Roth Advantage not discussed?

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K72
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Roth Advantage not discussed?

Post by K72 » Mon Feb 11, 2019 11:53 pm

I know Roth 401K vs traditional 401K has been thoroughly discussed in this forum, but I think there is one aspect that perhaps hasn't been accounted for, and that is with a Roth 401K you end up with more $ at your disposal when you withdraw. This assumes the amount contributed is the same in both cases (after tax in the case of the Roth option, which means you are out of pocket the contribution amount + tax as opposed to the contribution amount in the case of the traditional 401K). It also assumes you can afford the higher initial cost of the Roth contribution. It just seems to me there may be more to the story than just a comparison of tax rates. Less efficient perhaps but more money in the end.

If this aspect has been included in previous discussions or is such a corner case that it doesn't merit consideration, I apologize.

bryanm
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Re: Roth Advantage not discussed?

Post by bryanm » Tue Feb 12, 2019 12:08 am

Yes, it's true. A Roth 401k effectively has a higher initial cap than a traditional, since after tax dollars are worth more than pre-tax.

At least for me, this effect is swamped by the tax rate arbitrage available by contributing at my maximum marginal rate and withdrawing at my effective rate. I can offset the effectively lower cap on the traditional account by investing in other vehicles (e.g taxable). All of this only becomes relevant if you can actually max your advantaged space.

John Laurens
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Re: Roth Advantage not discussed?

Post by John Laurens » Tue Feb 12, 2019 12:09 am

I don’t know? What did the person do with the upfront tax savings from the pre-tax 401k contribution? Did they fund their HSA, Backdoor Roth, taxable investment account, 529, prepay their mortgage, or pay off other debts? Or did they just blow it on a boat payment?

Regards,
John

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FiveK
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Re: Roth Advantage not discussed?

Post by FiveK » Tue Feb 12, 2019 12:50 am

Ken72 wrote:
Mon Feb 11, 2019 11:53 pm
I know Roth 401K vs traditional 401K has been thoroughly discussed in this forum, but I think there is one aspect that perhaps hasn't been accounted for, and that is with a Roth 401K you end up with more $ at your disposal when you withdraw. This assumes the amount contributed is the same in both cases (after tax in the case of the Roth option, which means you are out of pocket the contribution amount + tax as opposed to the contribution amount in the case of the traditional 401K). It also assumes you can afford the higher initial cost of the Roth contribution. It just seems to me there may be more to the story than just a comparison of tax rates. Less efficient perhaps but more money in the end.

If this aspect has been included in previous discussions or is such a corner case that it doesn't merit consideration, I apologize.
No need to apologize - there is a lot of material here.

But do see Traditional versus Roth - Bogleheads, particularly the section about Maxing out your retirement accounts.

See also the recent thread Whats better to hold, Roth dollars or Tax-deferred dollars ? - Bogleheads.org, particularly the last three posts (as of this writing).

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FiveK
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Re: Roth Advantage not discussed?

Post by FiveK » Tue Feb 12, 2019 12:56 am

bryanm wrote:
Tue Feb 12, 2019 12:08 am
...this effect is swamped by the tax rate arbitrage available by contributing at my maximum marginal rate and withdrawing at my effective rate.
If only that were true, traditional accounts would be so much better. Unfortunately, that's not how it works.

Your most recent traditional contribution gets withdrawn on top of the withdrawals supported by all previous contributions (let alone other "unavoidable" income such as a pension, SS benefits, taxable dividends, etc.). Thus it gets taxed at the applicable marginal tax rate at withdrawal.

02nz
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Re: Roth Advantage not discussed?

Post by 02nz » Tue Feb 12, 2019 1:21 am

Ken72 wrote:
Mon Feb 11, 2019 11:53 pm
This assumes the amount contributed is the same in both cases (after tax in the case of the Roth option, which means you are out of pocket the contribution amount + tax as opposed to the contribution amount in the case of the traditional 401K).
Well of course you're going to end up with more money in Roth. You effectively contributed more money in the Roth. The question as always is the tax rate on the front end vs on the back end. For the vast majority of people, it's better to pay on the back end (in retirement).

