401K vs Roth 401K

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pingpong
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Joined: Wed Jun 20, 2018 10:33 pm

401K vs Roth 401K

Post by pingpong » Wed Nov 28, 2018 12:55 pm

Hi,

I have been maxing out for the past few years for my 401K and 457 plans. My employer also offers roth options for both of them.
I am considering switching them to the roth options.

I understand that I will be losing out on the current tax breaks associated with 401K and 457 plans but I am not sure if it will be worth the tax advantages I get on the earnings.

My current age is 33 and current marginal tax rate is around 22%. I max out on my Roth IRA (through backdoor) every year.

Please advice.

Olemiss540
Posts: 621
Joined: Fri Aug 18, 2017 8:46 pm

Re: 401K vs Roth 401K

Post by Olemiss540 » Wed Nov 28, 2018 1:01 pm

What's your current account balances? With a 22% marginal rate I assume you are not paying any state taxes? Any expected pensions? A lot goes into this above what your current marginal rate is so better info on planned retirement and existing assets would be helpful!
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

lakpr
Posts: 322
Joined: Fri Mar 18, 2011 9:59 am

Re: 401K vs Roth 401K

Post by lakpr » Wed Nov 28, 2018 5:16 pm

The decision to move 401-k contributions to Roth 401-k should be taken only if you believe that in your retirement, the combination of social security + withdrawal from the traditional 401-k / IRA accounts would completely fill out the lower tax tiers than your current marginal tax bracket.

Currently, for MFJ tax status, the 12% tax bracket tier ends at $77,400 of MAGI. Include the standard exemption of $24,000, that means until the total annual income = $101,400. Let's be generous and assume that the couple draws SS income of $48000 per year together. Which means our hypothetical couple could be drawing $53,400 from their 401-k and still remain within the 12% tax bracket.

If we assume the couple uses the 4% thumb-rule to "safely" withdraw from their retirement accounts, it implies that the balance in their retirement accounts should be $53,400 * 100/4 = $1.33 million.

So until the combined balance in the couple's retirement accounts reach $1.33 million, neither should be contributing to Roth 401-k account if they are currently in the 22% marginal tax bracket.

pingpong
Posts: 7
Joined: Wed Jun 20, 2018 10:33 pm

Re: 401K vs Roth 401K

Post by pingpong » Wed Nov 28, 2018 9:59 pm

Olemiss540,

Yes, I agree that this is a complex question. Here is some other information. My current state (and local) marginal tax rate is around 7.5%.
We have recently gotten aggressive with retirement contribution. We each have a retirement account balance of around 125K each. Both of us are 33 years old. We do not expect any pensions.

lakpr,

That is a neat calculation. Makes good sense when you look at things today and if we retire today. My concern is that the whole point of rothifying is to gain on the growth with time. So Yes, if we are retiring today then it does not make sense to contribute to the roth accounts.

I am thinking more like let us say my marginal tax rate is 24% and that the $10K I contribute to my retirement account in 30 years from now grows to $40K (doubling at a very conservative rate of every 15 years). Assuming 8% is my future marginal tax rate and every year I withdraw my 40K balance I am at the same tax bracket.

Case 1: Normal 401K: Saving 24% tax on $10K currently. Will pay tax on $30K growth at say 8% = +0.24*10K - 0.08*30K = 0
Case 2: Roth 401K: Savings say 8% on 30K growth. Will pay tax at the rate 24% on 10K = 0.08*30K - 0.24*10K = 0

8% is the break even point and at any rate above 8% the Roth option will win. Most probably we will be above 8% rate unless something drastic happens to the tax code. What am I missing here? Clearly our model conclusions are different.

justsomeguy2018
Posts: 144
Joined: Wed Oct 03, 2018 8:11 pm

Re: 401K vs Roth 401K

Post by justsomeguy2018 » Wed Nov 28, 2018 10:27 pm

lakpr wrote:
Wed Nov 28, 2018 5:16 pm
The decision to move 401-k contributions to Roth 401-k should be taken only if you believe that in your retirement, the combination of social security + withdrawal from the traditional 401-k / IRA accounts would completely fill out the lower tax tiers than your current marginal tax bracket.

