dollar will be worth less.
I don’t understand how inflation would affect things in this particular situation. Can you elaborate?
Using an example posted above, if i'm in the same tax bracket in the future as I am now:

"Let's say you have $5000 and pay 20% taxes. If you pay taxes now and invest in Roth, you have $4000 invested. Suppose that doubles so you then can take out and spend $8000.

Alternatively, put $5000 in traditional, that doubles. You take out $10,000 and pay $2000 in taxes, leaving $8000 to spend."

In both scenarios you pay $2000 in taxes. The difference is when you pay taxes. Future dollars will be worth less. I guess you can think about this is real or nominal terms. But in any given year, my tax rate is nominal. In other words, 20% of income will be the same whether its 2019 or 2049. Inflation obviously hurts the value of the $8000 you have left as well, so it ain't perfect. But money kept away from the tax man now can be used (invested, spent) to your benefit. You could buy ibonds or TIPS to match inflation. In the OPs example you can buy stocks or bonds. Maybe you save that money up for a down payment on the house. Maybe you start a business or use it to cashflow your kids education expenses. I guess my point is, from today until the day I take distributions, I can do whatever you want with it. You control it, not Uncle Sam.

When its time to pay the man, its time to pay the man. But I'll be 20-30 years closer to death, my kids will be out of school and (hopefully) independent, and I will presumably in a secure place financially.

If I'm not, and I'm eating alpo in a cardboard box under a bridge.....I will probably be in a lower tax bracket and traditional wins again.
Unless you spend the money today, inflation is still going to eat away at it. But if you spend the deduction today, then you're deviating from the thought exercise of the OP.

edit:
But to join the chorus, first of all, you need to determine whether the tIRA is even deductible given your tax circumstances. But assuming it is deductible, then it comes down to marginal tax rates now and at retirement. But the future is uncertain so... I don't know. Maybe make the decision on whether the deduction would get you access to other tax benefits or subsidies based on AGI.

Post Reply