For those who can afford to max out a 401k with 19K in contributions, yes that's effectively a larger tax-advantaged space than traditional. But this wouldn't overcome the difference between say 22% federal taxes in the working years and 12% in retirement.

Having Roth is great. But paying 22% or higher tax rates to get Roth is usually a bad idea.

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FiveK
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Re: Roth Advantage not discussed?

Post by FiveK » Tue Feb 12, 2019 1:30 am

02nz wrote:
Tue Feb 12, 2019 1:21 am
Well of course you're going to end up with more money in Roth. You effectively contributed more money in the Roth. The question as always is the tax rate on the front end vs on the back end. For the vast majority of people, it's better to pay on the back end (in retirement).
Perhaps Ken72 is referring to the comparison some popular financial journalists use. E.g., for a 25% tax rate: $6K in Roth (and $2K tax paid) vs. $6K in traditional (and $2K dissipated in profligate spending).

02nz
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Re: Roth Advantage not discussed?

Post by 02nz » Tue Feb 12, 2019 1:41 am

FiveK wrote:
Tue Feb 12, 2019 1:30 am
02nz wrote:
Tue Feb 12, 2019 1:21 am
Well of course you're going to end up with more money in Roth. You effectively contributed more money in the Roth. The question as always is the tax rate on the front end vs on the back end. For the vast majority of people, it's better to pay on the back end (in retirement).
Perhaps Ken72 is referring to the comparison some popular financial journalists use. E.g., for a 25% tax rate: $6K in Roth (and $2K tax paid) vs. $6K in traditional (and $2K dissipated in profligate spending).
I'm well aware the average Joe is lacking when it comes to personal finance knowledge and discipline. But I think on this forum, if we're going to make a comparison between two different types of accounts, then we should use numbers that allow for an apples-with-apples comparison. Factors related to behavior can certainly be taken into account (as I certainly would when giving advice to family/friends), but in that case state them clearly. As an example we frequently recommend DCA for behavioral reasons, even though lump sum is better more than half the time. But that’s always clearly stated.

The Wizard
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Re: Roth Advantage not discussed?

Post by The Wizard » Tue Feb 12, 2019 3:23 am

FiveK wrote:
Tue Feb 12, 2019 12:56 am

Your most recent traditional contribution gets withdrawn on top of the withdrawals supported by all previous contributions (let alone other "unavoidable" income such as a pension, SS benefits, taxable dividends, etc.). Thus it gets taxed at the applicable marginal tax rate at withdrawal.
Correct.
So maybe $1M to $1.5M in tax deferred (per person) is optimal, depending on whether you annuitize some of it or just do the SWR/RMD thing.

So once tax deferred gets over maybe $600k, start putting a percentage of contributions into Roth 401(k)/403(b) instead of all into tax deferred.

This scheme is for people who:
1) are prolific savers, and
2) who will be in same or higher AGI level in retirement as when working.

MOST working people do not meet these qualifications...
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JustinR
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Re: Roth Advantage not discussed?

Post by JustinR » Tue Feb 12, 2019 5:44 am

Look up Roth Conversion Ladder, in which you fund a traditional 401k with pre-tax money, withdraw it early before retirement age, and pay zero taxes on it ever.

Not possible with a Roth 401k obviously, since you paid the tax up front like a dummy.

https://rootofgood.com/roth-ira-convers ... etirement/

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TomatoTomahto
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Re: Roth Advantage not discussed?