Currently, for MFJ tax status, the 12% tax bracket tier ends at $77,400 of MAGI. Include the standard exemption of $24,000, that means until the total annual income = $101,400. Let's be generous and assume that the couple draws SS income of $48000 per year together. Which means our hypothetical couple could be drawing $53,400 from their 401-k and still remain within the 12% tax bracket.

If we assume the couple uses the 4% thumb-rule to "safely" withdraw from their retirement accounts, it implies that the balance in their retirement accounts should be $53,400 * 100/4 = $1.33 million.

So until the combined balance in the couple's retirement accounts reach $1.33 million, neither should be contributing to Roth 401-k account if they are currently in the 22% marginal tax bracket.
I am skeptical that tax rate will continue after the TCJA expires. If it reverts to 2017 rates, you are looking at:

Married Filing Jointly or Qualifying Widow(er)
Taxable Income Tax Rate
$0 – $18,650 10%
$18,651 – $75,900 $1,865 plus 15% of the amount over $18,650
$75,901 – $153,100 $10,452.50 plus 25% of the amount over $75,900
$153,101 – $233,350 $29,752.50 plus 28% of the amount over $153,100
$233,351 – $416,700 $52,222.50 plus 33% of the amount over $233,350
$416,701 – $470,700 $112,728 plus 35% of the amount over $416,700
$470,701 or more $131,628 plus 39.6% of the amount over $470,700


Obviously these and the standard deduction will adjust for inflation.

Biggest issue to me is the 7.5% state tax rate. I wouldn't pay that for a Roth if I had the option to avoid it and retire in a lower tax state.

bgf
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Re: 401K vs Roth 401K

Post by bgf » Wed Nov 28, 2018 10:31 pm

all that matters is the tax rate. growth is identical. you put more in tax deferred and less roth. just compare the tax rates (which is impossible because future rates are unknown). so you gotta guess.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

H-Town
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Re: 401K vs Roth 401K

Post by H-Town » Wed Nov 28, 2018 10:45 pm

lakpr wrote:
Wed Nov 28, 2018 5:16 pm
The decision to move 401-k contributions to Roth 401-k should be taken only if you believe that in your retirement, the combination of social security + withdrawal from the traditional 401-k / IRA accounts would completely fill out the lower tax tiers than your current marginal tax bracket.

Currently, for MFJ tax status, the 12% tax bracket tier ends at $77,400 of MAGI. Include the standard exemption of $24,000, that means until the total annual income = $101,400. Let's be generous and assume that the couple draws SS income of $48000 per year together. Which means our hypothetical couple could be drawing $53,400 from their 401-k and still remain within the 12% tax bracket.

If we assume the couple uses the 4% thumb-rule to "safely" withdraw from their retirement accounts, it implies that the balance in their retirement accounts should be $53,400 * 100/4 = $1.33 million.

So until the combined balance in the couple's retirement accounts reach $1.33 million, neither should be contributing to Roth 401-k account if they are currently in the 22% marginal tax bracket.
The thing is if you wait until you have $1.33 million in your 401k, you're likely in a high tax bracket and at the top of your earning years. Then you'll have to prepay tax at top rate. I contributed a good chunk of money to my Roth 401k when I just started out my career and prepay my tax at a much lower tax bracket. If you're a saver, it's not hard to save over $1.5M in your 401k after your working years.

pdavi21
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Re: 401K vs Roth 401K

Post by pdavi21 » Wed Nov 28, 2018 11:03 pm

Calculate your tax (including state) at 0 percent and 100 Traditional and a few points in between and get the slope (except for special credits/deductions) it will be .22 plus your state rate. Do this for several years past present and future. Figure out if your marginal rate is higher or lower than average. Then make your decision.
For me, I only Roth 401k under 21-25% including state tax. EITC phase out is 21.1%. Retirements savers credit can yield huge marginals around income caps. When you get into the high 12 and 22-24+ brackets, I think it gets more straight forward...although you may have to consider dividends and cap gains rates in there somewhere.