Post by TomatoTomahto » Tue Feb 12, 2019 7:04 am

The Wizard wrote:
Tue Feb 12, 2019 3:23 am
FiveK wrote:
Tue Feb 12, 2019 12:56 am

Your most recent traditional contribution gets withdrawn on top of the withdrawals supported by all previous contributions (let alone other "unavoidable" income such as a pension, SS benefits, taxable dividends, etc.). Thus it gets taxed at the applicable marginal tax rate at withdrawal.
Correct.
So maybe $1M to $1.5M in tax deferred (per person) is optimal, depending on whether you annuitize some of it or just do the SWR/RMD thing.

So once tax deferred gets over maybe $600k, start putting a percentage of contributions into Roth 401(k)/403(b) instead of all into tax deferred.

This scheme is for people who:
1) are prolific savers, and
2) who will be in same or higher AGI level in retirement as when working.

MOST working people do not meet these qualifications...
We accepted the prevailing conventional wisdom until recently, when we started putting DW’s contributions in Roth 401k (employer match still goes to traditional).
Okay, I get it; I won't be political or controversial. The Earth is flat.

aristotelian
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Re: Roth Advantage not discussed?

Post by aristotelian » Tue Feb 12, 2019 7:07 am

OP, you are missing that the tax deduction from traditional more than makes up for the higher after-tax value of Roth dollars. Say you contribute $19K in the 22% bracket. With Roth, you get no money back. With Traditional, you get $4180 extra to compound over time. If you can stay in the 0% LTCG bracket in retirement, that will turn into a lot of free money.

The key is to compare your tax rate now versus in retirement. Do not forget that you can be quite wealthy with high spending and pay zero federal tax in retirement. Here is a spreadsheet you can use to run your own numbers. As you can see with the sample numbers, a hypothetical couple spending $100K in retirement delaying SS can pay zero tax in retirement and Traditional comes out ahead:

https://docs.google.com/spreadsheets/d/ ... 1374797127

Dandy
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Re: Roth Advantage not discussed?

Post by Dandy » Tue Feb 12, 2019 7:09 am

It is a tricky choice. Retirement can be 30 years or more almost as long as a career. We often look at our TIRA/401k as what will be the "number" at retirement and under play the fact that the compounding continues after retirement and the impact of RMD on post 70 taxes. The tax savings while working of making the contribution to the TIRA/401k is welcome and fits with the idea of avoiding/postponing taxes. One thing to consider is what happens to the tax savings. Are they needed for critical expenses e.g. paying the mortgage, funding education etc or are they used to increase luxuries (not that that is bad).

I am almost 71 and have a large TIRA. I delayed SS until age 70 and delayed a pension until age 65. I contributed high double digits to my T401k. I only had access to a Roth 401k for a couple of years before retiring. My pension and SS cover all or most of our life style. That makes my substantial RMD mostly a highly taxed luxury. (not a complaint just a fact). Looking back I might have been better off, if I had the option, to allocate say 2/3 to the T401k and 1/3 to a Roth 401k if the reduction in tax savings by not doing all T401k would not have short changed critical expenses - just fewer luxuries.

I did some Roth conversions before age 70 but I think that is a more difficult decision to incur large taxes in retirement rather than making modest allocations to a Roth 401k during the accumulation years. I think during the accumulation years we have a lot on our plate e.g. mortgages, education, career, and enjoying life with the family. As far as retirement it is mostly how do I get to retirement with a decent nest egg. Post retirement tax issues? -- I'll cross that bridge when I come to it or at least when our youngest graduates. :happy

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TomatoTomahto
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Re: Roth Advantage not discussed?

Post by TomatoTomahto » Tue Feb 12, 2019 7:23 am

The math, not my strong suit, assuming identical marginal rates pre-retirement and post-, makes it a wash in terms of absolute value of traditional and Roth assuming that I will save the tax savings in taxable account

What is different is at least:
One of them has RMDs, the other doesn’t
I don’t believe marginal rates will remain as low as they are, even 2017 rates, into the future
Our intentions are substantially bequest oriented
Okay, I get it; I won't be political or controversial. The Earth is flat.

bradpevans
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Re: Roth Advantage not discussed?