Long story short, depends on your current and future marginal tax rates and may not be 100% on or other.

Olemiss540
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Re: 401K vs Roth 401K

Post by Olemiss540 » Thu Nov 29, 2018 6:34 am

At a 29.5% marginal rate, I would stick to traditional 401k contributions. You are a long way from having to worry about high tax rates in retirement at your account balances and could really use that extra 29.5% towards boosting your savings rate.
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

bada bing
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Re: 401K vs Roth 401K

Post by bada bing » Thu Nov 29, 2018 7:10 am

lakpr wrote:
Wed Nov 28, 2018 5:16 pm
The decision to move 401-k contributions to Roth 401-k should be taken only if you believe that in your retirement, the combination of social security + withdrawal from the traditional 401-k / IRA accounts would completely fill out the lower tax tiers than your current marginal tax bracket.

Currently, for MFJ tax status, the 12% tax bracket tier ends at $77,400 of MAGI. Include the standard exemption of $24,000, that means until the total annual income = $101,400. Let's be generous and assume that the couple draws SS income of $48000 per year together. Which means our hypothetical couple could be drawing $53,400 from their 401-k and still remain within the 12% tax bracket.

If we assume the couple uses the 4% thumb-rule to "safely" withdraw from their retirement accounts, it implies that the balance in their retirement accounts should be $53,400 * 100/4 = $1.33 million.

So until the combined balance in the couple's retirement accounts reach $1.33 million, neither should be contributing to Roth 401-k account if they are currently in the 22% marginal tax bracket.
This calculation ignores RMD's. You don't get to just withdraw 4%/yr steady after age 70. Current table starts at 3.6% RMD at age 70, 5.3% at age 80 and 6.7% at age 85. A more accurate calculation requires guesses on future portfolio returns, changes in mortality tables and tax rates. Most likely, 4% overestimates the portfolio value that stays below individual brackets at least moderately and perhaps greatly. The "tax torpedo" that some people have waiting for them at age 70 can be unexpected huge if you don't pay attention. Of course, there are worse things than being in an upper bracket in retirement.

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rkhusky
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Re: 401K vs Roth 401K

Post by rkhusky » Thu Nov 29, 2018 7:12 am

pingpong wrote:
Wed Nov 28, 2018 9:59 pm
8% is the break even point and at any rate above 8% the Roth option will win. Most probably we will be above 8% rate unless something drastic happens to the tax code. What am I missing here? Clearly our model conclusions are different.
Check out the second table at https://www.bogleheads.org/wiki/Non-ded ... tional_IRA, which explicitly shows that, if the contribution and withdrawal tax rates are the same, Roth and Traditional accounts yield the exact same result. The growth rate does not matter. There is also a comparison to a taxable account.

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prudent
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Re: 401K vs Roth 401K

Post by prudent » Thu Nov 29, 2018 11:24 am

Topic moved to Investing - Help with Personal Investments.

Ben Mathew
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Re: 401K vs Roth 401K

Post by Ben Mathew » Thu Nov 29, 2018 1:32 pm

pingpong wrote:
Wed Nov 28, 2018 9:59 pm
I am thinking more like let us say my marginal tax rate is 24% and that the $10K I contribute to my retirement account in 30 years from now grows to $40K (doubling at a very conservative rate of every 15 years). Assuming 8% is my future marginal tax rate and every year I withdraw my 40K balance I am at the same tax bracket.