Post by bradpevans » Tue Feb 12, 2019 7:47 am

TomatoTomahto wrote:
Tue Feb 12, 2019 7:23 am
The math, not my strong suit, assuming identical marginal rates pre-retirement and post-, makes it a wash in terms of absolute value of traditional and Roth assuming that I will save the tax savings in taxable account

What is different is at least:
One of them has RMDs, the other doesn’t
I don’t believe marginal rates will remain as low as they are, even 2017 rates, into the future
Our intentions are substantially bequest oriented

For those who retire early, delay pension(s), delay SS, they have the option to do Roth conversions.
That's where the traditional really takes the lead, due to our progressive tax brackets.
This strategy also lowers the RMD dollars by drawing down the tax deferred balances

But many people save more than 401K limits, giving them *both* Roth and Traditional,
which is a good problem to have ;)

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TomatoTomahto
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Re: Roth Advantage not discussed?

Post by TomatoTomahto » Tue Feb 12, 2019 8:04 am

bradpevans wrote:
Tue Feb 12, 2019 7:47 am
For those who retire early, delay pension(s), delay SS, they have the option to do Roth conversions.
That's where the traditional really takes the lead, due to our progressive tax brackets.
This strategy also lowers the RMD dollars by drawing down the tax deferred balances

But many people save more than 401K limits, giving them *both* Roth and Traditional,
which is a good problem to have ;)
I get that, but I don’t think that we’re the only high earning family that will have very few years in which to do conversions due to (involuntary) deferred income, one spouse having to do RMDs while the other is still working, etc.

My point, I guess, is that the conventional wisdom should be double checked.
Okay, I get it; I won't be political or controversial. The Earth is flat.

The Wizard
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Re: Roth Advantage not discussed?

Post by The Wizard » Tue Feb 12, 2019 8:14 am

TomatoTomahto wrote:
Tue Feb 12, 2019 7:04 am
...We accepted the prevailing conventional wisdom until recently, when we started putting DW’s contributions in Roth 401k (employer match still goes to traditional).
One problem with "conventional" thinking is that it looks at a working career from age 20 to 60+ as a given.
This is a mistake.
There is no guarantee that you will continue to be employed after age 45 with salary continuing on an upward slope.
Health issues, layoffs, job satisfaction all factor in.

Additionally, young people in 20s and 30s benefit from traditional contributions while paying off edu loans and buying principal residence.

Discretionary income while working is highest in latter decade if fortunate to maintain career path. So do partial Roth contributions then if numbers project similar tax bracket in retirement.
I should have done that...
Attempted new signature...

smitcat
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Re: Roth Advantage not discussed?

Post by smitcat » Tue Feb 12, 2019 8:20 am

The Wizard wrote:
Tue Feb 12, 2019 8:14 am
TomatoTomahto wrote:
Tue Feb 12, 2019 7:04 am
...We accepted the prevailing conventional wisdom until recently, when we started putting DW’s contributions in Roth 401k (employer match still goes to traditional).
One problem with "conventional" thinking is that it looks at a working career from age 20 to 60+ as a given.
This is a mistake.
There is no guarantee that you will continue to be employed after age 45 with salary continuing on an upward slope.
Health issues, layoffs, job satisfaction all factor in.

Additionally, young people in 20s and 30s benefit from traditional contributions while paying off edu loans and buying principal residence.

Discretionary income while working is highest in latter decade if fortunate to maintain career path. So do partial Roth contributions then if numbers project similar tax bracket in retirement.
I should have done that...
"I should have done that..."
Fact is ...it has not been available for that many usable years for some folks retirement timings.

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TomatoTomahto
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Re: Roth Advantage not discussed?

Post by TomatoTomahto » Tue Feb 12, 2019 8:54 am

smitcat wrote:
Tue Feb 12, 2019 8:20 am
"I should have done that..."
Fact is ...it has not been available for that many usable years for some folks retirement timings.
We had a window where we could have done more Roth 401k investing. We had a very brief mega backdoor Roth opportunity.

In our 60s now, as you say, some of that has not been available to in meaningful quantities.
Okay, I get it; I won't be political or controversial. The Earth is flat.

KlangFool
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Re: Roth Advantage not discussed?

Post by KlangFool » Tue Feb 12, 2019 9:12 am

OP,

If you can afford to pay tax and contribute to Roth 401K, you can afford to contribute to Trad. 401K and put the tax savings into Roth IRA. So, why Trad. 401K and Roth IRAs is not a better option? It works 90+% of the time. Why choose anything else?

KlangFool

smitcat
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Re: Roth Advantage not discussed?

Post by smitcat » Tue Feb 12, 2019 9:27 am

TomatoTomahto wrote:
Tue Feb 12, 2019 8:54 am
smitcat wrote:
Tue Feb 12, 2019 8:20 am
"I should have done that..."
Fact is ...it has not been available for that many usable years for some folks retirement timings.
We had a window where we could have done more Roth 401k investing. We had a very brief mega backdoor Roth opportunity.

In our 60s now, as you say, some of that has not been available to in meaningful quantities.
Yes- the mega backdoor Roth was very helpful for us , but most do not have the opportunity to excecute that.

The Wizard
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Re: Roth Advantage not discussed?

Post by The Wizard » Tue Feb 12, 2019 9:53 am

KlangFool wrote:
Tue Feb 12, 2019 9:12 am
OP,

If you can afford to pay tax and contribute to Roth 401K, you can afford to contribute to Trad. 401K and put the tax savings into Roth IRA. So, why Trad. 401K and Roth IRAs is not a better option? It works 90+% of the time. Why choose anything else?

KlangFool
Roth IRA contribution is limited to $7000/year/oldperson nowadays.
My last few working years, 2009-2012, I was putting over $40,000 per year into traditional pre-tax 403(b), including employer contribution.
If you want half pre-tax, half Roth, just doing the IRA won't work...
Attempted new signature...

KlangFool
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Re: Roth Advantage not discussed?

Post by KlangFool » Tue Feb 12, 2019 10:05 am

The Wizard wrote:
Tue Feb 12, 2019 9:53 am
KlangFool wrote:
Tue Feb 12, 2019 9:12 am
OP,

If you can afford to pay tax and contribute to Roth 401K, you can afford to contribute to Trad. 401K and put the tax savings into Roth IRA. So, why Trad. 401K and Roth IRAs is not a better option? It works 90+% of the time. Why choose anything else?

KlangFool
Roth IRA contribution is limited to $7000/year/oldperson nowadays.
My last few working years, 2009-2012, I was putting over $40,000 per year into traditional pre-tax 403(b), including employer contribution.
If you want half pre-tax, half Roth, just doing the IRA won't work...
The Wizard,

A) Or, you can do Megabackdoor Roth IRA. Then, you could have 40K of pre-tax 403B and a lot more than 40K of Megabackdoor Roth IRA. So, it is possible.

B) Why half pre-tax or half Roth is the right answer for anyone in the first place? It may not be.

C) If someone is motivated to learn to calculate and do the right thing for them, more power to them. But, for anyone else that is less motivated, Trad. 401K/403B/457 with Roth IRAs works 90+% of the time. It is good enough.

KlangFool

MotoTrojan
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Re: Roth Advantage not discussed?

Post by MotoTrojan » Tue Feb 12, 2019 10:14 am

Ken72 wrote:
Mon Feb 11, 2019 11:53 pm
I know Roth 401K vs traditional 401K has been thoroughly discussed in this forum, but I think there is one aspect that perhaps hasn't been accounted for, and that is with a Roth 401K you end up with more $ at your disposal when you withdraw. This assumes the amount contributed is the same in both cases (after tax in the case of the Roth option, which means you are out of pocket the contribution amount + tax as opposed to the contribution amount in the case of the traditional 401K). It also assumes you can afford the higher initial cost of the Roth contribution. It just seems to me there may be more to the story than just a comparison of tax rates. Less efficient perhaps but more money in the end.