Case 1: Normal 401K: Saving 24% tax on $10K currently. Will pay tax on $30K growth at say 8% = +0.24*10K - 0.08*30K = 0
Case 2: Roth 401K: Savings say 8% on 30K growth. Will pay tax at the rate 24% on 10K = 0.08*30K - 0.24*10K = 0

8% is the break even point and at any rate above 8% the Roth option will win. Most probably we will be above 8% rate unless something drastic happens to the tax code. What am I missing here? Clearly our model conclusions are different.
The breakeven marginal tax would be 24%, not 8%. You can't compare $ values across time without accounting for growth. At 8% future marginal taxes, the traditional will be better:

The $10K you contribute today in a traditional account becomes $40K 30 years from now. When you withdraw the money, you pay 8% tax, leaving you with $40K*(1-.08) = $36,800 for consumption.

If instead you go with Roth, you pay 24% tax on the $10K today, leaving you with only $10K*(1-.24)=$7,600 in the Roth. This grows to $7,600*4=$30,400 in 30 years, all of which is available for consumption because no tax is due. This is less than the $36,800 that traditional would have gotten you.

If you redo the above example with a future marginal tax rate of 24% instead of 8%, you'll find that traditional will equal the Roth. The reason for this is simple.

In traditional you'll get: $10K * growth * (1-future tax rate)
In Roth, you'll get: $10K * (1-current tax rate) * growth

If current tax rate = future tax rate, these amounts will be the same because multiplication is commutatitve.

You can read more about this in the Bogleheads Wiki on Traditional vs Roth

pingpong
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Re: 401K vs Roth 401K

Post by pingpong » Wed Dec 05, 2018 12:16 pm

Ben,

I am thinking more about putting the same money in either of the accounts. Whereas you are speaking about the case where I have only 10K and I want to invest in either of these accounts.

Let A be the amount, g be the growth, f be the future tax rate, c be the current tax rate.

So case 1: Traditional 401K, assuming I save the money from tax savings into a taxable account and withdraw it at the same later date as the retirement money withdrawal.
I will get: A.g.(1-f) + A.c.g(1-f)

Case 2: Roth 401K, I account for the taxes in the second term.
I will get: A.g - A.c

Case 2 is better than case 1 if and only if A.g.(1-f) + A.c.g(1-f) < A.g - A.c
i.e. g.(1-f) + c.g(1-f) < g - c
i.e. -gf + cg - cfg < -c
i.e. (f-c+fc) > c/g
i.e. f> (g+1)c/(g*(c+1) = (g+1/g) * c/(c+1)

I ran this function {f = (g+1)*c/(c+1)/g } on a few scenarios (g=3,4,5,6;c = 15% to 50%) and almost all of them show me that traditional is better than Roth.

Thank you for all your input. It helped me think about this issue better. Let me know if there are any holes in this logic.

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ruralavalon
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Location: Illinois

Re: 401K vs Roth 401K

Post by ruralavalon » Wed Dec 05, 2018 4:32 pm

pingpong wrote:
Wed Nov 28, 2018 12:55 pm
Hi,

I have been maxing out for the past few years for my 401K and 457 plans. My employer also offers roth options for both of them.
I am considering switching them to the roth options.

I understand that I will be losing out on the current tax breaks associated with 401K and 457 plans but I am not sure if it will be worth the tax advantages I get on the earnings.

My current age is 33 and current marginal tax rate is around 22%. I max out on my Roth IRA (through backdoor) every year.

Please advice.
pingpong wrote:
Wed Nov 28, 2018 9:59 pm
Olemiss540,

Yes, I agree that this is a complex question. Here is some other information. My current state (and local) marginal tax rate is around 7.5%.
We have recently gotten aggressive with retirement contribution. We each have a retirement account balance of around 125K each. Both of us are 33 years old. We do not expect any pensions.
. . . . .

Olemiss540 wrote:
Thu Nov 29, 2018 6:34 am
At a 29.5% marginal rate, I would stick to traditional 401k contributions. You are a long way from having to worry about high tax rates in retirement at your account balances and could really use that extra 29.5% towards boosting your savings rate.
+ 1, most likely traditional contributions will be better. For most people traditional 401k contributions will likely be better.