If this aspect has been included in previous discussions or is such a corner case that it doesn't merit consideration, I apologize.
People also don’t often discuss that you’ll have more money at your disposal if you save $1M a year vs $1. If you compare things with equal tax and tax-adjusted savings rate (how much of your paycheck) it’s an identical amount at your disposal.

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2pedals
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Re: Roth Advantage not discussed?

Post by 2pedals » Tue Feb 12, 2019 10:57 am

Beyond the RMD avoidance of a Roth IRA (not 401k Roth, 401k should be converted to Roth IRA before 70.5) the biggest advantage of the Roth is for legacy planning. The heir of a Roth can "stretch" the RMD over a lifetime. “stretch” is a strategy to distribute the IRA assets well beyond the lifetime of the person who established the IRA. It can allow the heir of a Roth a very long time for compound investments tax free. For example a grandchild at 21 can inherit a Roth and allow for a 60+ years of payout period to the beneficiary. For this grandchild the tax free RMD will be initially <2% and will allow to the investments tax free to grow over a lifetime.

bryanm
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Re: Roth Advantage not discussed?

Post by bryanm » Tue Feb 12, 2019 10:57 am

FiveK wrote:
Tue Feb 12, 2019 12:56 am
bryanm wrote:
Tue Feb 12, 2019 12:08 am
...this effect is swamped by the tax rate arbitrage available by contributing at my maximum marginal rate and withdrawing at my effective rate.
If only that were true, traditional accounts would be so much better. Unfortunately, that's not how it works.

Your most recent traditional contribution gets withdrawn on top of the withdrawals supported by all previous contributions (let alone other "unavoidable" income such as a pension, SS benefits, taxable dividends, etc.). Thus it gets taxed at the applicable marginal tax rate at withdrawal.
That's true. However, my marginal rate now is still much higher than my expected marginal rate in retirement. I consider it as an effective rate because my "unavoidable" income will be minimal (SS only, no pension, I can control dividends by selecting different investments). Thus, I can play the arbitrage game by "filling in" my lower brackets with traditional-derived income. Until my traditional accounts reach a level that it can support yearly withdrawals in retirement that exceed my current income (not bloody likely at the moment, or I would be retired already), then traditional wins for me.

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FiveK
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Re: Roth Advantage not discussed?

Post by FiveK » Tue Feb 12, 2019 1:14 pm

bryanm wrote:
Tue Feb 12, 2019 10:57 am
FiveK wrote:
Tue Feb 12, 2019 12:56 am
bryanm wrote:
Tue Feb 12, 2019 12:08 am
...this effect is swamped by the tax rate arbitrage available by contributing at my maximum marginal rate and withdrawing at my effective rate.
If only that were true, traditional accounts would be so much better. Unfortunately, that's not how it works.

Your most recent traditional contribution gets withdrawn on top of the withdrawals supported by all previous contributions (let alone other "unavoidable" income such as a pension, SS benefits, taxable dividends, etc.). Thus it gets taxed at the applicable marginal tax rate at withdrawal.
That's true. However, my marginal rate now is still much higher than my expected marginal rate in retirement.
And that's what matters!
I consider it as an effective rate because my "unavoidable" income will be minimal (SS only, no pension, I can control dividends by selecting different investments). Thus, I can play the arbitrage game by "filling in" my lower brackets with traditional-derived income. Until my traditional accounts reach a level that it can support yearly withdrawals in retirement that exceed my current income (not bloody likely at the moment, or I would be retired already), then traditional wins for me.
As it does for most - just not the ~100% it would win for if "save marginal and pay effective" was correct.

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