The income tax code is progressive, with a lower tax rate for lower income. Retirement usually means that employment income has ended. Therefore, most people are in a lower tax bracket in retirement and for most people traditional 401k contributions will probably be better. In addition when you withdraw from your 401k in retirement, your income is not all taxed at your marginal tax rate specified for your tax bracket. TFB blog post, "The case against Roth 401k". "I think for most people the majority, if not 100%, of the contribution should go to a Traditional 401(k)."

Wiki article, "Traditional vs Roth".
"Tax considerations:
* If your current marginal tax rate is 15% or less, prefer a Roth.
* If you expect to have higher marginal rates than your current marginal rate for most of your career, prefer a Roth.
* If you will have a traditional account or a pension large enough to meet your expected retirement expenses (and you expect to take that pension shortly after retiring), prefer a Roth.
* Otherwise, prefer a traditional account."

justsomeguy2018 wrote:
Wed Nov 28, 2018 10:27 pm
I am skeptical that tax rate will continue after the TCJA expires. If it reverts to 2017 rates, you are looking at:
. . . . .
I would not try to predict future tax brackets, and would not plan based on a guess about the future tax code.

"Temporary" tax provisions have a way of becoming permnent if wiidely popular, so I would not plan based on the idea of a tax break expiring.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

JBTX
Posts: 4243
Joined: Wed Jul 26, 2017 12:46 pm

Re: 401K vs Roth 401K

Post by JBTX » Wed Dec 05, 2018 4:51 pm

ruralavalon wrote:
Wed Dec 05, 2018 4:32 pm
pingpong wrote:
Wed Nov 28, 2018 12:55 pm
Hi,

I have been maxing out for the past few years for my 401K and 457 plans. My employer also offers roth options for both of them.
I am considering switching them to the roth options.

I understand that I will be losing out on the current tax breaks associated with 401K and 457 plans but I am not sure if it will be worth the tax advantages I get on the earnings.

My current age is 33 and current marginal tax rate is around 22%. I max out on my Roth IRA (through backdoor) every year.

Please advice.
pingpong wrote:
Wed Nov 28, 2018 9:59 pm
Olemiss540,

Yes, I agree that this is a complex question. Here is some other information. My current state (and local) marginal tax rate is around 7.5%.
We have recently gotten aggressive with retirement contribution. We each have a retirement account balance of around 125K each. Both of us are 33 years old. We do not expect any pensions.
. . . . .

Olemiss540 wrote:
Thu Nov 29, 2018 6:34 am
At a 29.5% marginal rate, I would stick to traditional 401k contributions. You are a long way from having to worry about high tax rates in retirement at your account balances and could really use that extra 29.5% towards boosting your savings rate.
+ 1, most likely traditional contributions will be better. For most people traditional 401k contributions will likely be better.

The income tax code is progressive, with a lower tax rate for lower income. Retirement usually means that employment income has ended. Therefore, most people are in a lower tax bracket in retirement and for most people traditional 401k contributions will probably be better. In addition when you withdraw from your 401k in retirement, your income is not all taxed at your marginal tax rate specified for your tax bracket. TFB blog post, "The case against Roth 401k". "I think for most people the majority, if not 100%, of the contribution should go to a Traditional 401(k)."

Wiki article, "Traditional vs Roth".
"Tax considerations:
* If your current marginal tax rate is 15% or less, prefer a Roth.
* If you expect to have higher marginal rates than your current marginal rate for most of your career, prefer a Roth.
* If you will have a traditional account or a pension large enough to meet your expected retirement expenses (and you expect to take that pension shortly after retiring), prefer a Roth.
* Otherwise, prefer a traditional account."

justsomeguy2018 wrote:
Wed Nov 28, 2018 10:27 pm
I am skeptical that tax rate will continue after the TCJA expires. If it reverts to 2017 rates, you are looking at:
. . . . .
I would not try to predict future tax brackets, and would not plan based on a guess about the future tax code.

"Temporary" tax provisions have a way of becoming permnent if wiidely popular, so I would not plan based on the idea of a tax break expiring.
The current tax code has rates increasing in 2026 or 2027. Anything beyond using the current tax code is guessing/speculation. There are reasons why the current rates may very well expire as per current tax code, but that subject is not allowed, so I'll stop there.

That said, at 29.5%, I'd probably opt for traditional, depending on the specifics of the situation.

justsomeguy2018
Posts: 144
Joined: Wed Oct 03, 2018 8:11 pm

Re: 401K vs Roth 401K

Post by justsomeguy2018 » Wed Dec 05, 2018 7:02 pm

ruralavalon wrote:
Wed Dec 05, 2018 4:32 pm
pingpong wrote:
Wed Nov 28, 2018 12:55 pm
Hi,

I have been maxing out for the past few years for my 401K and 457 plans. My employer also offers roth options for both of them.
I am considering switching them to the roth options.

I understand that I will be losing out on the current tax breaks associated with 401K and 457 plans but I am not sure if it will be worth the tax advantages I get on the earnings.

My current age is 33 and current marginal tax rate is around 22%. I max out on my Roth IRA (through backdoor) every year.

Please advice.
pingpong wrote:
Wed Nov 28, 2018 9:59 pm
Olemiss540,

Yes, I agree that this is a complex question. Here is some other information. My current state (and local) marginal tax rate is around 7.5%.
We have recently gotten aggressive with retirement contribution. We each have a retirement account balance of around 125K each. Both of us are 33 years old. We do not expect any pensions.
. . . . .

Olemiss540 wrote:
Thu Nov 29, 2018 6:34 am
At a 29.5% marginal rate, I would stick to traditional 401k contributions. You are a long way from having to worry about high tax rates in retirement at your account balances and could really use that extra 29.5% towards boosting your savings rate.
+ 1, most likely traditional contributions will be better. For most people traditional 401k contributions will likely be better.

The income tax code is progressive, with a lower tax rate for lower income. Retirement usually means that employment income has ended. Therefore, most people are in a lower tax bracket in retirement and for most people traditional 401k contributions will probably be better. In addition when you withdraw from your 401k in retirement, your income is not all taxed at your marginal tax rate specified for your tax bracket. TFB blog post, "The case against Roth 401k". "I think for most people the majority, if not 100%, of the contribution should go to a Traditional 401(k)."

Wiki article, "Traditional vs Roth".
"Tax considerations:
* If your current marginal tax rate is 15% or less, prefer a Roth.
* If you expect to have higher marginal rates than your current marginal rate for most of your career, prefer a Roth.
* If you will have a traditional account or a pension large enough to meet your expected retirement expenses (and you expect to take that pension shortly after retiring), prefer a Roth.
* Otherwise, prefer a traditional account."

justsomeguy2018 wrote:
Wed Nov 28, 2018 10:27 pm
I am skeptical that tax rate will continue after the TCJA expires. If it reverts to 2017 rates, you are looking at:
. . . . .
I would not try to predict future tax brackets, and would not plan based on a guess about the future tax code.

"Temporary" tax provisions have a way of becoming permnent if wiidely popular, so I would not plan based on the idea of a tax break expiring.
I don't know...if the tax rates are set to sunset in 2026/2027, it sounds like YOU are making a guess about the future code. You are guessing they will not sunset.

rkhusky
Posts: 5891
Joined: Thu Aug 18, 2011 8:09 pm

Re: 401K vs Roth 401K

Post by rkhusky » Thu Dec 06, 2018 8:06 am

pingpong wrote:
Wed Dec 05, 2018 12:16 pm
Ben,

I am thinking more about putting the same money in either of the accounts. Whereas you are speaking about the case where I have only 10K and I want to invest in either of these accounts.

Let A be the amount, g be the growth, f be the future tax rate, c be the current tax rate.

So case 1: Traditional 401K, assuming I save the money from tax savings into a taxable account and withdraw it at the same later date as the retirement money withdrawal.
I will get: A.g.(1-f) + A.c.g(1-f)

Case 2: Roth 401K, I account for the taxes in the second term.
I will get: A.g - A.c

Case 2 is better than case 1 if and only if A.g.(1-f) + A.c.g(1-f) < A.g - A.c
i.e. g.(1-f) + c.g(1-f) < g - c
i.e. -gf + cg - cfg < -c
i.e. (f-c+fc) > c/g
i.e. f> (g+1)c/(g*(c+1) = (g+1/g) * c/(c+1)

I ran this function {f = (g+1)*c/(c+1)/g } on a few scenarios (g=3,4,5,6;c = 15% to 50%) and almost all of them show me that traditional is better than Roth.

Thank you for all your input. It helped me think about this issue better. Let me know if there are any holes in this logic.
If you are not maxing tax-advantaged accounts, the math is:
Tax-deferred: A*g*(1-f)
Roth: A(1-c)*g

TD=R, if f=c. TD>R, if f<c. TD<R, if f>c.

If you are maxing tax-advantaged accounts and investing tax savings in a taxable account, the math is:
Tax-deferred: A*g*(1-f) + A*c*g*(1-q) = A*g*(1-(f-c*(1-q)))
Roth: A*g

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

TD=R, if f=c and q=0 or if f=c*(1-q). TD>R, if f<c*(1-q). TD<R, if f>c*(1-q).
If f=c, then T=R(1-c*q)

For my situation, I found that q was about 15-20%.

You can use the second table in https://www.bogleheads.org/wiki/Non-ded ... tional_IRA to provide a comparison for that tax situation. Add the results of using $2,106 (0.28*$7,200) in the taxable column, with $7,200 in the Traditional IRA column, and you will find a total of $68,881.13, which is less than the $72,451.13 from using Roth. Since here c=f=0.28, then q=18%. And tax deferred would have been better if the future tax rate was less than 23%.

nolesrule
Posts: 812
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Re: 401K vs Roth 401K

Post by nolesrule » Thu Dec 06, 2018 9:33 am

pingpong wrote:
Wed Dec 05, 2018 12:16 pm
Ben,

I am thinking more about putting the same money in either of the accounts. Whereas you are speaking about the case where I have only 10K and I want to invest in either of these accounts.

Let A be the amount, g be the growth, f be the future tax rate, c be the current tax rate.

So case 1: Traditional 401K, assuming I save the money from tax savings into a taxable account and withdraw it at the same later date as the retirement money withdrawal.
I will get: A.g.(1-f) + A.c.g(1-f)

Case 2: Roth 401K, I account for the taxes in the second term.
I will get: A.g - A.c

Case 2 is better than case 1 if and only if A.g.(1-f) + A.c.g(1-f) < A.g - A.c
i.e. g.(1-f) + c.g(1-f) < g - c
i.e. -gf + cg - cfg < -c
i.e. (f-c+fc) > c/g
i.e. f> (g+1)c/(g*(c+1) = (g+1/g) * c/(c+1)

I ran this function {f = (g+1)*c/(c+1)/g } on a few scenarios (g=3,4,5,6;c = 15% to 50%) and almost all of them show me that traditional is better than Roth.

Thank you for all your input. It helped me think about this issue better. Let me know if there are any holes in this logic.
rhusky discussed the math, but the premise that you can put the same money in Traditional or Roth ignores the opportunity cost on the money used to pay taxes if you make the Roth contribution. That money would still be in your pocket if you make the Traditional contribution, and what you do with that additional money in your pocket must be accounted for.

Nate79
Posts: 3716
Joined: Thu Aug 11, 2016 6:24 pm
Location: Delaware

Re: 401K vs Roth 401K

Post by Nate79 » Thu Dec 06, 2018 10:08 am

bada bing wrote:
Thu Nov 29, 2018 7:10 am
lakpr wrote:
Wed Nov 28, 2018 5:16 pm
The decision to move 401-k contributions to Roth 401-k should be taken only if you believe that in your retirement, the combination of social security + withdrawal from the traditional 401-k / IRA accounts would completely fill out the lower tax tiers than your current marginal tax bracket.

Currently, for MFJ tax status, the 12% tax bracket tier ends at $77,400 of MAGI. Include the standard exemption of $24,000, that means until the total annual income = $101,400. Let's be generous and assume that the couple draws SS income of $48000 per year together. Which means our hypothetical couple could be drawing $53,400 from their 401-k and still remain within the 12% tax bracket.

If we assume the couple uses the 4% thumb-rule to "safely" withdraw from their retirement accounts, it implies that the balance in their retirement accounts should be $53,400 * 100/4 = $1.33 million.

So until the combined balance in the couple's retirement accounts reach $1.33 million, neither should be contributing to Roth 401-k account if they are currently in the 22% marginal tax bracket.
This calculation ignores RMD's. You don't get to just withdraw 4%/yr steady after age 70. Current table starts at 3.6% RMD at age 70, 5.3% at age 80 and 6.7% at age 85. A more accurate calculation requires guesses on future portfolio returns, changes in mortality tables and tax rates. Most likely, 4% overestimates the portfolio value that stays below individual brackets at least moderately and perhaps greatly. The "tax torpedo" that some people have waiting for them at age 70 can be unexpected huge if you don't pay attention. Of course, there are worse things than being in an upper bracket in retirement.

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The 4% is only fixed at the retirement age and then will increase with inflation every year after. If inflation is ~3% per year the 4% will grow enough that the difference between SWR and RMD will be almost negligible. That combined with retirement before age 70 means SWR will be higher than RMD in most cases. For example if you retire at age 67 and start taking 4%, with 3% inflation SWR will be higher than RMD. So I think this is mostly a nonissue.

If you retire early you can do Roth conversion in very low tax year giving you even more flexibility.

rkhusky
Posts: 5891
Joined: Thu Aug 18, 2011 8:09 pm

Re: 401K vs Roth 401K

Post by rkhusky » Thu Dec 06, 2018 5:08 pm

rkhusky wrote:
Thu Dec 06, 2018 8:06 am
If you are not maxing tax-advantaged accounts, the math is:
Tax-deferred: A*g*(1-f)
Roth: A(1-c)*g

TD=R, if f=c. TD>R, if f<c. TD<R, if f>c.

If you are maxing tax-advantaged accounts and investing tax savings in a taxable account, the math is:
Tax-deferred: A*g*(1-f) + A*c*g*(1-q) = A*g*(1-(f-c*(1-q)))
Roth: A*g

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

TD=R, if f=c and q=0 or if f=c*(1-q). TD>R, if f<c*(1-q). TD<R, if f>c*(1-q).
If f=c, then T=R(1-c*q)

For my situation, I found that q was about 15-20%.

You can use the second table in https://www.bogleheads.org/wiki/Non-ded ... tional_IRA to provide a comparison for that tax situation. Add the results of using $2,106 (0.28*$7,200) in the taxable column, with $7,200 in the Traditional IRA column, and you will find a total of $68,881.13, which is less than the $72,451.13 from using Roth. Since here c=f=0.28, then q=18%. And tax deferred would have been better if the future tax rate was less than 23%.
To complete the thought, suppose that one is in the 22% bracket now with a LTCG rate of 15%, and in retirement one is in the 12% tax bracket with a LTCG rate of 0%. A similar analysis to the above would yield a TIRA + Taxable balance of $84,955.11, compared to a Roth balance of $78,488.72. The taxable drag "q" turns out to be about 8% in this situation, due to taxation of the 2% qualified dividends each year.

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